Preston Pysh  06:56

So you get a lot of them just because of their Type A personality that wants to turn it into $100,000 by next year?

Brian Rutherford  07:05

There are plenty of old wives’ tales about the person who’s at their $36,000 and within three months they have turned it into $100,000 and they are living large at West Point. Nobody knows that that’s actually true. I bet that there’s somebody around who has day traded, taken on a bunch of risks and it’s worked out for them. But in the short term… As a matter of rule that is probably not the case. So I guess I’ll start here with my top seven mistakes.

Preston Pysh  07:37

Are these prioritized orders?

Brian Rutherford  07:39

These are not in prioritized order. As I was thinking about this, I think about the questions that I get from young people who are generally fairly intelligent. They’re well-reasoned folks that have just come into a little bit of cash and so they’re thinking about what to do with it, alright?

So the first one, and this is where I start when I’m asked about how I think about investing. The first thing they do is they look at a chart, either it’s the day, week, month or year. And they think that is some sort of arbiter of future performance, right? That it’s just like going to the casino and looking at the roulette board and saying, “Okay, it’s been black five times in a row. So I’m going to bet on red next time.” Like that has any bearing on what’s going to happen next.

It’s the same thing in the stock market. You look at a stock and you look at where it is. And you look backward. Maybe you want to look back three months because you’re smarter than everybody else. And you know what happened a year ago doesn’t matter, but maybe three months really matters. And they’ll look at a chart and say they’ll make some sort of estimation of cheap or expensive or I should be buying or I should not be buying. And I say that is abstinence fool’s gold. That is when you look at… And you can’t go look at a stock without seeing a chart. There’s no site that gives you information about a stock that doesn’t also offer a chart. And I think that’d be the biggest mistake or one of the mistakes that I see is people relying on the charts. People seeing some…

Preston Pysh  09:16

Pricing charts?

Brian Rutherford  09:17

Yeah. Pricing charts. Exactly. They just simply charge a price, you know, over the course of either day, week, month, year, whatever it is.

Preston Pysh  09:26

They’re not even looking at the profit?

Brian Rutherford  09:28

They don’t even know what the business does. And that’s one of my other top seven is not understanding the underlying business. I start a class in my accounting class by talking about different fast-food restaurants, right? And so I ask, “What’s the difference? How does McDonald’s make their money? What is McDonald’s?” You know, the typical answer is, “Oh, well, they sell hamburgers, and you know, they’ve gotten their strategy now is to get into more healthy things. They’re doing salads, and maybe now they want to get into coffee because they realize that Starbucks is making a lot of money. And now I think the newest thing was, you know, we’re going to serve breakfast all day because there are some people that prefer to have breakfast all day.”

So they told me a story about how they make all of their money by how many hamburgers they sell. And I say, you know, you’re right and you’re wrong.  McDonald’s is actually, if you look at their balance sheet, they are a real estate company. They are a real estate company. They own the ground that every McDonald’s is on. They own the ground, and then the proprietor of that franchise probably owns the building, right? And they probably sell… They probably buy their hamburgers from McDonald’s corporate and a whole list of other things that they must do. But first and foremost is that they are a real estate company, probably the largest real estate company in the country.

Preston Pysh  10:58

So when you look at it from a simplistic standpoint and you’re going to go buy a real small business on Main Street. And let’s say that you are getting ready to buy it. And I said, “Okay, well, how does this small business make money?” And you give me the wrong answer. You don’t even know what it is. My impression of your ability to actually do well in that venture of buying that small business, you have no idea what you’re getting yourself into.

Brian Rutherford  11:22

That’s exactly right. Yes.

Preston Pysh  11:23

And so when you see these students or anybody out there and they’re getting ready to buy ownership of just one share, that one share might only be $30. And they can’t even tell you what the major operational earnings that they’re bringing in. That’s really bringing in, the breadwinner for the company. They don’t even know what that is. That’s an issue, folks. You can’t invest in stocks over the long term and do it successfully if you can’t answer some of those basic questions.

Brian Rutherford  11:54

Knowing the underlying business is really important. So the first decision is icy. It’s gone from 50 to 30. And therefore, it’s a good value right now. Well, what else? What has caused it to go from 50 to 30? Has Wall Street lost faith in it? Has something gone wrong with their…? Are they now reporting a loss? Why is that loss? Is it a one-time restructuring? Or is it a core business reason that they have swung from profits to loss?

