Scott Reardon - Study The Greats
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[The Business Brew theme]
Bill: Ladies and gentlemen, welcome to The Business Brew. I'm your host, Bill Brewster. This episode features Scott Reardon. I've known Scott for a while. I met him through Toby Carlisle and Jake Taylor. Somebody pinged me and they said, "Hey, you should interview Scott Reardon," and I thought self, "That dude is right. I totally should interview Scott Reardon." And I pinged Scott, and we got to talking, and he shared some papers that he has written. He's studied the greatest investors, and then he did one on Cyclicality Markets and Life, I will drop both those in the show notes. It's a very interesting conversation. I had a good time. That said, I had to record it twice, because I messed up the first one, but I'm not perfect. Anyway, as far as the cadence goes, I am going to try to do weekly shows. There's going to be times that I can't get it out. I don't want to force episodes upon you that I would not want to listen to. I don't want to get in this cadence where I get jammed up and then I'm releasing something that I don't like. And I don't really like the idea of having a backlog, because I think that some of the conversations get stale. I'm going to ask you to bear with me a little bit on the release cadence. I'll do my best. But this dude's got a lot going on in life right now and sometimes, getting the pod done just isn't quite the top priority. But I appreciate you all as listeners and I do want to get stuff out in a regular and timely manner. As always, nothing that you hear in this program is investment advice. You should consult your own financial adviser. Do your own due diligence. This is for entertainment purposes only. Assume I know nothing and enjoy the show. Thanks for listening. Oh, PS. I'm probably going to drop some Spotify ads in the show. Hit me up @billbrewstertbb on the Twitter machine to let me know your feedback on whether or not the ads were disruptive to your experience, whether or not you found them targeted. I'm interested in using this as a group learning exercise. Spotify says that they have some good ad solutions. Call me skeptical, but I want to try it and I'd love to hear your feedback. All right. Enjoy the show. Ladies and gentlemen, welcome to The Business Brew. Thrilled to be joined by Scott Reardon. Not Scott Pearson. I don't know what I was thinking there. So, we were just talking about offline. You finished your fifth novel?
Scott: Yeah, I just finished it a couple of weeks ago and then I feel I can do absolutely nothing. I'm just totally drained. And then, you reached out to me, and I was like, "This is perfect."
Bill: I reached out to you for a second time.
Scott: You reached out to me for Season 10.
Bill: The first time, I ruined the conversation. So, I apologize to you, even though, apparently, you didn't think so.
Scott: I enjoyed it. I had a great time. I was psyched. I went downstairs afterwards, and my in-laws were here, and I had a couple of cocktails. It's the first time I'd ever been on a podcast. I was excited.
Bill: Well, here's the second, but it's technically going to be the first.
Scott: And as I told you, I'll be on here as much as you'll have me.
Bill: Well, I'll have you a lot. I don't know what the issue was. My mind, I had a lot of disjointed thoughts. My wife and I were listening to it in the car and she was like, "You didn't finish many sentences here." So, [crosstalk] that.
Scott: I was struggling, too. I didn't want to admit it. But I hadn't slept the night before. There was some issue with one of my kids. And then, we had a cocktail. And normally, when I have the cocktail, I feel great. I feel like myself.
Bill: Yeah.
Scott: I just feel wonderful. But that time, I just felt a little bit blank.
Bill: Well, there you go. So, now, neither of us are blank-
Scott: No.
Bill: -and today I'm drinking water as opposed to Bourbon.
Scott: I'm drinking water as well.
Bill: We've got that going for us.
Scott: Yeah.
Bill: This may go better.
Scott: I thought the last time went fine, but I hope it goes even better.
Bill: Yeah. I don't know what it was. I think when I was listening to it, I'm reading the psychology of intelligence analysis and thinking in bets, and I'm caught up on my own perception of reality versus reality, and how I don't think that I perceive reality as reality or whatever. There was just a lot of weird conversation when I listened to it, but I'm glad that you enjoyed it. I enjoyed it, too. I always enjoy talking to you. So, hopefully, people enjoy the listening experience of this conversation.
Scott: Yeah, I hope so. Actually, for people at home, Bill and I used to go to investment conferences together before COVID with Jake Taylor and sometimes, Toby Carlisle. And it's given us a chance to reconnect.
Bill: We met through Toby, right?
Scott: Yeah. We [crosstalk] at the--
Bill: Because you and Toby is used to talk a lot or still do. But that's how I think that I met you.
Scott: Toby. And I lived together in LA for years. I saw Toby more than anyone else other than my wife. We used to hang out all the time.
Bill: And then you move to the East Coast.
Scott: And then I moved to the East Coast. Well, then he had kids. He had kids first. And then, that started to make things more difficult. And then he moved out of Santa Monica and then I moved.
Bill: Yeah, kids will do this.
Scott: Yeah. But we did a good thing for a while. It was a lot of fun.
Bill: Did you guys do research together when you were hanging out? How'd you guys meet?
Scott: Ah, we met through Chuck Gilman. I was working for Chuck and Chuck wants to meet everybody. Chuck does proxy battles. And so, he wants ideas. And so, we met Toby. And as soon as I met Toby, I was like, "Oh, this guy's going to be my friend." And he and I wound up hanging out twice a week for five years or something like that.
Bill: So, did you do stuff with Chuck?
Scott: Yeah, I worked for Chuck.
Bill: I should know this.
Scott: No, no, don't worry about it. My first job in finance was for Chuck Gillman and Ken Shubin Stein. I used to be an attorney, and I hated it and sucked at it, and I loved investing for a long time, and I wound up getting a fellowship at Columbia Business School as a research assistant. And this was back when there wasn't enough work for law firm associates. And so, they'd offer you a fellowship and they give you 60 grand to go work somewhere else for a year and I jumped on that. Yeah, and I went over there worked for Ken, and then he and Chuck wound up hiring me and I worked for them for two years.
Bill: Ah, that's awesome. So, were you doing proxy battles with them?
Scott: I didn't actually get to do one, but I was sourcing them for them, and doing investment analysis, and all that.
Bill: Yeah. Chuck reaches out occasionally. I think he's a listener of the show. Shoutout to you, Chuck. Hello.
Scott: Yeah, Chuck's a good guy. I love Chuck. He's a very intense guy, but he's a good guy.
Bill: Yeah, I first met him at Berkshire a while back. And then, he always stays in touch. He's good at pinging you and saying, "Hey, let's hop on the phone and chat."
Scott: He has a huge infrastructure that makes that happen.
Bill: Yeah, well, it's a smart way to do things. That's how you can make sure it happens. So, then after Chuck, what was your investment journey like?
Scott: Well, then I started a fund, a deep value quantitative strategy. Then from there, I actually wound up creating another strategy, that's our flagship strategy right now, which is not quantitative, but it's very-- I think of it as systematic, but a lot of it involves non-quantitative factors.
Bill: How do you do that? When you say non-quantitative, I'm hearing qualitative. But what does that look like?
Scott: Yeah, first of all, we want to create-- When you have a quant strategy, you want to have the fewest rules possible. Because the more rules you have, the less robust it is, and the more likely it is that it's been corrected. And actually, that applies to anything. I really admired how Robert Vinall. He does the same thing as a quant does. He has this investment checklist, and he tries to make it as short as possible. I thought that was just brilliant. I loved how systematic that was. And so, we did the same thing. The first thing we look at is pay offs. We want something where we think it's worth at least 100% more than where it's trading right now. And ideally, more like something where we could make three times our money in three years. And obviously, we're not going to hit that every time, but that's what we're trying to find. And then the second thing would be, we want things that are in oligopolies, or duopolies, or that have high market share in a fragmented market. And then third thing would be something that where it's has very low obsolescence risk, where I can really-- If I had to stand before a judge and say, "This company will exist in 10 years," I would be telling the truth and it would be likely to be true. Factors like that and we try to really stay true to them and occasionally you have to relax one rule over another, but that's what we're trying to do and really faithfully execute it, But to me, it's a quantitative approach to something that's not quantitative at all.
Bill: Where does the quantitative part come in? Just because I'm hearing you talk about industry structure, relative scale advantages, obsolescence risk, reduction of obsolescence risk, none of that is quantitative. So, outside of the payoff structure, how do you quantify some of these factors that you're discussing?
Scott: We don't we don't really do it. But I guess, I think of it as quantitative in the sense that it's systematic.
Bill: Okay.
Scott: I think that's the power of quantitative models and things like that is that they're very systematic and you're really trying to stay true to some principle. And so, we're trying to use that. But we think there's a large a deeper reality than can be captured by numbers and quant. But we're trying to use that discipline to really try to get the best of both worlds.
