Stephan Aarstol 11:29
Yeah, I had a previous business that was a high end poker chip business. The same chips you can buy in casinos, I sell those to consumers for their home game. That’s a business I started in 2003. It’s a business that was doing maybe a half a million a year, but took 10 to 12 hours of my time. I had a lot of free time and so, I was looking for other businesses.

Because I was starting businesses with no money, you got to figure out how people are going to find out about this. SEO is basically just sort of a cheap marketing strategy. And so, when I look at other businesses, I would analyze them in a proven SEO perspective: can I go into this business? Spend no money on marketing? Can you get sales? Because if you started with no money, that’s what you have to do, basically.

I sort of looked at every business through that lens. I looked at a bunch of different opportunities. When I looked at paddleboarding, I looked at the search statistics on it and they were off the charts, because the industry is growing 100% a year for five years straight.

However, nobody was doing it in a very tech savvy way. It was a bunch of surf companies, but I figured I could go in there in a very short period of time and sort of dominate that industry. So your question is, did I start a business and then apply SEO tactics? No. I wouldn’t start any business unless I do SEO work for it.

Preston Pysh 12:54
I just want to throw this out to our audience, for anybody that might want to start their own online business, what Stephen just said is really the important part that you’ve got to understand. The people that are truly at the top of their game with online business, people like Stephen, they go out and they understand the search engine optimization.

Why this is so important is because if you rank in the number one spot on Google, for whatever your business might be, guess what? You don’t have to pay for advertising. It is free. If you have 10,000 people looking for a certain key search word, and you come up as a number one search, and they click on it, you literally paid nothing for that advertisement that basically popped up number one.

What he’s saying here is that he knew that this market was ripe. He knew there were a lot of people searching for paddle boards. Then he optimized his entire business around that search engine optimization keyword. He’s done extremely well.

Stephan, when you went on the show, your full year revenue was 250k. The last thing that I saw was in 2012, you had over 1.5 million in revenue. You’re probably well over two or 3 million at this point. Correct?

Stephan Aarstol 14:19
Although the numbers are a little different there. So you got the revenue, the year we aired. When I pitched the sharks, we had $100,000 in revenue lifetime for the company. It was maybe nine months into the end of the business. Then in this last year, 2014, we did 5 million in revenue. We recently got an award for the fastest growing company in San Diego. Now that’s any company, your tech companies or VC funded companies, and they had this award show where they’re counting down the 100. They get to number one. We go up there and five people in the company. It’s a surf company. everybody’s like, “How does this happen?”

Preston Pysh 14:55
That’s fantastic. Now have you been able to hold on to the other 70% of equity I’m assuming you have?

Stephan Aarstol 15:00
Yep.

Preston Pysh 15:01
Great for you. That is awesome. What a great story. Okay, aStig. Go ahead and fire away your question.

Stig Brodersen 15:09
This is actually related to what you said before about you evaluating Mark Cuban’s money to be worth a lot more. I think I read somewhere where it said like three times as much. I mean, he was really a guy that you want to do business with.

Aside from the immediate media attention you got and the funding, of course, how else have you been able to benefit from your relationship with Mark Cuban?

Stephan Aarstol 15:32
That really goes into why I value his money more. The investment was only $150,000. So it wasn’t a large amount of money. I probably could have got that money somewhere else. I’m not an expert at raising money, but I probably could have through friends and family, if the business was taking off.

The deal was actually $150,000, or 30% of my company. Plus, he negotiated for the first right of refusal to invest in any business I do in the future. That was another thing I was thinking: I’ll make a little money on this company, but if I do well here, I potentially set myself up to have a backer for any business I want to do. That was another important reason why I took that deal.

So how I’ve been able to leverage him is when we were negotiating the deal, I asked, before I signed the papers, “Hey, Mark, I want to put your face on the front page of our website?” To me that was actually more important than the money, having a check that has a Mark Cuban signature on it for PR purposes. It is actually more valuable than that check itself.

