Clay Finck (02:44):

It’s funny that a lunch with Warren Buffett kind of kicked off your journey as an investor. I’m from Nebraska and TIP was founded on those Warren Buffett principles. And I went to the University of Nebraska and studied actuarial science. And there was a finance class there, where if you took the class, I’m pretty sure you were essentially guaranteed lunch with Buffett. And it was probably something similar, so it’s funny that you do that. But I ended up not taking that class, because it wasn’t a requirement or anything. Did he have like a speech with you or what exactly resonated about Buffett that pushed you along on this journey?

Jake Taylor (03:21):

The format was you went to Berkshire’s headquarters on Farnam Street and they get you into a room and he comes in and he stands up at the front at this podium. He has a series of prepared remarks that he gives to everybody. And you could tell that he’s delivered it hundreds of times probably, but then after that he opens it up to a Q&A so people, they kind of take turns, raising their hands and ask questions. There’s basically like nothing is off the table at that point. He’ll talk about whatever. And then after that, that probably was like three hours, two and a half, three hours. And then everyone goes to the local steakhouse there, Gorat’s, and he treated us to a steak lunch and he walked around the different tables and he’d sit for a little while with everybody and then kind of work the room in a little bit smaller format. So, that was what that day looked like.

Clay Finck (04:13):

So Buffett puts a big emphasis on determining the intrinsic value of a company and only purchasing companies that are trading well below that intrinsic value. Do you end up taking a similar approach or how is your approach potentially different than Buffett’s?

Jake Taylor (04:29):

I take a very similar approach. I think I probably have less circles of competence than he does. So his ability to look at a company and especially fit it into the competitive context of that industry, I think is probably light years ahead of where I am. It’s something I’m still working on trying to figure out. And I kind of feel like it might be a little bit harder to do now just because the way how rapidly businesses are changing and technology is changing industries. I have somewhat shifted from where I was before and I think maybe Buffett wouldn’t disagree with this, but I would say probably 20, 30, 40 years ago, the dynamics of the industry changed slower for the most part, which allowed you to sort of bet on specific businesses and you maybe didn’t necessarily have to know as much about management, because if you had a great business, it sort of took care of itself. And he made the joke before about picking businesses that were so good that even a ham sandwich could run it because maybe someday there will be a ham sandwich running it.

Jake Taylor (05:34):

I have shifted a little bit now more recently in the last several years that looking for actually the managers who will be able to change the business to adapt to whatever the shifting environment is. So not so much betting on the current business quality, but maybe spending more time trying to figure out the quality of the management, who then theoretically may be able to pivot the business and keep it relevant and make good capital allocation decisions and grow and adapt the business to match the new environment, which in a more rapidly changing environment, I think might be a more resilient strategy.

Clay Finck (06:11):

You touched on a few interesting points there. You mentioned a circle of competence, a strong emphasis on management and the fact that things are changing so fast nowadays. When most people think about value investing, they might think about these boring businesses that are in a stable and mature industry with lower P/E ratios. With how fast technology is advancing, that might mean that these industries were once stable and they were stable for a really long time are now potentially being disrupted. Are you finding yourself, adjusting your strategy based on that?

Jake Taylor (06:47):

Yeah, for sure. I think it’s harder now than it used to be to identify what would be called a moat for a business and not so much, like it’s easy to see a moat today, but to know if there’s going to be a moat 10 years from now, which is a lot of what the investment is based on. And that dependability, the sustainability, the duration of the moat is, I think maybe harder than ever to predict. And if that’s the case then, it’s hard to pay up for those businesses that are very good today, which they really, the moat has to last quite a while. And a lot of super normal profits have to materialize over time to justify today’s price for a lot of businesses.

Jake Taylor (07:27):

And so if that’s the case and if there is that kind of disruption, I feel like there’s kind of a fair amount of risk being taken in buying some of these higher quality businesses today at a very lofty price. That business is going to have to do really well over the next 10 years to justify that price. And I’m certain that there are lots of businesses that will do that. It’s just, I think it’s a little harder to identify a priority today, who’s going to actually be able to make it to that 10-year time period and still have that deep, healthy moat with the potential of the disruption? So I think the game’s a little bit harder now than it used to be.

Clay Finck (08:06):

It does make sense that you’re putting more emphasis on the management, which is a qualitative factor. Whereas prior you could depend more on that quantitative factor and you’re betting more on the management’s ability to fend off any disruption that might be coming their way.

Jake Taylor (08:21):

I would say analysis of management doesn’t necessarily have to be qualitative. I mean, there’s certainly a huge degree of that because you’re dealing with a person, they’re not a number. But my favorite exercise or one of my favorite exercises to do in the evaluation process is, what I call an exercise of empathy around the cash flow statement. So what I do is I’ll look at a series of the cash flow statements and I will put myself in management shoes and say like, what would I have done if I had their business, their ability to redeploy capital into that business, their stock price and the valuation of their, like to justify buybacks or not, their potential to do dividends, their potential for M&A, how they manage their balance sheet.

Jake Taylor (09:08):

All those things I will look at and say like, well, what would I have done if I was in their position? And that is largely a quantitative exercise. I’m looking at the numbers and those numbers tell me the entire story of what was going on in that business and what the decisions were that they made. So, although looking at people generally who are managing a business is a qualitative exercise, there’s still a large amount of quantitative that can be used and drawn from to assess the decision making of those people.

