How many people do I know that are billionaires that implement that strategy? Without like deep machine learning? And you know, the really hardcore technical people that have computers that do this? I would tell you, I don’t know any that conduct day trading that have risen to an extreme level of wealth in the market.

When I think about other people, call it George Soros, Warren Buffett, Stan Druckenmiller, people that are billionaires that have implemented strategies, they’re not doing day trading. They’re doing other strategies, which, you know, I’m sure we’ll talk about on the show. So I always start there. Because what I’m trying to do is I’m trying to figure out what the strategy is that these people are using? What are all the resources that taught them how to do that strategy? And then how can I read and try to understand what those resources are so that I can try to gain those insights on how to implement that strategy, because it obviously worked?

So when I think about day trading, I don’t have a source and I don’t have a person that represents, you know, extreme success in that strategy. I start there. The next thing I would tell you is, what is your edge? So if you’re going to put on a position, let’s say you’re going to go out there. And you’re going to buy stock in a company, call it Google. What is the edge that you have to know whether that’s going to go up or go down in that 24 hour? Or you could even say a couple day period of time? What is it that, you know, that’s driving…that you know it’s going to go up or go down?

And I would argue if you ask a person that question, that person’s going to not have a response. And if they do have a response, it’s probably going to be so superficial deep as to the reason that it’s completely… you can completely write it off as 50-50 odds. Okay, best case scenario. That’s where I can’t recommend the strategy either. That doesn’t mean that maybe, there’s somebody out there that could make it work in the future. That’s a potential. I would just tell you that I think that it’s, it’s not something that I can understand how a person can do it successfully. I don’t know that they’re going to be able to prove too much to you.

Robert Leonard 4:39
I completely agree, Preston, that you need to find somebody that’s been very successful investing in the stock market, and then try and copy what they’re doing. But a very important distinction that I think we need to make is that you need to find somebody that is truly successful investing in the stock market and that’s how they made their money. And the reason I say that is because for me personally, I thought I was doing exactly that.

I thought I had found somebody who was super successful investing in the stock market. And I started emulating them. And that was actually using a day trading strategy for trading penny stocks, and have come to find out, thankfully, it was pretty quickly that I realized this. But come to find out they were actually earning more money from selling their courses and being a coach or a mentor to other students than they were from actually trading in the stock market.

And while they might have had some moderate success in investing in the market, that’s not the person that you want to emulate. You really want to emulate somebody who has truly had success investing in the stock market. And that’s how they made their money, not from selling courses, or their paid advertising, or all of these other things you could do on the internet these days. Really, you want to follow somebody who is that expert in stock investing.

Preston Pysh 5:43
And I’ll tell you what, as a as a millennial listening to this show, you should question everything you hear. If Preston pitches opinion that you can’t do day trading successfully, you should try to seek out a source and then ask them extremely hard questions, which is what’s great about what you’re doing. And I love that. Get somebody who has the exact opposite opinion as you. Ask them some really hard questions. And then, you know, maybe there’s something to be learned there.

Maybe there’s a small piece of that strategy that could augment the strategy that you have, I don’t know. But I think that people, one of the most important things that I’ve learned from studying extremely successful people, is they approach everything with an open mind. And they always approach things with the appreciation that they could be wrong. And I think that that is probably more of an important lesson than anything else… is having that mindset and having that openness to other ideas. And to listen and ask really hard questions and troubleshoot it.

Robert Leonard 6:44
Yeah, that’s exactly right. And you have to make sure that you’re not falling victim to confirmation bias. You need to make sure that you’re not just looking up resources, or books or articles that show that your strategy and your thoughts are true. You need to research the other side of it and see if there’s any validity to the opposing argument to yours. And that way, you can make a fully educated decision based on what you think is best.

And one more point I want to make about day trading is that you might be able to make a few good trades here and there. You might be able to have a small streak of good investments that are profitable. But over the long-term, it’s very difficult to get it right and to be able to day trade successfully. And not only that, but it’s really difficult to come out ahead after taxes and commissions when you’re day trading.

Preston Pysh 7:28
I’ll take it a step further than that. So if you were a day trader for the last eight to nine years, okay, so if you’re… let’s just say you’re 30 years old, and you started trading as soon as you got out of college, pretty much all you know is that the stock market goes up. That’s pretty much all you know, because that’s all that’s happened since you’ve participated in the market.

Okay, so if you were implementing a day trading strategy, and let’s just say that the market has gone up 70% of the time, if you went day by day, the market went up 7 out of 10 days, right? Something like that, whatever it was. So if you’re implementing a day trading strategy, or there you’re doing the trade every day, it’s going up 7 out of the 10 days that you participate in the markets, and what are you thinking if you’re a day trader? You’re thinking, “Oh, I’ve got this thing figured out. I’m doing really, really well.”

What I would tell you is that you have to compare that to another strategy. If you would have just taken your money and just bought, never sold anything and just bought over the last same eight to nine year period of time. And you never sold but you just kept buying the S&P 500, I can’t say anything as a guarantee. But I would be absolutely flabbergasted if a day trading strategy beat what I just described, as far as the no brainer, just buy, buy, buy for the last eight to nine years.

