TIP685: Top Takeaways From 2024 w/ Kyle Grieve & Clay Finck
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You're listening to TIP. 2024 offered significant insights from several of our guests and some of the most impactful books that we read. It was actually really hard to distill all my learning into only one episode as I could have easily made this multiple hours long.

But I wanted to bring Clay on today to help dive into some of the core concepts that we addressed this year and which we thought were the most impactful, both for our listeners and for ourselves. This episode has a little bit for anyone who invests in stocks. Chris Mayer will help you understand the importance of focus and a few simple ways to avoid being caught up in the large amounts of noise that we're constantly bombarded with on a daily basis. We'll learn how hard it is to pick stocks successfully and just how few stocks can beat even lowly bond yields.

Then we'll touch on the importance of actively seeking disconfirming evidence and how that can help shave away some of the problems that we all have in our decision-making. And speaking of decision-making, we'll look at how you can utilize Nick Sleep and Kay Sicaria's Cone of Uncertainty to help you improve your ability to do destination analysis. We'll loop that idea into Annie Duke's thoughts on how long-term decision-makers can close feedback loops to make quitting easier.

One of my favorite mental models I learned this year was from Pulak Prasad in his instant classic, What I Learned About Investing from Darwin. His idea of punctuated equilibrium is an idea that we should be taking very, very seriously. It helps investors in multiple ways. I'll review how this principle can help you maintain conviction in your best ideas and help you avoid making poor decisions when the market corrects. We'll also cover an area that's near and dear to me, John Huber's excellent points on the three sources of stock market returns.

When looking at the market, there are points where the pendulum just swings too far in one direction. And I think in 2024, John observed the pendulum swinging too far towards the quality end of the spectrum, meaning that prices also rose going towards that spectrum. While I love quality as much as anyone else, I can also respect where valuation and capital returns fit into the overall value creating equation. No matter where you fall in the quality spectrum, John's insights are invaluable if you want to continue making sufficient returns in the market.

And finally, we'll cover some of the timeless principles that Monish Pabrai imparted to Stig during their excellent interview this year. These principles go beyond the world of investing. They will help prompt you to think about your relationships and how to optimize yourself to win by providing value to others through some essential virtues. Now, without further ado, let's get right into this week's episode with my co-host, Clay Fink.

Since 2014 and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your hosts, Clay Fink and Kyle Grieve. Welcome to the Investors Podcast. I'm your host, Kyle Grieve, and today I'm joined by my co-host, Clay Fink. Clay, happy to have you here with me here today.

Great to be here with you, Kyle. Thanks for having me. So seeing as 2024 is nearly complete, we decided we'd want to compile some of the best lessons that we've learned from our episodes this year. We both learned just so much from the guests we've had on interviews, as well as the books that we've read. And just so that you know how this episode is going to be kind of formatted, we're going to play some audio clips that we found very profound, and then we're going to provide our opinions and takeaways from each of them.

So let's jump right in and let Clay discuss his first takeaway from his conversation with Chris Mayer.

Yeah. So before we play the clip here, I'll paint a little bit of background. So I asked Chris how he's able to distinguish the signal in a very noisy world. So even if you think back just 30, 40 years ago, there was just a tiny fraction of the noise that we see today in our world as investors. So perhaps your typical investor 30, 40 years ago would read their local newspaper in the morning and watch the news in the evening.

So when you open up the paper, you might occasionally see a Wall Street Journal article on a stock you own, and you'd probably read their quarterly annual reports just to keep up with the business. So the signal to noise ratio was quite high, and you don't have people just constantly chatting in your ear, trying to talk your stock up or down. But today, with the rise of social media and the speed at which information travels, there's just noise everywhere. So log onto Twitter, you'll probably see

accounts with 200,000 followers making a macro forecast, or people are always chatting about different names. And there's just so much more news flow, I would think, with so many of these companies today. So I think the ability to really distinguish what truly matters for us as investors versus what really doesn't matter is such a critical skill set because it's just so easy to get swept up in the noise. So during my interview with Chris Mayer earlier this year,

I asked him how he's able to distinguish that signal from the noise. So here's a response from Chris. Yeah, I mean, that's important to do. I think, you know, one thing I do is I don't spend time on that macro sort of guesswork. So, I mean, I can't tell you how many times someone has sent me, you know, some kind of think piece about something or other. And, you know, I politely thank them. And then I put that in the delete pile. I don't spend any time on that.

I spend more time on my name. So I mean, last year I met with several CEOs and of course, then I spend time looking at new ideas, which is always fun. And so it's really where you put your attention. I really guard that attention.

carefully. If you allow yourself to, you know, read into these narratives that people create, then it makes it more difficult to make a good decision, I think. You know, another thing is just kind of habits. I don't, it's taken a long time, but I don't, I don't log into my account every day. I don't, I try not to look at stock prices during the day. You know, I try, I usually will check in the morning, see what's going on. And then I look again at the close, but even that's probably too much, you know, for most people, I don't think they should probably be looking at it every day.

So, you know, I think another key part of distinguishing the noise from the real signals is if you spend time on

on the businesses that you own and really try to drill down on what the essentials. Figure out what really will matter for this business over the next, say, 10 years. And when you make that your filter, you know, what are the critical success points for this thing over the next 10 years? What has happened? A lot of these other details sort of dissolve. Talks about whether there might be a recession next year. It doesn't become very important because, again, you're thinking way out.

You're thinking 10 years and you're going to own it through a recession or two, you know. And so I spent a lot of time in that figuring out what one of the essential pieces of a business that will help it succeed and identifying that and then really staying focused on that.

So my biggest takeaway from him are pretty much completely aligned, I think, with my strategy and one that I think we usually kind of recommend and talk about with a lot of the listeners here. And that's kind of three parts, which is number one, don't spend time attempting to predict the macro because you probably won't get it right. And unfortunately, even if you do get it right, you have no way of actually knowing how the market is going to respond to it. The second one here is focusing your attention on things that really are going to just drive your investing returns.

That's things like learning about the business, speaking to key personnel, and learning about the industries that you're invested in. I think that's going to be a much better use of your time rather than trying to speculate on what's going to happen with the economy or interest rates. And the third one here is just make habits that prevent you from straying on what you should focus on. Chris talked about there about not obsessing with checking stock prices multiple times a day, but if you can try to find some of the

factors and areas of focus that probably aren't delivering much return on your time. Those are things that you should try to make a habit to get rid of.

Yeah. I mean, his point on guarding your attention carefully is just so wise. And I think it really can carry over into all parts of life. I think we just really need to be careful how we use our time and attention because it affects us whether we realize it or not. And our time and attention is one of our scarcest assets. So when Warren Buffett and Bill Gates, they were asked for one word that accounted for their success, and they both mentioned the word focus. So

a lot of this noise is there to really distract us from what's really important. And to Chris's point on looking at each business we own, ideally, we want to be able to hone in on a few things that really matter for the long-term success. And once you use that filter, you can really filter out a lot of the noise and see that it's just totally irrelevant. I think a lot of people can get tripped up about, say, near-term risks or the potential of a near-term recession.

And I think another key point from Chris that I've learned is not to underestimate a great business's ability to weather through a recession or potential slowdown and come out even better on the other side of it. So yes, perhaps the share price suffers in the near term as a result of it, but the short-term share price movements are largely unpredictable. And we really want to hone in on what sort of destination that business is heading towards over the longer term. Robert Leonard

So next year, we're going to play a clip from my conversation with Professor Hendrik Bessembinder. Hendrik, he put out this great study. It was titled, Do Stocks Outperform Treasury Bills? And it showed that over the past 100 years or so, all of the net wealth creation in the stock market came from just 4% of companies. So I thought Bessembinder's research was really interesting and really important for all investors to really understand. So I was really happy to bring him onto the show. So the key point I'd like to drive home here

from his research is that just most stocks are going to lose you money, or at least most stocks in the stock market do lose money relative to treasury bills. And it's just a select few that drive the majority of the overall returns in the market. So we'll play the next clip here from Besson Binder, who's going to expand on his findings from his study.