Preston Pysh  12:22

It’s funny you say that because there’s… Say a business comes out and they say, “Well, we’re gonna… This is a $1 billion loss for the company.” So my immediate question is, “Okay, so what does that loss turn into per share?” At $1 billion dollars for a really big company, that might turn into one penny per share. But yeah, you might see the stock price go down by $3. So it might be a total overreaction, and it typically is a total overreaction to the news, but what was it per share?

And it’s funny that you brought this up as your first point because the one on my list, the very first thing I wrote was “not understanding that one share is the same as owning the entire business.” I think those really go very close hand in hand, that if you own one share the business, that’s the same thing as owning every single share of the business. And you’ve got to treat it that way. And you got to understand what does the business do? How does it make its money?

Brian Rutherford  13:13

Yeah, exactly right. So the first one, again, is looking at a chart and trying to make a determination of cheap versus expensive. And that ties into my second one, understanding what is cheap versus expensive.

So I always bring up Apple, you know, everybody understands Apple. Most of my cadets have an iPad in class. And we talked about is Apple cheap at I think today it closed at around $126. So he’s Apple cheap at 126? Well, two years ago, it was about $700. So I guess it’s cheap, right? Yeah, this is the rationale that I did. It’s cheap. And therefore, I should maybe be buying it because I really liked Apple products. Okay. Well, why did they go from 700 to 10? Was there a massive decline in value? Oh, no, there was a stock split. And so we get into a discussion about what is stock splitting. The stock splitting, or reverse, but does that create any value? Well, you all are smart. Yeah, absolutely not. It does not create any value. Okay, then why does Apple do it? Well, I think the word on the street a lot of people believe that Apple split their stock to maybe be included in the Dow one day and that most stocks in the Dow are at $100, roughly $100 or less right. And a $700 share was never going to be included in the Dow. I think we would all agree that Apple is integral to… It is a representative company of our economy and the Dow is supposed to be 30 representative companies that make up our economy.

So I think a lot of people believe that maybe to be included in the Dow 30 that they would have to have a lower share price and Apple sees itself as kind of the every man company. Every man should be able to maybe buy a share. Everybody should be…

Preston Pysh  15:04

I mean, you get more people that can do that at 100, then…

Brian Rutherford  15:06

That’s exactly right because there’s psychology in the market, right? There’s the psychology that 700 is expensive and 100 is less expensive. But really, those have nothing to do with cheap or expensive. It’s all about earnings per share.

Preston Pysh  15:20

It is price and value.

Brian Rutherford  15:22

That’s exactly right. But if you don’t have an understanding of that, you might be buying at $126 whereas that might or might not be a good value. And 700 might have been a great value because the seven for one stock split they did, that would make the shares $100.

Preston Pysh  15:39

So that’s a really important point. So the market is offering you a price of $126. So you can buy it for $126. But what is it worth? What is that one share of equity in the business worth? And that’s where you have to go and you have to discount cash flow models or whatever. That’s where you really have to do some legwork to figure out the discount cash flow. How much are they going to earn in the future? What’s the profit of the business? And if I discount that back to the present day value, what’s it actually worth? And then you have to relatively compare that to other things that you can buy on the market. That sounds like a really jumbled up and massive confusion for a lot of people that might not be into this stuff.

Brian Rutherford  16:22

But it’s not. We understand that this is one of my other big seven is not understanding risk and not, you know… I will have a cadet who will come in and tell me that they invested in… That they did really well last year. They invested in two or three stocks. Let’s just say they invested three stocks, and they earned 20%. Great. They’re really happy about that. I did wonderfully. I’ll say great. What did the broader market do? What did the S&P 500 do? What did the Wilshire 5000 and Russell 3000 do? We got to compare it to something.

If the S&P also did 20% then I will look at them and say, “You lost to the market because you took on extra risk. I invested in three stocks and only was rewarded with 20% where I could have invested in 500 stocks reducing my risk and also earn 20%.” So I say that they lost relative to the market. And that concept blows their mind. They believe that they have now they’ve picked three winners and they are really good stock pickers.