Bill: How do you think through staying disciplined, but also having a short checklist? Because one of the things that I've thought about with a checklist, that's a little bit difficult is, my perception sometimes it's like, if you want to be very systematic about something, "The checklist almost has to be insanely long." But just to say, "No, that doesn't belong here. Yes, it does or whatever." How do you focus in on those few key variables and how long do you think it takes to get to the point where you can?
Scott: Well, I guess, what really inspired a lot of it was we've put together a database of the greatest investors in history. We found 85 people who have 20 plus year track records, and they outperform by more than two and a half percent a year on average for that time period. So, really pretty stellar track records over market cycles. When I looked at what those people were doing, first of all, they're overwhelmingly value investors. 66% of those people are value investors, which is a pretty incredible thing. Because only 5% of financial assets worldwide are managed by True Value investors. Out of that tiny 5%, you get 66% of the greatest, so that value's very overrepresented, which suggests how powerful it is. But when we looked at what they were doing, we just studied everything we could about these people, and they tended to have very short checklists. They didn't weren't trying to hit 10 things. They're trying to hit one or two things. Not one, two or three things.
Bill: Was there a commonality with the two or three things that they were looking for? Did it look different depending on the investment strategy?
Scott: Well, just looking at the value people that 66% of the total, the value people, I think the number one thing that jumped out is they were looking for things with big payoffs. Whether that's higher returns or looking for something that's going to return 20% a year and definitely versus the market on average returns 8% to 10% a year. They were looking for something where it's double the return stream of the market or they were looking for something where it's worth 50% to 100% more, at least. What's striking about that is that it's so different from say-- You read a lot of stuff that mutual funds put out and they do not target big payoffs like that. Not even close.
Bill: What do they tend to target?
Scott: Well, there's really two portfolios within each mutual fund. It's interesting. C. Thomas Howard has done an interesting study on them. And basically, if you look at the top 10 holdings of the average mutual fund, they outperform the market by 4% a year. This idea that mutual fund managers aren't talented isn't true. They're actually very talented. But that's just the top 10 holdings. Once you get out of that they typically hold 50% to 100 things. So, they're just blowing up their portfolios with garbage.
Bill: Huh?
Scott: Yeah, that's why they don't outperform. They're smart people but they're just using asset bloat to make as much money as possible.
Bill: Hmm. Yeah, that makes sense. And then they're diversifying the potential for outperformance in favor of not basically not taking career risk, right?
Scott: Exactly.
Bill: Because if they don't-- Yeah.
Scott: Yeah, it's interesting.
Bill: Interesting.
Scott: It's interesting. It's a flawed model. I think it's a broken model, because basically, their whole incentive is to run to have the least amount of alpha necessary to keep you as a client.
Bill: Hmm. Yeah.
Scott: And so, basically, you're giving them money in exchange, they get lifetime employment from you. That's the hope.
Bill: Yeah.
Scott: Your interests aren't really aligned.
Bill: Yeah, I've thought about in the past. Even Charlie, who I think we'd agree is one of the greatest ever. Let's forget about what he is now and let's rewind to when he's starting his funds. Could I have actually stomached that volatility with him at that time not knowing he would become one of the greatest? I don't know what my answer is. I think I'd like to say yes, but I'm not sure that I believe that.
Scott: Yeah, I see the same way. It's funny. People talk about how irrational clients are, where they'll look at the best mutual funds over a 10-year period, and the average client in it loses money.
Bill: Yeah.
Scott: And people are like, "Oh, well, clients are stupid." And certainly, some of them are. But the fact is, there's just a huge disconnect in terms of trust.
Bill: Yes.
Scott: And so, it's this situation where they can't trust you. And so, they can't be long-term investors, because things change. People change their strategies. All sorts of stuff happen in mutual fund land. So, trust issue almost makes people do things that are stupid.
Bill: Yeah. I think it's funny. It's not limited to money management. I think that it happens a lot with companies and often the trust is tested when the performance goes against you. It's like, "Oh, boy, well, now, did I really know what I thought I knew?" You hit that point where you're forced to look in the mirror and say, "Do I know what I own?" And I think that's the same for a manager. Do I know why I actually hired this person, and do I actually believe that they can get through this?
Scott: Yeah, it's so hard to find. That's one of the reasons why we put together this database is, is we wanted to study these people as people. When you read their investor letters or their interviews, you see that these are people who are walking through the fire, and this is their lives. They're into this stuff.
Bill: Yeah.
Scott: You take someone like Seth Klarman, he said something in an interview once that really struck me and made me realize just how passionate and thoughtful this guy was, where he was saying, he felt that Graham and Dodd were sentinels watching us all and seeing whether we could live up to the principles they'd handed down. That's a guy who feels that he's executing a calling.
Bill: Yeah.
Scott: That isn't someone just trying to get rich or play the market. That's a different game.
Bill: Yeah.
Scott: And a completely different level of commitment. It's beautiful.
Bill: What were some of your big takeaways from the study? When we had spoken previously, you told me that there were basically two strategies, if I could summarize it. One was a deeper value, maybe less predictable business and the other was focusing on more predictable return streams. Is that fair or am I butchering that?
Scott: Yeah. Well, we noticed within the value investors, that there seemed to be two types. It's what a lot of people think. There were ones who bought high-quality things that were inevitable and they're these islands of sameness in the ocean of change that you see in the world. And then the second type were the deep value people. It's interesting, probably, only 1% to 2% of assets are managed by deep value investors. It's a deeply unpopular strategy. And yet, they're 33% of the greatest investors in history. They're vastly overrepresented among the greatest investors. And with them, you see that their payoff pounds. They're like, "It doesn't matter what you buy. It's the price you get it up."
Bill: Yeah.
Scott: That said, I noticed the best deep value investors cared quite a bit about quality, but they were willing to go into some really ugly situations to get it. Like the Chandler Brothers, I think, are the greatest deep value investors in history. They've made 37% a year for 20 years.
Bill: Wow.
Scott: Yeah. I believe it was a $10 million into $1 billion or 2 billion in 20 years. You can see from their filings that they actually have the money. They weren't running a fund. They were investing their own money. What they buy today, they'll buy a $300 million position in a company. It's one of 20 things they own. But they had a strategy that was very interesting because it married the two different schools of value just to the extreme, where they would-- Basically, their strategy was, go around the world and figure out where can I buy a country's crown jewel assets at one, two, three times earnings. And so, they bought Japanese banks after the Recession in 2001. They didn't even have earnings. It was just a disaster. But they bought it at basically two or three times normalized earnings and they made four times their money in a few years. But they would do that in several different places. They went into Russia at one point, they bought telecom assets in Brazil. So, it's very interesting.
Bill: It sounds like for countries that might be having problems or trading it depressed valuations, because of whatever reason. But then, they were looking for the highest quality assets within that beaten down market?
Scott: Yeah, exactly. And they wanted large stuff. It's very interesting. There's this bias today towards small cap and even micro-cap, where people think, "That's really the only place you can get alpha." And I used to think that back when I was working for Chuck and Ken. And I realized by looking at a lot of these great investors that that's not the case at all. In fact, if you're willing to leave the United States, a lot of times the best thing to buy is the biggest companies. Because they're the safest, they're the highest percentage. Gazprom in Russia isn't going anywhere. What I invest in Russia today? I don't know. But the biggest telecom operator in Brazil isn't going anywhere. The Japanese banks aren't going anywhere. They're just investing in these things that are huge and powerful. And in fact, I think a lot of the greatest investors, when you look at their past investments, I was shocked. That's why in our own strategy, we started focusing on oligopolies and duopolies and things with high market share, because I noticed a lot of these great investors, they would buy large caps, blue chips, and things like that when they gotten crushed. The thinking was, it's easy to know, this is something-- Will it be missed? Absolutely, if this thing didn't exist to be a disaster.
Bill: Yeah, that makes sense. You're taking the probability of zero off the table, I think, if you're focusing on the most important assets. Maybe you're actually truly limiting your downside to-- Sometimes, if there's a probability of zero, the only way to limit that is by position sizing. But then maybe you're not able to optimally bet your stack.
Scott: Yeah, exactly. You're really reducing that business risk. In exchange, you have to take more country risk. There's really that risk in some of these countries that they might confiscate your shares.
Bill: Yeah.
Scott: That's not some airy-fairy thing. In these countries, it's very low percentage, but it's such a scary thing that it tends to depress the values and in some cases, you can create incredible opportunities.
Bill: Yeah, that's wild. What were some of your other favorite investors?
Scott: [crosstalk]
Bill: Just real quick to close the loop on the Chandler Brothers. Didn't you say they were down like 70% on a position and they were just like, "No, we're right. We're keeping it."