And so what I think people have to be able to do is that they have to be able to objectively look at themselves, and compare what it is that they’re doing to something else, something else that’s easier. Something else that literally requires almost no thought whatsoever, that would outperform something that is insanely time consuming, insanely fee-based expensive, like you said.

And so are you outperforming the market? Absolutely not, with what I would suspect you’d have, as far as returns with a day trading strategy versus something that was just buy and hold. So you’ve got to compare what it is that you’re doing in a very objective way to what other possibilities that are out there. That’s called opportunity costs. So I would tell people to be open-minded to other possibilities. And maybe there are better ways of doing with what it is that you’re trying to accomplish.

Robert Leonard 9:45
Before we move into the next investment strategy, I want to dive deeper on something that you just mentioned. And that’s the level of effort that it takes to day trade. When you’re day trading stocks, you need to be in front of your computer from the time the market opens until the time it closes, or at least for a few hours in between there. Which means it’s a very time-consuming and difficult task to do. It takes a lot of effort and time. Whereas other strategies, such as value investing, you essentially set it and forget it for a long period of time. So there’s very little time or effort commitment once it’s set in stone. So that’s another dynamic of day trading that you need to take into consideration when you’re trying to decide which strategy you want to implement.

Now shifting gears to another strategy called momentum investing, I know it’s become an aspect of your portfolio over the last few years, Preston. Can you talk us through what momentum investing is and why you’ve come to like it?

Preston Pysh 10:37
So I have to give credit to a couple of different people for this strategy. Because I was, you know, I thought this was not something that was worth my time when I first started out investing. I had a real strong bias to value investing, which is Warren Buffett’s style of investing. But I had some people that have influenced my thinking. Some of those people are James O’Shaughnessy, who in my opinion, is one of the greatest quant investors out there.

And we’re really kind of put a fire into this entire field of quant investing. And one of the aspects that he talks about is mixing value investing with momentum investing. Now, you have two people, Tobias Carlisle and also Wes Gray, who piggybacked on a lot of what James O’Shaughnessy did as far as his research. And they also further confirmed that when you when you mix a momentum strategy and a value strategy, you can produce better results. And this is all based on back testing, which doesn’t mean that the future results will be the same. But it’s very convincing when you look at what they’re doing.

Here’s momentum investing, when a company is doing well, call it Amazon, the company continues to accelerate in price because the market continues to pile into it. The keep now it gives them more capital in order to employ, which allows them to further produce better results, and so on and so forth. And it thrives itself, the success story thrives upon itself.

Robert Leonard 12:01
I know Preston just mentioned quite a few people. And it might be difficult to remember them all, if you’re listening to this while you’re driving or working out or just busy doing something else. So I’ll be sure to put links to all of those people in the show notes so that you can go back and check them out later, which I would highly recommend that you do. All of the people that he just recommended are highly successful investors. And those are the types of people that you want to emulate, like we talked about at the beginning of the show. Those are the types of investors that you want to go research, study, and try to mimic your investing strategy after.

Now, talking about momentum more specifically, it almost sounds like you’re timing the market. Intuitively it makes sense. I understand what you’re doing. But it almost sounds to me like you’re timing the market? And if you’re waiting for certain indicators, isn’t it too late for you? And you kind of already missed that opportunity?

Preston Pysh 12:50
Well, yeah, I think that for anybody who thinks they can absolutely nail the top of a market and you’re starting your journey, you’re going to have some painful experiences ahead of you. I look at it as a “stop loss” strategy. So if I’m locking in gains, and I’m making money, and I want to protect my downside risk, momentum for me is a great way to protect my downside risk by understanding what the normal operating volatility is.

And if I’m not participating in a company that has insanely high volatility, let’s say the annual volatility ranges 8%, I might lose a 10% from the top of whatever it hit, and I’m fine with that. Because I’m hopefully entering the position using very similar principles. And buying them not just based on momentum, but also value indicators. And so I’m able to buy them at a severe discount, and I buy them after the momentum changes to the upside, and then I hold on to them for a while. So if I, if I lose a little bit on the top, I’m fine with that.

What I think is a really, really, really important math equation for people to understand is a very simple but a highly misunderstood math equation, and it goes something like this: If you have a stock that rose to $100, and it now drops 50%, you now have to get 100% return to get back to where you were. That’s a 50% loss to 100% gain.

So now, if you study financial markets, and you realize that a business cycle usually last seven, let’s call it seven to eight years, and it typically has a 50% contraction at that point before it goes on another big giant growth spurt, that means that if you don’t protect your wins, and you don’t protect your principal, and you participate in the whole downturn, and you keep locked and loaded into that downturn, and you have a 50% loss, what you’re really kind of losing there is the long time that it’s going to take to get back and gain 100% return to get you back to the principle that you were at.

So Buffett has a saying. He says rule number one is don’t lose money. Rule number two is refer back to rule number one. And what he’s really getting at with that is this math equation that I’m saying is really important, is that if you lose 50%, it takes 100% return to get it back. And you got to understand that if you’re participating in financial markets is do not lose money. You got to protect your principal, you got to be very defensive in the way that you invest.

Robert Leonard 15:23
Now, with all that being said, do you think this is a good strategy for millennial investors to implement?