Clay Finck (09:36):

That makes sense. You’re really referring to capital allocation right there. And you wrote a book called The Rebel Allocator. So you’re surprised you even got the attention of Charlie Munger as he personally gave you a call to tell you that he loved reading it. And I had a chance to go through a lot of this book and I was impressed with how much of a page turner it was for me for being a finance-related book and it is a fiction book as well. I’ve definitely enjoyed it. So tell us a little bit about your book and your motivation to write it.

Jake Taylor (10:07):

I was trying to understand when I would do this exercise of empathy, I would look at a lot of companies and be like, what the hell are they thinking? Like these aren’t stupid people, clearly, but they’re making decisions that make no sense to me from a logical business person’s perspective. What’s going on here? And my takeaway was that getting an MBA myself, we didn’t look at any cash flow statements in an MBA program, hardly. We talked about accounting, we had accounting classes, but things focused more on other stuff. There was no capital allocation elective to take, at least that I ever saw. And I thought, well, shoot, this is like what Buffett has identified as one of the most important roles of management. And yet there aren’t that many resources for this. So you have a few, like The Outsiders by William Thorndike. It’s a capital allocation book largely. But even then, that’s more sort of vignettes of different people who did it. And there’s a lot to learn from them and their historical experience, but I wouldn’t really call it a framework that you could take away from it necessarily.

Jake Taylor (11:13):

So I wanted to build a framework for capital allocation. So of course, it’s basically like stealing a bunch of stuff from Buffett, Munger, Henry Singleton, all kinds of different people. Really, like the last 10 years before that of me just reading widely business and investing stuff and trying to pick the best of the best and put it together into one cohesive framework. I started working on that book as a nonfiction to explain this, but even I was bored to tears trying to imagine writing and/or reading through that kind of book. And there were a bunch of little nudges that told me like, if you can tell this in a story somehow, it has a much better chance of resonating and sticking with people and having them actually adopt it and having it resonate.

Jake Taylor (12:00):

And so I got this crazy idea of trying to tell a story around it and then bake in the principles along the way. So it’s basically, if you’re familiar with The Karate Kid, just imagine Mr. Miyagi, but as Warren Buffett or a Charlie Munger. And that’s really what the story is written out as, but then the lessons, as opposed to punching and blocking and kicking are cap allocation built from the ground up from the individual sort of customer transaction level, all the way up through corporate finance of buybacks and dividends and all that stuff.

Jake Taylor (12:33):

That was the intention behind the book was to provide something that maybe gave confidence to managers who basically sort of copying what everyone else was doing, which was my only real thing that I could come up with an explanation for why they were making stupid decisions. They were basically just like, well, what’s everyone else doing? I don’t really know what to do. I don’t want to make a mistake. If it gave any people, any decision maker in a business context, the inspiration to follow what they think is the most logical and right thing to do, then that would’ve been a good outcome for me. That was a lot of the impetus behind the book.

Clay Finck (13:08):

You mentioned in the book that an important role of a management team is to determine how capital should be allocated throughout the company. A lot of the people that end up in management nowadays were good at one thing within the company and they got promoted into management. Essentially, they are making capital allocation decisions, which might be decisions they’ve never made in their career before. And that’s when it clicked for me, why two companies in the same industry could end up with vastly different results over the long run.

Jake Taylor (13:40):

Yeah. And this was why I was a little excited to come on this millennial-specific investing podcast, because part of the book is also, I don’t want to say defense, but a little bit of an oh to capitalism and the role that it can play when well done. And if you believe surveys of younger people today, I think there could be the potential of maybe not appreciating some of the finer points of this. And specifically, if you care about the environment, good capital allocation, if you actually look through it deep enough, actually makes a big difference for the environment. Like you don’t put money towards resources that end up not being used at all. So let’s imagine, let’s make it a very extreme example. And you have a company that goes, and they build a bunch of factories and machinery for products that no one ever wants. All of those resources now, basically can’t be redeployed back to anything useful for humanity.

Jake Taylor (14:40):

And so we’ve taken a wear and tear on the environment in such a way that it never needed to be done. And you see that all the time. That’s what a write-down is when a company writes off an asset. That is basically what happened is, we just kind of put a hit on the environment because we built something that no one actually ended up wanting. So a good management team who’s actually building what will serve the customers is hopefully allocating resources in such a way that is minimizing the impact on the environment. And if you think about capitalism as I do, as a business owner and someone who wants to own businesses for a very long time, horizons, that business has to have a win-win relationship with all of its constituents, not just me as the business owner, which I think capitalism gets a little bit unfairly painted with the brush of short-term-ism and only thinking about what’s good for the profits of the business for the shareholders. I don’t agree with that.

Jake Taylor (15:39):

As one of the stakeholders and my other stakeholders, being the customers, the suppliers to the business, the government, the interaction with the government and regulators, the communities that the business does its job in, and then of course, the employees, everybody has to be in a win-win relationship with that business for it to be longterm sustainable. And that’s what I want. I want a business that’s going to be around in a hundred years. And if you are cheating on any of those stakeholders and getting over them somehow, that is not a sustainable relationship. And eventually there will be consequences to be paid.

