Preston Pysh  07:24

So I got a few points of what you’re talking about here, Hari. So first, I want to highlight that if you’re reading this book, the tone, and the style, this book is going to drive you mad. I had a hard time getting through it. To be quite honest with you, I got very frustrated with Taleb’s writing style and the irony of the fact that you’re talking about being overconfident. And then you’re reading his writing style. It was pretty much the ultimate irony I think that you could ever read in a book but the content is superb. The content is amazing in this book, and that was the only reason that I kept going is that the points that he is laying out are very profound.

And I think one of the reasons Jeff Bezos has really treated this book with so much respect is because he is hitting on the exact same point that Hari is talking about. He’s talking about oversimplification. And this is something else that we learned in the book “Influence,” which billionaire Charlie Munger’s favorite book, is that people come up with shortcuts. And I think that that’s just the inherent human nature is to come up with shortcuts to live your life in a manner that’s more predictable and more, I guess… You can be more fruitful whenever you live in these predictable patterns. And how you do that as you come up with these shortcuts, you take a few variables, you come up with a, “Hey, this is going to be the outcome because this is what happened the last three times that this happened to me.” And you develop that shortcut of the mind. And that’s what Taleb is talking about in the book that is so dangerous is you have people that are doing this modeling based on a few variables and they think that that the future outcome is going to be more predictable than they actually think because they don’t actually understand all the other outside influences that they have no comprehension for. And that’s where the mistake occurs. And that’s what he’s really getting at.

09:07

And when you talk about statistics, okay, and going back to this bell curve. So when you look at the bell curve, all the data points are almost all in the middle, and then they slowly go out. And there’s very few data points out on the very ends of the potential outcomes, or the potential data that’s collected. What Taleb is talking about is that almost all data points of whatever system you’re collecting on are actually skewed to the left or to the right. And when you do that, let’s say that all the data points are pushed to the left side of the bell curve, okay? So your mean is pushed out to the left, your data points have a long tail out to the right. And what he’s saying is when that long tail is pushed out to the opposite side of wherever that might be, the potential for that that extreme data point on the far outside limit is extended much further than most people think or could understand, and that’s the Black Swan. That data point that’s way out there in the long tail is the thing that has some type of catastrophic change in the fundamental nature of how things work.

Preston Pysh  10:12

So, Hari, I saw you had something.

Hari Ramachandra  10:15

Yeah. Stig and Preston, you brought up a very good point. In fact, Taleb points out to some of the fallacies are biases that we humans face while making decisions about the future and also how we react to events in the present context. In fact, he lists some of the fallacies that we should avoid to protect ourselves from a Black Swan: the error of confirmation, also known as confirmation bias, which is in the book “Influence,” as you mentioned, the narrative fallacy, the problem of silent evidence or survivorship bias, and tunneling, which is basically focusing on a specific and ignoring what’s happening around you. So these are all some of the biases that we all have inherently. And we can’t really escape them and Nassim’s point and if when we are overconfident, we underestimate the influence of the environment, and also our own biology on us.

Preston Pysh  11:25

So one of the things that I think it’s a really important discussion to talk about, is understanding the potential for extreme circumstances. And the way that he’d really described this in the book, he talks about Mediocristan versus Extremistan.

I think one of the best ways for people to really understand this is he provides this example of talking about, you’ve got to understand the range of your data points or the potential range of your data points. So he talks about the distribution of people’s height. He would say if we took all the different data points of how tall a person could be, based on historical evidence, your range is fairly finite, okay? It’s not a very big range.

Preston Pysh  12:06

Let’s say that on a small scale, you could have somebody that maybe is like 3 or 4-ft. tall. And I don’t know what the extreme numbers are here. So you got to excuse my inability to talk about this too intelligently, but let’s just say that it’s three or four feet, and then on the tall and maybe your ranges eight feet, or something like that, really tall. Okay? So when you look at that range and let’s say you had 100 people in a room, and you were going to guess what would the tallest person versus the shortest person might be, your ability to predict that is probably a little bit better than if it was a more extreme circumstance, which I’m going to talk about next.