Preston Pysh 15:27
Well, let me put it this way, I don’t do momentum investing on its own. Period. I don’t put on a position strictly based on momentum. I put on a position that starts with a value investing principles, which involves reading a 10-K or 10-Q and kind of determining what the value of something is. And we can talk about what that looks like and what that is. And then whenever I determine I think that something is being penalised in the market that has value that I think is giving me a return higher than what like the S&P 500 index could give me, then I’m looking at the momentum indicators to determine whether the pain is over.

Because typically, when you’re finding great buy, just because they’ve been penalized on their market price, and the market has sold them off, these companies or financial assets had been sold off in a major way. And so then they become a value because everyone’s penalized the price so much, which pushes the yield higher. And so what I’m doing is, I’m trying to find those companies, those fixed income securities, whatever it is that I think has been severely penalized, but then I’m looking for the statistical change in the momentum.

So I augment the momentum with a value-based approach in order to not catch the falling knife, which is a term that is used in value investing. And that I can kind of, I hate to use the word time, but I think I can get my timing right a little bit better whenever I augment my value investing approach with momentum investing,

Robert Leonard 16:57
For all the reasons you’ve mentioned and that we’ve talked about, I’ve begun implementing a momentum aspect into my personal investing as well. But just like you said, it’s not momentum on its own. It’s paired with value investing, or at least another strategy. Now, I want to shift gears and talk about another strategy. And that is screen-based investing or quant-investing.

What this strategy is, is when you look at the fundamentals, or financial statements, or key ratios of a business, and make an investment decision almost solely based on what those show you. Now, I’ve used this strategy in the past. This was actually the strategy that I implemented right after day trading that I mentioned before. And I implemented this because I thought that this was what value investing was, this is what I thought Warren Buffett was doing. I quickly realized that that was not what he was doing. And I decided to move away from the strategy.

But essentially, what a screen-based or quant-based strategy is, is when you invest in a company based solely on what the financials or fundamentals are showing you. Now, the downside to this is that you missed the entire qualitative perspective of the business. And I want to talk about Blockbuster for a second here. I don’t know for sure that they had great fundamentals prior to their bankruptcy. But let’s assume that they did as an illustrative example for why it’s so important to look at qualitative perspective.

So if Blockbuster had great fundamentals, if everything historically had been good, because their business had been good up until it wasn’t right. So let’s say that they had really good financials, everything was looking good. So you were willing to make an investment because of their financials in their key ratios. And on a quantitative basis, everything looked good. But what you’re missing by not considering the qualitative perspective, is what’s coming ahead, the challenges that are ahead.

And so if you invested in Blockbuster based solely on a quantitative strategy, you would have entirely missed that Netflix was coming. If you were looking at the qualitative perspective, you might have seen Netflix coming in disrupting Blockbuster’s business, and you might have been able to get out in time. And that could have saved you from losing a lot of money. So this is just one example. But it’s really important to look at the qualitative perspective of a business. It’s not always just the financials. Preston, can you talk to us a bit more about what a screen-based or quant strategy is?

Preston Pysh 17:46
Well, I love your point that you’re talking about with quant investing is that you’re looking at the previous weather, right? You’re looking at all the things that have happened up until the time now. But what’s so important about investing is you’re making capital outlays that are based on what’s going to happen in the future, and that expectation of what’s going to happen in the future. And that’s where it can get difficult with a quant-based strategy.

Now you can understand what it means to invest in a stock. Let’s just say that if you bought one share of a business, and this is the whole principle of value investing is that one share of the business is the same as owning the entire business itself. Because all you do is, if there’s 10,000 shares outstanding, if you add up all those 10,000 shares that your market cap of the entire business. But let’s just value one share if we’re valuing the entire business, so if you give me the hundred bucks, and I give you one share, what is the number that you’re getting back? I’m kind of curious how you would respond to that? What would be the number that you would come up with? If you had to answer that question, Robert,

If I was going to argue with myself, I will tell you that the biggest hedge fund in the world and arguably, one of the greatest investors of all time, Ray Dalio uses a completely algorithmic-based decision-making model for every single investment that his hedge fund puts on, and it’s the biggest hedge fund on the entire planet with, you know, I think it’s around $200 billion dollars or something like that he manages. So that’s out there, too.

So for somebody just to kind of take an opinion in one way or the other, I don’t think this is a safe way to do it. I think that there are arguments to be had on both sides of it. I would tell you that a smaller size investor, like myself, I use value filters to help me understand what is something I should maybe look at. And then I start implementing my approach where I value and I look at those future cash flows, and all those things to try to determine a value.

So if I was going to describe value investing, I personally like to use kind of an example, for people… So if I was going to ask and for people listening to this, just kind of come up with your own answer to this, if you are going to give me $100. And one year later, I’m going to give you some type of profit in return. And what would be the number, what would be the dollar amount that you would expect to get back from me to consider that a good investment? So you just gave me 100 bucks, and I’ll give you that 100 bucks back at any point in time.

But if you gave me $100, and that represented like, let’s say I had a little tiny business, and it was making money, and it’s going to kick off some profit, how much profit would you expect back from that $100 after one year of time? And you don’t have to do any work. You just give me the hundred bucks, and then a year later, so whatever number you came up with.