Jake Taylor (16:16):

And so me, as one of those, the shareholder version, I want everyone to be happy in this dynamic. And that’s the job of the management is to design this entity, this business that will function across all of these domains and serve all of the stakeholders in a balanced way. So like, I don’t need maximized profits today, if it is going to short change the longevity of this business. And I think that, to me, it shows some of the good that business is capable of when it’s done in the right way.

Clay Finck (16:47):

You mentioned that brilliant capital allocation is good for everyone at all levels, whether it business owner, the customers, the employees, and everyone else in between. Could you maybe dig a little bit further on that? We’re seeing things like push for things like green energy and maybe the government trying to incentivize certain things. So how can the free market kind of produce the best outcome for all stakeholders?

Jake Taylor (17:12):

It’s difficult because free market’s a reflection of human desires, and there’s a lot of competing desires to that, right, and different timeframes. So green energy, for instance, I think humans want to not trash the environment more generally, but they also want cheap power and cheap resources, cheap goods and services. Well, those two things might be not necessarily in balance with each other, especially if you consider, especially with great energy, the capacity that is required of other energy types to fill the intermittency of renewable energy. So when the wind stops blowing and there’s clouds, those fall off, and now you have to have something that is ready to go in real time. That usually means like a natural gas turbine that has to be ready to be spun up. Well, okay. That’s more expensive than just running the gas turbine only at the moment. And especially green energy is maybe one and a half percent penetration of the total energy usage production. Wow. That’s like, we got a long way to go and it’s going to be expensive. We’re going to have to have lots of different solutions there.

Jake Taylor (18:25):

And probably a younger version of myself would’ve been more steadfast in saying like, yeah, the market will figure it out completely, like get the hell out of the way. Maybe a little bit older version of myself allows for some more externalities and more nuance in that because it is humans making these decisions at the micro level. And if they are more short-term focused, they will maybe pick things that are short-term wins, but long term losses for everyone else. Maybe that is a role that government can play is to provide a little bit of balance across time horizons of optimization. Maybe credits are a way to allow a market to function, but also create the incentive structure that leads to a more balanced optimization problem over short and longer term horizons.

Clay Finck (19:19):

Now I think many investors today will invest in companies solely because they’re growing very rapidly. They might be growing revenues of 50 or 100% a year, something like that. However, if the company is allocating capital poorly to produce that growth, it actually might be a bad thing for them. Could you explain why that might be the case?

Jake Taylor (19:42):

There’s lots of companies where today’s unit economics, so the singular transaction with the customer, that company is losing on that deal. For a long time Uber, I believe was probably… The price of an Uber was less than the cost of delivering the ride to you. And so all of us were getting rides that were subsidized by venture capital money basically. Obviously that’s not sustainable. A business cannot exist and be around in a hundred years if they’re losing money on every single transaction. And the idea is then, the reason why people believe in these kind of companies that the revenue is growing like that is, the thought is that at some point you’ll tip over past some kind of fixed costs and then you will be profitable when you get to scale. That sounds great in theory. I’m not entirely sure that it’s going to work out for all of these companies. And a lot of them have big unit economic problems like that individual transaction problem, that it’ll be very curious to see who can get to scale and actually be profitable or not.

Jake Taylor (20:44):

And I can’t help but wonder some of these, they’ve already become very, very large businesses. Like how big do you have to get? What is the scale that we’re talking about that’s going to be required to ever get you over and above to be profitable and therefore sustainable for a longer period of time? Maybe I just don’t have the vision to be able to look out far enough and believe that however some balance of revenue growth and cost savings eventually is going to create a profitable company that can be around in a hundred years. But there are a lot of people who seem to be willing to make that bet today. And they’re paying to me very large multiples to participate in that bet becoming true.

Jake Taylor (21:25):

When you get to why I said that growth is not necessarily good, if the returns on capital are destructive to the business, so losing on every single… You put out a dollar and you get 80 cents back as the company, doing more of that is not going to be good for you, right? Eventually, you’re going to run out of money and the game is over. That’s why I said that growth is not necessarily good. Profitable, long term, productive growth then is what you’re looking for.

Clay Finck (21:57):

It reminds me a lot about Amazon who invested in their growth for decades before ever deciding to make any profits. For many years, people said they aren’t profitable and they have no sustainable path to profitability.

Jake Taylor (22:11):

Yeah. I mean, Amazon, I can’t help but wonder if Amazon on net has not been a bad thing for most investors, because it’s such an anomaly. It’s gotten so big. It’s been so dominant and it’s been so productive really. And it’s had incredible management. It’s a world-class organization. To then have that be this example that people are looking for all over the place, I think is kind of a dangerous thing, because then people start applying the same potential outcome, which has been a very, very rare circumstance to produce an Amazon. If you look around and you start seeing Amazons everywhere, which it sort of feels like people are doing, I think that’s actually a dangerous game to be playing because there’s kind of only been one Amazon. So if you’re like thinking that you own 10 other companies that are Amazon-like, I have to imagine that as a base rate bet, that’s a dangerous game to be playing. There’s only going to be so many Amazons. It’s just a rare thing. On net, perhaps it’s been kind of bad for investors because they start to look for Amazons in every domain.

Clay Finck (23:19):

Amazon makes a headline in 2020, 2021. What doesn’t make the headline is the hundreds of other companies that settled into the dust. So as someone who has studied capital allocation of a business, you also need to decide how you allocate your capital in your portfolio. How do you think about capital allocation in your portfolio and how does that differ from how a business might allocate their capital?