Scott: This is my favorite investment of theirs. This is why I love them. Because they're not like anyone else I know. They bought Gazprom, I believe it was. They put in, I think, a billion dollars into it, which was something like half their net worth. It might have even been more. And it went down 70%. And the guy, Richard Chandler said to himself, "I could just say I was wrong, but I just don't feel I'm wrong. I just don't think I did anything wrong. I think my analysis of the company is right. The price just changed." I think that's so different from a lot of investors today who would be humble. They'd say, "Oh, I realized my mistake and moved on." Whereas this guy didn't. He just dug in without being arrogant. And he dug in and he wound up going back up and basically, he got back to even, which is a huge win.
Bill: Yeah, especially from down 70.
Scott: Yeah. I think that was their greatest investment. And frankly, even with their investment in Brazil in the telecom operator there, they bought, that stock crashed, and they basically lobbied the Brazilian government. This is in the 90s to invest in the company. And the Brazilian government said, "Okay, you can do it." They put in whatever it is they put in $100 million or something. It went down, I think, another 40% or 60%. So, these guys invested in stuff that you almost couldn't run a fund doing this.
Bill: Yeah, you would get redemptions.
Scott: Yeah. You get death threats.
Bill: [laughs] Yeah, that's interesting, man. How many of the deep value people have had some element of control or the ability to influence an outcome? For example, they lobbied the government, right? I think of Buffett as a younger investor building these stakes in companies and drawing the line on the wall and saying, "You got to get inventory below this line." He was not a passive deep value investor that was just waiting for the market to become a weighing machine. He created a lot of catalysts. Is that something that you saw as a commonality?
Scott: In my experience, they were doing almost nothing to influence operations. In the case of the Chandlers, if they could get it, they would want a seat on the board. But they really weren't doing much beyond governance. Meaning, wanting to make sure there was good corporate governance. And among the others, I saw almost nothing, where someone was getting activist was something or even getting actively involved in the operations of the business or anything like that. I was surprised.
Bill: Yeah, that is surprising. It requires a real belief that the weighing machine will work. One of the things that I have wondered a little bit about value as a factor, especially among smaller companies is, with private equity everywhere now, at least in the US and likely going worldwide, have some of these leftovers. Why is the company leftover is the question that I am asking myself more and more as I look at some of the cheaper, smaller things. It's like, "I have to think." The rebuttable presumption to me is almost that it's been diligence, if it's under call it a billion dollars.
Scott: Yeah, I get that. That's certainly a concern. Frankly, a lot of the stuff we see that smaller has been owned by private equity or they tried to own it.
Bill: Yeah.
Scott: It's interesting. It's just been churned. But that's the smaller stuff.
Bill: Yeah. I was having a conversation with somebody, who focuses on smaller, I think. Well, I know, but he said, "If you really want to focus on smaller, maybe start at a $1 billion or $2 billion and don't go real small, because the return on brain drain is probably not worth what you think you're getting in opportunity." He said, "There's plenty of inefficiency in that billion-dollar range and they're real businesses."
Scott: Yeah. I think that's great advice. When I first started investing the place where I got burned, the worst was in micro-caps.
Bill: Yeah. Easy to buy, hard to sell.
Scott: Oh, yeah. I've never forgot it. The worst investments I've ever made were in micro-caps. And frankly, something that I'm a little embarrassed to cop to now, but at one point, when Kombucha got really hot, I almost bought some shares and reads, which made Kombucha. There's this whole thing. There were writeups on Value Investors Club. Everyone was like, "Kombucha, it's this new thing." And guess what, a lot of these companies are trading at value prices. I wound up speaking to a friend, and he had looked at it, too, and he was he talked me out of it, but it's just been a disaster. Looking back on it now, it's such a stupid idea.
Bill: I don't know--
Scott: I don’t even know what I was thinking.
Bill: Beverage is very sexy. Beverage is something that when it works, it can work in a big way. And Celsius is probably the current beverage. But I had a successful investment in national beverage following a short report there. It's interesting. They've got high margins, there's a real takeout potential by some of the big guys. I could see it.
Scott: Yeah, I'm glad-- [crosstalk]
Bill: How did you approach the conversation with your friend with an open mind? Because sometimes that's hard if you like an idea to discuss it with somebody and be open-minded enough to say, "You know what, this person's got a legitimate point. I should stay away from this."
Scott: Well, I was 100% receptive to what he was saying. The other thing is, he makes a good point. He's never seen a micro-cap actually fulfill its promise and become a mid-cap or large cap. That's what everyone's always all about. They're like, "Oh, no, this thing's going to be big." It never happens.
Bill: I got to look at Expel. Expel has done a good job, at least on a market cap basis. But yeah, I think it's definitely the rare bird that does that.
Scott: It is vanishingly rare. I don't know, it's something that just seems to incinerate people's capital. We don't invest in stuff typically that size, unless there's something really special about the business.
Bill: I think something about the allure of small caps is, it's one of those things that should make sense that they can grow a lot, right? You get yourself law of large numbers, what's the base rate, the big winners can come from this. But I think the base rate of really bad outcomes is quite high relative to the larger stuff also.
Scott: It's really high. It's really high. And a lot of the people involved with them too are a mess.
Bill: Yeah.
Scott: You get some of these CEOs running their fiefdom and some of them are just nuts with the micro-caps. It's a completely different world.
Bill: Yeah. And then you've got this situation, where you're relying on somebody, it's weird to have a micro-cap in the first place, just in general.
Scott: Yeah. Why are you tapping the capital markets?
Bill: Yeah.
Scott: It's very odd.
Bill: Yeah, you need some good answers to these questions.
Scott: And there usually aren't good answers.
Bill: Yeah. Well, I think-- I guess, that goes to a little bit of what I was trying to get at. I think people see good answers, because they want to believe they're good answers there, but not because they're actually good answers. Does that make sense?
Scott: Oh, yeah.
Bill: Yeah, it's the allure of getting rich, I think
Scott: It's funny on value investors club, which has all these people who are very sober, serious people. I've noticed that every once in a while, every few years, someone posts something where it's this company, this microcap has just created a new, nonnutritive sweetener and they're about to sign something with Pepsi or something like that, where there's some story, and it gets some really high rating, and a huge number of ratings, and people pile into this thing, and the stock shoots up, and it's all these sober value investors. And then what inevitably happens is that the person who originally posted the idea gets so much shit from other people as it does not work out as the story slowly deflates that they never post on the site again.
Bill: [laughs]
Scott: This repeating phenomenon.
Bill: I can understand that. I can understand that.
Scott: But it's almost just ignoring the money and everything. It's really you're betting parts of your life getting involved so wrapped up in this stuff. But it turns so ugly and bitter. It's not worth it.
Bill: Well, I think part of the issue, too, is with the microcap area of the market, there is no liquidity when it goes wrong.
Scott: Yeah.
Bill: So, people are truly trapped and screwed, whereas at least, if you're pitching something like Netflix and it goes wrong, anyone at any reasonable size can get out quickly. It's micro-cap's not that game.
Scott: Yeah, it really isn't advantage in business just to have scale to be big.
Bill: Yeah.
Scott: It's funny. It's such a simple thing, but it's huge. It's huge. You can even see it. We've invested in a company that does aseptic packaging and they're the third biggest player. If you look at the second biggest player, which is a public company, they've just got far better margins. And no one knows what the margins are of the top player, but they've got to be incredible. But those scale economics are so hard to be.
Bill: Yeah. I spend a decent amount of time thinking about media, but you look at Netflix and-- I just brought it up, but it's interesting to see Warner Brothers is now pivoting and they're going to pursue a different strategy. There may be a world where Netflix has a real relative scale advantage. I don't know. We'll see. There's a lot of alternative worlds that exist what I've been working on seeing as I used to think that Netflix would inevitably have that dominant position. And what I'm trying to get myself to realize is, that was the first lens that I used to look at things through. What does that lens make me blind to today that could cause me to miss a world where Apple and Amazon actually do have scale or Warner Brothers, and NBC, and Paramount are end up merging and now, you have an oligopoly, but it's got relatively low barriers to entry, maybe big barriers to distribution? I don't know. But what I'm going through is, just trying to remind myself that the original lens that I saw something through is going to color the lens, I see something today through it and how to avoid that analysis. I think maybe the answer is, you wait until it all shakes out. And then maybe you make a little less return, but your return stream is more defined.
Scott: Well, taking Netflix as an example. Is that something that you've done a lot of work on? Is that something you're considering owning at these prices?
Bill: I would be open to owning it at these prices. Yeah. I don't know. I'm a little uncertain on the payoff risk reward structure.
Scott: Yeah.