17:28

And that’s one of my other top seven is that what’s really dangerous is to earn money in the short run, to earn money on one or two stocks in the short run and then overestimate your ability to take a more idiosyncratic risk and not understand why you’re taking that risk. And you will fail at one point. You will put more money into one or two things that will lose 50% of value when the whole stock market maybe only goes down. You know it has a normal correction of maybe 10% and they’ve lost half their money. And they realized that maybe this isn’t good.

But the problem is when good things happen –and this is basic psychology– when good things happen, they attribute it to themselves. When bad things happen, they attribute it to things outside of their control. They say, “Oh, the market, the company something bad happened. It’s surely not my fault.” Because remember back you know, when I first started doing this, I picked a couple of winners when the whole market was going up.

Preston Pysh  18:29

This is a compounding problem because when they get back into the situation again, it was I didn’t lose money last time, that wasn’t my fault. Yeah, but whenever I did make money, that was my own ability.

Brian Rutherford  18:38

Absolutely, yeah, absolutely. So we’ve talked about a few of the top sevens. We said, looking at a chart. You know, the most dangerous thing that can happen is making a little money early or a lot of money early and attributing it to yourself and not market forces, right? Making a determination about cheap versus expensive based on the stock price alone, I’ve so many people who want to invest in stocks under like that the $10 range. They think they can buy penny stocks and oh I can buy 5000 shares, and all it needs to go up is, you know, two or three cents that I’ve made a lot of money. And I said it will just as easily go down two or three cents. And because those are generally very thinly traded shares, they don’t know what thinly traded means today, right? That they could be, they could be locked in and not be able to offload those things.

So again,  this is an opportunity for me to bring up different aspects of investing in people who don’t know and they’re all trying to do the right thing. They all want to you know, they’re acting in kind of their self-interest. They’re motivated. They want to read and they want to consume and this is the first time for many of them. And that’s great.

And I really appreciate the opportunity to be able to stand up there as somebody who did this himself. I was doing this like 2003 or 2004. I thought, you know, I got my loan at the dawn of really a seven-year bull market, right? I got it in 2003. So I guess maybe, maybe not quite seven years. But I invested in individual securities. I was making good money, and then again, not attributing it to market forces. I was attributing it to myself. And sure enough, you know, when the market went down in 2008, I went down with it.

Preston Pysh  20:29

So it’s almost like looking in a mirror at yourself.

Brian Rutherford  20:34

Decade older. I looked at all of my instructors as they were out of touch and they didn’t know and now I’m that instructor who is clearly again, out of touch, I don’t know. But that’s okay. You know, some of these lessons I want them to learn with their, you know, $30,000 now. I would appreciate that you learn lessons now versus, you know, 20-30 years from now when they’re talking about millions of…

Preston Pysh  21:00

When they inherited a lot of money.

Brian Rutherford  21:02

Exactly. So learn these lessons now and so try it out. So the losses aren’t too steep.

Okay, so the next one that I’d like to talk about is really opportunity cost, right? And we ask this at the very end of the semester, what is the biggest lesson that you’ve learned? A lot of them talk about personal finance, and they talk about just the idea of opportunity cost. If I’m investing in one thing then I’m not investing in another thing, right? And we see this in a number of ways. I have some cadets who understand and they believe, I believe, because their parents probably did this. They’ve invested in treasury bills, CDs, things that are very safe and that’s very common that people invest in there. They’re very risk-averse, and so they invest in things that are very safe.

But then when you relate that back to investing in CDs, or T-bills or bonds, you know, when they’re at 19, 20, 21 years old, they sometimes don’t make that logical leap, right? And I try to help them see that what if you’re 20 years old, and you have money to invest and you know that this money is for when you retire? Say you’re 60, 65 years old, you probably shouldn’t be in CDs with that money right now, that doesn’t make sense. And there it comes with an opportunity cost so, and they overtime, we talked about opportunity cost in many different realms. And so I think they come down and appreciation.

But if you’re investing in something that provides you one or 2%, then you’re not investing in something. Yeah. And so they just that that starts to blow their mind that there is something else out there. “Oh, no, no, I’m really happy with one or 2%?” I said, “Are you happy with one or 2%, because you don’t know that there’s something else out there, or you’re happy intrinsically with one or 2%?

And then I talked about, you know, it leads into a conversation about inflation, right? That if you’re only earning one or 2%, you’re going to be lucky to keep up with inflation and you’re losing your buying power. And so again, we have discussions about the power of money, would you rather have $1 today or $1 a year from now? And that seems pretty simple.