For online, no conversion rates are very low. When we started this business, our conversion rates were maybe at point 5%. So we have 1000 people come onto our website through SEO, and five of those would buy. In a regular retail store, you go into a store and 1000 people go into that store, 600 of those people will buy. There’s this massive chasm between what’s online and in retail.

Anything you can do to enhance the trust of your brand can ratchet up your conversion rate. So just putting Mark Cuban’s name… I mean, he’s not a huge celebrity, but a good chunk of people know him, especially in the sports world. We’re sort of a sports themed product at that time. That really bumps our conversion up.

We’ve seen our conversion go up to almost one and a half percent, through Mark and some other stuff that we’ve done. We have organically grown our brand over the past three or four years.

Stig Brodersen 17:37
That’s really impressive. One thing I want to highlight was actually the first thing you said about you’re selling 30%. I think that you hit the nail on this one, because I think what a lot of people are missing is that 100% of zero is really still zero.

What you were talking about is, even though they might have a small percentage, even though 70% ownership is a lot, it is really important how big the pie is. It’s not like if you own the whole pie or not. That’s really the key to stock investing, which is the main issue here for the show.

Preston Pysh 18:17
I wanted to add to that. Stephan, you might not be familiar with this stuff that we do, but what we try to do is we try to teach people how to value assets, particularly the way that Warren Buffett values assets. That’s what our podcast really does. We have a couple sites that teach people how to conduct asset valuation.

One of the things that a lot of people really struggle with is how do you value intangible assets? It’s funny, because you’re talking about Mark Cuban, and how you were saying his signature on the check in just being associated with him was worth countless more dollars than the $150,000 he wrote the check for. That’s something that I think a lot of people miss, especially if they’re getting ready to start a new business, to give up 30% equity just for his brand, or his stamp of approval, which is completely intangible. There’s an enormous amount of value.

You actually see this on the numbers that Stephan is talking about. He’s producing $5 million dollars in revenue from the numbers that he started with. It’s incredible. He’s one of the fastest growing businesses and the majority of it…

I mean, I’m sure your hard work and everything else you’re putting it through, I don’t want to discount that, but there’s an enormous piece of it that’s coming from this intangible value of being endorsed by a celebrity. That’s something that it’s very hard to stick a price tag on, but it’s something that you have to properly value whenever you’re looking at a business.

Stephan Aarstol 19:40
Yeah, that’s a good point. Mark Cuban is one aspect here. The other aspect is Shark Tank that airs to maybe 7 or 8 million people every Friday, and you would get reruns on there. We’ve aired like seven times. Every time that happens, we’ll get 40 or 50,000 in sales. It’s like hitting with another advertisement for our brand. Those two things are hugely valuable and way more valuable than the money.

Stig, you mentioned, when you left in there, it was a slip of the tongue, but you said you gave away 30% of your company for this amount, but that’s exactly how I look at it. Like, there’s no way I would have taken 150,000 or 30% of my company. My business plan maps this company out over the first three years to a valuation of about $11 million.

Actually when Shark Tank called me to be on the show, they made me do a pitch tape, right? Never seen the show, I just figured, well, how am I going to pitch investors? I said, well, okay, first, they’re going to want control of the company. No investor is going to put in a bunch of money and not have control of this company.

I said, number two, they will not make a small investment. I asked for $5 million for 60% of my money in this pitch tape. The producers got this. They came back to me and they said, “Nobody’s ever asked for that bunch of money. Are you crazy?”

I’m like, well, are these guys investors? Aren’t they billionaires? How else would they do it? Then I went back and watched a few episodes of the show. I saw, okay, all of these guys are investing in basically no man’s land. 150,000 to 250,000 to 5 million where no regular investor would come in and because who wants to have 20 tiny investments?

Then they didn’t want control of the company. They just want to make a little side bet on this horse and let them run with it. So that show is a little different from regular investing. I get a lot of calls from people who are approached to be on the show or ahead of me, and they’re really close. They’re like, “I don’t know if I want to go on there and give away some of my company because I think I can raise more elsewhere.”