So let’s just say we think that the tallest somebody could be in the room would be maybe six foot six, and then the shortest would be maybe four and a half feet or something like that. That would be the range that I would probably guess to have an 80% chance of guessing correctly of every single person in the room.

12:58

Now, when he talks about the range of net worth, okay? The range of net worth could be drastically larger because you’re talking about, some people don’t make any money in a year. And then you could go clear up to somebody like Bill Gates who has a net worth of call it $80 billion. So our distribution is so lopsided when you think about if we plotted, let’s say, say we took the world’s population, and we plotted those on a bell curve, that would be skewed and so lopsided as to the high end versus the low end of that distribution. It’s very lopsided, it’s not a normal distribution that you’d be thinking about. So that would be the Extrimistan, as you would be sitting and guessing what the probability and those outcomes could be. You could be off by a landslide if one person in the room had a net worth of call it $500 million. And you guess that the upper limit was only, a couple million because there are so many more people out there with that distribution that could hit that range.

So I think what he’s really getting at in the book is if you are a stock investor, or you’re a person that is living in this realm of really understanding what probabilities could potentially occur, you have to have a firm understanding of what is the potential range of the distribution before you start making some calculated risk, first reward decisions without having a firm understanding of what the possibilities could be with respect to the range.

Stig Brodersen  14:34

And I think it’s really important that you mentioned that, Preston, because he really doesn’t say that this is the solution because like, inherently, you can predict a Black Swan and the impact will be severe. So what do you do? It’s not like Nassim is saying, okay, you should just do this and then you’re prepared. Basically, he’s saying, you should just be prepared for the worst because the worst is not very likely to happen, but it can happen and the impact can be severe.

And so if, for instance, we’re talking about stock investing, my takeaway would be to diversify yourself. I mean, that would just be the simple consequence of what he’s saying when he’s he’s saying that you should be prepared. But that’s really an overall concept, I guess most people would say.

Preston Pysh  15:19

I totally agree. I think it’s having respect for the risks that are actually there and not living in this world where you only consider a couple of variables, but you understand the potential for anything to happen.

One of the reasons why we are all confident is that we confuse situations from Mediocristan with Extremistan, as Taleb talks about in the book. In fact, in one of the chapters, he has a table that helps us understand how to decipher or how to distinguish a situation and identify whether it is a situation from Mediocristan or whether it’s a situation from an Extremistan. And the problem with many of the financial models is they try to apply the tools that apply to Mediocristan to Extremistan situation, like the stock market and the modern portfolio theory which he viciously goes after in the book is one such example.

And let me just throw on an example. So we were talking about Amazon and Jeff Bezos. So everyone values Amazon so highly, and I guarantee you if something would happen to Jeff Bezos, God forbid anything like that would happen to somebody because of a comment. But let’s say something would happen to Jeff Bezos, you would see, and let’s say somebody had a significant amount of their savings in Amazon because they think that Amazon is a great company and Bezos is changing the world. But if something would happen to him, the value of that company would just plummet on the markets, it would go wild. And that’s one variable circumstance, that could absolutely happen. But people don’t think of it in that context if they put a very large substantial portion of their net worth into that company. The same thing could be said about Berkshire Hathaway. That is a very real potential that I don’t think people think about when they take half of their net worth and they put it in a company.

Hari Ramachandra  17:26

Just to get into the technicals of a bell curve, why he hates the bell curve is that in a bell curve the average and the median are both assumed to be saying that what it means is, there is no dispersion, there is no diversity in the events within a sample. And this makes it really really hard for us to handle a situation from Extremistan because the bell curve has a dramatic increase in the speed of decline in the *inaudible as you move away from the average of the center.

To illustrate that, when you’re looking at a bell curve 68% of all the samples are supposed to live within the first standard deviation or they call it sigma. And 95% within the second standard deviation are two sigmas and 99.7, within three sigmas. And in one of the chapters, in fact, he goes through an example where he illustrates very clearly how this is totally wrong. And I highly encourage whoever is reading the book to pay attention to that chapter on the bell curve.