One of your comments that stuck out to me at the start of your answer was that the average return for a stock is negative and that surprised you. For those that might not be math inclined, why did that finding surprise you?

Well, there's a big economic body of theory and evidence about risk-return trade-offs. And stocks are one of the more risky asset classes, maybe not the very riskiest. Maybe venture capital is more risky. Maybe some exotic markets like, say, electricity derivatives might be more risky. But stocks are among the riskier assets. So we expect a positive average return in stocks. And I should clarify, it is true that the average return, the mean,

the same average you've been talking about since sixth grade or so. The mean return on stocks is positive.

It's that return on a typical stock is not positive. So that's one of the striking things that came out in my original study. I used a database, acronym is CRISP, Center for Research and Security Prices, is put together by the University of Chicago. It's what most academics study, and it's kind of considered the gold standard database for reliable historical stock return data. I studied this CRISP data since 1926, all the individual stocks,

found that the majority of stocks lose money. I focused in the paper on comparing stocks to treasury bills because I had in mind the idea of a risk premium. We're supposed to earn a risk premium in stocks as compared to something low risk like treasury bills. Anyway, what I found is that the majority of stocks, about four out of seven, don't beat treasury bills in terms of their compound returns. If I focused on the number that I called shareholder wealth creation,

which the biggest difference between that and a compound return is it just takes the size of the investment into account. So if we want to ask a question like, well, investors, the body of investors, the group of investors in the stock market, how have they done in the long run? How much wealthier have they become? With that sort of question, it's natural to think about things in dollar terms, which then puts more importance on big stocks. In any event, when I did look at things in dollar terms, this wealth creation measure

It was even more striking. About 4% of the stocks accounted for all of the net wealth creation in the stock market since the US stock market since 1926. So I was surprised because we usually think there's a positive risk return trade-off. And I should mention, it is there on average, but it's not there for the typical stock. How can it be there in the average even while it's not there for most stocks?

Because there's a few stocks that do tremendously well that pull up the average. That's the essence of the findings.

Yeah. And if I can paint some numbers from your research, I believe one of the earlier studies, it looked at 25,000 companies in aggregate, they created $35 trillion in net wealth creation. But if we tune into those top, top performers, the top 90 account for over half of that $35 trillion. And it's the top 1,092, that is the 4% figure you've referenced there that accounted for that

in aggregate, $35 trillion. So I think that top 90 really stands out to me. So it's just like this tiny subset is driving so much of the performance of the broad overall market. Robert Leonard : So those were among the results that surprised me and I think surprised a lot of people.

I should mention, when I first came across these results, I was starting to talk to some of my academic colleagues about it. Many people like me were surprised, but there was a handful of them who said, well, of course, what did you expect? Which just shows that some people had already thought carefully through these issues, even if they hadn't stopped to actually document it previously.

Robert Leonard : You mentioned venture capital. People often think that a venture capitalist is going to go out, they'll make 100 investments and they're very happy if one or two or three work out very well. People perceive that as a risky activity, venture capital in general, but they're doing the same thing when they buy a passive index fund. Just a select few is going to be driving those returns. So skewness is something that we see in many areas of investing, life,

a lot of areas and people talk a lot about power laws and it relates to that as well

Yes, agreed. So I think skewness is pervasive. One of the ways I've described the results of this study is I said, look, I'm going to tell you about an asset class. And in this asset class, most of the investments lose money. As a matter of fact, the single most common outcome is losing all your money. But there's a few really big winners. There's a few of these investments that really pay off handsomely enough to make this asset class worthwhile and desirable.

And if I described it that way, a lot of people would respond, "Yeah, we know that about venture capital." But of course, I'm talking about publicly traded common stocks over longer horizons. So what I conclude from this is that this positive skewness, it's not something that just shows up in some corners of the capital markets like venture capital. It's really pervasive. It's fundamental to investing in an entrepreneurial economy.

So this was a fantastic clip that I think you chose, Clay, as it really emphasizes how hard investing is and the importance of power laws as well in investing. Just thinking about how a few excellent winners are going to be generating the lion's share of the wealth in the stock market. However, I think I do have some pushbacks on this study and how I think it affects the average investor. Clayton

And this concerns multi-baggers. So a business at the top of this list might have created a ton of wealth for the index. Something that comes to mind that everyone's going to know is Amazon. Amazon's clearly made a ton of wealth for the S&P 500. The stock price has compounded at 25% per annum since 2001. But here's kind of where I think the study misses a slight point, and that is that you don't necessarily need to have businesses at the top of the index inside of your portfolio to generate wealth.

There are comparatively smaller businesses that compound at much higher rates than Amazon. During the same period as Amazon, for instance, Monster Beverage was compounding at 35% per annum. And you can find other tiny businesses as well that compound at very high rates for much shorter periods of time. But the difference here is that Amazon's market cap as of November 28th, 2024 is 2.1 trillion. And Monster's beverage is only 53 billion.

So yes, Amazon has created a ton more wealth in terms of absolute, but in relative terms, if you'd invested in Monster many, many years ago, you would have done very, very well. And so my point here is just that there are many wealth creating businesses that can create wealth for stock pickers, but might not necessarily move the needle or even be included in the index. So while I definitely agree with Hendrik's premise, it's very, very hard to invest. I don't think it's necessarily

a reason why individual stock pickers should just quit stock picking because of this study.

Yeah. One of the points that Hendrick made later on in the interview, I thought was really funny that everyone just sort of is going to carry their bias through when looking at the study. So if someone's an index investor, they're going to say, hey, see this study? This is why you should invest in the index. And any stock picker will look at it and say, hey, look how big these winners are. This is why you should pick stocks. But I do agree with you. We don't need to own the largest wealth generators in order to generate returns for ourselves. And I also think that a

One important point that I wanted to reiterate from Hendrik is that more than half of stocks underperform treasury bills. So to be exact, four out of seven underperform treasury bills. And usually we're referring to the market or the S&P 500 here on the show. So maybe it's 70% or 75% of stocks, something like that is going to underperform the market over long periods of time. So if an investor owns 10 or 20 stocks, you're statistically very likely to at least own a couple

that do underperform. And that doesn't necessarily mean you're a bad investor, just sort of how the math works out and how the odds aren't stacked in our favor for a lot of these businesses. So since it's so hard to outperform the market over long periods of time, we really want to have a good process in place for allowing stocks to enter our portfolio. And if you don't have a good process for making investments in stocks, then you're bound to end up with a lot of mediocre companies and wonder why so many are underperforming

In a way, it also increases my conviction for those that do want to invest passively in index funds. So by owning index funds, you're likely exposing yourself to these mega winners that can just compound and compound for many, many years ahead. And you can really sleep well at night knowing that the greatest wealth creators in the world are sitting in your portfolio, and you don't even have to know what companies those exactly are. So

Having one of those mega winners in a concentrated portfolio can even be more exciting for us as stock pickers too, if we're able to manage to grab one of them. So the next clip here that I want to share is from William Green's conversation with Brian Lawrence. Just to give you a little bit of background, what they're talking about here is how Brian deals with periods of underperformance. So William mentioned how Jean-Marie Eveyard, a legendary investor who was profiled in his book, Richer, Wiser, Happier, had just an incredibly difficult time during the tech bubble.