I tell them, you’re looking at this wrong. Well, you need to go on there. You’re just giving away a chunk of your company, maybe for $0, don’t even look at the dollar amount. Then how are you going to leverage that? How can you make this much bigger pie, which you were talking about, Stig?

Stig Brodersen 22:05
Yeah, is it that Shark Tank actually has an option on the companies? Are there entrepreneurs during the show?

Stephan Aarstol 22:15
There used to be an option. It was 2% royalty at the time I did it. So 2% royalty and option for 2% royalty on profits, I guess, and then 5% equity in the company. Then if you had an exit or something like that they can exercise this. They didn’t exercise that in many companies, but a lot of people that I talked to other investors in the show were really, or other entrepreneurs, were really concerned about that option. I looked at it like I had it coming in at $100,000 lifetime. I mean, just 5% of nothing at this point then you get to be on TV. That’s no brainer.

It’s a $5 million company, I would love nothing more than for ABC to exercise that option because then I basically have an immediate partner for another tiny percent of my company. They can re-air this thing into oblivion. I mean, they’re actually coming out with a follow on show called Beyond the Tank. Have you guys heard of this show? It’s a follow up to Shark Tank, the spin off. I assume it’s going to air in the hour after Shark Tank.

Preston Pysh 23:35
Yeah, 5% for all the marketing and the advertising to millions of people is just…

All right, I’m going to get to this next one. One of the unique caveats in the final contract was Mark Cuban with the first term rights to any equity sale that you have in the new businesses that you create. When I watched that, I took that as a huge compliment to you, because this was Mark Cuban basically saying, “I know you’re not just going to do with this business, but you’re going to do with a bunch of more businesses, and I want to be on that gravy train, ” was basically what he was saying.

Have you thought about any new businesses or have you done any more business deals with Mark?

Stephan Aarstol 24:18
I’m a big fan of focus so I’m trying to figure I’ve got a big opportunity in front of me. I want to knock this one out first. Then I have some other businesses that I would look at doing.

But the reason that whole thing came up and it was probably hard to read that from the show, because in one part you guys didn’t mention so when I started my pitch, I forgot my lines. I was silent for what was like three or four minutes in real time at the start. They actually edited it down, but it was still hard to watch from friends and family. Then I had to come back from there. Part of that was I looked like an idiot on TV.

The other part was I was pitching this paddleboard company that had no proprietary IP. I didn’t have a really competitive band. I had no money behind me. I had no traction even. I was going up against huge brands that have been around for 30 years.

These guys were like, “How is this kid going to compete?” I said, “This is no brainer. I mean, I’ve got free marketing for three years. We’re going to be the biggest company in this industry. Just give me five years.” These guys just thought I was on crack. They didn’t like the paddleboard business. They didn’t realize how big of a market that was. It’s kind of a tricky big market.

And so, I had to go back and tell them okay, I’ve done this poker chip business. My brother did this tree trimming equipment company that he took from basically about a quarter million in sales to 8 million in sales over a period of seven years. This was a 20 year old company that he basically injected search engine optimization strategy into, and you just basically eat the lunch of everybody else. You’re just eating market share, even in an industry that isn’t growing.

So I went through several of these examples that I’ve been involved with. I said, “Look, you guys have all of these companies and hundreds of millions of dollars behind you. Let me use your sort of war chest.”

It’s hard to actually start a company from zero and grow it to five minutes sales. That’s very difficult. What’s an easy task is you buy a company for $10 million. It doesn’t have this stuff. You inject that and we flip it for $30 million in two years.

That is actually where Kevin O’Leary’s eyes pop, because he’s sort of an MMA guy. These guys saw that like the bigger picture. Who cares about the paddleboard company? He could potentially help us in our other businesses. He can do what he’s done in the paddleboard business for any other opportunity to come.

Preston Pysh 26:52
This is a consultant in my back pocket is the way that they’re looking at. I can consult this guy because he understands SEO better than anybody else out there. He can turn and assist in these other ventures that we have. That’s brilliant.