Preston Pysh  18:45

I absolutely love this point because it really gets back to the normal distribution versus non-normal distribution and I think Taleb’s big gripe with his community, the education community, with respect to statistics, is that everyone teaches the normal distribution. Everyone does the math behind the normal distribution. And I think he had made the argument that the normal distribution is that 1% type environment that actually exists in reality.

What he’s saying is that almost everything is non-distribution, the magnitude of how skewed the non-distribution that it is, is really the crux of what environment you’re operating in. And when he brings that up to me, I’m like, that makes sense. That makes perfect sense to me. And he’s exactly right. And it is amazing how much emphasis is spent in the education community on the understanding of the normal distribution. And it’s almost like, “Oh, well, if you got non-standard data, let’s not talk about that. Or let’s push that over there because that’s a really hard calculation. It’s not something that we can put any definitive statistical evidence behind. So we’re just going to try to maybe change the way we collect the data or whatever so that we get a normal distribution.”

20:03

I know that because when I got a black belt in Lean Six Sigma, and I mean, it’s all about statistics. And it was amazing to me as you do different projects and you look at how you can optimize an organization and you’re collecting all this data, how everyone wants to get the normal data. But when you’re actually looking at the reality behind things, you really got to move away from that. And you got to have an appreciation for the Black Swan. And I really like the content of the book. I can’t say that enough. If you haven’t read this book, and you’re in financial markets, or you’re in something that’s data-heavy, I can see why this book has gotten so much traction despite the atrocious tone of the book.

Stig Brodersen  20:41

And a one really, really great example that Nassim is bringing to the table is this investment for Amaranth. And apparently, this fund lost 7 billion of the investors’ money, that was basically all the money. And supposedly the fund has been saying that they have employed 12 risks managers, so that was their way of saying to the customers or to the investors, “Well, you shouldn’t be worried because we hired as many as 12 managers to make sure that you won’t lose your money.”

And what he’s saying is that if the model you’re using is not right, it doesn’t matter if you employ 100 managers. And so I also think that what Taleb is saying is that the problem is inherent in the system. Like I can just say from my part, you can’t graduate from my education if you don’t know how to use a non-distribution. That is a part of the standard curriculum. So you can’t get this business degree if you don’t apply and use the non-distribution. And now we’re talking about why you can’t use it.

Preston Pysh  21:40

So you’re part of the problem, Stig, I mean, there you go. You have it.

Stig Brodersen  21:44

Yeah, well, probably rather say it’s my wife’s fault because she is teaching statistics. I’m only doing economics.

Preston Pysh  21:50

Oh, my. I hope so if she’s listening. Hey, so this was in the book. I love this point. This was really fun. He talks about this fat Tony character. So let me just throw this out to the audience. I want to describe it from the vantage point of whenever I was reading the book. So Taleb says if you had a coin toss, and the chances of a coin landing on heads or tails are 50%. Let me tell you that there’s this coin and I flipped it 99 times. And of the 99 times, it landed on heads. So what’s the probability during the next flip that it’s going to land on heads again?

And so, anybody who understands gambling fallacy, the gamblers’ fallacy, they know that the mathematical or the educated answer is 50%. And I know whenever I was reading the book, I immediately thought, “Oh, it’s 50% because that’s what you’re, taught in school. That’s what you immediately think when you have any type of like statistics background, you understand that the chances are 50%.”

22:54

So, Taleb talks about this character, when we were basically a description of street smarts versus book smarts. So the book smart person is going to say, “Oh, it’s 50%.” But the street smart person who he described as Fat Tony, Fat Tony says, “Oh, it’s 100% that it’s going to be heads.” And he, the question is, well, why? Why do you think that it’s 100% that it is going to be heads? This is because there’s absolutely something that’s going on that the probability of it landing on heads 99 times. That’s a trick coin. And I think it’s a fantastic discussion. I think it’s a fantastic discussion of stepping away from okay, we know this is the book answer. But there’s also another answer out there. And that’s what really happens in reality. And I think that that’s his way of comparing, hey, the person who talks about normal distributions, talking about the book answer, the person who’s talking about what happens in realities, talking about non -standard distribution of probable outcomes. And he’s thinking about things from, “Hey, what’s going to happen in practicality?”