During the rise of the bubble, he ended up losing about 70% of his shareholders during a three-year time period, and his assets under management shrunk from $6 billion to $2 billion. You mentioned to me, look, I'm way less emotional than most people. Can you talk about the wiring that you actually need to be able to handle the pain of this? Yeah. I think that I'm pretty... I think in a...

I think I found really what I want to do, like analyzing businesses, trying to understand the world, developing conviction, you know, looking for places where the conventional wisdom is wrong. I just, I love living in that world and I enjoy this. And so when

When something starts to go against us, you know, we bought something and it's down. That's I really enjoy that. That's really distinguishing between a mistake and an opportunity is is where you make progress.

a lot of the money doing this. And I just really enjoy that. And I think a lot of people don't. I think that they don't like confronting their own mistakes. I'm really struck. Apparently, Charles Darwin had this saying, the human mind is like the human egg. Once impregnated with an idea, it's impervious to new ideas. I really value disconfirming evidence. I welcome

One of my favorite things to do is to talk to a short seller. When things start to go against us, my intensity of desire to figure it out

kicks in. And we've gone back from the beginning of Oak Cliff 20 years ago. If you measure being right as the stock that we bought, either we sold for more than we paid for it, or it's trading now, we own it still for more than we paid for. We've been right 70% of the time and wrong 30%. We're definitively wrong 30% of the time. And identifying where we're wrong, that's where we work most intensely. And I just think that's

how we're wired. And then we've done the things that we've done structurally choosing clients, having clients choose us for the right reasons that mean that when we're down, we don't get calls saying, oh my gosh, you promised us something that isn't going to happen. Right. So that's, that's, that's a huge advantage we have that we have clients who understand that what we do. And, uh, uh, you know, I, I, I have emotions like everybody else. I mean, I'm not inhuman, but, uh,

We own 15 companies right now. They're trading at 14 times trailing free cash flow. The S&P 500 is at 22 times. These are very high quality companies. And just learning more about them and the dozens of companies on the watch list that we'd like, it's just...

the emotion drains away and you live in a world of learning more about each one continuously. And I don't know, maybe I'm just wired in a way that that's what happens. Robert Leonard : Let's take a quick break and hear from today's sponsors. Buy low, sell high. It's easy to say, hard to do. For example, high interest rates are crushing the real estate market right now. Demand is dropping and prices are falling even for many of the best assets.

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I really enjoyed the insights from this clip so much because of the emphasis on spending time specifically, I think, on where you're wrong. Brian Lawrence mentions that his most intense periods of time are specifically spent on where he is wrong. And the other thing I really liked and respected was that he knew that he's going to be wrong 30% of the time. And even with that knowledge, he...

can use his ability to look at these mistakes and acquire new insights and also hopefully improve his decision-making in the future. And then another key that really stuck out to me was this reference to this Charles Darwin quote and how the human mind is like a human egg. So once again, it was, once impregnated with an idea, it's impervious to new ideas. Now, this quote just made me think of a wonderful Charlie Munger quote as well, which is, there's no way that you can live an adequate life without making many mistakes.

In fact, one trick in life is to get so you can handle mistakes. Failure to handle psychological denial is a common way for people to go broke. To me, I think Brian has just mastered this. You can tell in the clip that he's almost excited when he talks about finding disconfirming evidence. I think as investors, if you can reach this point, you're just going to become much better at welcoming mistakes rather than fearing them.

And when you get to that point, you're going to rapidly increase your ability to learn and to also come to more accurate conclusions. And if you fail to reach that point, you risk, as Charlie Munger says, going broke. Now, just personally, over the last few years, I've kind of learned here a lot about a lot of my shortcomings in investing and areas where I should probably stay away from. And this has been from reflecting on my own mistakes and identifying where I think I've gone wrong. Now, I can use these reflections to improve myself going forward.

How? I can simply avoid investing in areas in which I haven't succeeded. Or if I think there's an area that I believe I can succeed in, I know I need to improve my competence and probably spend some more time in those areas before investing in it again.

Yeah, I really enjoyed this clip with William Green and Brian Lawrence as well. I mean, a 70% hit rate is certainly impressive. So they discussed the need to be wired a certain way to be able to handle those periods where an investor inevitably underperforms for a certain time period. And I think most people are wired to assume if they're underperforming the market for, say, a year or two, then they've made a mistake. And that leads them to selling their positions at a loss.

And Brian, he just has this extremely deep intellectual curiosity to really get to the essence of what's actually happening and determine if the stock price drop is actually rational or not. So he actually enjoys being challenged, which I think really shows the level of humility he has. Perhaps when the price drops, he should actually be buying more. And if he determines he makes a mistake, then he would end up maybe selling that position.

And that Darwin quote is just so powerful. Once the human mind is impregnated with an idea, it's impervious to new ideas. I mean, man, what a powerful bias to think about with regards to our own tightly held beliefs. And it's very discomforting to know you've been wrong. So Brian's ability to take on his mistakes head on is just so powerful.

So next year, we're going to play a clip from my conversation towards the start of this year with Morgan Housel, and we discuss why most competitive advantages are doomed for failure.

Buffett's very well known for trying to find companies with strong moats, strong competitive advantages. And you have a chapter on this as well and how you talk about most companies are naturally doomed for failure. You share this sort of daunting statistic that between 1980 and 2014, almost 40% of all public companies lost all of their value. So how about you talk a little bit about Sears and how that might relate to sales?

some of the giant companies we all know of today. And what's amazing to me about that statistic is those were the public companies. Those are the winners. These are not garage startups. Those are companies who became so successful at what they do that they went public. And 40% of them within one generation are gone.

They're out. They didn't merge. They went out of business. Almost half. It's incredible. And I always think of something like Sears as being really incredible because obviously, particularly if you're young, you don't know this or you'll forget it. But there are very few companies in the history of capitalism that had a moat stronger than Sears. Sears from the 70s to the 90s had a moat around it that you would equate today to Apple or Google. It was like nobody could compete with Sears.

And now they're nothing. It's zero. They're bigger. It's not really a thing anymore. To go from that strong to where they are is astounding. And I honestly think if you look at the long history of business, that's kind of par for the course. And I think in a very generalized way, what tends to happen to a lot of these companies is the strength and success that they built and maintain caused them to let their guard down.

And they said like, look, we don't need to be scared and paranoid anymore. We are freaking seers. Nobody can compete with us. And once, and then they've lost that competitive grind, that edge that made them so great. And then the downfall is from there. So I've always been interesting on like why competitive advantages die. And one of the interesting, I think the most common one is that, and this goes for individuals as well, where you are grinding and working hard specifically because in your head, you're like one day I'm working this hard. So one day I don't have to work this hard.

And then if you're successful and you have a big net worth, you're financially independent or you're a business that is like dominating your competitors, you feel justifiable to say, I'm going to take a break. I don't need to work as hard. I don't need to worry. I don't need to wake up at 4 a.m. to chase off my competitors anymore. You feel justified saying like, I've earned the right to breathe a sigh of relief now.

But then at that very moment, the thing that made you great is gone. And you've planted the seeds of your own demise at that point. So even more fascinating than Sears might be the companies who have successfully fought back against this. One is Sequoia, the most successful venture capital firm of all time that has dominated not just in the last decade during this VC boom, but they've dominated for 50 years. And it's so incredibly rare. And Mike Moritz, who runs Sequoia, was asked many years ago,

by Charlie Rose. Charlie Rose said, like, how do you explain Sequoia's success? And how do you explain that it's been successful for so much longer than any of your competitors? And

And Mike Moritz, his answer was, we've always been scared of going out of business. And this is a guy for whom if there's anybody in VC who has the right to say, the reason we're successful is because we're smarter than everybody else. He has the right to say that, but he didn't. He said, we've been scared of going out of business. And so that competitive drive that made them successful 30 years ago still exists today. The other more recent example is NVIDIA, which I read this in this interview with Jensen Wong that I thought was so interesting. He said...