Jake Taylor (23:45):

Yeah, it’s actually very interrelated. Like I said before about going through a cash flow statement and running an exercise in empathy, looking for talented capital allocators, I often view my portfolio as this is an empire that I get to build every day and I could tear it down tomorrow if I wanted and reconstruct it in however my mind views what I want my empire to look like. I view outsourcing part of my empire to Warren Buffett. He runs some of my empire. Other managers run another part of my empire. And I’m perfectly happy to let them make the capital allocation decisions at their level. And then I’m one level above them deciding who I want to trust running my capital for me. That’s often how I view the decision on how to allocate my own capital is, kind of a look through to see.

Jake Taylor (24:37):

And so then a lot of the exercise is determining their talent and then determining their opportunity set. So what are the things that they can invest in that are within their circle of competence and what kind of deals are they seeing in their industry? What are the buybacks available for them? Right? So if a company is very expensive right now, not only is that bad for me as maybe overpaying for that business, but then also that takes one of the tools off of their shelf that they could be using to deploy capital in a smart way, which would be buying back their own stock. So they’re a little bit hamstrung in that instance as well. So they have to find other things to do with the money.

Jake Taylor (25:13):

That’s basically how I look through to see where do I want to put my money and who am I putting in charge of it? And of course, always, the talent and the opportunity set that they have has to be balanced against what am I paying for that option for them? The best capital allocator on earth is not worth paying an infinite price for, just like the best business is not worth paying an infinite price for. There has to be some level where it makes sense from evaluation standpoint.

Clay Finck (25:42):

So you mentioned Buffett and share buybacks again, and I can’t help but think of the giant cash trove that Buffett has built over the years. I think it’s something like 140 billion plus today. And he has been doing more buybacks as of late. So on top of that, he’s vastly outperformed the S&P 500 with the exception of the last decade, part of that’s just kind of the market environment we’re in and the size that Berkshire has gone to. So what are your thoughts around that, the buybacks and the recent underperformance?

Jake Taylor (26:19):

Yeah. I mean, I couldn’t care less about the underperformance. In a long term hold, there’s going to be time periods where certain investment style will work less well than others. I’d love to see every article that says Buffett’s lost it. To me, that’s like, this has happened at every single market top, he’s lost it. It’s very counter cyclical, I think. To go back to the cash treasure trove that they have, I mean, first of all, boy, what a nice problem to have, right? Like, oh, we’ve got money coming out of our ears. But second of all, if you look at that, call it 140, 150 billion maybe at this point, we’ll find out tomorrow what it’s at as they’re going to report third quarter results, but I would say that probably 60 to 70 billion of that is restricted cash for the insurance operations. So it’s not really as big of a chunk of money as it looks.

Jake Taylor (27:09):

The other thing I would say is that if you look at the total amount of assets on Berkshire’s balance sheet, which is upwards of $900 billion now, that’s 70-ish billion of free cash, excess cash. It’s not that big a percentage and, in fact, it’s not that far off as a percentage compared to what it’s been historically. I think historically, and I’m leaning on Chris Bloomstran’s analysis here, who I think is the best Berkshire analyst that’s out there, if you ever want to deep dive on Berkshire, call it maybe 12 to 13% of the total assets on Berkshire’s balance sheet have been cash historically. And we’re at like, I don’t know, call it 16 or 17%. I mean, you tell me, is that a dramatically different amount of cash relative to normal, or is it just because it’s a big number, 70 billion, our eyes kind of glaze over when the numbers get that big?

Clay Finck (28:01):

Now, many of our listeners are younger investors with some millennials being under the age of 30, like myself. Whether it’s related to investing or not, what are some things you wish you knew in your twenties that you know now?

Jake Taylor (28:16):

Yeah, that’s a great question and something I was thinking about a lot actually before this interview because I’m 40 and I’m sort of in between boomer and millennial. And I thought, hey, I wonder if being at that age, perhaps I could be a good =in between because I’m neither one of them basically. And you see a lot of, I don’t want to say ageism or classism or what, but it feels like there’s been more friction between boomers and millennials. You see that come up in maybe cryptocurrencies, especially where maybe millennials would say, boomers don’t get it. And boomers would say, you guys are idiots. Everyone’s sort of like… It’s gotten a weird kind of personal attacks now around that. I find it to be a little interesting, but I thought it might be helpful for younger people. This is what I would’ve wanted to hear when I was in my twenties.

Jake Taylor (29:12):

And I think the first thing is that you really have to like… Working from a first principle is like, what is the point of investing? I would say that the point is laying out money today to get more money in the future. Now that question then is also like, can be reworded to say, laying out purchasing power today for more purchasing power later, or deferring consumption today for more consumption later. All those things are sort of equivalents, but they carry within different connotations. But to just use the money as the easiest to understand example, you can really divide up the universe into three categories when it comes to investing. And by the way, this is basically like stealing Buffett’s, an article that he wrote in February of 2012 for Fortune. It’s one of the best articles actually, that he’s written, I think, because it’s so clear in his thinking. But I’m going to try to steal it and then condense it down for you to make it easier and shorter.