If it was a passive investment that I didn’t have to do a ton of work on, I’d be very happy with 10% to 20%.

Okay, so when when we have an expectation to get a 10 or 20% return on your investment, that would be considered a very high growth in the stock market today. So like companies that are doing margins of like 10 or 20%, and that doesn’t necessarily mean that that’s the kind of return you’re going to get. But in this scenario, it would be, that’s a very high return. Most people wouldn’t realize that the S&P 500, based on the price that you would pay for one share of the S&P 500. And the earnings that it kicks off.

When I say earnings, I mean profit, it’s around $3, for every hundred dollars you would invest. You’d get that back one year later. It’s at a 3% return based on where the S&P 500 price is today. So when a person can put it in that context, and they can understand that, “Hey, I’m investing $100. I’m going to get a profit back one year later, and the profit is $3, out of that hundred dollars.” That’s what the S&P 500 represents today. That is something that anybody can understand, they can understand it very quickly. And that we’re coming up with a value for what we expect to get back based on our investment.

So when you buy a stock, it’s the exact same thing. So what that profit does, you’re getting back it’s called EPS. That stands for earnings per share, the profit I’ll get back out of this company for owning one share of the business. So if you go and buy a $50 stock, and you look at the EPS on that stock, and it’s five bucks, well, your profit from that little business, just think of it as a little micro business, you could put on a table for $50. And there’s little people in there working and they’re making things and they’re selling it and they’re making a profit… They’re going to hand you five bucks back at the end of the year.

That’s your EPS, that’s a 10% return. This is how people have to think about stock investing, because these are businesses that you’re buying. This is not some Hocus Pocus. You buy something. You hope it goes up, you hope it goes down. So what happens with that profit, after that $50, the company makes five bucks after one year? Well, the company can retain it, they can keep it in their bank account. And they can reinvest that $5 to buy more assets, so that maybe next year, they can make $6 instead of $5. Or they can pay some of that out to the investor, the person who gave them the 50 bucks. So you could pay all of it, the 100% of it as a dividend. I can receive literally a $5, you know, addition into my account for being a shareholder of this $50 company.

Or you could have a hybrid of both, let’s say I get paid $2.50, the company retains $2.50, and they use that money to grow and become stronger. Instead of making $5, next year, hopefully they’re making $5.50 or whatever. This is how stock investing works. This is how value investing… A person who’s a value investor is going to look at the business, they’re going to look at the numbers, they’re going to come up with a value that they think the businesses worth. And it’s completely based off of the return, based on how much money they’re allocating into the business to be an equity holder of that company.

Whenever I’m doing investing, this is how I think. And then I augment it with call it momentum investing or whatever else, because momentum investing is just looking at the price action like that’s… there’s nothing more to it. Whereas value investing is looking at a whole lot more, you’re looking at what assets are they going to create next year? What kind of revenue stream is that going to produce? What kind of margin is that going to produce? And ultimately, what’s that going to give me on my bottom line?

I love that analogy that you just gave, Preston. I think it’s so important for new investors to realize that when you buy a stock, you are truly buying ownership. And in business, you’re not really just buying a blip on a screen, you’re really starting to own a small percentage of that business. But that being said, say someone invested in a stock and the company has done very well just like they expected, profits have grown.

But the stock has actually stayed flat. Or maybe it even declined a little bit for whatever the reason may be. Maybe the market is just being cyclical or the market is being irrational. But for whatever reason, the stock declined. How can a new investor overcome the mental hurdle of not seeing those profits actually hit their brokerage account?

So Warren Buffett, in my opinion, probably the greatest investor that’s ever walked the planet from like a stock investing point of view. I’d say it’s between him and Dalio at this point. Buffett has a quote, he says the stock market is a voting machine in the short-term, and it’s a weighing machine in the long-term. So when a person hears that they’re probably thinking, “Okay, so what in the world does that mean?” Well, what it means is everyone’s got an opinion. There’s craziness driving the short-term market behavior.

And that’s why I would argue that you can’t do it successfully. Because there’s no way of really knowing whether bad news is going to hit and 10 minutes from now, and drop or raise the price of the stock… There’s no way people can actually know that. That’s called insider trading. If you do know that, it’s against the law. So it’s a voting machine. And it’s kind of going all over the place. And it’s trying to find what an aggregate people think it’s worth.

But what Buffett would also tell you is if the price drops, and you know that the companies have value. So let’s go back to our $50 example. Let’s say we bought the company at $50, one share $50, it makes $5 a year. Some bad news came out, the market got scared, and it drops down to $25 a share. But the company’s still producing a profit. In fact, they might even be still producing the same $5 profit that they were making before. And if they aren’t, maybe it’s $4.75 now in the profit. But you can now buy it for $25 and not $50.

So what Buffett would tell you is you got to buy more of that stock, because it just went on sale. It would be like going into a store and the jeans that you used to buy for $50, you can now buy for $25. It’s the same pair of jeans. Well, you would buy two pairs of jeans and try to sell the other pair or whatever.