The unofficial model of NVIDIA, their unofficial corporate motto is, we are always 30 days from going out of business. And that's why even though NVIDIA is worth a trillion dollars and absolutely utterly dominating their field, I think their management team wakes up terrified every morning. And that's why they're successful. So the companies like Sears that fall for the knee-jerk reaction of like, oh, we deserve to let our guard down. We've earned that right.

versus the companies that stay scared even when they are dominant. It's a fascinating thing. And the Sears examples are way more common than the Sequoia examples.

So this was such a powerful teaching point because I think it really highlights the importance of the impermanence of business. It's also further proof that investors who initially buy into a company with the thought process that their business is undisruptable can be very wrong. And that's even if the market consensus is that it can never fail. I mean, just look at some of the businesses that were in the nifty 50. Some are still around today, sure. But many of them, Polaroid, Xerox, these are long gone.

And I personally know I've invested in a few businesses that I thought had incredibly powerful and deep moats, but very quickly learned how wrong I was. So I think this point really reinforces the ability of investors to admit that they will be imperfect and to move on from investments where the fundamentals are less likely to be attractive than they initially assumed.

Yeah. And I love how Morgan tied in the point on competitive advantages just to how people think and people operate and how the natural human condition is really complacencies, you know, whenever we start to feel comfortable. So I think about, you know, times I've ran like half marathons in the past. So I do all this training, I do all this work and I go and do the half marathon. Then for like the next few weeks, I don't even want to run another mile just because, you know,

I hit that achievement and I hit that goal and I just wanted to relax. People want to relax after they work their butt off. And another interesting thought I had on competitive advantages was that a company can become so entrenched in just doing things a certain way. And that is what might even prevent them from maybe even needing to disrupt themselves before another company disrupts them. So for example,

You look at Google, their cash cow comes from Google search. They can't disrupt their own search business overnight and overhaul the entire thing and implement LLMs because that would mean tens of billions of dollars in lost revenue and likely a plummeting stock price chasing an unproven concept. And I think we also need to remember that most executives aren't incentivized to necessarily innovate. They're incentivized to keep their jobs and taking such risks would

potentially get them fired, or probably likely get them fired. And think about Blockbuster 25 years ago. Executives at Blockbuster didn't want to invest in delivering movies online because it was speculative. It was an unproven concept, and that might lead them to losing their jobs if they chase an investment that doesn't pan out. And they also had the proven model in retail with over 9,000 stores. And Costco is another business that's sort of top of mind for me, since I have an episode going out with them in a few weeks.

Most of Costco's investments are in building warehouses. Then all of a sudden, Amazon comes along and this e-commerce trend is just exploding. If you're Costco, you're not going to all of a sudden just stop investing in these brick and mortar retail stores. You somehow have to keep people coming into your warehouses, which they've actually been very successful at doing while other retailers that took the easy road got their lunch eaten by Amazon. So

a company already being established in itself can actually help enable a new competitor to come in with just an entirely new business model. And at the end of the day, capitalism is brutal, and I think the future belongs to the discontented. So next here, we're going to jump to a clip with my interview with Jon Huber, and we are going to discuss the three sources of stock returns. So here it is. Jon Huber :

So one of my favorite articles you wrote up was outlining the three sources of returns. And one of the reasons I really loved this article is because it really helps simplify the game of investing and just kind of points to how it's pretty simple math at the end of the day on what drives the performance of a stock. So I was curious if you could outline the three sources of returns that end up driving the overall performance of a stock.

Yeah, as you said, there's lots of factors that go into this, but at the end of the day, there's three things that matter. There's three things that determine the stock price. It's earnings growth,

It's the change in the PE multiple, so up or down. And it's the amount of cash that you receive from the company via buybacks or dividends, so capital return. So growth, the change in the multiple, and the capital return are the three engines. And the stock price is going to be governed by those three factors, the stock price appreciation. And of course, you could use

Sales growth. It's really growth and the multiple. You can use sales growth and price to sales ratio, the change in that, or you can use free cash flow growth and price to free cash flow, as long as the growth metric is the same as the denominator and the valuation multiple. But those are the three things that determine your stock price. So I think it's helpful to keep those in mind when you're thinking about stocks and you're thinking about those three drivers, because that is what's going to determine your returns over the long run.

we'll be getting to how you invest in some of the opportunities you're sort of seeing in the markets. But I think it really just points to returns from a stock can come from a variety of different ways. So I had read in one of your articles, how you just sort of outlined this basic example where you can have one company that has 20% return on capital, they reinvest everything. And if your multiple stays constant, you're getting 20% returns over time.

And then you sort of flip that and say, you have another company that has 0% reinvestment, but they're trading at a multiple of five and they're buying back or paying out dividends with all of their earnings. And that also leads to a 20% return. So it's not all about just earnings growth, or it's not all about just share repurchases and dividends. And I think it just points to when you enter any position, sort of setting the expectations on where your returns are going to come from. Robert Leonard

Yeah, absolutely. And, you know, I think in recent years, part of the reason I wrote that article, the three engines is because it's such an obvious thing, I think, when you think about it, but a lot of people naturally gravitate towards the growth engine. And so the, you know, the term compounder has been

I've been using that term for 10 years and I kind of feel like it's been hijacked. And there's so many businesses now that are referred to as compounders, but what you really want to do is you want to compound your capital. It's not about finding the best. It's like Charlie Munger says, it's not about finding the best business. It's about finding the best investment, the highest quality investment.

And a great business oftentimes can be a great investment, but it occasionally can be a very poor investment or even a risky investment at a certain price. And the simple math on that is like if you use an example of a stock that grows at, let's say, 7% per year, that stock is going to double, that earnings of that company is going to double over the next decade. So 7% per year over a decade is roughly at 2X.

If you paid 10 times earnings for that stock and it goes to 20 times earnings, that is another 7% growth on the PE multiple expansion. And so it's very important to not pay too much because it's nice to have that tailwind. If you have the opposite, right? If you pay 25 times earnings and you end up at 12 or something like that, your multiple gets cut in half. And so-

You can achieve great returns in stocks by buying something that's undervalued and seeing a tailwind to all three of those engines. 7% earnings growth, 7% on the multiple, that gets you to, let's say, roughly 14. And then perhaps if some of that is returned to you in the form of a dividend or a buyback, you can achieve a further return from that third engine. And so you want to look at the interplay of all three of those, not just growth, because a business that's growing at...

20% a year is phenomenal. There's two things to worry about there though is one is it's very difficult to grow at that rate for a long period of time.

But even if you could sustain that rate of growth, and that would be, let's say, roughly a six or seven X over a decade or something, if you pay too much for that stock and the multiple shrinks by half or even more, that eats into a lot of that return. And I think that's the risk of some of these growth engines. And so you just want to be very careful with paying too much. And that's our

I mentioned in a post recently about how Buffett rarely pays over 15 times earnings for a stock. And that's, I think that's a big reason why is he understands that you don't want to have that headwind on that second engine, right? You want to pay a price that's fair or preferably below fair, right? So you get a tailwind on the PE going up.

you don't necessarily have to rely on the PE multiple going up, but I think people under appreciate how significant that can be even over a period as long as a decade. If you buy a stock at 10 PE and it goes to 15, that's a 4% per year tailwind over a decade. And if it happens in five years, that's like an 8% or 9% per year tailwind. So that's really important to consider. And you can earn great returns. You can have high rates of compounding

on a fairly modest rate of growth if you don't pay too much. And that's basically the lesson there.