Stephan Aarstol 27:02
That’s fine the way you put that because the one negotiation after the Shark Tank, we went to do all the due diligence stuff. The one thing that I asked that wasn’t included in the show offer was I wanted to put Cuban’s face on my homepage. He agreed but he said, “But I want you to basically freely consult with my other companies on SEO.”

Stig Brodersen 27:33
Let me just pick up what you said before, Preston, because as a successful entrepreneur, and I know, Stephan, that you’ve done a lot of different things. You mentioned the poker chip business. You must have a ton of different opportunities. If you are like the rest of us, you only have like 24 hours a day, how do we prioritize which project you should pursue?

Stephan Aarstol 27:58
Well, I’ve really now focused on the paddleboard company. It has really evolved into more of what we’re calling a beach lifestyle company. So we have paddleboards now, but our initiatives over the next year is we’re starting this digital magazine, initially, but it will be a glossy magazine. We’re going to try and leverage the reach of social media to grow just this massive audience of beach lifestyle enthusiasts, by giving them content similar to your business model, right? You’re just bringing in this whole audience interested in investing.

Then you’ve got the audience and then you make products for that audience, as opposed to the traditional business strategy, which is, “I’ve got this great idea for a product,” you build a product and then how the hell am I going to market this now?

So we’re sort of flipping the script there. We’ve got this nice base, a $5 million business that’s really profitable and that’s probably going to just sort of organically grow to 10 or $15 million. Then what else can we do?

We’re going to use that money to grow this big beach lifestyle audience and then bring in other products. The initial product we’re bringing in is like wooden sunglasses. We’re going to bring in bikinis. We’re actually doing a podcast as well. We have this sort of side shoot of our business called the Tower Girls, which is just beach models. We’re going to have two Tower Girls doing podcasts of successful people in the beach lifestyle and industry athletes.

Preston Pysh 29:25
This is a rough line of business you’re in. I’ll tell you.

Stephan Aarstol 29:30
It’s funny you say that. So I was in the poker chip business before. and when you’ve got a business that sort of supports you, and you’re working 10 to 12 hours a day a week, you’ve got a lot of time to think about what business you really want to be in?

I did about two years prior to starting this. I’m like, “What would be the perfect job?” and I live in San Diego here by the beach. I thought it would be sweet to be the CEO of a surf company. Then my buddy went paddle boarding. I was like, “Holy cow, this all sort of fits together.”

Stig Brodersen 30:06
Basically, for the last 10 years, it has been poker, bikini girls and surfing? Is that really what you’re telling the audience?

Preston Pysh 30:15
And the fastest growing company in San Diego? I mean, geez.

Stephan Aarstol 30:20
When people say it’s a lifestyle business, they think, “Okay, well, they’re checking out on growth and paying their bills. Work as little as possible.” This is a lifestyle business, but I believe this has the potential to be a 100 million to a billion dollar brand.

Preston Pysh 30:34
Good for you. We’re just so delighted to have you on the show. I know our audience is eating this up, because we’re having a blast talking with you.

Okay, we just have a couple more questions and then we won’t take up any of your time, because we know you’re a busy guy.

This one here is something that I really am interested in hearing your response to: for anyone wanting to start their own online business, or just any kind of business brick and mortar or whatever it is, what are your top three things that you would focus on during the beginning stages of the business?

Stephan Aarstol 31:06
The first thing is your burn rate. You need keep your costs super low. I’ve spoken a lot of universities, and the kids are always like, “When should I start a business or what should I go into?”

I said, “Actually, the perfect time to start a business is when you’re in school, because basically, you’ve got student loans, finance the business out of some of that, you can live on nothing. Also, you don’t have any expectations,.You don’t have kids, family, car payments, mortgages and stuff like that. As you get older and older, it gets harder and harder to jump from that secure job and start a business. But when you don’t make any money, it’s very easy.”

As you start this business, you’re going to sort of go through cash and a lot of people say, “Well, I’m going to give myself a year to start this business and if I run out of money, then I’ll go back to doing something else.”

But you want to get to sort of cash flow positive, as quickly as possible. We’re not making any revenues. The best way is just have zero expenses. I mean, don’t have an office. I don’t spend any money on marketing, just refuse everything and say, “I’m only going to do stuff that is basically free.”