So in the long-term, the stock market is all about a weighing machine. And what he means by that is the person who is accumulating more and more shares at great prices are the people that’s going to get a really fat return because… Let’s go back to the yield that you’re getting on a company. If it’s, say for simplicity, say that the profit is still $5 a share. But you know, you can buy it for $25 instead of $50. Well, when it was at $50, you were making a 10% return. Then when it’s at $25, you’re making a 20% return. So whenever it goes on sale, your yield goes up, assuming that your profits are similar to where they were at before. And this is where it becomes a weighing machine, and you need to load up on it. And so it’s just a change of mindset.

And most importantly, it’s all about patience. If you think you’re going to knock out a 100% return on something in six months, you know, you can do that in some type of markets. But you can also lose 100% of it in those same markets. So if you if you want to make a lot of money fast, I’ll tell you your risk is sky high. If you want to make a lot of money slowly, your risk is maybe lower depending on what your approaches are and how thoughtful your approaches are.

But I would tell you, it’s lower, and it’s more methodical. And the person who has the correct protocol, that has the right process and the right mindset. And I would argue you’re owning a business folks, whether you want to believe that or not, you’re owning a business when you buy a share stock, okay? You’re an owner at that point, whether you believe it or not, you’re an owner. And the more that you can start to think like an owner, I would argue the more long-term success you’re going to have. You’ll be in the game for a very long period of time, if you think like a business owner.

Robert Leonard 29:37
I think the biggest takeaway there is the long-term horizon. I think that is so important. Over the short-term, the market can certainly be irrational. It can go up or down without reason, really. But over the long-term, 5, 10, 15, 20 years, the markets will generally price stocks correctly. And that’s why it’s so important to hold them for the long-term. Now I want to talk about how you can find stock opportunities.

I want to bring up Peter Lynch. He wrote “One Up on Wall Street” and he was one of the most successful mutual fund managers of all time. He managed the Magellan Fund at Fidelity for years. But what his strategy said was that individual investors actually have an advantage over hedge fund managers or money managers because they’re able to see hands-on what products are going to be big first.

So, for example, say you go to Starbucks, and you see a lot of people at Starbucks with you. That might give you a hint that Starbucks is a good business, and you might want to look into investing there more. Or you might have noticed that everybody around you is using iPhones.

Now that we’ve talked about a couple of strategies, I want to talk about how you can actually find some individual stock picks. And I want to talk about Peter Lynch’s strategy. And Peter Lynch is a very successful investor. He’s one of the most successful mutual fund managers of all time. He managed the Magellan Fund at Fidelity. And basically, in his book “One Up on Wall Street,” he talks about how individual investors like you and me, the listeners and Preston, actually have an advantage over money managers and hedge funds because we’re able to make investment decisions based on products and services that we use, much quicker than a hedge fund or a much larger institution could.

For example, if you went into Starbucks, and you saw that every day you went into Starbucks, there was a line out the door, that might give you a hint that Starbucks might be a good opportunity for an investment. Of course, you need to dive into the financials more and do more research than just that. But just by seeing that, you’re able to get an idea that Starbucks might be a good investment opportunity. And some of the best investors in the whole world, Warren Buffett and Charlie Munger, use this same type of strategy.

Charlie even said, at this year’s Berkshire Hathaway meeting, that everybody in his house, everyone in his family uses iPhone. And out of everything that they own, the last thing that they would want to give up is that iPhone. And that more or less is why Charlie believes in Apple so much. And to take it a step further, not only can this idea help you find good opportunities, but it can also help you stay interested in investing. If you’re investing in company you don’t care about you might lose interest in investing.

But if you’re investing in companies that you use every day, and now you can think, “Hey, I actually own part of this company that makes this product,” that might help you keep interest in investing much longer, which would be beneficial for your investing career.

Preston Pysh 32:14
Well, some of your points there you’re talking about, you can have a fantastic business. But if it’s not there, if you can’t buy it at the right price, maybe it’s not a good investment. So let me just highlight this with the best example I can give you. I’m going to sell you a money machine. Truly a money machine, like this thing will print money, and whatever it prints out, you get to keep. I’m going to sell this to you.

And so what’s the first thing you’re going to ask me whenever I say I want to sell you my money machine. And let’s just assume that it’s all legal, like the money that it makes, you get to keep. It’s no problem, right? I’m going to sell you the money machine. So what’s the first question you will ask me?

Robert Leonard 32:54
How much does it cost?

Preston Pysh 32:56
Bingo. How much do I have to pay you to purchase this money machine? And so the money machine costs $10 million. So now what’s your next question? You ask me?

How much money is it going to give me? How much money is this thing going to print per year? It’s going to print $100 a year. I’m selling it to you. Like, what could possibly go wrong with buying a money machine? It’s literally a money machine and I’m selling it to you for 10 million bucks. It’s a great deal, right? No, it’s a terrible deal. This is the epitome of a terrible, terrible deal. Because what else could you do with $10 million in a year? Well, you could do a whole lot if you go out and you even get a 3% return on 10 million bucks. You’re making $300,000 a year, right?

So I use that as an example because there are companies out there, ther are stocks out there. There’s all sorts of things out there, that in a person’s mind psychologically, it’s a money machine. It’s like Apple, like you just hear the word Apple, you’re like, “Everybody has an iPhone. Everyone has an Apple computer in the entire planet. I need to own Apple, right?” But they’re not asking themselves the two basic questions of, well, how much is the Apple money machine? Oh it’s this much.