So the three sources of stock returns has really been a really helpful mental model for me to help simplify the game of investing. So as investors, we want to think about where our returns are likely to come from when we're investing in a stock. And I think this also ties in well with Chris Mayer's twin engines for growth from his book, 100 Baggers, which was earnings growth, and then just the PE multiple expansion. Robert Leonard

So while you might have the strong earnings growth tailwind, we need to be mindful if there is a potential for a PE contraction or even a potential dilution and the share's outstanding. I also love how John discussed during my interview with him that we don't want to pigeonhole ourselves into a specific investment style if possible. So during a time like today here in late 2024, a lot of companies that are higher growth and they're in the limelight, they just aren't going to be at attractive valuations. So

You might need to pivot your style a bit if you're investing in individual stocks, and not one specific style is always going to be in favor throughout our investing lifetime. So we sort of have to evolve and change as the times change as well, and the opportunity set changes. And when thinking about what types of companies we should be looking for, I was actually reminded of a quote from Brett Gardner's book on Buffett's early investments. So the quote from Buffett essentially said that,

a lot of his sure money was made in his quantitative bets, and a lot of his big money was made in his qualitative bets. And the qualitative bets were largely based on insights that just can't be found by looking at a screener, filtering on these certain metrics, or just looking at the numbers. I think nowadays, almost all of the best investors are going to be on the qualitative side because of all this technology that's out there to

get the low hanging fruits on the quantitative side. So I think from time to time, you might find something that's a quantitative idea that hits you over the head, as Buffett would say, but it's likely going to require some qualitative insights as well. So Apple in 2016, it traded at a multiple of 11 or 12. And I would argue that a lot of Buffett's money made on that bet was the qualitative analysis, the understanding of the brand, and the power of their app store.

So we shouldn't expect these qualitative insights to be easy to uncover and identify. But sometimes, you know, even in a case like Apple, it might be hiding in plain sight, so to speak. And John Huber also referred to these as unpopular large caps.

Yeah, I resonated so much with what John mentions here. My evolution as an investor has really highlighted this point. Investing isn't necessarily about just finding the best businesses, but also the highest quality investments. I really started realizing this in 2023 and understood its power much more in 2024. With prices right now increasing in nearly all market cap deciles, it's just become more and more challenging to find attractive prices for many of the high quality businesses that

either already own in my portfolio or ones that I'm looking at, or even ones that I just want to add to. So one thing I do every quarter is to calculate my expected risk adjusted returns on my businesses based off of current prices. And I can tell you from doing this exercise, the businesses that I want to add to the most right now are the high quality businesses in my portfolio. And unfortunately, many of these have just run up so far in 2024.

Now, for me, luckily, I have a different segment of my investments that I look at these undiscovered businesses. And this is where I've successfully been able to deploy cash this year and earn decent returns with some downside protection as well. But I can admit that these businesses aren't the same quality as some of my more expensive names. I think this still speaks to some of John's points about finding quality investments and not focusing exclusively on quality businesses.

If there's one thing that I've learned from investing, I think, in quality businesses, it's that I require a margin of safety. Otherwise, I think I risk losing money if my analysis of both quality and growth is incorrect. And these are investing bedrocks that Ben Graham, Warren Buffett, and Seth Klarman have been touting here for ages. And this is just a reminder to continue following them. So Pulak Prasad inspired the next lesson that I want to share with you, which is from his excellent book, What I Learned About Investing from Darwin.

Since Pulak doesn't do public interviews, these insights will be from my own episode that I did on his book. The final chapter of the book deals with the power of stasis in nature and investing. One of the biggest problems that Darwin came upon was outlined in chapter six of The Origin of Species.

Poulak wrote, "He argues that since natural selection gradually eliminates minor well-adapted forms, extinction and natural selection must operate simultaneously. Hence, logic dictates that innumerable transitional forms that were unable to adapt to their surroundings should have existed." But, as Darwin himself points out, transitional fossils have rarely been found.

He admits that the incomplete fossil record poses a significant hurdle to anyone trying to prove that species evolve gradually." But two scientists, Niles Eldridge and Stephen Jay Gould, came up with the idea of punctuated equilibria that seemed to make sense of Darwin's original thesis by looking at the problem in a different way. The simple definition of punctuated equilibrium is that most species stay in stasis

for long durations and are interrupted periodically by punctuations in this stasis.

So when paleontologists found larger changes in the morphology of a species, they should assume these changes happened rather suddenly rather than slowly over time. Prasad came up with this framework for investing from the concept of punctuated equilibrium. 1. Business stasis is the default, so why be active? 2. Stock price fluctuation is not business punctuation. 3. Take advantage of the rare stock price punctuation to create a new species.

Let's dive into these three frameworks in some detail to find out how we can use them to be better investors. If we assume that most businesses are in stasis by default, it means that what has happened in the past should largely stay intact into the future. If this is true, then simply finding wonderful businesses with a long history of excellence

means that they should continue being wonderful into the future. A great example of this is how infrequent great buying opportunities occur. Pulak uses the example of a business he has first-hand knowledge of, Unilever. It was his first job, and when he started, he could see the business was truly exceptional. He discusses how he went out with a sales manager one day and was in awe of how much respect this sales manager had from customers. Their product was so in demand that Unilever had to ration its orders to different clients. His

His point is that exceptional businesses have a way of staying exceptional for a long time. So when the opportunity comes to acquire one at a great price, you need to be highly active.

But in those periods in between, your default activity should be to do as little as humanly possible. A great example I noted of punctuated equilibrium in real life was how infrequently Nalanda buys stocks. Page, Havels, and TTK Prestige are three exceptional businesses that Nalanda holds. Pulak notes that since 2007, there are only three months of time where they could buy these businesses at prices they deemed worthy.

This comes out to only 1% to 2% of the time period. I think many of the great investors follow this strategy of understanding a business very well, but rarely taking action.

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This and other information can be found in the funds prospectus at fundrise.com slash flagship. This is a paid advertisement. All right, back to the show. This was my favorite takeaway from Pulak's book because I think it highlights just some of the strengths and weaknesses of investing in general.

The first point here is that patience is a necessity when investing because the best opportunities truly occur infrequently. When you look at prices for the highest quality assets, like we were just talking about, it's very rare that they're depressed. And because of that, you have to be willing to deploy capital when everyone's getting scared. I mean, that's what Pulak has done. He holds these businesses for a very long period of time, rarely adds capital, but

But on those times where the market is just scared and everything's being punished, this is when he's going out and deploying capital. And I think this just talks to his strength of being contrarian. I mean, when everyone's exiting, that's when he's entering, right? So like I think almost all good investors, he's a contrarian. And I think that's a really good characteristic that you should try to emulate to the best of your abilities. Robert Leonard

And then the second point here that really stuck out to me was that since the default state of a great business is to be in stasis, you'd be wrong to really mess with a great thing if you already own it. So it's really important here to delineate that this is an important point only in regards to genuinely great businesses. If you own Warren Buffett's cigar butts that are these kind of cheaper, lower quality businesses that you're just waiting for their price to come back in line with intrinsic value,

This doesn't apply. This only applies with really high quality businesses that are also going to be really high quality, hopefully years, maybe decades into the future. So I want to go over a business that I own and I've spoken on the podcast before here, which is Aritzia. So I personally think Aritzia is an above average business and it also has some really unique brand strength and a very desirable growth profile.

But right now, it's getting to a point where the price is being pulled forward multiple years. And I think the business is good. And even if I sold it to put into something else, which also is kind of hard to find right now, I think it's unlikely that I'd understand it as well as I do with Aritzia. Aritzia is the stock that I've actually owned the longest. So I think I understand it very well. So my problem is whether or not I should sell it or not. And if I follow Pulak's principle here, I should probably just hold onto it and face the facts that

The returns for the short term are not going to be very attractive, but the long-term opportunity of the business will end up taking care of itself.