And I think the truth of what’s actually happening here is in the middle. And I think that a person has to have respect for the book’s answer. And they have to understand the fundamentals of how this even works in the first place. But at the same time, you have to understand how does it apply in real life? And how can I really learn from both scenarios? And I think that that’s really important and a great discussion and a great highlight of the two different mindsets and how you need to be thinking about this stuff.

Hari Ramachandra  24:21

Preston, I love the story. That was really insightful. In fact, in day to day life, we have seen such people at our work, are when we are interacting with people in society. Some people are book smarts and some people are street smart. And for the audience, I want to also let them know that Taleb is not just an author, he was actually a trader before he became an author. He also has an MBA from Wharton and then a Ph.D. in mathematics. So he’s an ultimate combination of both worlds. And he understands that all these models, financial models that are used by many investing firms break down at certain points when human irrationalities are in the picture. And that’s the point he’s trying to make in this book.

Preston Pysh  25:28

I’m glad you highlighted that because I think it’s a really important part of the discussion is the fact that he’s just not an academic that has studied this. He actually worked on Wall Street. I think he was a commodities trader. Is that right? Yeah, he was a commodities trader. And he doesn’t come out and directly say this in the book, but he definitely implies the fact that he was shorting the market in 1987 whenever it crashed during that, that really deep crash in 1987, which I thought was pretty cool, if he’s, being completely forthright with his positions during that time.

And I think it tells you, I think it shows you how contrarian he really is with some of his ideas. And it’s a really neat discussion. And that’s something else that I really liked about the book is you see a lot of his examples from working in financial markets come out in the book. So if you’re thinking that it’s a purely academic type read, it really isn’t. He gives a lot of experiences from his time of working on Wall Street. And a lot of financial information is discussed throughout the book as examples which we liked here at our show.

Hari Ramachandra  26:30

And Preston, in fact, he also talks about the problem of making decisions under uncertainty. And his main squabble with academicians, or professors is that they never have to make their decisions under uncertainty. In fact, in one of the chapters, he talks about these professors and philosophers and economists, who get their paycheck every Friday, and part of it is invested in their 401K. And they blindly trust the market, they don’t think. Whereas as a trader, how to constantly make decisions that can make or break their careers and under uncertainty and that’s where he, has really distilled his thoughts into in this book.

Preston Pysh  27:27

Yeah, he was doing that as he was like basically bashing academia over the head with the idea like, hey, these guys not only teach that everything’s normally distributed, but then they go and they invest in that manner as well, thinking that everything is normally distributed when it’s not. And I totally agree with his point is just the way he goes about saying it is very brutal, I guess to that community. Stig are you with us?

Stig Brodersen  27:51

Oh, yeah, I’m just trying not to feel to hurt and wondering how he ever got a Ph.D. without applying the norma distribution.

Preston Pysh  28:01

Seriously, how did he ever get through that gate? Go ahead, Hari.

Hari Ramachandra  28:06

Stig I want to, like, get your take on his attack on academics and professors because I know you and some of the other academicians who are also quite practical and are also doers as hr says not just thinkers. So what is your perspective on his opinion about the academe?

Preston Pysh  28:29

Yes, Stig, what’s it like being a Black Swan?

Stig Brodersen  28:33

Well, I definitely agree with the Nassim. I hope I’m not as brutal as he is when he’s talking about academics. But now, when I was graduating, and through my graduate studies, I was told that the efficient market hypothesis was true. I remember I found it was quite weird because that was back in 2009. And everything used to be like, double in price and how could that be efficient? And then six months after its half and there was also efficient, I really wasn’t sure how to grasp that. But that is what we were told. And then I actually got a job as a commodities trader, exactly the same as Taleb. And you were just seeing, the minute you stay on the commodities trading floor that nothing is efficient at all. The only thing you can be sure of is that someone will yell something nasty in the next five seconds.