It does a couple things for you. It gives you a longer runway to start. Then it also forces you to find hacks. For example, I started a paddleboard company and I had $500,000 to go out and do this paddleboard company, which a lot of people do in this industry. They go out, they buy a magazine, and they go to trade shows, etc. They have this big plan of how to get from A to B, which is the same plan that everybody else has. But if I say I want to build a $100 million paddleboard company, and I have no money to do it, you have to find a hack.

And a hack is a growth hack. For example, SEO. I can go for three years and spend $0 on marketing or leveraging social media. Any way you can figure out how to spend no money and get free marketing.

Then you’re going to refine that hack. Three or four years down the road, you’re going to have this natural built in advantage that you’ve learned because you were forced to.

Preston Pysh 33:18
I don’t want to interrupt you, but I’ve got a comment on what you’re talking about. Because so many people think I need to go to the bank, or I need to find some venture capital person to give me $100,000 so I can go advertise, or I need to go do something else.

They missed the point and they missed the essence of what you’re talking about because they don’t understand that the only way that you’re going to get to that cash flow positive position is by being enormously creative in minimizing your costs, like you’re saying.

These people that get $100,000 influx of capital, they just burn straight through it in a couple months. They never had to become creative with how they’re actually producing cash flow.

Stephan Aarstol 34:09
Yes, that’s one point. You have to keep your burn rate low.

Then the second point is, and this is something that I struggled through. I mean, when I went off into being an entrepreneur, I was 31 and I wanted to be an entrepreneur. In college, I was taught here’s how you value the business and then once you got the value on the business, then you will go out and shop this to investors. Then get your investment and then start your company.

Well, the problem there is that getting an investor is really hard. I mean, I got an investor, it was a fluke thing on TV, right? But the idea of just having a business idea and finding an investor is an enormously rare proposition. It happens in small pockets and in Silicon Valley. It happens if you have a rich uncle or something like that.

Aside from that, there’s no money out there and forget the banks. They are not going to lend you money. We just got our first line of credit or anything, even a credit card about three months ago. We’re talking about the fastest growing company. We made a million dollars last year. We couldn’t get a $5,000 credit card from a bank. So you have to assume there’s no money out there.

But if you’re looking at businesses, and you say, “Okay, this business requires money to start. This business does not require money to start. You put them in two columns. Then you take every business that requires money and you throw it.”

Unless you actually have money yourself, or you have a rich uncle or something like that. That’s the second thing. I picked a business based on whether SEO would work for this business or not? You also have to pick a business: does this business work for having no money at all? Then focus all of your effort there, because I spent probably 10 years looking at businesses that were these grand business plans, but it required 3 million in capital or 500,000 in capital. It’s a waste of my time, because I don’t have the ability to raise money.

And so, if I would have just said, I can’t do any of that. What can I do for free, even if that means starting as a consultant, or whatever? Put a shingle up and get started, because you need to get off on your own and then sort of go from there and iterate.

Preston Pysh 36:19
You got to stay at it like you’re saying, you got to find something that doesn’t cost a lot of money to start and but you have to set something on a daily basis that I’m going to put an hour or three hours a day into, and progressively work at it.

Time is on your side when you’re working in that manner. That’s how you’ll eventually grow into that position where you will have the credit, or you will have the opportunity to get that influx of capital, if you even need it at that point. Most companies don’t need it like yourself. You’re saying you didn’t even have the line of credit and look what you grew it to.

Stephan Aarstol 36:51
That’s a good point there. There are some book talks about a 20 mile mark, like every day, you need to do that minimum over a long period of time. That’s really the basis of success.

When people hear that I was on Shark Tank, they’re like, “Oh, you got so lucky to be on Shark Tank and do this.” But if you look at that, I’ve been working for basically 15 years to get to this point. I learned all the stuff that I know how to do now, starting in 1999, early on working for another company. Then I started the poker chip business and worked on SEO.

Now getting on Shark Tank was much more than I had planned for. It’s this long path and a grind for a long time.