Yeah. And I would also add that Prasad's firm is actually in a privileged position of being able to call capital during market panics and individual investors, unfortunately, don't have that luxury. So while I generally agree that the best time to deploy capital is when everyone's running for the exits, I don't necessarily know when those panics are going to occur. So I personally just try to find the best opportunities now in the meantime, and not try and build up too much cash in anticipation of a panic.

And buying and selling, I think, is a very personal decision based on your understanding of the business, how certain you are of the valuation, and one's opportunity cost. So there are the rare instances when it can make a lot of sense to sell or to trim a position. And a lot of tech stocks, I think, clearly got ahead of themselves in 2021, and they were due for an eventual pullback. We might see the same thing today, actually, for a lot of technology-related names or even higher quality names.

I think part of the struggle for anyone holding these stocks is that in some cases, the range of outcomes can just be so wide and your potential downside can be very high when valuations get extreme. So I wanted to use an example of Spotify, which is a stock that Stig pitched in the mastermind discussion in Q1, 2023. Around then, the stock was around 120 a share. And Spotify has been a very difficult stock to hold onto. So in 2021,

It got caught up in the tech rise in that year. So it was up around 100% just in one year. And then it went from around 360 a share down to 75 during the bear market in 2022. Now it's closing in on $500 a share. So it's been quite a rollercoaster for Spotify shareholders

So if the valuation appears stretched, but you're still confident about the long-term outlook of a business, then it might be wise to hang on to it. But I think there's some businesses where a high valuation can actually signal that a very positive future lies ahead for that company, which makes it very difficult. So I look at someone like Dev Contisaria, who continues to hold a few businesses whose valuations appear stretched.

So I wouldn't say there's a hard rule. And in many cases, selling a great business tends to be a mistake over the long term. So the following clip is from my interview I had with Annie Duke. I wanted to get her insights on how we can close feedback loops for specifically long-term investments. Closing feedback loops in certain activities is easy when you get instant feedback, but we don't have that luxury if we're investing for the long term. So let's listen to her thoughts on closing feedback loops on long-term investing.

So I know that feedback loops are your obsession. So when I think about feedback loops myself, I think a lot about jujitsu, an activity that I'm very fond of. So the beautiful part about jujitsu is that feedback loops are pretty much instantaneous. I can try a new move or a new submission and instantly I know it works. My opponent taps or it doesn't work, they escape.

But obviously in investing, those feedback loops aren't instantaneous. You might make a decision today and you might not actually know if that decision was good or bad a couple of years out. So I'm really interested in knowing how do you best close feedback loops on decisions where the outcomes won't be clear for a few years?

I'm so excited that you asked me that because it's one of my favorite things to talk about. Two of my very long-term clients are venture firms. And they're both early stage. One is focused on seed. That's first round capital partners. I'm a special partner there. And then the other is focused more in the series B area. And that would be Renegade. Love them both. Prior to my working with them...

I had lots of... I was invited to talk to partners at a variety of different venture firms.

And they all kind of said two things to me, which I thought was interesting because I heard it echo through the whole industry. One is, well, you can't really close feedback loops appropriately in the way that you talk about in Thinking in Bets. So this was after Thinking in Bets came out where I talked, there's this obsession in Thinking in Bets about closing feedback loops. So you can't do that when there's power law, like when power law applies. And just for those people who might not know what power law is,

It's when you have a very small number of winners that win a ton, but most things die. So this should sound very much like venture. It's actually a little bit like social media where like 2% of the users are producing all of the content and everybody else is kind of quiet. You know, the power law applies in a variety of different places, but it definitely applies to venture.

And so their point was, well, if everything's dying and you only have a couple of winners, you could never tell anything about the quality of your decisions. And the second thing that they said was the feedback loops are too long. If you're investing at seed, it's going to be five or 10 years, really, before you get whatever the outcome is. I said the same thing to all of them. And it was only when I got to first round and to Renegade that they went, oh, I'm

Okay, I hear what you're saying. This is why I work with them.

And in particular, Renegade was new. Josh Koppelman was the one that I originally talked to who's the founder of First Round. And he's so tremendously successful. So I just want to give like a big shout out to him because somebody that successful doesn't need to be open to changing the way that they think about things, right? And very often aren't open. And he was completely open to changing the way that he was thinking about this. So let me tell you what I said to them, because this is the answer to your questions. I said, what do you mean the feedback loops are long?

And they said, what do you mean? We don't know if it exerts for... And I said, I'm sorry, do you invest in the company? And then you go to sleep like Rip Van Winkle. And 10 years later, you wake up and you find out what happened. When you invest in a company...

A couple of things are true. Two different categories of things are true, both of which allow you to close the feedback loop more quickly. Thing number one is that you actually know objective things about the company. You know whether ARR is growing. You know whether they're hiring top talent and retaining the top talent. You know whether they fund a Series A.

You know whether it's an up round, a flat round, a down round. You know what the quality of the syndicate is. Same thing for B, same thing for C. If you're, depending on the speed of the market, if you invest at seed, for example, you're going to know something very significant about that company between six and 16 months later. That sounds like a lot faster than 10 years.

The first thing that you know. The second thing, and this is true across all investing, is that you're investing in the company because you're making a particular bet. And the bet is your thesis. If it's in the market, you're saying, I think that I know something that the market doesn't know. Why do I know that that's what your thesis is? Because otherwise, you would be indexing the market. You're not indexing the market. So you're saying, I believe that the market has this mispriced

temporarily. I believe the market is efficient, but not every single moment. It's overall efficient. So I believe that at this moment, when it comes to this stock or whatever, this stock or this option, the market does not have this price efficiently.

So you have a thesis about why that is true. It's true when you're investing in a company. I believe that this market is going to be a great market to be in. This product is going to have a competitive advantage. They're going to execute in this particular way, so on and so forth. And those kinds of things, you can find out very quickly, even when you're investing in a seed stage company. You can see like, are they executing in the way that I thought they were? Is their product gaining traction?

Like so on and so forth. Right. So all of these things like, look, is it like poker or jujitsu where you're going to find out two seconds later?

No, but you're going to find out way more than 10 years. And that's what we're obsessed with, right? Is how are we thinking about the way that we can grade these companies as they develop, where we know things about the quality of the decision long before 10 years is up.

So Annie's response there reminded me of Bayesian analysis, which is essentially updating our view based on the new information we've received since we initially made the investment. So let's say you bought a company and you expected the earnings to grow by 15% per year. And in the first year, the earnings grow by half that amount. Then you would want to look at why that happened, whether you expected that as a possibility in the first place, and if you think earnings are going to pick back up to the amount you anticipated when

when first entering the position, as well as your probability of success and if that's changed based on the new information. So you might have a sort of how you view the future when you first enter the position. Inevitably, there's going to be times when the future doesn't play out how you thought. So how does your updated views change in light of that new information?

So Annie Duke just blew me away during our conversation. She's clearly a very deep thinker, specifically about decision-making and how we can all improve it. So I was kind of on the fence with this clip here because there was kind of two that I really liked, which was this one that I chose on closing feedback loops, but also about using kill criteria, which has been a big part of my learning in 2024 as well. So I ended up going with the feedback loop point here because I think it's just so crucial for long-term investors. It doesn't really matter what you're invested in

Understanding feedback loops is just going to help you determine if reality is congruent with your initial thesis. I also think Annie discusses feedback loops in relation to different time horizons. I found that incredibly helpful. So when I'm looking at a business that I own, I have some internal goals that I tend to want to see by a specific time point or a deadline. That deadline might be five years from now or maybe one year from now or three years from now.