I guess that’s it, but he’s definitely right. And when he’s talking about academics, it’s just because we in academia, if I can say we about that, is that we like to put things into an equation, like we need to put this into an exam. And how can you put anything into an exam in finance economics, if you can put it into a formula? And I think that’s also one of his main things here. He’s not only trying to prove his own point. He’s also trying to, having like a class with the whole academic community,

Preston Pysh  29:59

I think the amazing thing is, I mean, Stig didn’t mention this. But I mean, he’s talking about when he was at Harvard. I mean, this is Harvard University that is teaching these models. And I think that that’s just amazing. I mean, you talk about one of the best business schools in the entire world, is teaching these models. I know when we had Guy Spier on the show, he went to Oxford, and he’s talking about these models being at the forefront of what they’re teaching at these high-end Ivy League schools. And it just goes flying in the face of you talk to anybody on Wall Street, what they think and I mean, they’re going to laugh at you, if you say, efficient market hypothesis. I mean, you’re going to get laughed out of the room.

Hari Ramachandra  30:39

Preston, that’s a good point. In fact, that reminds me of a comment by Charlie Munger. He said, investing is so simple, it’s just three points, and you’re done within a day or two. So what are the university is going to do for the rest of the semester? They have to justify the fee that they’re charging the students.

Preston Pysh  30:59

You want to talk about a bubble, start talking about college tuition. That’s a whole different conversation but watch that thing pop, but it’s some great points. Really fun conversation. Did you guys have anything else you want to highlight that you thought was really a good discussion point in the book? I don’t want to drone on because I think his point was really fairly concise. And then he gives a lot of examples, a phenomenal book, just be prepared for the tone. I’m telling you right now, there are times that I want to throw the thing across the room. But in general, the content is phenomenal, it is very good. It’s well worth your time. I think that you will definitely get a lot out of it. I think that you’re going to look at things a little bit differently. I think you’re going to take the approach where you’re going to really think twice about simplifying anything. And I think you’re going to have a greater appreciation for what the potential outcomes could potentially be, especially on that long tailpiece of the distribution of whenever you think about all these possible outcomes and probabilities.

So Hari and Stig, anything else you want to add?

Stig Brodersen  32:01

I just have one thing because it really wouldn’t be a good episode if it didn’t round off with a *stuck my good observation. I remember reading this book, just before we were talking with and walking down with the author of “Oil 101.” And one of the things that we also talked about here, about overconfidence is that, as Hari said before, that you overestimate what you do know and underestimate what you don’t know. And, I’m following the oil sector and I am definitely not an expert in oil, but I think I can give my two cents about this oil discussion and which oil stocks to invest in and how to look at oil stocks.

But Morgan was giving me so much knowledge about the oil market that I had no clue about. So that really made me think also reading this book at the same time. Like I probably overestimated when I didn’t know about oil and definitely underestimated all the things that I didn’t know actually existed. Now, this is not the same as for me as saying, I’m not full-on oil anymore. I think most people probably know that that’s my opinion an oil is different than a fact, it’s an opinion. But I just think it’s really important to know that as a stock investor that to pick out individual stocks, you really need to know a lot about that compared to when doing index investing, for instance.

Preston Pysh  33:25

So I got a story to tell and it has nothing to do with investing, but it does have to do with Stig’s point. So I’ve mentioned a few times on the podcast that I was a former military pilot. I was an Apache helicopter pilot, which is an attack helicopter. It has, missiles and all that fun stuff on it. And whenever I first started flying, and I was a brand new student in flight school, one of the things that were easy for me to do is just to climb into the cockpit and just fly around because I was flying with somebody else. It was a very good experienced and somebody who had a lot of hours and a lot of flight time. And so it wasn’t really scary to do, a landing at night with a sensor, a small little sensor. For anybody that’s familiar with the Apache, there’s this little eyepiece that fits on one of your eyes, only one of your eyes. And it displays images at night based off of heat sensing and that’s how you gotta land and fly the aircraft. And so it’s extremely, extremely difficult to do especially as you’re starting out, but it was never really that scary for me because I always had this person that was flying with me that would, if I messed up, he’d take the controls and assist me and help me with a maybe a night landing on a really small landing zone or whatever it might be.