Preston Pysh 38:06
I think it was Malcolm Gladwell, his book where he says you have to have 10 years of experience in something before you become an expert of it. A lot of people watch Shark Tank, and they just say, “Oh, that guy is so lucky.” However, they didn’t see the 10 or 15 years of growth in learning and how you understood SEO and all those other things that led up to that culmination point.

Stig Brodersen 38:31
Stephan, sorry that I keep returning to this whole poker chip business. It is probably because I used to make a living playing poker. I think what’s really amazing that you saw this trend when *inaudible* was winning the World Series. We’re sorry if it sounds really geeky, but Stephan still knows what I’m talking about. Because I’m sure that you saw that this was really a trend in poker because it was now on TV and you saw this average Joe winning the World Series of Poker.

It’s also just to say to the entrepreneur out there that you don’t have to be a genius. That’s really not to discount you anything different, but I mean, you don’t need to have an IQ of 200 or something to be successful.

If you see that a new trend is coming like poker or paddleboarding, there are so many e opportunities out there and there are so many changes that are about to come.

Stephan Aarstol 39:28
The interesting thing was that the poker chip and the paddleboard business exactly like you sort of nailed it on the head. Chris came in there and poker has this huge rise in popularity, 50% or 100% growth a year. That is actually very friendly for SEO too, because you’re running a race that I know how to run much faster than anybody else.

Then when paddleboards came, I saw that. I was like I already know the finish line of this. There was no risk in this business.

I was actually six months into a different business, a green energy portal for the green energy industry. Then I saw this which… And the green energy thing needed to raise money, it was a much bigger opportunity, but I was like, paddleboard. This is exactly like poker chips. I can actually see around corners in this business. It was much less risky.

Stig Brodersen 40:17
Well, the final question from me, Stephan, is we receive many different pieces of advice, probably more bad than good ones. But what is the best investment advice that you ever got?

Stephan Aarstol 40:33
I’m not really an investor. I’m still trying to figure out how to borrow money from people. You guys are the investment experts. I’m just trying to get money and invest in yourself, I guess that is probably the best investment , because you don’t have to invest a lot of money.

Preston Pysh 40:54
There you go. That’s some fantastic advice.

I have two ways of seeing things. There’s basically two ways that you can invest your money. You can create assets, which is what Stephan is doing or you can take the money that you’ve got and you can buy assets.

And so, typically Stig and I focus on the latter category of going out and buying assets that already exist. But there’s a whole nother side to that equation and that’s what Stephan is talking to us about today. That’s creating assets for yourself.

To be honest with you, there’s a lot more risk in that area but the reward is enormous. A lot of people want to become millionaires overnight in the stock market. It is almost somewhat humorous. Because when you’re buying assets, that timeline doesn’t occur at the same speed as which it does whenever you’re actually creating an asset and putting something out there for people to consume.

I don’t want to throw that out there because a lot of people, I think, lose sight of that difference between asset creation and purchase of assets. And so, just something to highlight.

Last question, and we really appreciate your time. We didn’t intend on taking up so much of your time, Stephan. So we really appreciate that. Our last question is, do you have any books that you’d recommend for people as they conduct their self improvement, maybe an SEO or entrepreneurship, something like that, that you could recommend to the audience?

Stephan Aarstol 42:23
For SEO, there’s a good book, it’s called “Search Engine Visibility” by a lady named Shari Thurow. It was written like 10 or 12 years ago, it’s very basic stuff, but the thing about SEO is, it’s actually very basic. Just roll your sleeves up type stuff, there’s no sort of quick hacks. If you’re looking at sort of long term strategies, you have to provide value to people that are searching on the web, give them information, basically.

Don’t worry about any of the blackhat hacks, or the latest algorithm? I mean, that’s all sort of propaganda, I think within the industry so you’ll hire a consultant. It’s very easy stuff, roll up your sleeves and do it.