And I think if we continue to be able to close these feedback loops on short timescales, it really improves the certainty that our long-term goals are going to be met. So let's say that we own a business that everyone here is going to be familiar with that Clay has already mentioned, which is Google. So let's say I have a hypothetical thesis on the business that it's going to double in market cap here over the next five years. So a lot can happen in that time. But what might some of the feedback loops look like? Perhaps we'd look at some of the revenue generators that have really started to kick in over the last few years. These are

Revenue generators include things like Google Cloud Revenue, the YouTube Ads Revenue, and Google Subscriptions. So let's say that we expect these three to continue adding value for the business. And maybe what we track from these segments is that they can continue growing at historical growth rates. And as long as they do that, then we should hopefully meet that long-term goal.

Another one that we might look at is just capital efficiency. Maybe we're going to demand that the returns on invested capital continue to rise maybe by small amounts each and every single year. There's so many ways to look at feedback loops. And if you really understand the business, hopefully you'll be able to come up with better insights than I could, especially in regards to Google there. But the hard part, I think, about feedback loops is knowing when you need to give something a little bit of leeway.

If you're demanding that a business year in, year out is going to just improve on a step-by-step basis, I think you're going to be very, very disappointed because that's just not how businesses tend to work. And you'll also need to understand if a business is faltering, are these long-term issues or short-term issues? Because I think what happens with a lot of the times in the market, they confuse the two. They think that short-term issues are long-term issues.

So this part on feedback loops, I think really goes well with the next clip that I want to share, which is about the cone of uncertainty, which is a concept that I learned from Nick Sleep and Kay Sicaria while researching for my solo episode on the Nomad Investment Partnerships. Let's listen in.

Now, I really liked how Nick and Zach weaved this concept of risk into certainty. They said that they spent a lot of time trying to find out if a business was doing what they thought was necessary to increase the probability of reaching a specific destination. I enjoy how they looped it into this concept that they called their cone of uncertainty. And once they found a business that was executing at a high level for extended periods, they felt that this cone of uncertainty would get smaller and smaller.

which resulted in two main things. One, a de-risking of the investment and two, an increased probability of reaching a good destination in the future.

And this is why I think eventually they just settled on three primary investments, which were Costco, Amazon, and Berkshire Hathaway. My guess is that those three businesses had the smallest cones of uncertainty out of anything that they own in the portfolio. Because of that, they allowed the positions to continue increasing in size, eventually making up a very large portion of the portfolio. Now, this is one concept that I'm starting to really appreciate as I spend more and more time researching other great investors.

One of my favorite recent examples was from my co-host William Green's interview with Bruce Berkowitz in Richer, Wiser, Happier 41. In that episode, Bruce Berkowitz discussed his conviction in St. Joe. St. Joe makes up an eye-popping 82% of Bruce's fair home funds. But it hasn't always been this way. It started at a 3% position and grew for a variety of reasons. And he's allowed it to grow due to his familiarity with the business.

It's pretty clear that once you understand a business at such a higher level than everyone else, then allowing it to grow is probably a very good strategy. I will say that getting to this point of understanding will require a lot of work and time. I don't think you can understand St. Joe like Bruce Berkowitz does in a very short period of time, even if you were to spend every waking moment thinking about it. The idea has to play out and you need to continue learning more, looking at different angles and coming up with views on the business that aren't widely shared by other investors.

It's evident today that Amazon and Costco are wonderful businesses, but I think Nick and Zach realized how wonderful they were a lot earlier than other investors. And they had the patience to allow their thesis to play out while making the decision to not remove these positions from their portfolio just because they thought they might've become optically expensive.

Certainty plays such a prominent role in investing. Robert Hagstrom has outlined four tenets that Buffett uses to find out whether a business would make a good or bad investment. So the first one is the certainty with which long-term economic characteristics of the business can be evaluated. The second one is the certainty with which management can be evaluated both as to its ability to realize the full potential of the business and to wisely employ its cash flows. The third point is

the certainty with which management can be counted on to channel the rewards from a business to the shareholders rather than itself. And the fourth point here is the purchase price of the business. So you're probably going to notice here that three of those four points have the word certainty in it. When you have a higher degree of certainty that an investment is going to work out for you, you're going to be just way more comfortable holding that business in your portfolio.

And I think that can help save you from panic selling during market turmoil, which I think is one of many, many investors' biggest mistakes. Certainty is something that investors, including myself, cherish, but there also is a downside to certainty. Since the market does crave this certainty, you'll also see that when a stock has a high degree of certainty of success, it's also going to have a high certainty that the stock price is going to skyrocket.

And this offers all sorts of new problems, like how long you should hold onto your business when it gets expensive, or how to deal with volatility, like Sleep and Zecaria had to deal with for a company such as Amazon. I think the cone of uncertainty is probably most valuable when determining position sizing. So let's say that you take a starter position in a business that you feel has many of the characteristics that Buffett just covered.

You start a small, let's say, you know, two, 3%. You own the company for a few quarters, talk to some more customers, more employees, suppliers, management, and you're starting to build more and more conviction in that business. Now there's going to be certain areas probably of that business where you might've had some uncertainty. And as you learn more of it, but more about the business, that uncertainty is going to get lower and lower. So you can say that your cone of uncertainty is starting to get smaller and smaller.

And as it closes, you might realize that you're very happy with the position that you have, or maybe you even want to increase the size of it. And I think that's really, really significant and useful data that can help you with your decision-making going forward. You can also do things like observe whether your cone of uncertainty is getting larger or smaller over time. If your cone of uncertainty is growing, that could signal that maybe the business isn't going as well as you thought, and maybe you should exit the position or go back and do more due diligence to help close any of the gaps in your thinking process.

As I've just developed as an investor and been a host of this show, I've gained a greater appreciation for business certainty. There's many great businesses out there whose future just isn't nearly as certain as other businesses. And big tech actually falls in this camp for many value investors. So I recall Joseph Shapochnik, he stated those four criteria that you mentioned related to Buffett, and he's implemented it into his own approach.

Both Joseph and Dev Contisaria have both mentioned to me on the show how some of these big tech players simply have an unpredictable future. If we look at Meta as an example, they're somewhat at the whims of Apple's policy on privacy, since their app is on countless Apple devices. Apple might limit Meta's ability to target their customers effectively through advertising.

Or for many of these players, there might be a lot of uncertainty related to AI and how that mega trend is going to be monetized. And I'm not sure how anyone could have owned meta in 2020, 2021, and been able to predict 37% revenue growth in 2021, 0% revenue growth in 2022, and 23% growth here in the trailing 12 months around 2024. So I guess the point is that

You can have a great business, but it still have an uncertain or unpredictable future. And certainty is really just all relative. So some great businesses like Meta can be painful to hold because the market's opinion on it can change drastically depending on what they're currently going through. And on the other hand, many businesses with more certainty embedded in the business can provide a smoother ride in terms of the shareholder returns for investors. Robert Leonard

We're going to end the episode here with a clip from Monish Paprai. This is from Stig's interview earlier in the year, and they're discussing the core principles that Monish lives by. So I'm going to take the liberty here and define a principle as something that's timeless and something that's similar across all cultures. If we use that definition, which principles do you live by and why do you live by those principles? Stig Brodersen

Well, I mean, I think that there are some principles that are very front and center, right? I mean, a lot of these become intertwined with mental models. So for example, like we talked about power versus force and the importance of truth and the importance of candor, right? So I think that becomes a very core principle. I think integrity, honesty,

trust. Basically, again, these are attributes that will make the world your oyster. So it's a huge advantage to be trustable. And being trustable is a long game. It's an infinite game. It doesn't happen overnight. And you have to be willing to play that long game to build the trust.