Okay, well, now that I know how much you’re willing to sell me the Apple money machine, how much does the Apple money machine make each year? And then you answer that question. And then you can look at something and come up with an idea of whether that’s a good deal or not. And what are you doing whenever you come up with the yield, right? You’re looking at how much… what’s my profit margin each year for owning this.

You’re comparing it to your other opportunities, you’re looking out there, and you’re saying, well, that’s a great company, but it’s giving me 2%. And I could go over there and buy this really super boring box company that I am calculating the value of 20% for. I’m going to take the boring box company all day long, because of the price, right? Because the price is incredible. In fact, no one’s trying to compete with the box company anymore.

Everyone’s trying to compete with Apple, though. So like, there’s all sorts of things. And I’m not saying Apple is bad pick. In fact, I actually wrote a Forbes article, I don’t know, it’s probably a year and a half old. But at that time, it was a great value. It was… I was calculating it to be a great value. So it really depends, but you have to look at it from that lens. You have to ask yourself those questions. What can I buy it for? What’s it going to yield? Just like simple things but people completely look past that.

Robert Leonard 35:35
I really like that example of the money machine, Preston. Being a value investor myself, I certainly know how important prices are and I put a lot of emphasis on it myself. But I had never heard of an example like that, or had someone explain it to me like that. I certainly wish I had that when I was just starting out because it just makes it so clear, it makes a real world example, so simple and easy to follow.

So if you’re a millennial investor, or if you’re a new investor, I really recommend that you go back and listen to that again, at least once, if not twice. And make sure that you really understand how price makes such a big impact on your investment returns.

Now, all this talk about price provides an interesting segue to the next strategy that we’re going to talk about, and that is growth investing. And the reason it’s so interesting to segue into this is because those who invest in growth strategies don’t necessarily put a lot of weight on the price they’re paying, which kind of goes against everything that we just talked about. Companies like this are great in bull markets, like they have been over the last decade, but they get hit very hard when the economy slows down, and the stock market takes a turn. I know you’re a value investor, Preston, so I’m really curious to hear what you think of growth investing,

Preston Pysh 36:44
I don’t think anything negative of growth, to be quite honest with you, I think that is a strategy that can work for certain people. I think it’s something that absolutely probably has more risk just because of the volatility. If you’re dealing with a smaller company that is growing rapidly, sometimes that can be a wonderful thing, especially if there’s not a lot of competitors in the space, and they’re kind of first in the market. There’s a lot of considerations that you have to take into consideration to trade this type of market well. I would tell you, you have to really, really do your homework.

There’s also kind of this, I would argue this kind of dynamic over the last 10 to 20 years where you can get very large growth companies. I mean, Amazon’s a great example of just a mammoth company that I would consider a growth company, when you look at the top line and the percent of how quickly it’s growing. And so you got to ask yourself, “Is that something that’s going to be easier for me to project?”

And understand when you’re dealing with such a macro-sized business, that I’m going to be able to exit the position maybe a little bit easier without such the hit that you get with a small cap company, that as a new competitor that enters in their growth just literally gets splits in half, and then your stock price goes down 70 or 80% in a single shareholders call.

Those are the concerns that you run into with growth is if the top line does not keep pace with and when I say top line, this is the sales of the business. This isn’t the profit. This is the the money as it enters the business before any expenditures are subtracted out. So when I say top line, that’s what I’m describing.

People that do a growth strategy, they’re really paying attention to that top line and how quickly the company’s growing. And if they miss any semblance of that growth rate, the company’s just going to get hammered. So I think people can do this successfully, especially people that are really well-versed on what the product or the service that company is providing, and the competitor, the market size, and the growth rate of the market.

You know, have I done growth investing? Absolutely. I’ve done growth investing. I don’t do it nearly as much as some of my other strategies, but it’s something that I have done. And I’ve only really kind of entered into areas where I feel like I understand what I’m getting myself into. I’m not just going out there and trying to find growth companies and just then buying them. I’m trying to participate in areas that I feel like I understand them well.

Robert Leonard 39:21
I think it’s important to note that most of these strategies are not binary. You are a value investor, Preston, but as you said, you add aspects of momentum. And you’ve also done some growth investing. So you can certainly mix in multiple strategies. Maybe you want a value strategy, maybe you want to value investing base with a small percentage of your portfolio allocated towards growth picks.

It really just comes down to what you’re most comfortable with and what you understand. You don’t want to invest in high fintech companies that make you lose sleep at night, and that you don’t understand. But if you find a high growth company that you believe in and understand really well, and you want to allocate a portion of your portfolio to it, I say go ahead.

Preston Pysh 40:00
So let me just provide an example to just show you how difficult this is, but how people that are implementing this may be buying it 200 times sales and come up with a justification in their mind. So let’s talk about Tesla. When you look at the market cap of Tesla, the company is priced at the same value as like GM and Ford.