For entrepreneurs, I would say “The Four Hour Workweek.” I think it is sort of a Bible for entrepreneurs. It shines a light on the fact that we are really living in a different world today. I mean, you guys have this podcast. You guys could run this to several million viewers. You live on two continents. You’re not even working in the same office and you could create a major media channel. That’s what we’re doing with our Tower Life site, which is a beach lifestyle magazine. We really believe we can roll out to several million.

I think “The Four Hour Workweek” really sort of lays out a roadmap of what this new world is.

Then for sort of like a business optimization, and sort of an iteration guide, I think the “The Lean Startup” is a great book. This is some stuff that I’m getting into now of where we had a big run with our business initially. Now, it’s how do we take that base and how do we iterate that and go from there? Because it’s one thing to grow to a $5 million company, it’s a whole nother thing to take that to a $50 million company or $100 million company. That’s the challenge in front of me.

There’s a book called “The Lean Startup” I think it’s by Eric Reese. Another book on lean analytics so it’s application of statistics to this. It’s basically the idea of just getting product market fit and figuring out exactly what people want to buy.

Preston Pysh 46:04
Stephan, seriously, thank you so much for coming on our show. This was such an enlightening interview. I know everyone’s really going to enjoy this. It was really kind of a neat glimpse into what’s behind the stages of Shark Tank and then your wealth of information as an entrepreneur and startup with the company is just really exciting to listen to and to hear firsthand. Thank you so much for coming on our show.

If our audience wants to learn more about you or they want to go out and buy a paddleboard, how can they find more information about you?

Stephan Aarstol 46:38
Sure. Our paddleboard company has Tower Paddleboards so you can just google paddle boards. Go to towerpaddleboards.com. We have a new online beach lifestyle magazine at tower.life, if you’re interested in anything to do with the beach lifestyle. We’ve hired a full time filmmaker and full time writers. There’s just a lot of great content and interesting stuff to anybody that’s interested in the beach lifestyle.

Preston Pysh 47:30
So what we’ll do is we’re going to have links in our show notes for all those different things that Stephan had talked about, so that if you want to check it out, you want to go get some cool sunglasses, these sunglasses sound awesome. I think I might pick myself up.

Alright, so this is the point in the show whenever we play one of our questions from the audience. This question comes from Nick Patel and here’s his question.

Sender 48:05
Hi, Preston and Stig. My name is Nick. I’m calling from Atlanta, Georgia. Let me start by saying that you guys are doing a fantastic service for the value investing community. Thank you so much for bringing in Guy Spier on the podcast.

So I had a question about putting all your eggs in one basket, I’ve heard that saying a lot. I do understand the inherent risk that it poses, but I do understand that when stocks are at maybe an all time high or you know, close to their all time high. And if you put all your eggs in one basket, and if you have a drop, like the recent drop in oil that we had, you’re likely going to incur a lot of losses.

However, what about when the stocks are beaten down 50-60%? I’d like to talk about oil again, where you have really good companies that are just severely beaten down because of oil, but they’re still fundamentally very strong. Nothing has changed fundamentally, in terms of valuations for those companies, and they look really cheap.

At that particular point, what do you think about putting, if not all, the majority of the eggs in one basket, maybe 50 or 60% of your portfolio in oil related stocks? I’d really appreciate your answer and insight to this question. Thank you so much.

Preston Pysh 49:32
Okay, fantastic question. Stig will answer your question for you.

Stig Brodersen 49:37
Nick, like you I’m a strong believer in a concentrated portfolio. When I say concentrated, I would say for most investors, if you have something like 10 to 15 stocks, in different industries, as a rule of thumb, you should be good to go.

So you specifically asked about 50 to 60% in oil stocks. As you could probably hear from my more generic answer, when I say like 10 to 15 stocks, I would probably say that 50 to 60% is way too concentrated. I would say it’s too concentrated for advanced investors. It’s definitely too advanced for beginning investors.

On the flip side, I personally think that you’re right about the oil industry. That is probably one of the few industries where you can still find great stocks at decent prices.And know that I’m seeing decent prices. I’m not saying that it’s like once in a lifetime bargains. It’s not like, even though you hear in the news that oil stocks drop this and that I don’t think that we’re in 2009… It’s not really that great an opportunity, but it’s definitely great companies with somewhat low prices that we’re seeing at the moment.