Preston Pysh  23:13

I think a lot of people don’t realize that investing in general, it’s all relative game. So if you take the United States population as a whole, you got a few people investing at 1%. You got other people out there making 20% returns like Warren Buffett made through his whole career like it’s, it’s all relative to the other person. So there’s only a certain amount of cash flow. And if you’re one of these people that are protecting your principle, but you’re at the bottom end of the returns, you’re going to be at the bottom of the barrel.

Brian Rutherford  23:51

Exactly right. Understanding that the counterparty to what you’re doing this is my other mistake that people make, they don’t understand when they’re buying something, they’re making a bet. They think if I’m buying clearly you believe that some security is going to go up in value. Well, somebody’s selling you that security. And clearly, they believe it’s going to go down.

So, cadets, they love to believe that they know something that other people don’t, right? They are a little bit smarter. And maybe this is a function of the institution a little bit. They get inundated, told many times that they are the best and brightest and they are you know, everybody’s a valedictorian from high school and everybody’s amazing. And now, generally, they are a great group of young men and women and it’s great to be there and teach them. But I remind them, just 50 miles south of where West Point sits on the Hudson, just 50 miles south is New York City, where there are lots of people whose whole livelihood depends on them making a bet about things going up or down. And I asked them if, who do you think has more information? Do you think it’s you, cadet, who’s trying to speculate or trade a little bit in between your classes, or somebody whose entire livelihood is based on, you know, betting on a stock going up or down, who is there 18 hours a day, they have a team of analysts… You know, I’m talking about a portfolio manager or somebody who’s working down on Wall Street, and they have access to tons of information. They have access to the CFO, CEO of these companies. They are on investor calls. They are on earnings report calls.

Preston Pysh  25:31

35 years of experience.

Brian Rutherford  25:33

Absolutely. Yeah. I said who do you think has more information? You know, and they almost all agree that somebody who does this 24 hours a day, they have more information. I said, okay, but when you’re buying a stock, somebody’s selling it to you, and who do you think is selling it to you? You know, it could be somebody else just like you, small investor, you know, playing around with a few thousand dollars, or it could be a big seller who has potentially… And I know that we want to believe that all stock market information, all company information is public. Well, it may be public, but that doesn’t mean you as a small investor has actually read it and knows it and assimilated that into the price.

So just understand that whenever somebody’s selling you something that they have the exact opposite view of you. And they don’t have a clear understanding of where they are in the market. In fact, some of them, some of the people who trade believe that they are buying stock from the company, that the company is selling the shares, and then when they decide to sell, that they’re selling it back to the company.

That’s not exactly… We could do a discussion about IPOs. And that’s when the company gets money the first and only time unless, you know, they’re buying back shares. But again, when that level of understanding is kind of what I’m dealing with, and that’s perfectly legitimate. I probably thought that at one point somebody had to explain what’s going on when you’re buying and selling in secondary markets and that sort of thing.

Preston Pysh  27:00

I like to always think right before I push the buy or the sell button on any type of security to think to myself, “Am I this smart person or either dumb person on this deal?” And if I can’t, you know, say with a whole lot of confidence and backup quantifiably all the reasons why I think I’m the smart person on the deal. It’s a little harder to push that button and to execute the order. And I think that if a lot of people had a little bit more respect for maybe the person on the other side of the deal, what is their vantage point? How can I understand their vantage point a little bit better?

And I think if you don’t do that due diligence and really try to shoot holes through your own opinions, you’re going to probably have a hard time being successful in the market and in the Jack Schwager book, who profiles the very best investors of all time. One of the things that I found really interesting was he talked about how some of the guys were really good traders, specifically. They could change your opinion on a dime where they would be really bullish on one thing. And then literally the next minute, they would turn into an absolute bear. And he attributed this to the turn of their ability to really look at things objectively, and say, “Hey, I had this opinion. And these were all the reasons why.”

But then whenever I thought about the other person’s perspective, maybe the person who was, you know, selling when you were buying, whenever they assessed all the reasons why they were doing it, they were easily able to say, “You know what, not only was I wrong, but now I’m going to take the exact opposite position, and I’m actually going to go in the opposite direction.”

So I think if you’re the type of person that’s a very idealistic type person, where you come up with three reasons why you think something is right or wrong, and you really hold tight to that and you’re not open to other people’s perspectives, you’re probably going to have a hard time being a successful trader, let alone investor.