34:44

Now, what was really crazy is the more that I learned and the better that I became at flying, and I started becoming in charge and I was the pilot in command in the air mission commander. Those landings got really scary all of a sudden and the reason why is because I wasn’t sure now and I knew that there was no one there to bail-in and save me from the mistakes that I was going to potentially make. And so what seemed to be really simple and just like, yeah, yeah, I can do that. And I just fly in and do it because I knew somebody was always behind me ready to save my butt. And then whenever I was in charge, it totally flipped. And what was amazing as I got more experienced, it got scarier, and it got worse. And I think that there’s a lot of people in investing that can empathize with this idea of the as the more you learn, and the more that you now understand commodities, you understand macroeconomics, you understand microeconomics, you understand accounting, you understand all those different variables and how they all fit together.

I think you find that the more experience you get, and the more that you understand all the variables, you start to realize this is a little scarier and a little bit more difficult than I ever thought whenever I was a beginner and whenever I was first starting out, and so I tell that story, to really act as an example, for maybe somebody who’s entering the market. And they get a little bit of experience or they maybe start understanding. Let’s say you just started understanding accounting and you really feel like you understand the income statement, but you don’t know all that other stuff, like you don’t know M1, M2, M3 currency, all that stuff. It can be, I guess what I want you to have is that deep appreciation for what’s actually happening behind the scenes and that there are so many more variables to understand. And I’m not saying that to scare you away from investing. But I guess I’m saying it for you to have an appreciation for investing and for what’s really happening behind the scenes that you might not actually understand.

Hari Ramachandra  36:32

But still, that was an amazing story. Thanks for sharing that with us. And in fact, I think if somebody has to take away one thing from this book, that would be that “Black Swan” is a sucker’s problem. And our goal should be to not be that sucker or the turkey that gets killed on the thousandth day. And as an investor, the more we know, the less confident we should be because skepticism should be inherent in the process of investing. And through your story, you beautifully illustrated that essence. And I hope we all remember that as we move in our journey towards being a better investor.

Preston Pysh  37:21

So, Hari, I like that, because how do you become the guy or the turkey that’s not slaughtered on the thousandth and first day? And I know, I would argue, I think the best way to do that, or at least the approach that I’m taking is, and this is what I took whenever I was flying, who is the best pilot in our unit? Who’s the guy who has the most hours, who has the most experience? And what is the best advice I can gain from him? Until I get to that point where I really feel like maybe I have become that guy.

And so I think with investing, the best thing I know to do is who is the best, who are the people that have the highest net worth? And how did they get that net worth if they got it through actually investing in markets, and that’s how they acquired it. That’s somebody I want to track. That’s somebody that I want to really listen to and fully understand. What do they know? How did they know it? What did they read?

But if you’re the type of person that acquired a billion dollars on a whim, because you invented something that was really revolutionary, but it wasn’t in financial markets, that’s somebody I’m not probably going to pay nearly as much attention to. So I think it’s twofold: who’s done really well? And does it relate to the topic or the environment that I’m trying to understand? Is that how they acquired that knowledge? That’s the people that I think you want to study. And I think if you try to go on those people’s coattails and really follow them closely, don’t do exactly what they’re doing. You need to understand the essence of their knowledge and understanding. That’s what you need to understand. And I think that’s how you become the person that avoids that slaughtering on the thousand and first day.

Hari Ramachandra  38:56

I would just add one more thing about following great investors, I would look at who’s done really well, and for how long, but at the same time with a bit of caution, because one of the stories that Taleb tells in the book is of the captain of the ship, who was in charge of Titanic. And he had no accidents, no incidents in his long career until Titanic. So, with that, I think we all should follow great Investors, but at the same time, know that everybody is human, there can be mistakes.