Bill: Yeah. I think look, it's obviously better down here than it was at $600 a share. But yeah,
Scott: Netflix for me is one of those things where it's just-- I haven't done a ton of research on it, but when it crashed, I looked at it and it's just surprising to me that their free cash flow is so low given just how much market share they have and how dominant they are. I don't know their exact market share, but just their mind share is so big and yet, they seem your content costs are so big that they just can't get positive free cash flow.
Bill: Yeah, I guess that one of the biases that I think about this through is, I would just say, yet. And I think that when you're rewarded for doing something in the market which is driving sub growth, I don't know how many internal conversations you're having about cost. And now, they've got a large recurring revenue top line base. And now, maybe cost matters and I think that's an easier problem to solve than it is to get to that top line.
Scott: But it's interesting, because Uber is in a similar situation, where they obviously haven't turned a profit. But they occupy a very easy part of the ecosystem in terms of getting a ride and all that. They're doing the easiest part. The software is the easiest part. And it would seem they should be making a huge amount of money and they're not. But if they ever figure it out, it seems it would basically be a value stock.
Bill: Yeah, I need to figure out more about that company. There's one investor that I know that I have a lot of respect for that's long that and I should probably get more curious about why. Sometimes, they get bogged down and just covering the same stuff over and over again. I think that, one, I guess, it provides a sense of comfort, but I think the downside is, I miss a lot of potential other things. Obviously, there's a tradeoff and how you allocate your time. But I don't know that the next piece of news on whatever content strategy paramount is pursuing. The marginal benefit to my life of covering that I think is pretty low relative to trying to figure out stuff like, what's going on at Uber and being able to zoom out more and saying, like, "That's not even an industry I really want to mess with right now. This is an industry I do." How many in your-- And maybe the answer is none. But how many investors that were really good were focused on consolidating industries? That's something that I see Buffett and Munger talk about a lot.
Scott: I didn't find it a lot, but it did seem people wanted higher market share. That was a big thing. They wanted those solidify entrenched players in the industry. That came out, I didn't find a lot specifically on consolidating. It was also tough to find that level of granularity for a lot of these people. Some of them lived in the 1930s and 1940s or 1950s and 1960s and the language people use today to describe investments is so much more sophisticated and rich than it used to be.
Bill: Yeah.
Scott: There's so many people who know so much about investing right now. People talk about it in a much richer way. You even look at investment write ups from 20 years ago and they're shorter and more succinct, but they're just far less intellectually dense than you see today.
Bill: Yeah.
Scott: It's a different world.
Bill: You know what I think is interesting is, I was reading-- Gosh, I think it was an old-- Well, I guess, it was only like six years old, the Graham-and-Doddsville. Maybe it was only five. I don't know. But they were talking about credit acceptance, which I know is-- Oh, yeah, it's a subprime lender for cars for those that don't know and it's very controversial shorts have gone after it a number of times. I've talked to financial investment like an investment banker that covered financial entities and he was like, "I know the results are incredible, but I can't figure out how they do it." But that's a company that over the years as you read the pitches, they really haven't changed and yet the returns of the stock are quite good. It's almost like, I don't know, it's some of these businesses are truly endowed with winning.
Scott: Yeah. That's an interesting business. And to the banker's point, we actually owned it years ago. I would run through a sample loan for them, and I couldn't square the economics. I could not square it. I wound up connecting with somebody who walked me through it and I'd be happy to send it to you, but he helped me figure it out. I actually think that it does make sense. Just looking at the average loan level that the economics do square. I was thinking they were somehow screwing over the dealers, or something wasn't making sense. But I don't know, this guy helped me and was the only reason I was able to figure it out and we wound up buying it and it was a decent investment for us.
Bill: Yeah, it's an interesting space. I don't know. I had a conversation with Tyrone V. Ross, when this podcast started, and I used to have such a natural aversion to subprime. And now, I guess, how I would say it is, it's a shame that it has to exist but it does have to exist. If it didn't exist, there's a larger shame out there, I think that's reality. So, it's one of those unfortunate consequences of life.
Scott: I feel the same way about the company. I've been torn. Are these people actually helping people who are lower income? Are they being pretty rough with them? Because a lot of the stuff, they have key locks and stuff like that on the car. That's pretty ugly stuff.
Bill: Yeah.
Scott: And yet, at the same time, the company was founded because certain people just couldn't get a car. They couldn't get to work. They couldn't function.
Bill: Yeah. If you don't have the keylock, then what are your loss ratios actually look like and then what are the interest rates have to be to the person that does want to make the payments back? I don't know. The older I get, the more I realized there's a lot of gray area in life that I used to think I had answers. Now, all I have is questions.
Scott: I don't know about you morally. Now, that I'm middle aged, I'm exhausted.
Bill: Yes. I'm super apathetic to a lot of moral debates, which makes me feel horrible to say out loud. But I used to have strong opinions. And the more that I've learned, the less strong my opinions have gotten.
Scott: That's how I feel, too. I feel I've just hit a point, where I don't know anything anymore, almost. You see these pat answers to things, and you just see how much it falls short. The stuff is so complicated and hard. I don't know what it is. I really do feel when so many of your cherished beliefs have not panned out the way you thought they would and all these things that you thought were true, or maybe half true. it really, I don't know, it strikes at something deep in you and you just wonder, "What is true out there?"
Bill: Yeah.
Scott: It's very hard.
Bill: Well, I think what is true is thinking in terms of probabilities and rather than being certain that subprime lending is bad, maybe training my myself to say, "Look, I am almost never going to be more than 70% sure of anything." So, if I say, "I'm 90% sure," that's really about 65% sure or 63% sure." So, my highest degree of confidence on anything is 55% to 63%, which is a sad way to live, [laughs] because it leads to boring conversations. But I used to think I like new things and I just don't know that I knew anything.
Scott: That's how I feel. I guess, on the one hand, it's exhausting and it's difficult, but I feel there's something good at the end of that.
Bill: Yeah.
Scott: I think when you look at someone's life, people who have such certainty and such big hopes and dreams when they're younger, and there's now all these statistics out on human happiness across a person's life. And people are the most unhappy in their 40s.
Bill: Well, that's because they have no time to themselves. That's what I'm convinced of. [laughs]
Scott: I think that's a big part of it. I think the other thing, though, is as a young person, you set the bar so high that it could never pass over that bar. Your expectations are, it's almost a tyranny how high they are.
Bill: Yeah.
Scott: And I think when you go into middle age, they come down and that's very painful. It's so painful to have them come down. But then I think, when you come out of that, I think you have a more realistic view of things and you're more appreciative of what you do have. I think there's some almost like, you're just burning stuff away and a fire and what's leftover is the good stuff.
Bill: Hmm. I like how you said that. When I was talking to William Green, and he had mentioned-- I forget how the story goes. I think this the second time I bring it up on a pod and he brought it up. But these great investors, they ended up having these personal lives that were in shambles or, if not. I shouldn't say in shambles, but I don't think that people would want their personal life. If you asked a young person, "Do you want to raise your family this way?" They're not going to say yes. I just I said that I'm only 70% sure of anything. I'm 90% sure that the time that I put in with my family, I'm not going to regret, and I am 80% sure that if I have to live in a smaller house, down the road because of it, I'm going to be okay with that. I'm somewhere between 80 and 90% sure that my kids aren't going to blame me for that decision. So, I guess, that I used to value things that I now perceive to be a being right. I used to care about I don't fucking care anymore.
Scott: No, I don't either. I just avoid it.
Bill: [laughs] Somebody else wants to be right. Fine.
Scott: Yeah.
Bill: And I don't know, it's weird how life has shifted in that way.
Scott: I think what you're talking about is, I feel the same way. And I think what you're talking about is, I think it demonstrates the power of seeing so much stuff that you once cared about and once meant gave you so much thing it just burned off and what's left over your kids, right?
Bill: Yeah.
Scott: If you think about it, if you an asteroid were heading towards planet Earth, right now, what would you do?
Bill: Yeah, I just hanging out with my family.
Scott: Yeah, I call up some people and say goodbye, and then I hang out with my kids, and I don't know, try to make some sense of it with them, but just spend time with them.
Bill: Yeah, that's right.
Scott: But to your point about percentages, the low percentage stuff is just gone. That is fucking gone. But what left with is the high percentage stuff, your kids, you're doing stuff with your spouse.
Bill: Now, when it comes to work in the markets or whatever, I do enjoy competing.
Scott: Oh, yeah.
Bill: But I have realized that I don't enjoy it nearly as much as some people. Some people are obsessed with it.
Scott: The funny thing is, there's competing and there's competing. It's funny. I was talking with my dad the other day, because my son is going through this thing, where he's trying to decide whether to do travel soccer or travel across and Lacrosse is one of these things where you have to get plugged in early or you're on a lower track. And my wife and I have been going nuts over this and wondering what people we've turned into.