Jake Taylor (30:14):

So, three categories of investment. The first one is what you would call like a currency denominated asset. And so that would be things like bonds, mortgages, certificates of deposit, and maybe money market accounts. And this is basically like, it’s a contract where you give someone money and they’re going to give you more money later. And it’s a predetermined amount of interest that you’re going to get. Now these are considered safe investments because the price tends to not move around a whole lot. Think about like a US Treasury, you don’t see it moving 50% in a day, right? Even like a one or 2% move can be a pretty big movement for that kind of security. So it appears very safe, however, it might be the most dangerous investment on earth at the moment, because when you look at the actual purchasing power part, right?

Jake Taylor (31:06):

So it’s like, this is the difference between that money now, money later versus purchasing power now, purchasing power later. If you believe the government’s CPI numbers today of 5%, let’s call it, and then you look at the US Treasury 10 year, which is giving you call it 1.4, 1.5%, you are guaranteed, you’re baking in a loss of three and a half percent of your purchasing power by owning this per year, over the next 10 years, if inflation stays at 5%. Well, to me, that seems like a terrible bet to be making. I’m guaranteed, I’m locking in three and a half percent real loss today. I don’t see how I can win here other than just interest rates continuing to go lower than one and a half percent, which then theoretically moves up the price of that bond. Well, that’s not a bet that is very interesting to me to be making at all. And so I basically do not own any bonds at the moment.

Jake Taylor (32:05):

This is the other important thing then is like, what is risk? Some people would say that risk is the movement of prices, right? Therefore, the bond that the price doesn’t hardly ever move is not a risk at all. I would say that in the short term, that’s actually not a terrible definition of risk. If you are doing things that are short term in nature, the price movements mean a lot to you. If you’re looking very long term, which I would suggest that if you are in your twenties, you should be looking very, very long term because that’s your advantage. Then the price movement means nothing to you really, especially in the short term. Short term price movements are not an indication of risk at all. Now the permanent loss of the capital over that long period of time would be your risk. So, that’s category one is investments that are denominated in a given currency, whatever that currency is.

Jake Taylor (32:56):

Category two is what Buffett would call sterile assets. So these are things like gold, art, baseball cards. I would probably put crypto and NFT in this category as well. These are things that do not yield more of themselves to you. Like they are not producing anything. There’s no yield to measure against. Really, kind of the mocking example too, would be maybe tulips in the 17th century. If you look at all of those things, they require an expanding pool of buyers. You need someone else to come along later who’s more excited about that asset than you are today to want to pay you a higher price for it. Now, if you are good at this game, I think you can do terrific and make a ton of money and look like an absolute hero. And the price action will attract more people in. That is human nature. There’s a bandwagon effect.

Jake Taylor (33:55):

But eventually history shows that all of these things run out of steam eventually, and those aren’t the kind of games that I want to be playing. I want to be finding things that are very long term, that are growing and it doesn’t require necessarily a new pool of buyers to be expanded that want to come and buy it. Now that’s sort of call it a boomer argument down on millennials. I will say the millennial argument back upwards that is interesting to me is like, I think it’s super cool that you can cross an international border with a billion dollars worth of Bitcoin in your head just by knowing what the password is to your assets, right? I think that’s awesome. I think it’s really interesting. And I think there’s going to be a ton of cool things that come out of blockchain and cryptocurrencies.

Jake Taylor (34:46):

However, as an asset, as an investment, it doesn’t make much sense to me in that context of growing your purchasing power. 21 million Bitcoin from here to eternity is not much different than the amount of gold, like a block of gold that currently exists on planet earth. And therefore, like all of these, there’s a scarcity to them, right? Like owning the one Picasso or the one Monet or one of the 21 million Bitcoin or some ounce amount of the total amount of gold that’s been mined, all these things are scarcity driven. And I much prefer to operate from an abundance mindset where it’s a business that’s growing and they’re doing more good for humanity to go back to our six counterparties who we’re trying to take care of. Really good business are playing non-zero subgames. They’re playing additive games. I find all of the sterile assets to be zero subgames. Like, there’s only so many. There’s 21 million Bitcoin, and we got to argue and fight over who’s going to own which percentage, right?

Jake Taylor (35:50):

So that third category, which I kind of already started stepping into is what I call productive assets. This is businesses, real estate, farmland, all these things have a yield. So then the trick is figure out what that yield is, and then try to buy that yield at a price that makes sense to you. And that’s basically what I work on all day. You can then subdivide the business part into call it like seed stage or angel investing, venture capital, public equities, private equity. There’s a lot of different flavors of business ownership today. But I personally have been drawn to the public equities market, one, because I guess sort of by default, Buffett operated there and because I was a know nothing when I started out. Like, well, that’s what Buffett did, that’s what I’m going to do.

Jake Taylor (36:38):

But at the same time, a big part, I think of figuring out how to be a good investor is actually understanding your own strengths and your own weaknesses. And that just so happens through upbringing or wiring or whatever that I have a strength in that I really don’t care what other people are doing. And if they’re doing well on something, I’m very happy for them, but I’m just going to be doing things the way that I want to do them and what makes sense to me. And with that kind of a little bit of stoic mentality, the public markets offer the best opportunities because that’s where the most noise is. You get just wild price swings, which for me, that volatility is not something that scares me, because I don’t care what the last person wanted to buy or sell their shares at. I have what I think the company is worth. And then when that price moves around from it, that’s for me to take advantage of. It’s not for the market to tell me what my shares are worth.