And this, I think, the market price was as high as like $60 billion, which is just huge for for a company that’s only manufacturing the number of cars that they’re manufacturing. I mean, they’re just like, not even at like, and I don’t know the figure, but it’s around like 1% or 10% of whatever these other companies are producing, as far as cars. So why would somebody pay such an enormously high multiple, fully knowing that there’s no way they’re going to take that much market share away from those companies?

I would argue, if I was just going to play devil’s advocate and try to argue on the side of how that valuation could get that high… I would argue that in the future, that autonomous driving vehicles are going to come down to a really, really important question: Is this software load the safest software load based on a million plus hours of driving? Okay, that’s what people in the future, somebody from 15, 20, 25 years from now, what they’re going to ask themselves whenever they get into a car, is what software baseline am I operating on whenever I’m riding in this vehicle?

Am I riding in the GM software load, which is statistically proven to be the safest software load? Or am I riding in the Tesla software load that is hands down five times safer than any other artificial intelligence-based driving system? I believe that what you’re going to find is some company is going to emerge as the safest software load, then it’s going to be licensed to all the car companies. The car itself is going to be completely commoditized. And it’s going to come down to who can run the safest software load. Because a lot of that’s going to come down to the design of a deep neural network machine learning-based model. It’s going to come down to who has run the most data through that deep neural net to come up with the prediction model that’s giving such safe results. All that stuff, I think, is going to come into play.

And so if that scenario plays out, now all the sudden, we can kind of understand why a Tesla company could be valued so high, if everybody’s got to run that software load in the future, and all that licensing that’s going to be associated with it. Now, as I say all that, and I basically built up this argument for how a company could be valued so high, in the same breath, I’ll tell you, none of that has happened at all.

For any company, who is leading that charge? Well, you could make make the argument that it’s Tesla. You could make the argument that it’s Google, who’s not even really in the car business right now. You could make the argument that it’s whoever. And I would put the probabilities of any of those arguments being pretty comparable to probably the top three or four companies that are out there, which could even be a Chinese company, because they’re probably going to run a whole lot more data than any US-based company in the future.

But to be able to say that one of these companies is going to emerge as the winner at this point in time, I tell you, you are doing some really fancy numbers with your statistics, on your projections and your probabilities. So you get into these really deep intellectual arguments with people really, really fast when you start talking about growth companies. And you really have got to understand what you’re talking about.

And not only do you have to understand what you’re talking about, you have to understand the statistics associated with what in the world you’re talking about. And so I say all that to just try to give people an appreciation of how hard it is to really kind of understand what the future holds, especially when you’re dealing with a company with a really high growth rate, and a really high premium that’s being paid in order to own the equity of that business.

Robert Leonard 44:07
To take it even a step further than that, not only do you have to understand the statistics and understand where the business is going, you actually have to be right. We can think we understand the statistics and where the business is heading and all of that. But we could be dead wrong. And then our position is completely blown up anyway. Now in this final part of the episode, I want to talk about the last strategy that we’re going to cover here, and that is dividend investing.

And so what dividend investing is, is essentially when you buy companies that have a high dividend yield, which means they pay out a lot of their profits as dividends to their shareholders, in general, because the companies are paying out a lot of their profits in dividends, and they’re not retaining it for themselves and reinvesting it in growth. These companies tend to grow slower. They tend to be more stable than your high growth companies.

And for that reason, you usually just get stable income from the dividends, but you don’t get a ton of growth or appreciation from the stock. Because of that this strategy is generally recommended to investors nearing retirement or in retirement because they need less volatility and more income for their retirement time. But I’m curious to get your opinion, Preston. Could a dividend strategy be beneficial for millennial investor?

Preston Pysh 45:15
I personally don’t think that it would really benefit a millennial investor all that much. I think whenever you’re younger, you have big opportunities to make mistakes and kind of go after the bigger returns. And I would tell you, I would not go after the bigger returns in necessarily financial markets. I would tell you to go after the bigger returns and creating operational businesses. If you really want to create value for yourself, you gotta try to create an operational business.

When we study all these different billionaires and all these different people, you know, we focus a lot. And I think it’s just because that’s a bias that Stig and I both have, because we thoroughly enjoy stock investing. And we’d like the math associated with stock investing and that kind of stuff. But that’s all non-operational subsidiaries that we buy for a business, it’s the money that you employ, because you don’t have a great idea to invest operationally in your own business that you then basically outsource the purchase of some other financial asset in order to get some type of return on that.

As a young 20 year old or young 30 year old person, you have a big opportunity to go out there and invest in yourself, invest in something that you can create a low-risk business that can quickly prove whether it’s going to be something that works or something that doesn’t work. And you can invest that way as well. And I think that that’s something that is often neglected, and should be talked about way more is “Do I invest operationally or do I invest non-operationally?”

All this stuff that we’ve talked to up to this point in time is all non-operational investing. It’s the stuff that you do, where you don’t have a great idea to invest in something that’s going to give you a 300% return on your money by next year. And when you’re operating at a very micro level, call it your businesses, you, yourself and yourself, you can get those kind of returns on your money. If you go out there and you put a little elbow grease into whatever it is you’re doing. You can get a 5,000% return on your money, if you go out there and you create something. That is money to be had. That’s for you to figure out.