Bill: You've turned into the normal American parents at this stage of life. My friends and I were having this exact conversation.
Scott: It's terrible-- [crosstalk]
Bill: Anyway, continue.
Scott: Well, I was talking with my dad about it and he was making me feel like shit for caring so much. And he was saying, "You know how much is your son picking up on how much you guys care about whether he's one of the best at something or really good at something and how much of that is coming from him?" And saying actually, a decent amount is coming from him, but a lot is coming from us. He was saying, "Well, does he know that there's anything else out there other than winning?" Basically, when they're playing a game, is there's something else out there that's more important than just the outcome of this game? And for a kid to know that and understand that that this is just a part of something much more important his life and his development as a person. And I guess, bringing it back to the competition thing, there are competitive people and they're competitive people. There's competing, where you're just trying to kick someone else's ass, and be the best, and have that feed your ego. And then there's, I think, doing more what Seth Klarman is doing, where you're just trying to be thoughtful and you're really trying to stay true to first principles. And you do want to win, you do have that. But it's by doing that that you win.
Bill: Yeah.
Scott: And I love the latter and I think the first is just scumbaggery.
Bill: I guess, I'm going to push back on your dad a little bit and say that we don't want to have a society, where playing sports isn't about winning.
Scott: Who's not saying that?
Bill: No, I know. But I think like your kid, my kids are going to step on the field and think like winning is the goal here. But I will say, one of the happiest moments in my entire life was an eighth-grade football game that we played, and we lost. But the amount of improvement that we showed from the first game that we played to that last game, and the way that we came together as a team, and how we all executed what we could execute to our best ability, that was one of the highest moments that I remember. So, I guess, it's not all about winning. There is something to be said for-- We were just flat out not going to win a football game against this team that we played. We just didn't have it.
Scott: In life, it pays to be a winner. But at the same time. as I pathetically you take two athletes, and one of them is say a great quarterback, and the other one is just decent. Just because the one of them is great and not that you're saying this, but just because the one of them is great, it doesn't make him a better person than the other one.
Bill: Yeah, no doubt.
Scott: We all think there's some larger reality there to it. And my dad's point was me, Scott and being a little shit about the whole thing. It's not just totally about that.
Bill: Dude, I'll tell you what, though. I wish that that you sports were a publicly traded stock, I would buy it all day long. It is such a racket.
Scott: It's such a racket. Lacrosse-- [crosstalk]
Bill: It’s so expensive.
Scott: One fall season of Lacrosse here in Fairfield County is $2,000.
Bill: Yeah, they have a fucking stick in a ball. What are we charging for here?
Scott: It's crazy. It's totally crazy.
Bill: It also seems to be the sport that my peer group has leaned into as it's the one sport that our kids, I guess, still have a chance to be moderately good at.
Scott: Totally.
Bill: [laughs] I remember when Lacrosse was still something new and now, I've got all my friends have their kids and Lacrosse like, "Oh, this is just the next thing." I got to get my kids on the next, next thing.
Scott: Yeah, you do. I don't know what that is, though.
Bill: I don't either. There's probably going to be dark throwing or something. We'll make that professional.
Scott: My parents are the type where they're all about-- They'd be so mad if they saw this, but they're all about getting into a good college. And so, they made my kid sister play the harp for years.
Bill: Yeah. That makes total sense.
Scott: But she's forgotten. They've gaslit her and she's like, "Oh, no, I love the harp."
Bill: [laughs]
Scott: And she hated the harp. It was like watching a kid in a factory or something. Her little fingers working the strings on the harp, just miserable. And it's just this sham thing she's engaging in to get into college. But my dad was telling me the other day, he's like, "You got to get Scotty into fencing. That's how you get into college." And I was like, "Yeah, we have other priorities." We would like him to not be a virgin when he's 30 years old.
Bill: [laughs]
Scott: So, that's more important to us and then getting into Harvard. And he was just flabbergasted. He was just like, "How could you say that?"
Bill: [laughs] You don't think that fencing is a hot thing to tell whatever you're interested in about? That's funny. Oh, man, that floored me. That was a good joke. It's also true, by the way. I've got a kid that I don't know that he's-- Actually, I shouldn't say this, because we bribed him with money. We said, "If you can do your spelling by the time that school starts, we'll give you 200 bucks." I have never seen this kid work so hard in my life and I never thought that I would be that parent. But I don't give a shit. I will pay this kid for every single A and I just hope that I don't set the bar too high, because he's going to keep asking for more and more. But I used to see kids that would get paid for grades and I think I was jealous of it and my parents never motivated me in that way. Now that I see what it's doing for the child that I'm motivating in this way, I'm 100% going down this road.
Scott: This is very interesting. I might try this myself.
Bill: Oh, dude, he is a machine at working in this spelling right now.
Scott: What does he want to spend the money?
Bill: He'll walk by me, he'll be like, "You're going to owe me the $200."
Scott: [laughs]
Bill: And I've never seen this side of him and I'm like, "Okay, dude, I will happily pay it to you."
Scott: You know what the funny thing is, what he's doing is in a sense smarter than just blindly wanting to learn whatever they teach you.
Bill: Yeah.
Scott: I'm sure he's got some very interesting ideas for how to spend that money.
Bill: Yeah, except part of the problem is, he was telling me about this stupid G-Wagen he wants on Roblox.
Scott: Oh, no.
Bill: I was like, "You're going to take some of this money and you're going to buy a digital G-Wagen that you're going to get tired of this game?" In like whatever, three weeks, this is stupid.
Scott: We went through that. My son played this game, where they took dinosaurs, and they would put guns on them and just shoot each other. But the dinosaurs cost $100 some of them.
Bill: Yeah, it makes no sense.
Scott: It's just insane.
Bill: Mm-hmm.
Scott: It's totally insane.
Bill: But kids like it. I guess, I did stupid stuff like that, too, but I'd like to say, I didn't.
Scott: But I love that. I love that you guys are doing the paying for the grades. I will admit, we've done something similar.
Bill: Child younger than him blew my mind. Read Winnie-the-Pooh and like, "How you're going to give one kid some money and then not the other one when the other is naturally motivated?" So, now, what I've ended up doing is that kid got 50 bucks for finishing the book.
Scott: [laughs]
Bill: He's younger. So, 50s like feels big. And he gets another book.
Scott: I love it.
Bill: I can't spend $50 per book, like this kids' just churning through books. I got to figure out, I got to get some deflation in my life.
Scott: Yeah. Now, the next thing is this, can you start paying your wife? Can you bribe her too?
Bill: I think my wife and I are paid plenty. I think we need to pay ourselves less.
Scott: [laughs]
Bill: [laughs] We need to reduce the consumption to give the money to the children.
Scott: Okay.
Bill: I think that's the best way this goes.
Scott: Okay. My wife and I have started, we do these things where we're gambling against each other, where it'd be like, "If you cannot raise your voice with the children for 24 hours, I'll take you out here." Or, instead of playing strip poker or something, we'll play poker, but we're playing for, "You need to take me to Cape Cod for a weekend."
Bill: When's the last time you guys played strip poker? That sounds fun.