Jake Taylor (37:31):

So that mentality, for whatever reason, it’s not like anything that’s like… It’s no skill of mine. I think it’s just a natural inclination. I don’t care what other people want to sell their shares for. The public markets offer the best opportunities for me. Private markets don’t dislocate like that often enough to be where I feel like I would have as much opportunity as I do in public markets. But if you’re not someone who’s like that, and most people aren’t actually, like they care about the price. It’s hard for them to watch the price move down and feel good about it. It’s hard for them to not get too excited when the price moves up.

Jake Taylor (38:07):

You have to know that about yourself and then try to steer yourself, I think, towards the markets and the opportunities and the asset classes that make the most sense and offer the most opportunity for you, for your investment style, how you see the world. And like, maybe you’re one of those people who identifies a trend before anyone else knows about it. Maybe you know what the cool technology’s going to be before anyone else. Hey, go find that market, find that investment opportunity. You’re likely to do just as well, probably better than I will But that doesn’t fit how I view the world. I have my version and I just have to stick to what makes sense to me. A lot of these things are sort of cliches about like know thy self and stick to your circle of competence, stick to what you understand. But it’s when you stray away from those things that you end up getting your head handed to you.

Jake Taylor (38:57):

And I guess as a younger investor, I would say, start with small amounts of money and dabble in a bunch of these things to figure out where your strengths and weaknesses are, and it’ll become obvious what is easier for you to understand. You kind of know yourself already, like where do you fall on the spectrum. Figuring that out and then adapting yourself to that, I think is the best. This is why I find investing to be one of the most interesting exercises is because it combines everything. It combines your own psychology. It combines understanding crowd psychology. It combines economics and finance. It combines all the business stuff like, how does a business work and =understanding in the world, how does that ecosystem fit in? You have to really understand so many different things to really wrap your mind around it. And it’s always changing. So it’s like, it’s always updating and you have to stay updating too. There’s a book that’s called Investing: The Last Liberal Art. And I think that’s really true. It is an exercise in liberal arts.

Clay Finck (39:57):

A lot of good points there. On the crypto piece, I think it’s important that you understand what bucket it falls under and you generally understand for the most part, both sides of the argument.

Jake Taylor (40:09):

I would probably push back and say that I don’t understand as well, probably either side, as they would say. I don’t know all the use cases. I don’t probably understand all the technology as much as someone who’s really, really been deep diving into it, but I can recognize which category it sort of falls into. And then therefore, is that something that’s interesting to me? I just happen to have a preference for that third category of productive assets. Just know where you are on the map at least and understand what game you’re actually playing, I think is helpful advice.

Clay Finck (40:42):

And where it’s at on your circle of confidence, right?

Jake Taylor (40:45):

Yeah. I wouldn’t put it in mind at all. I’m more of just a tourist who’s curious about it and non-judgmental, or at least trying not to be too judgmental about it. Honestly, I feel a little bad for millennials in that the cards that you have been dealt in general have been kind of bad. And when I say that is like, okay, maybe got, I don’t want to say suckered, but pressured into taking a bunch of student loans for an education that may or may not have actually provided that earning power for you that would justify mortgaging some of your future to get that earning power through your training and the things that you learned and the degree that you earned. It’s like, it’s ridiculous to expect an 18 year old to understand probably some of these deals that they were getting into. And it’s really unfair, I think. And then you’ve inherited a housing market that is crazy expensive. How are you suppose to buy a house when you have a bunch of student debt and maybe a job that is not quite paying what you thought it was going to be paying?

Jake Taylor (41:49):

The stock market that you have inherited is very expensive. So if you wanted to own businesses, the amount of business that you can buy for every dollar of yours is relatively low compared to other times in history. Like you could get a lot more business for your money at different points in history than today. In general, your net worth today as a millennial is lower than historical cohorts of people of your similar age. And I don’t think that’s really been your fault, like you are doing. And I think a lot of it’s unfair and a lot of it’s, frankly, a little bit of like class warfare from some of the older people in our society and the way that they’ve used the strings of power to create the system. I’m not going to go down any too crazy a rabbit holes or tinfoil hats or anything, but the deck has been stacked a little bit against you.

Jake Taylor (42:38):

So I understand why something that the price can move up in crazy ways that like crypto has, would be attractive because it’s like, shoot, we’re down early by a lot of runs. We need to aim for grand slams. That’s our only chance of trying to get back in this game. And I would tell you that I think that’s actually wrong and that that is not the right way to think about it. And I would encourage you to, even with your small potential starting base of how much money you have saved, put it into a calculator and even plug in a modest return of, let’s say six to 10%, and run that out to what I would say like, I would expect if I was 20 years old today that you’re going to live to a hundred with the advancements in medical technology. I would be planning for a hundred easily. Even I at 40 am already planning for a hundred. I might be a little more optimistic than you guys are.

Jake Taylor (43:35):

But run the numbers out on what your wealth will look like if you compound at 6% a year or 10% a year for the next 80 years. Your problems will be solved over that long of a time period if you can earn even a modest, consistent return. You don’t have to aim for the home runs and grand slams today that might be offered in what I think are very risky and potentially will make your net worth to zero actually, and the things that are very exciting today. And it may be finding something that’s a little slower and more steady will actually get you to where you need to be in 80 years. And try to project yourself out into that time period and not have a short-term mindset. You have the biggest advantage of anybody on earth in that you have 80 years in front of you in which to do things. And the 80 year old today that’s worth a billion dollars would trade you in a heartbeat for your spot because you have so much time in front of you.