And I would tell people to start thinking that way, start thinking what can I do to start my own business? What can I do to participate in a start-up or whatever, where I get a small portion of the equity? That kind of stuff is insanely valuable. And I know I totally shifted gears out of the dividend investing strategy, but I would argue, a value-based strategy where you’re investing in a stable business, usually as dividends associated with it. And so you’re just getting kind of, you’re getting some dividends, you’re getting some earnings that are being retained inside the business. And so I kind of look at the strategy as being very similar to just a value based company that’s stable.

Robert Leonard 48:00
I think one of the biggest hurdles for millennial investors is that they think they need to build the next Apple or Uber in order for their business to be successful. But I just don’t believe that that’s the case. You could take a couple thousand dollars that you have that you were planning on investing in the stock market, and you could invest it in an operational business, like you said. Maybe it won’t become worth billions of dollars, but say the business becomes worth $100,000 or $200,000. That’s still an incredible return on investment. That’s an ROI that is very difficult and highly unlikely that you’ll be able to match in the stock market. And even if it isn’t a billion dollars, these types of businesses can go on for a significant period of time, and maybe it’s a few thousand dollars a month and that type of money. Even if it’s not billions, it can change your life.

Preston Pysh 48:46
You know, this is gonna sound totally ridiculous, but I want to say it anyway, you could go out if you had 5000 bucks, okay. You could go out and buy yourself the cheapest truck with the cheapest trailer and you’ll buy a $1,000 lawn mower. If you had just ridiculous work ethic, you could go out there, start knocking on doors. Next thing you know, you can go buy, you could go spend 50 bucks on a spreader and start selling fertilizer at a markup of 300% from what you’re buying it, and go start spraying yards like, you could get out there and get your hands dirty, work your tail off.

But after doing that for three years, you might be sitting on $100,000 of money, if you really go after it. You had great marketing, you had great personality, when you’re there talking to people at the door selling your service, undercutting every competitor that’s out there, dropping your rates, whatever. Ask them what the other person’s selling their service for you. Drop the rate. Like, this is just like bare bones, like grit that you could implement literally right now.

And you could knock the socks off of somebody who’s coming out of whatever business degree, that’s now going to go work for some company and make $50,000 a year, but they don’t own something they’re working, they’re creating value. And they’re creating a bigger bottom line for another person opposed for themselves. And I mean, I’m just throwing out the easiest, most generic thing I can think of.

And so for people that are listening to this, there’s something that you’re great at, there’s something that that in your past and in your history that gives you a competitive edge at something.You just got to figure out what that is, and what has happened in your past that has put that asset and that opportunity right on your lap. And then just exploit the living heck out of it.

Whatever your competitors are doing, go study it, right, study the heck out of it. Figure out how to do it better, and then go and do it better. But it requires a ton of work and a ton of effort. But in the end, you’ll have something that is extremely valuable. If you’re, anytime you’re creating equity for yourself, through your labor, your time will often produce ridiculous returns if you stay at it and you work hard. And you try to figure out what your competitive niches.

Robert Leonard 51:09
And not only are you potentially getting better returns by doing that. But you’re also likely becoming a better investor. Warren Buffett has a quote saying I’m a better investor, because I’m a business owner, and I’m a better business owner because I’m an investor. So they can go hand in hand and they can help each other out. And you can definitely do both.

Preston Pysh 51:25
And you know what Buffett, 65 years ago, Warren Buffett when he was like age 16. He was worth $50,000 at age 16, 65 years ago. So if you had to figure out what that’s worth in inflation dollars today, you know, he was worth a couple hundred thousand dollars back then, as a 16 year old. And you know how he did it? With a paper route, throwing newspapers. That’s insane. But what it is, is it’s hard work and it’s pretty freaking grit. And that’s how this dude got started. That’s how this guy crushed it. And so then, what did he do with his $50,000?

He went out and he started buying pinball machines. And then he worked a deal with barber shops to put the pinball machines inside the barbershop and he would give the barber a cut of the money that came out of the pinball machine so that he would have them on site. So he’s there working deals, he’s out there buying more assets that he doesn’t have to, that don’t require his time.

Anytime you’re starting out, it’s going to require your time but then after you retain some earnings, then you can go out and buy other assets that then kind of don’t require your time. This dude was doing this in his teens, and he was crushing it. I guarantee you, there wasn’t a kid in the entire United States that probably threw more newspapers than Warren Buffett at age 16. There’s no way.

Robert Leonard 52:55
Preston, thank you so much for coming on the show today.You added a ton of value for the audience. And I really, really appreciate your time. And for those of you who are listening right now, I know I mentioned this briefly before, but I highly recommend you rewind and re-listen to some of that golden information that Preston shared today.

Whether it be implementing a new strategy in the stock market or starting a new operational business, take what Preston said today and really put it into action. If you are inspired by this episode, and you put what you’ve learned into action, I’d love to hear your story and what you’re building. You can share it with me on Twitter. My Twitter handle is @RobertatTIP, that is ROBERT AT TIP. Or you can send me an email at robert@theinvestorspodcast.com. I’d really love to hear from you guys and all about what you’re building. And that’s all I have for this week’s episode of Millennial Investing. I’ll see you again next week.

Outro 53:46
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