Scott: No comment. Bill: Yeah. Tuesday? Good for you. Scott: No, not Tuesday. Bill: [laughs] Ah, life changes. Anyway. Where were we? We were talking about these great investors who never talked about things like this, I don't think. Scott: Actually-- [crosstalk] Bill: And that's a shame. They missed out on stuff. Scott: Actually, let me say something about strip poker now. I don't want to play strip poker with her, because I don't want her to see me just sitting there with my shirt off. Bill: Yeah. Scott: It's not as pretty sight as it used to be. Bill: I do get that. We're eight days into being fully dry here. So, I'm not saying that I'm stopping drinking. But the amount of sugar that I can avoid and the weight that is coming off is quite nice. Scott: Yeah. It's impossible to lose weight when you're drinking. Bill: I think so too, especially at this age. Scott: Yeah. Bill: It's a good lubricant for social activity. But once you hit the age that I have hit, I think it's time to start worrying about how fat you're going to be when you're older. Scott: It's awful. I hate it. Everything I love to do makes me fat. Bill: I understand. Scott: How old are you? Bill: I definitely understand that. I had just hit 40. Scott: Oh, God, I'm 42. Bill: I think-- [crosstalk] Scott: 40 is a difficult birthday. Bill: Yeah, I don't think I took the birthday that tough. But I definitely think I've got signs of midlife crisis here and it's manifesting itself in apathy. Scott: [laughs] Which I still argue is wisdom. Bill: [laughs] Yeah, it could be. But I've gotten fully fucking mode. Scott: Actually, I got it. I've hit that point, too. But there's something powerful about that. Bill: I think that's probably right. I also had some big life events that-- I do think that I've done things over the past three years that have-- I used to run from a lot of insecurities and now, I've taken care of those things. I'm like, "Okay, I'm actually a man and I can be proud of what's going on." So, now, I just don't care as much about things that I used to feel-- I guess, used to be insecurity driven at their core. Scott: That's interesting, because if hung out, I don't pick up on that at all off of you. You do seem very confident. Bill: Well, it's a nice shield, but it's not true. But I'm getting there or have gotten if that makes sense. Scott: Yeah, I get that. Bill: Some of it was. I don't know, for a while, I wanted people to like the ideas that I had. Some of the ideas have turned out to be really terrible. So, that hurts when you're public and people are listening, and the ideas are terrible. But now, I just don't really care, if people like the ideas, if that makes sense. It's more important for me to like the idea than other people to like the idea. Scott: I nobody likes my ideas. I never get much traction. Anyway, I never did. No one seemed to care and no one wanted to hear it. Bill: It's probably a good thing. Scott: I guess. Even this investor study I did, I was all excited about it and I tried to tell people about it, and their eyes glaze over. [laughter] Scott: This means so much to me. They're like, "Oh, yeah, that's nice." [crosstalk] Bill: How much time did it take you to do it? Scott: I spent years doing it. Bill: How many years? Scott: Couple years. Bill: Yeah, that's a lot of work, man. Scott: I didn't only do that. I would just-- Bill: Yeah. But it was a passion project. Scott: Yeah, exactly. Exactly. And to me, the results are life changing to me, but not to anyone else. Bill: Okay. You went into the project more of a deep value guy and it sounds you've come out of it more of an industry structure, potentially GARP-y? Is that fair? Scott: Not really GARP-y, but it's so hard to get those where you can make a big payoff on a lot of those. So many of those are just so well priced. Even when they're cheap, it's really hard to get a big bargain there. But yeah, definitely come out of it more-- When we were doing the quantitative devalue stuff, we didn't care about the quality of the business at all. I think now, I care quite a bit. Bill: I'm personally intrigued by these ideas, where you have a good business under a crappy business. And the good business is less than call it 30% of the crappier business, because my fear with some of those really good businesses to your point is that, there's nothing that I am going to discover about those. Because there's very few insights that I'm going to have about those businesses that are like, "Yeah, the market thinks it's great, but I think it's awesome." Scott: Right. Bill: Or, "The market thinks it's awesome and I think this is the greatest business that's ever existed." I do think that there's something to be said about the businesses that are-- I'm thinking of a couple that I own that they're smaller and they've got engines underneath them that I'm excited about, and I think that either the market underappreciates it or even if the market does appreciate it, I can see why my returns are going to be connected to the underlying business creating more value in the future rather than saying, "This stock is mispriced today and I'm waiting for a rewriting." And maybe that's a flawed way to think. But I do think that it's a little bit of a more stable premise, where you're looking for true economic value added over three to five years. I think that's more aligned with the way the world should work. Obviously, price paid matters. Scott: How focused are you on price paid out? I sense you're more focused on the quality of the assets and-- [crosstalk] Bill: Yeah, I spend a lot more time on the quality the assets. [crosstalk] I care about price now. In retrospect, it may not have worked. I laid down a bet that I took the long side of a Qurate, short Zoom trade in 2021. I obviously believe entry multiples matter. But I don't like to comp across industry necessarily would maybe be a decent way to say it. I don't think that just because something is priced at a 15% free cash flow yield, it's any cheaper than something else at a 4% free cash flow yield with no other information known, if that makes sense. Scott: Yeah, no, that makes sense. Actually, it goes back to a discussion you and I had a few years ago about deep value investing, where you were saying, "Look, I get a lot of these things the high free cash flow yield." But with a lot of these, there's a low terminal value and it's known. It's pretty high percentage. I didn't really have a good answer to you back then, which bugged me. But I have thought about it and I actually think the best deep value investing is the kind where you are investing in something that has a decent terminal value to it and where you can find that. Occasionally, the other kind is worthwhile, but you have to be compensated for that. It can't just be a 10% free cash flow yield. It's got to be huge, and they have to be distributing the cash or something which they usually don't do. But what you described is what actually kneecaps a lot of would be deep value investors, where they are truly buying garbage and it hurts them. It burns them. Bill: Yeah. I think the other thing is, I've put this out on Twitter a couple times and people hit me-- I prefer, if you have a specifically with commodity companies, because I think there's so hard to value for both management teams and investors, which may make them in the too hard pile, which I'm sympathetic to. But if you have a high free cash flow yield on a commodity company, I far preferred dividend to a buyback and people will say, "Well, you can sell pro rata into the buyback." I think that creates some timing issues. I've seen too many examples of management teams turning on the buybacks, pick it at the tops of markets, and turning it off at the bottom of markets to think that a buyback is actually going to be executed through the cycle. Whereas, if you are giving me a true cash back and it doesn't have to be a recurring dividend, it can be a special dividend. I'm fine with that. But cash back off the table to me, even though theoretically less tax efficient is probably what I prefer in those setups- Scott: Yeah, it's interesting-- [crosstalk] Bill: -to reduce the terminal value risk. Because every buyback, all you're doing is you're increasing your relative percentage of terminal value risk. Scott: Mm-hmm. That's interesting. If you look at the market historically, dividends are actually a far better proxy for free cash flow than what people say free cash flow is. You probably know this, but backwards and forwards. But you know the free cash flow yield plus growth equals your expected return? You've seen that? Bill: Yeah, plus or minus, whatever. Multiple fade, right? Scott: Yeah. But it's actually something Buffett uses. Bill: Yeah. Scott: Where he's valuing it like a bond except the coupons grow. Bill: Yeah, it's roughly by math. Yeah. Scott: But it's interesting. If you look at the market using that, if you take the dividend yield of the market, the average dividend yield is, I think about 3%. And then you add the average growth rate which is 6% for earnings. That gets you 9%, which is actually the average market return for the S&P 500. So, dividends are actually a really good proxy for free cash flow and arguably better than a lot of these models you see out there that forecast giant free cash flow in the future. Bill: Interesting. Just riffing on that topic, I think part of the reason maybe-- What we're really doing when we're buying minority interests in a company is, you're really trying to figure out what is the free cash flow to minority common equity and a dividend. I'm going to sound like such a boomer here. But a dividend, at least, I don't want to say guarantees, because it can always be caught. But it does. promise, at least in the near term, some true hard cash delivered to minority common shareholders. It reduces agency cost, in my opinion and I think that it's an underappreciated discussion. Scott: Yeah, agreed. So much can happen between the lip of the cup and that possibility those potential risks so frequently become actualities. Bill: Yeah. It's one thing that I also think growth investors tend to benefit from is a reduction in agency cost. I do think that they increase the probability of overpaying risk. But maybe they would say that that's a risk that they're paid to mitigate. So, that's within their control. And at least, if you're in more of a growth company, the risks that are outside of your control, I am sympathetic to an argument that they may be lower. Scott: But they have to reinvest in the business. Bill: That's right. Scott: So, they're stuck. Bill: Yeah. And everybody's on the same page. Scott: Yeah. And you want them to be-- It's like, the discipline of debt when it comes to private equity. You want there to be some strictures there, where they can't just do whatever the hell they want. Bill: Yeah. Ironically, you get that in public markets. It creates, I don't know, a lot of distortion and in behavior. Well, I shouldn't say distortion of behavior, but you see how some of these levered equities straight and it's just like, "Man, they fly around." Scott: Yeah. Bill: For somewhat good reason and somewhat