We had a high school intern at Pabrai Funds who would help us with the mailings and different things, sending books to stage and so on. And what my assistant told me is that he would say, I'm going to be there on Tuesday at three o'clock to work on stuff. And then he would not show up, right? Or he'd say, I'm coming Wednesday at this time, won't show up. Now, she said, when he does show up,

his performance is exceptional. When he says he's going to show up, it's a 60% probability that he's actually going to show up. And so I told her, I never talked to him, but I told her, look, Munger says that one of the most important traits is reliability, right? And I said that, unfortunately, this young person doesn't recognize how important it is to be reliable.

He can easily tell us I'm not available this week. We'd be fine with it. But why lead someone on, right? And Charlie says that one of the best educational institutes on the planet is McDonald's because McDonald's hires very young people. And one of the most important traits they learn at McDonald's

is reliability. Now, they're not like us in the sense that you tell your boss at McDonald's, you're going to show up at BPL and don't show up. By the second or third time you do that, you don't have a job. Even the second time you do that, you won't have a job. Reliability is extremely important for McDonald's because they will not be able to service their customers otherwise. And so the people, the young people who work there get that work ethic.

which is great. And I think that's why Jolly thinks that they do such a great job. So I think that these are, for the most part, the principles that carry the most weight are the most basic principles. Trust, reliability, integrity, honesty, truthfulness, hard work, diligence, fairness. People like to be treated fairly.

If there are people working for you, they really want to see that things are fair. And so these are just basic principles that you have to live by. If you don't do those, then in the end, you'll be the loser.

So I really liked that you picked this one, Clay, because if you hadn't, I definitely would have added this one myself. As I've reflected more and more on Monisha's points about reliability and trustworthiness, I think I've also just kind of began to understand how important it is for me. I think especially, you know, for me at least, when I was in my early 20s, I had friends that maybe were unreliable. You know, maybe they'd show up late for social events or not even show up at all. So when I was young, I would just write this off as one of their character traits.

But as I've kind of matured here and time has become more and more important to me, I've observed that I just don't have the time or patience to tolerate that type of behavior. So people who never matured out of being unreliable just don't have a prominent place in my life. That's the way it is.

And to his point on trustworthiness, I've never accepted that from people. If I had an inkling that someone wasn't trustworthy, I just wouldn't allow them to be part of my life. And I think this has done a fine job of keeping me out of those win-lose relationships. Now, circling this back to investing, an exercise that I've done while prepping for this episode was ranking some of the management teams that I own by who I trust the most in terms of management. I don't think any of the managers in my businesses are untrustworthy. Otherwise, I wouldn't invest in them in the first place. But

There are certain managers I have where I have more touch points with these specific management teams or maybe ones that I've spoken to more often. I tend to, I guess, gain trust more in those types of people. So for me, I'm just looking at what managers are doing and what they're saying and hoping that they're congruent with each other. And that's, I think, a really good way to see if a manager that you're investing in is trustworthy.

It's funny you mentioned that friend that might not be too trustworthy or reliable because it's just so disappointing to go through. And it's some of those experiences that you really never forget and it just tarnishes the relationship. And it can also be a good filter for who should be in your life, who makes it a point and who shows that being trustworthy and being reliable to you is important to them. So-

Robert Leonard : Yeah. I think most people make that pretty clear. And at the end of the day, being reliable and being trustworthy is something that is totally within our control. And it's interesting how you tied it into investing. I mentioned that Costco is top of mind since I had that episode coming up. And I've realized that Costco has really tied this into their DNA in terms of their culture and their business.

I had purchased some fruit from a local grocer, for example, and I was just disappointed that it just really wasn't that good. And I felt that I just didn't get my money's worth. And this made me just want to go to Costco because I realized that every time I go to Costco, it's always high quality. They're trustworthy. They're reliable. They always provide a consistent experience. Every time I go, I always get a good price. And in a world where uncertainty and a world that's just full of unreliable people,

it feels good to be able to rely on someone like Costco to provide a consistent experience. And Buffett, to no one's surprise, has also discussed the importance of being trustworthy. He had stated that over him and Charlie's 60 years of being friends and partners, Charlie never lied to him. And he wouldn't even tell a half lie or a quarter lie to try and stack the deck in the direction that he wanted.

And Stig also asked Monish in that interview why people don't follow these simple rules. And it's because the payoffs just don't come immediately. So it's easy to show up late to meet a friend or just not respond and not show up. And it's easy to fudge this quarter's earnings numbers and the shortcomings of such a short-term approach might not really be felt immediately. So it feels like a really easy thing to do.

Once you recognize the value of trustworthiness, the value of reliability, it's really easy to see why shareholders trust the likes of the most trustworthy brands in the world, the Costcos of the world, the Hermes, the Berkshire Hathaways of the world.

Yeah. I think you really nailed it on your point here with Costco and some of those other brands. Whether you're speaking about low cost providers like Costco or even luxury brands like Hermes, the concept of a brand has this degree of reliability, I think, embedded in it. And when you go there, you know what you're going to get. And that's a significant reason why I think these brands have these raving customers who keep on coming back. Clay, do you have any final thoughts for our audience here?

Yeah. I'd say that a lot of the hosts brought in some really interesting guests for 2024. When I look back at my episodes, I really enjoyed my discussions with Chris Mayer, Morgan Housel, Francois Rochon, Dev Kantasaria, and Derek Pilecki. I know I'm missing some other amazing guests, so please forgive me if you're tuning in here. I'd like to extend a special thank you just to all of our loyal listeners. I continue to be surprised by the number of people

who have been with us since 2015, 2018, 2021, and still listen to us today after all these years and all that's changed in the markets with value investing and with TIP. And I've just had such a pleasure being able to meet many of the members in the audience, both at various events we host or the events we host for our TIP Mastermind community in Omaha and New York City that we hosted this year.

which has also just been another amazing experience for me as a host here. It's just having the opportunity to connect and network with so many amazing people in our audience. And we have community members, for example, all over the world. So I'm actually recording here in Austin, Texas. And next week, I'll be grabbing lunch with a member of our group who's based in Houston. So just having the opportunity to connect with these people in person at our events or whether I'm traveling or whatnot is just...

Really amazing, to be honest. And with many of our members who travel a lot, they have an opportunity to connect with others in the US or Europe or even Canada too. So I think I'll leave it at that and just extend a special thank you to our loyal listeners and anyone who puts trust in us hosts and being a part of the community.

Yeah. And I'd also like to say thank you to our loyal listeners. It's pretty incredible, the quality of people that listen to our show. And so, you know, thank you for continuing to listen to our show and hopefully we can continue providing a lot of value for you here. And, you know, some of my just last takeaways here I want to share are the impact that the mastermind community has had on me. It's been wonderful to be a part of. I've thoroughly enjoyed it and meeting so many very, very interesting people. And another one of my biggest reflections has come

from being part of the Richer, Wiser, Happier Masterclass, which I helped William Green create. So one thing I've really noticed from being part of that masterclass is that I'm just surrounded by so many high quality people. It's pretty crazy. And I think that because I'm surrounded, it's really affected me in multiple areas of my life that I'm so grateful for. It's things like being more selective with who I spend time with,

And then just thinking deeper and deeper about subjects that I really want to learn about. And I think that I've learned a lot of this from just having super rich and deep conversations with other members of the masterclass. So if, you know, if there's a takeaway that I want to share with you from 2024,

It's find a way to surround yourself with people who can truly lift you up and make you better. We truly are the product of the five people that we spend the most time with. And that's all I have for you today. Clay, thank you so much for sharing some of your biggest takeaways from 2024 with me and the audience. It's been a fun journey with you, Kyle. Thanks for inviting me. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes.

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