Stig Brodersen  39:43

I think that’s a really good point, Hari. And I think the key is to understand the underlying thing about this… So why has Warren Buffett been successful in stock investing in really understanding what’s the idea behind value investing? I think that’s really key because you are also talking about the duration of that success. Now I have no clue about the whole thing about Titanic. The only thing I remember in the end was that Leonardo died and I was very sad. From what I remember, it was, a new ship and it was probably the first time he was sailing with that type of ship. I mean, that might be the element, that is the reason why he’s saying… I don’t know if it was a new route or whatever happened. But, I think we just really need to understand what is the underlying event that can happen and why don’t we think that this strategy will or won’t succeed?

Preston Pysh  40:37

I’ll tell you one thing that Leonardo DiCaprio, he’s a hell of an actor. And I say if you don’t know my personality, I’m extremely sarcastic so I did not mean that. There’s a book it’s called “Only the Petrified Survive,” is that right? I thought…

Hari Ramachandra  40:52

I think it’s “Only the Paranoid Survive.”

Preston Pysh  40:54

There you go, “Only the Paranoid Survive.” That’s on our list of books. I think it was Michael Dell whose net worth is in the like the 20 billion range that recommends that book and I bet you any money that that’s a large theme, and that book is what we’re discussing right now. I have not read it, I plan on reading it. But if somebody out there has read it, let us know if we’re on target here. But that’s all we have for you guys.

41:19

Let’s go ahead and hop over to the question from our audience. And the question this week comes from Sami Khan and this is what he’s got.

Sami  41:26

Hey, Preston and Stig. I love your podcast and all the great work you guys do. I hope you keep it up. A question comes off the heels of hearing Mark Cuban say that value investing is more applicable with people like Warren Buffett who can move billions of dollars. And I was wondering if there’s any validity to the notion that value investing is for the big guy and not the small investor.

Preston Pysh  41:47

All right, I love this question. Yeah, I think Mark Cuban’s wrong. I think that value investing is for any person out there who can understand what discount cash flow is and figuring out the value of something today, versus the relative environment that currently exists with respect to interest rates and fixed-income investments. That’s my personal opinion.

I think Mark Cuban is a very smart businessman. I think Mark Cuban understands business at a very deep level. I know if you watch the show Shark Tank, you can really get a glimpse of why he’s been so successful. But let’s face the fact,s Mark Cuban became a billionaire because he started a website company called broadcast.com. And he sold it to Yahoo for I want to say $4 billion. And that’s really where he made his quantum leap. He really didn’t make his quantum leap in investing, like Warren Buffett or Charlie Munger. He just didn’t. Now, a lot of people out there might love Mark Cuban. I’ll be honest with you, I’m a pretty big fan of Mark Cuban myself. I really liked the guy, but I think he’s dead wrong on this. I’m really curious to hear what Stig and Hari have to say though.

Stig Brodersen  42:58

Yeah, I think that I’ll side with you, Preston, on this one. I think he’s wrong. And if anything, I think that value investing is easier if you don’t have that much money.

Preston Pysh  43:07

I agree.

Stig Brodersen  43:08

So if you look at the S&P 500, I think that as the small companies, that’s probably around like 2 billion or something like that. So for someone like Warren Buffett, and his net worth is like 60 billion, something like that. And Berkshire Hathaway when he’s doing his investments, I think the market is north of 300 billion. Now, he probably has, I don’t know between hundred or 150 companies something like that when he invested he cannot even invest in the small, huge companies in the States because they would not make it know any difference in his portfolio. So he has a very limited investment universe that you and I don’t have. I mean, we can invest in extremely small companies and get very high returns. And just one thing I want to mention, so this is that early in his career, Warren Buffett actually has like multiple years where he made more than 50% a year. He’s been famous for saying he can still do that if you only had $1 million. But now that he has so much money, it’s really, really hard to make those returns.