This really makes me think of “Security Analysis” by Benjamin Graham, because in this book, he talks about how low prices in itself can be a margin of safety. So this is not the same as saying, as oil stocks cannot drop in price, of course it can and especially they can do that in the short run.

But it means that even if you’re slightly wrong in your perception of a great company, it’s very unlikely that you will lose your principal. That’s an extremely important point when you talk about stock investing, because what we see right now is high uncertainty in the oil industry. I also think that we see low risk, so in this sense, low risk of losing the principal.

Preston Pysh 51:40
So Nick, my thoughts, I’m in total agreement with Stig, The only caveat that I’m going to say as far as having the weighted portfolio of 50 or 60% into one thing, if you’re doing that potentially with an index, so you wanted to have 25% of your portfolio in an S&P 500 index, maybe the other 25%, and an index that has money into the top 1000 capitalized companies.

I think that that’s not a bad thing, because you’re spreading the money across just numerous companies. But whenever you’re dealing with individual stock picks, I think going anything over maybe 20 to 25%, is really starting to push it because you’re not protecting your downside at that point, if you’re not accounting for a variable that maybe you’re missing.

Whenever you’re dealing with individual stock picks, I’m always thinking to myself, what is it that I am missing? Because there’s just so many variables out there that there’s a good chance you might be missing something.

So your other question is about the oil industry in general and saying that they’re undervalued at this point, then that’s something that I think that you’ve got to be very hesitant to quickly come to that conclusion of that the oil industry is undervalued.

Whenever I see a large industry like that moving in a certain direction right now, with it all moving down, I try to understand what are the critical variables that are causing that. And so, I went through Lean Six Sigma one time, and I had this instructor who was this risk manager, efficiency expert that worked for the Bank of America.

He was a master black belt in Lean Six Sigma. He had this really funny saying, and I’ll never forget the saying, “Take the Jerry Garcia method. Get as high as you can and stay there for as long as you can.”

I thought it was really funny, because what he was saying was that he wasn’t implying that you should get high. What he was actually implying was that you need to look at things from the highest vantage point that you can.

So when you’re looking at the oil industry, the first thing you should ask yourself is, why are all these oil stocks going down? What is causing that? And so when you look at it from a very high vantage point, you realize that there’s an enormous shift and enormous change in the supply and demand of energy companies around the world.

Then you have to ask yourself, well, what’s causing that shift? Why is there a change in the supply and demand? What’s going to be the long term impact of supply and demand?

You have to start with those really big questions first, and you’ve got to fully understand those big variables, those big chunks. Then once you feel like you really understand it, you can start digging down more into the weeds of the smaller, maybe indirect variables that are causing it.

I guess my point is this, don’t be really quick to just say, the industry is undervalued. I would argue you have to fully understand the big variables and really try to pressure yourself to understand what those variables are before you act on any type of decision to buy an individual stock pick in that particular type of industry, because it might persist for another year or another two years.

Then you’re starting to worry about opportunity cost and where you could maybe put your money that would have maybe served it better, until you started to see that supply and demand maybe start to change and shift in the opposite direction.

Stig Brodersen 55:05
Yeah, and this is just a really quick comment here. I completely agree with Preston. One thing that you should definitely pay attention to when you are analyzing something, for instance, like the oil sector, is that the data that you’re having is looking back in time.

If you’re looking back, say the last few years, you’re looking at oil prices above $100. So you cannot say well, we’re probably gonna have the same earnings if the earnings are based on the old oil price of $50. So just remember that when you’re looking at the valuation today, and you’re using historical data.

Preston Pysh 55:41
When you’re looking at that, it’s undervalued, if you’re still valuing oil at $100 a barrel or more, but maybe the outlook in the future. That’s the hard part. That’s what you’ve got to do the research on, what is the value of a barrel of oil going to be as we look towards the next five or 10 years? Then you have to value the companies based on that. So we’ll leave it at that. Thanks for the fantastic question, Nick.

Outro 58:18
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