not good reason. I don't know. Scott: Something that has been a blind spot for me has been capital allocation. It's so hard to figure out and it's destroyed so many potential good investments. Bill: How so? Scott: A company being overly conservative and issuing stock in order to capitalize themselves and they don't really need to. But management cares more about being making sure they're way under levered. But it just completely decimates the upside in a stock in a bad acquisition, things like that. It just dilutes what's going on. Bill: Yeah. I think the person that has helped me a lot think through this stuff, and I need to implement more and think less. But this dude, Mike P., he's now at WCM but he used to write under non-GAAP. And his framework of looking at proxies for clues of how management is going to be incented. When they think that they're backing up the truck for themselves and how you can get like a clue from that, I think that's so important. Because to your point, a company as you're talking, that's ringing out my head is of Laura, who just agreed to a purchase price that I think most of the shareholders are pretty upset with. It's like, the management didn't have any skin in the game. If you have a management team that doesn't own a ton of the equity, and they do draw a salary of call it a million bucks a year, and they get some options that they're going to rebase down if the stock goes down, like, "Okay, issue some shares and we'll protect our means of living, we'll continue to draw this salary." It's not going to be a breach of fiduciary duty to raise capital through equity. The minority shareholders just screwed at the end, but that's not really our problem, I think is the attitude of a lot of management teams. Scott: Oh, yeah, definitely. Bill: And it's not even malicious, necessarily. It's just an incentive issue. Scott: It really is. It's not malicious at all. It has a malicious effect. Bill: Yeah. Scott: Everyone's just trying to get their own and- Bill: Yeah, that's right. Scott: -it so rare, where the interests line up. When it does, it's special. But it's just so rare. Everyone's just trying to do the thing. I'm constantly struck by that. Bill: Yeah. I would love to sit down with some of these great investors and ask them, "How much did you think about incentives and stuff like that?" I suspect a lot. Scott: Yeah, I think they did. I think they did, but they were willing to buy, excuse me, even when it wasn't there where they didn't know. Bill: Yeah, that's tough, though. That's the old Buffett. You can't make a good deal with a bad person. Scott: Yeah. Bill: Or, bad incentives rather than personalizing it. Scott: I think if it were obvious, they probably wouldn't go with it. But in a lot of these situations, it's just an unknown. There's really no way to bridge the gap. Bill: Yeah, that makes sense. Oh, I had a question, a follow up. Now, it's gone. Oh, well. What do you want to talk about? Scott: I don't know. We've covered middle age-- [crosstalk] Bill: That was a good-- [crosstalk] Scott: [crosstalk] paying off our kids. Bill: [laughs] I had an investing question, dammit. That upsets me that I dropped that. Oh, well, it's consequence of this format. Scott: Yeah. Bill: I should maybe have a couple questions written out. Scott: Ah, don't worry about it. Bill: Thank you. I appreciate your permission. Scott: What do you do? Do you edit around stuff, or do you just run it--? [crosstalk] Bill: No, I'll probably just leave this. Scott: Yeah. I like that. I like it when you leave it. I like the little dead spaces. When I first heard about podcasting, I was like, "This is such a stupid idea." Bill: [laughs] Scott: You're getting the worst. When someone goes on Bill Maher show, you're getting their best lines, right? Bill: Yeah. Scott: That's supposed to be the idea behind it. But with the podcast-- [crosstalk] Bill: Yeah, 10 minutes. Scott: Yeah. With the podcast, it's the opposite. You're getting all of it. I was like, "This is such a terrible idea." And then I started, I don't like to listen to them. I like to watch them. But I started watching them and I almost can't go back to the other format, because you're getting the best stuff, but it's polished and it's bullshit. It's a sound-- [crosstalk] Bill: Yeah. Well, that's the thing. And if you just get talking to somebody, you actually find out what they think. Scott: Yeah, exactly. I find that so much more interesting. Looking at someone like Louis C. K., who's a really funny guy. I think he's so much more interesting in an interview than his standard. Bill: Yeah. Scott: Or, even his show was, I enjoy him more than the product. And that's true for everyone I like. Bill: Yeah, I think that's right. I think that's what's so powerful about podcasts is, you get to know somebody. Scott: Yeah. Bill: It's amazing how many people want a podcast, myself included, by the way. But what a shitty business this is? [crosstalk] Scott: Well, it's a shitty business if you're only trying to make money off this. But if you have a fund or something like that and you're cross pollinating it, then it's perfect. Bill: That's right. Yes, it's a very good marketing vehicle. I still need to figure out what I'm trying to cross pollinate. My problem is going back to our conversation about I don't know anything, I don't know how to sell shit that I don't believe in. I got to come up with whatever the monetization planet. Scott: Yeah. Bill: I think, events, I would believe. I think I'd be quite good at those. Scott: I think you'd be really good at that. I think you'd be really good at that. Bill: Well, I'm going to do a couple. Scott: I saw that you emceed something. Bill: Yeah, it was fun. Markel? Scott: Is that what it was for? Bill: Yeah. Scott: But you're a natural for that stuff. I think that'd be really good for you. Bill: Let's see. I like it. Scott: You should put together-- Bill: Just talk to people. Scott: You should put together an event. You know so many people who could talk. Bill: Yeah. No, I'm going to do that. Some of it's a matter of-- Right now, I'm in the process of figuring out what time of year and where. So, basically, the first planning stages. But I've been thinking about this a lot. Scott: Florida in the winter? Bill: Yeah, that's an enticing idea for sure. Scott: But I bet you could get a lot of people, I think it'd be fun. I don't know, if people just want to go to something. Bill: Yes, now, they do. It's consequence of being locked up for a little while, I think. Scott: But I'd give anything for a good investing event. We went to the Fairfax annual meeting. Bill: Yeah. Scott: I loved hanging out with you guys, but the meeting was dull as dirt. Bill: I tell you what I what I liked about that meeting was I didn't realize how many portfolio companies they have. Scott: I didn't either. Bill: And throughout the world. Scott: Yeah. Bill: But I thought Prem's pitches on certain ideas were wild. The Greek bank that he was, it's trading it point two times book. And if it gets back to one times book, we're going to make a lot of money. I was like, "Yeah, Prem. That is how the math works." Scott: [laughs] Bill: Let's talk about the lies behind that. Scott: He's interesting, because he does both. They own part of Bangalore airport or something like that. Bill: Yeah. Scott: They these garbage wood products, businesses that are just cyclical and a mess. But he gets them so cheap. Bill: Yeah, they just got to take an ad RFP. Scott: Yeah. Bill: Oh, one thing that we talked about last time that we talked. You've got the deep value guys and then the quality guys, and I think with the commodity ideas, I think they're easy to know when to buy, because they're just so bombed out. But they're impossible to model the IRR. Because on resolute, they were objectively correct. A private buyer came out, and paid a lot more, and they've been buying the whole time. But that took a long time. That's a hard strategy to run. It's almost like a macro commodity type call. But I don't know. Copper in 2016 was super easy to see. This is my problem with commodity stocks. I bought Freeport-McMoRan. I'm pretty sure it was December 2016. It might have been 2015. It was my last time at the bank, the last December I had. It was so bombed out. It was 2015. Four bucks a share. Today, well, 435. Today, it trades for 3,141. You know what I made on that? Maybe 50%. Scott: It's so hard. Because I guess, this is why we don't do a lot of that stuff. One, I just find it hard, and I don't naturally understand it very well. But the other thing is, I want to try to buy stuff where it's relatively easy to come up or at least, simple to come up with a forever value for the company. Bill: Yeah. Scott: When it's not bounded by anything and the variance is so big, it swallows the mean, I really struggle with those things. Bill: Oh, I like how you said that. Scott: Thank you. Bill: When the variance swallows the mean, I think that you have to demand such a huge discount to what you even think it might be worth, because the probability that you're accurate and your assumptions is super low. Scott: Yeah, which most people don't do, right? They're more focused on trying to get the cycle right and all these things. But I would argue, what would be better in a situation like that would be to get a bigger discount, which is basically demanding a bigger payoff. Bill: Yeah, that's right. Scott: Which is actually, I would argue, that's what Nassim Taleb was doing back when he was trading and how he became independently wealthy is that he was basically value investing in randomness, where everyone would think, "Oil is going to do X." And he says, "Well, what if it does Y. Well, what's my payoff?" He would be guided by the payoffs. He'd say, "Well, if it does Y, I make 20 times my money." Bill: Yeah. Scott: So, let me bet on Y and that only needs to happen a certain percentage of the time, and you have a really interesting strategy. But it was very payoff centric. Bill: Yeah, which I think everything is. I got to follow up with Mauboussin. He had expressed interest in coming in and I'd like him to come on. But I haven't been ready to interview him. One of the things that I've been thinking a lot about is, with expectations investing, how do you implement that in a in a real world way? You can say, well, there's so many elements that can go into DCF that I want to figure out, if there's a way to have like, I put in the balance sheet, and the income statement, and the cash flow statements going to flow from those two. But can I have something that gives me back a Monte Carlo simulation of all the different ways that I could get to today's stock price? And then obviously, it's only as good as it's garbage in, garbage out type stuff. But I'd like a visual representation of what a stock looks like. I think this guy, Cem Karsan, who is one who would argue that that's what the options market is. But I don't know. I want to figure out if there's a computer program that would do that. Because then I think you get to actually see the variance and see the mean. Now, it's going to be imperfect, because it's the future, but