Preston Pysh  44:12

Well, let’s think about, if we think about this in a quantifiable manner, okay. So Warren Buffett has market caps of Berkshire Hathaway $300 billion. So if he takes a billion dollars, and he invested in let’s say, an IBM or something like that $1 billion is going to move the market price. I’m sorry, folks. It’s just a lot of money. And when you look at the volume of trade that it’s conducted daily, he’s going to just overwhelm that thing. And when you have an oversupply of buying and an undersupply of selling, it moves the market price higher. That’s just the fact. Okay, so the problem that he has is when when you talk about $1 billion on a company that has a market cap of 300 billion, guess what? That’s point 3%. Okay, that’s point 3%. That’s nothing. That is absolutely nothing and so he’s dealing with these very large numbers. And it’s very hard for him to get at a good price without actually impacting the price that he’s buying it out just because he’s dealing with so much money. So that’s why he has that quote. That’s why he says, if I only had a couple of million dollars, I could do a 50% annual return because he understands business at an extreme level, and he understands value investing at a deep level. So I think that’s why we have the exact opposite opinion of Mark Cuban.

But let me say this, we’re extremely biased. We are extremely biased in that opinion. So I need to say that because we study Warren Buffett, we love the guy. We think that he’s brilliant, and we know we’ve been manipulated by his thought process. So you got to take what we’re saying as a biased opinion. Hari, I want to hear what you got to say.

Hari Ramachandra  45:43

Preston, I believe value investing is all about your mindset. And I can sympathize with the question because I’m living in Silicon Valley. You see a lot of people lucking out by joining a startup or their startup going IPO or being bought or by other companies. It’s a get rich, quick expectation that builds into our mindset when we see such things happening. But coming back to our topic today, we have to remember, those are black swans, whereas value investing is a reliable way to make money and get wealthy, but it is definitely not a way to get wealthy quick. And if we understand the difference, then we can choose which party we want to go.

Preston Pysh  46:39

Alright, so Sami, we love this question. This was a really fun one to pick apart. And I really challenge people out there to just not take our advice for being right or wrong here. I think you really need to form your own opinion. And I promise you Mark Cuban has that opinion for a reason. And I think if you dug into it, you tried to understand why he has that opinion, I think you’d probably add better context to our obviously biased value investing approach. So I challenge people to go do that and form your own opinion. But that’s the way we, we’d like to answer the question.

So, Sami, thank you so much for submitting that. We’re going to send you a free signed copy of our book, the Warren Buffett Accounting Book. And for anybody else out there, if you want to ask your question and get it played on the show, like Sammy, go to asktheinvestors.com and you can record your question there.

47:23

So we really want to thank Hari for coming on the show. He has a great website. It’s called bitsbusiness.com. You can go there and how he writes a blog that is just phenomenal. So I really encourage people to go do that. And we just really appreciate everything that everyone’s doing out there for you. If you’re enjoying the show, go to iTunes and leave us a review because that helps us out tremendously with getting more listeners. And we just really appreciate that. I want people to really know that we truly appreciate that.

47:48

And one last thing, so every single book that we read, that we do a discussion on with the podcast, we type up an executive summary of that book. So if you go to our website and you sign up on our mailing list, you will get a free executive summary that Stig and I type up for this book. So for the Black Swan, we’re going to send that executive summary out to everybody on our mailing list. The summary is usually about five pages, and it summarizes the book chapter by chapter. So if you want to get that for free, go ahead and sign up on our list. We do not send marketing spam, we do not send advertisements, we only send out these books summary. So don’t worry about that. And if you don’t like it, you can always unsubscribe. So we just love interacting with our audience when we thank you so much for listening to the show. So that’s all we have. And we’ll see you guys next week.

Outro  50:25

Thanks for listening to The Investor’s Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www.theinvestorspodcast.com. Submit your questions or request a guest’s appearance to The Investor’s Podcast by going to www.asktheinvestors.com. If your question is answered during the show, you will receive a free autographed copy of The Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application.