Jake Taylor (44:34):

So take advantage of that time and let the power of compounding help you. And don’t take a zero early when that money is going to grow into such a big number. Try to shift maybe your risk preferences a little bit, if you can, if you can put yourself into that 80, 100-year-old mindset. I think that’s really what a young person might need to hear today.

Clay Finck (44:58):

Many millennials have essentially been in a bull market for their entire investing careers outside of the March 2020 blip that recovered very quickly. So I’m curious, taking this Buffett-style approach to calculating the intrinsic value of a company, could you dig into how that approach works for you in today’s market with valuations continuing to move higher?

Jake Taylor (45:19):

I will say that as I’ve gotten a little bit older and further along in this journey, I’ve spent less time on macro stuff, because I found it to end up being a distraction for me, to be honest with you, and that focusing more on individual companies has served me better. With all that said, I think anytime prices get expensive, and it’s hard to argue that prices of most things are very expensive today, I don’t think you can argue very easily that it’s cheap necessarily. There’s only one way that anything is cheap today and that’s if rates go even lower than they are. And we’re already at call it 1.4 on the 10-year Treasury. It’s pretty hard to go down from there. I mean, people might forget, but August of 2000, the federal funds rate was like six and a half percent. And then over the next two years, they lower it down to like one and a half percent to try to boost the economy during a recession. Six and a half is miles away from where we are today, right?

Jake Taylor (46:21):

And so it’s going to be… I don’t know how you’re going to go from one and a half to negative four to have the same kind of movement that would’ve been the equivalent. So all of which is to say, I think markets are expensive, profit margins of the S&P 500 are at all-time highs. And that tends to be a mean reverting data set. So not only are earnings kind of juiced by a high profit margin today, you’re paying a very high multiple for those earnings. Interest rates are very low. If they go the other direction, then everything is too expensive right now.

Jake Taylor (46:54):

Sum it all up, which is to say that you have to have muted expectations as to what any asset class is going to deliver, I think over the next 10 years, I would not be surprised if seven to 10 years from now, we are not much higher than where we are today. And I’m using 1999 kind of as an analog because there’s tons of stuff that rhymes with ’99 right now. Businesses that are mostly stories about how the future could unfold and then paying a very high price for that story, expensive general markets and pockets of extreme expensive speculative mania, a relaxation of call it standards or covenants for debt. Overall debt to GDP is higher than it was in ’99. We’ve added a lot of debt to the system, which is another way of saying like, kind of pulling forward demand. So at some point, maybe you have to demand less in the future because you demanded more today.

Jake Taylor (47:53):

So put that all together. And I think you just have to have low expectations over the next seven to 10 years. But I do think that this too shall pass just like all the other ups and downs. This is what markets do. And I think you’ll still over that… To go back to what I was saying before, about having 80 year time horizon, if you own businesses over the next 80 years, you will do just fine. You’re not going to probably do great over the next seven to 10 years, which is hard to hear, but you will be fine over the next 80. That is probably the most easy, sure bets to be making that you’re ever going to get in the finance world. So, that’s sort of my lay of the land right now is I do not expect large returns from here in general.

Jake Taylor (48:36):

And to go back to that March of 2020 little hiccup, that is very anomalous the way that that played out. The typical market correction takes on average 18 months, but it can be like a three-year grinding your soul every single day. It’ll go up and you’ll be like, oh, the worst of it is over. And then just rip your face off with the next move down. I think in 2000, if I remember right, it was like 17 different times where you went back up and then went lower and then went back up a little bit and then lower from there. And it was just punch in the face after punch in the face until you have to get to the point where everyone gives up and they throw up their hands and they’re like, why the hell would anyone ever want to own equities? And that’s the time when it will finally bottom, in which case we can start to move forward.

Jake Taylor (49:25):

We did not get anything like that in March of 2020, there was no capitulation. That was just people got scared for a second, government said, we’re going to throw everything at it. Everyone was like, okay, fine. Let’s go back to where we were. And that was such a weird call it bear market quote, unquote, I wouldn’t even hardly classify it. I would say that the March of 2009 to today is still just one kind of continuous bull market with one little drop in it that might be analogous to what happened from 1982 to 1999. And you had 1987, which was a one day 23% down move, but then we just kind of kept going back up.

Jake Taylor (50:06):

So I don’t think that there was any real blood letting in March of 2020 and that you couldn’t even really say that we’ve removed any of the excesses of exuberance that existed. And if anything, we’ve just added more, which is to expect then that the more that you drink at the party, the harder the hangover is going to be eventually and the more painful the hangover. And so I can’t help but wonder if we don’t have some hangover in our future for the next call it seven to 10 years.

Clay Finck (50:37):

Given the valuations of today’s market, does that lead you to have a higher cash position?

Jake Taylor (50:43):

To my detriment, I probably carried larger cash balances than most people for a while. That came in very handy in March of 2020. I bought a lot of stuff at prices that made a lot of sense to me and I thought were easy things to buy. Businesses that I’d been studying for a long time, hadn’t owned yet, because the price never made sense to me. But then I got my price and I was able to put money to work when it seemed like a no-brainer. The world made much more sense to me in March of 2020 than it does today. But with all of that said, this is to go back to our capital allocation answers and outsourcing part of my empire to different people, well, my cash balances, I also look through somewhat to see, okay, I laid out one of my dollars, but for that I’m getting, in the case of Berkshire, $900 billion worth of assets equivalently and 140, 150 billion of cash on their balance sheet. So, that’s part of my cash as the owner of the business.