it would intrigue me to see that. What does that sound like to you? Scott: That's pretty interesting. Well, it's interesting, because what you're saying-- He's right. I would never put that together myself. But he's right that, that is what the options market does. Bill: Yeah. Scott: It would be interesting is, if you could create a strategy by using pair trades and things like that, where you could recreate the same thing using equities. Bill: Yeah. I am certain it's possible. I don't think I'm smart enough to do it. Scott: You're basically talking about each company is several different future versions probabilistically. Bill: Yes. Scott: But then the way to harness that and only bet on a certain part of that would be through a pair trade, where you only want to bet on one or two of those versions that you think is interesting and you want to short the other part. Bill: Yeah, and which ones are priced well, right? Scott: I actually think there's something brilliant with that, because then you're not paying theta. You don't have to pay for the option. You're basically a costless option. Bill: Hmm. Scott: You got to pay the interest on the short, but up until quantitative easing and zero interest rate policy. I didn't know this. People used to make money on their shorts. Even get paid the interest. The rebate rate used to be 3%, 4%, 5%, 6%. Bill: Yeah. Scott: You structurally were making as a positive carry trade shorting wise. Bill: Hmm. Scott: I don't know, Bill, I think you're splitting the atom. You're on finance here. I think this is cool. Bill: Yeah, one of the things that's really neat about the podcast is, I get to talk to people that expand my brain. Scott: Well, you've just expanded mine. Bill: Yeah. Well, it's all about sharing and learning. That's the whole thing. Scott: I want you to throw an event. I'm [crosstalk] excited about this. Bill: Yeah, I will, I will. The first one is going to be a golf event, because I got to do something that I know I can do well, and that I can do well, and then I'll get into it. I like it. It gives me energy. I enjoy seeing people. I will do one for sure. But I just got to put it together, man. Scott: But I guess, what do you do is, you just have to rent basically a conference room at a hotel, and then you got to get speakers, and you got to plan basically two or three days of events and stuff, right? Bill: Yeah. Scott: It's a lot of work. Bill: Yeah. I don't want to give away too much of what I'm thinking. You do need speakers. I'm not sure that I think that the idea of somebody telling people what they think is their best idea is that the way that I would want to go with it. I think roundtable discussions would be more my version of what I would want to listen to, if I attended a conference. Scott: What if it was instead of someone presenting their best idea, which I agree is boring? What if it's someone sharing some part of their investing journey? Bill: Yeah. Scott: It's investing, but it's more personal. What do you think interest is both more? Bill: Yeah, well, that's kind of this brand, right? Scott: Yeah. Bill: Yeah. Scott: But that could be interesting. Maybe that in a roundtable setting. Bill: Yeah, I think that's right. Just need to do it. Scott: It's good. I think it's exciting. Bill: The execution is always more important than the idea. Scott: I know. I hate that. Bill: [laughs] Scott: I hate that. Executing sucks. It's so hard. Bill: Yeah. But it's also what's really fun. It's really fun when things come together. Scott: Yeah. Bill: So, you got that going for us. What's your day to day look like now? What do you do? What would you say you do here, Scott? Scott: Well, I've been really trying to market my fund lately. I've been getting on Twitter and putting out research through Twitter and submitting it. I just said something published by advisor perspective. Bill: Oh, nice. Scott: Yeah. I've just been putting that stuff out. I don't know, I've been just investing. But stuff we own, the day to day is boring it. We hold stuff for a long time. There's not a lot to do in terms of the day to day. We only own 10 stocks. I'd like to own more. Bill: How do you get comfortable with that? Scott: There's actually a lot on this. Basically, the benefits of diversification rapidly diminish after six stocks. Bill: Yeah. Scott: And so, we have about 25% cash right now and then the rest of it is in equities. I don't think any of it's in the US. It's all throughout the world. Bill: Wow. That's interesting. That's an interesting thing for somebody to consider from a diversification standpoint. Scott: Yeah. I'd love to be invested in the US. I haven't found a single thing now that meets our unofficial model. Bill: hmm. There's got to be something. Scott: I can't find big enough payoffs with a company that I think is an inevitable that's just an extremely high percentage business. I haven't come across that. Bill: So, what are some of the countries that intrigued you from that perspective? Scott: China, which obviously has a lot of issues. I'd say, unlike Munger, I'm not sure I admire them to the degree that he does. Although, it's great that so many people have been raised out of poverty. But obviously, a lot of other things, they're pretty horrific. And then just random places. It's more about investing in the company, not the country. Bill: Yeah. Scott: But we found stuff in China. We own Alibaba and we own Greatview Aseptic Packaging, which I think is actually a really interesting stock that's just been traded at a bombed-out valuation. But that's something that's a good example of what we've been talking about where it's got really good EBITDA margins for basically the last 20 years. With inflation going on right now, its earnings have cratered. But it's a consistently profitable business. It's just going through a tough period, and you can basically buy it at almost the same price it traded at in 2004. Bill: Wow. Scott: It's crazy. Bill: And you trust the numbers? Scott: I don't trust anything. But to a large degree, yes. They return their market cap. They pay a dividend, and they basically return their market cap every 13 years in dividends. So, could it still be a fraud? Absolutely. But does that reduce the risk? Yeah. Bill: Yeah, it's hard to make a fraud out of dividends. You need some cash. I guess, it could be a Ponzi scheme, but you need some cash. Scott: Yeah. But they don't even tap the capital markets so for financing. They're not a creature of the financial markets. They've got very little debt. Then we own a telecom operator in Latin America, and stuff like that. We're very payoff centric and trying to go where we think those are really big. We can be really wrong a lot and still come out ahead and not be investing in things that are just a complete disaster and dig ourselves into a hole. Bill: That's got to be exciting to have gone through the research formulated. It sounds to me like, this is probably who you're going to be for the rest of your life as an investor. And like to come to that part of a journey, that's exciting. Scott: Yeah, I feel the same way. It means so much to me to hear you say that, because no one else seems to think it's that interesting. But to me-- [crosstalk] Bill: Oh, no, I think it's super interesting. Scott: I think it's so interesting. Bill: Yeah. Scott: But that's exactly I feel. I feel I've found something that just really fits my nature and I think has worked for a lot of other people who I admire. Bill: Well, that's a pretty good way to borrow brilliance. Go back, study their track record, reverse engineer what worked for them, and then do something that is different from what most people are doing. So, now, the rest is up to you to make sure that it works. Scott: Yeah. Bill: So, you're just charged at the execution? Scott: Yeah. the hard part. Bill: That's right. [laughs] Scott: It's actually the same thing. I did the same thing with my writing. I have a select number of writers. I just really admire and I love researching their lives and how they write. It's funny. It's very hard to write and I'm always curious if there's some better way to do it. I've realized studying these other people, there is no better way. There's no shortcut. It's just this journey you have to go through and there's no way to make it easier, there's no way to make it faster, you just have to do it. And there's something about seeing that in the experience of other people, as well as your own experience that it's very powerful. You know, that goes back to what you were saying. It's a high percentage belief. Bill: Yeah. Scott: As a result, you're not wasting time on low percentage stupid things. You're not wasting your time on shortcuts. You're just trying to do the work and there's something just so powerful about that. Bill: I have come to believe that all the rewarding things in life are very hard, and many are very tedious. But executing that over time is where rewards come from. Scott: It really is true. It really is true. I used to believe when I was younger that if you were a fit for something, if your personality or temperament were fit for something, you wouldn't work a day in your life. That whole thing, if you have a job you love and you wouldn't work a day in your life, I think that is bullshit. Bill: [laughs] Scott: Nothing I've done that's worthwhile. I'm curious what your experiences has ever worked out that way. It is always cost me something big time. Bill: Yeah, I think that's right. I think if something is not work, there's going to be days it's work. I think that when Buffett says that he tap dances to work, a lot of life I think is repressing the memories that you hated as you were going through them and then looking back at them as if they were roses. Scott: [laughs] Totally. Bill: I highly doubt that when he was going to Salomon Brothers, that was some fantastic experience that he tapped dance to. He just probably like, "Motherfucker." [laughter] Bill: These guys are going to bring my ass down. Yeah, I think the work part of life is where the good stuff comes from. If there's no crappy parts, then it's probably not worth doing. Scott: Yeah. I would agree with that. Bill: I think that's a good place to end, man. Scott: I really appreciate you having me on. It's a lot of fun. I love that. Bill: I enjoy talking to you. You can come on anytime. Scott: I'll have anytime you need someone, let me know. I'll hit you up in a few months to let me back on. Bill: All right. I may need a guest sooner than that. You may become a regular. Scott: I'm around anytime. Bill: All right. Well, hopefully less. Hopefully, people discover your research, and what you're putting out, and I ping you and you say, "You know what, I got meetings that day." But if you don't, you're welcome to come on and thanks for doing this now, twice. I appreciate it. Scott: I love it and I can't tell you how happy I am that you've created such a great podcast. Bill: Well, thank you very much, man. I'll try to keep it going. Scott: Terrific. Thank you for having me. Bill: All right, take care. Scott: Take care. [Transcript provided by SpeechDocs Podcast Transcription]