Jake Taylor (51:45):

I think it often helps to abstract it back to a simpler thing. Imagine that you bought a liquor store. And when I buy that liquor store, I own all the bottles on the shelf. I own the cash in the till. I don’t own the people who work there, but effectively, they’re working for me as the owner of the business. And so I can look at all these different things and try to measure like, okay, well, here’s the number of bottles that we have. Here’s how much cash is in the till. That’s all my stuff now as the owner of the business. And so I look through to my businesses that I own and they have a bunch of cash. And so do I need to own quite as much cash or can I look through to the business, their balance sheet that is now basically my balance sheet by proxy, and so I have a lot more cash actually than it even looks like. I think there’s sort of multiple layers to it that you have to evaluate. And it’s not just like, what is my own cash balance?

Clay Finck (52:40):

Yeah. It’s important to remember that when you’re buying stocks, you’re not just buying a ticker on a computer screen. You’re buying a real business with real assets and real people working for you. And like you mentioned, things tend to play out quite well for long term shareholders.

Jake Taylor (52:55):

It makes the game so much easier if you have a sense of what you think a company is worth, and you have that number as an anchor. And then as the price moves around, which it’s inevitably going to do, and it will play with your emotions because we’re all humans, but if you have that anchor, that you think that it’s worth X and you see that it is all of a sudden, overnight trading at half of X, it’s a lot easier to go buy more at a price that you think is all of a sudden a deal. Or if it starts to move way above X, then like, well, I guess I’m going to trim a little bit of this, or maybe not exit completely if you really like the business and you understand it and the evaluation isn’t too egregious.

Jake Taylor (53:37):

I tend to hold through those periods more than I would maybe is optimal. I’m not sure. It’s really hard. These things are, they’re all approximations, right? I don’t have an exact number that I would tell you the intrinsic value of Berkshire is, but I kind of have a range in my head that I think it’s worth. And so having that anchor is such an advantage. This is one of the problems with a sterile asset, is that what is the anchor that you have for any of these things? Like, how do you know that if Bitcoin was to drop to 30,000, it’s, I think roughly 60,000 today, and it drops to 30,000, is it a better deal now, or is it half off? Is it half of what it was worth? What if it went to 120,000? Is it a better deal now than when it was 60,000?

Jake Taylor (54:21):

I have no idea because I don’t know how to calculate any intrinsic value off of something that has no real yield. And if there’s only price action to go off of, I don’t know, like price going somewhere, the prices are going to go everywhere over time. So how do you take advantage of it then? I don’t know how to do that. At least with businesses that I understand and what I think I can come up with what it might be worth, I have something to go off of to know like, okay, this seems like it’s cheap to me or not.

Clay Finck (54:51):

That approach definitely makes sense to me. Jake, thank you so much for coming onto the show. I know I learned a lot from this episode and I’m sure that those in the audience did as well. Where can the audience go to get connected with you and follow along with your work?

Jake Taylor (55:07):

Yeah, it’s my pleasure. And I hope that no one felt like I was talking down to them because I’m 20 years older than them. Hopefully it was more like, here’s really what I wish someone would’ve told me and that it wasn’t me preaching, although, maybe it got a little pedantic there at times. So, I apologize. Yeah. I mean, I’m not too hard to find on the internet these days. I’m on Twitter @Farnamjake1. My investment business is farnam-street.com. We tend to actually specialize in retirement accounts and especially people who have left a company and they have a 401(k) that’s sitting at their old company and they’re not really doing anything with it. Maybe they’re not even checking on it. We’ll take those 401(k)s and consolidate them into an IRA for somebody and then manage the whole thing in a holistic way.

Jake Taylor (55:58):

The great resignation that they call it now, like everyone quitting their jobs is actually pretty good for us as a business model. I do a weekly show with two other guys who are terrific guys, Bill Brewster and Tobias Carlisle. So we do this show called Value: After Hours. And it’s sort of just the three of us getting together and BSing on weekly topics and events. We cover some investment stuff too and sort of helping, maybe people untangle some things in the investment world. But it might be a little bit in the weeds because we don’t pull back on jargon or terminology. This is like, if you just heard three guys that were in the business, talking at the bar, this is like what they would be talking about. So that’s what we’re aiming for at least. Yeah. So that’s basically it. That’s probably enough stuff for now.

Clay Finck (56:47):

Yeah. The Value: After Hours, I can definitely attest to all three of you just being so knowledgeable in the finance space. And some of that stuff definitely goes over my head.

Jake Taylor (56:56):

Sometimes what they say goes over my head too, so don’t feel bad.

Clay Finck (57:00):

Jake, thanks again. We’ll be sure to link all that in the show notes for those interested in connecting with you. Really appreciate you coming on.

Jake Taylor (57:07):

My pleasure, Clay. Thanks for having me.

Clay Finck (57:09):

All right, everybody. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app so you can get these episodes delivered automatically. And if you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There you’ll find all of our episodes, some educational resources we have, as well as some tools you can use as an investor. And with that, we’ll see you again next time.

Outro (57:32):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.