Brian Rutherford  28:55

You’re exactly right. You know, and to illustrate this, and I know part of the theme is talking about billionaires. I’ll tell you who’s the billionaire that takes up a lot of the bandwidth in the classroom that we talk about is Elon Musk and Tesla’s right.

Well, first of all, we talked about how Elon Musk is not only linked to Tesla, that he has two other very large and successful business, SpaceX and Solar City. But people want to, my cadets they want to know about Tesla stock, Tesla cars. They are really interested in should I buy, should I sell? And I think this illustrates this point the press is talking about is you see wild swings in the price because people are changing their minds all the time about Tesla. I remember a couple of years ago, Elon came out and said at $160 that he thought his own stock was a little overpriced, right? So this is 2012.

Preston Pysh  29:53

He has an economics background.

Brian Rutherford  29:56

But there was more about what’s going on in Tesla than what we investors do. And when Elon says, “Hey, $160 is a little bit high,” we should all have been running for the door, right? When an insider says that and he knows his cash flow better than you and I, we should have probably gotten out, but that didn’t happen.

You saw it go up to $250 and then back down and up and down. And why is that? You know, there’s not a long track record for Tesla. Tesla makes, right now, one car. I know they’ve announced the battery for the home and you know, that’s an exciting potential market. But right now, there’s probably more risk and more questions than there are answers. The giga-factory that’s being built in Reno. That is their limiting factor for being able to produce cars. How many lithium batteries can we produce? I don’t think anybody knows the answer. If you read their *inaudible, they talk about putting $5 billion dollars to this project and Panasonic’s going to build, you know, show up with some money and they’re going to get some tax breaks from Nevada and this is all going to coalesce together and it’s going to be perfect.

Nobody’s ever built a lithium-ion battery, right?

Preston Pysh  31:08

We know that the market is for it.

Brian Rutherford  31:10

And oh, by the way, they’re buying a huge percentage of the world’s supply of lithium. I mean, they must believe that that’s going to do something to the price in the long term. So I think there are more questions than answers. And if you look at the mass market model, I think what is it the Model X? Not the Model X. It’s the SUV but the other one is supposed to be the mass-market $35,000 car this is all predicated on the factory being up and running full operating capacity at a certain time to be able to produce batteries at a certain price so that they can sell this mass-market car at $35,000.

We are all at 200, 250 whatever the stock price is today. We are pricing that in as being successful and I think there’s a lot of risks there. And, you know, this isn’t to rub on Elon. I think he’s an incredible person. And really, if I was to invest in a person, he would be near the top of the list. However, there are still market forces…

Preston Pysh  32:06

And they are still going to produce it.

Brian Rutherford  32:08

Absolutely there’s still some execution risk that he has to get through. And so ultimately, I try to showcase this for cadets that there’s a lot of risk in this price. And if you’re a speculator, if you’re investing in Tesla today, I would say, unless you’re going to invest and let it go and not look at it for 10 years, which is darn near impossible to do, then you’re a speculator. You are speculating that he’s going to be able to do some of these things, and that will turn into profits. But understand that that is not, that’s not like getting a dividend and taking, you know, 4% or 5%, as a good return. You’re speculating that he’s going to be able to do all this stuff.

Preston Pysh  32:52

It’s an interesting discussion because you’re bringing up the terms speculation and investment and the contrast between those. And so, Benjamin Graham, who was people know Ben Graham was basically the guy who taught Warren Buffett everything he knows. And he was his professor at Columbia. Ben Graham wrote the book, “The Intelligent Investor” and “Security Analysis,” which Warren Buffett says are the two books that have influenced him more than anything else.

And Ben Graham starts off “The Intelligent Investor”… In the very first chapter, he talks about this idea of speculation versus investing. And he defines the difference between speculation and investing as if you are an investor, you a.) protect your principal first and b.) you take a reasonable return. And the kind of quantity doesn’t really necessarily define what reasonable is, but I think a lot of people would define that as about a 10% return is kind of what you should really classify as reasonable. Anything above that you’re expecting a 50% return and there’s a huge amount of risk on your principal that immediately falls into this category of speculation which is is not investing. And I think that that’s where Graham really sets himself apart and Buffett and all these other billionaires that are really successful. They focus on what is probable, what is my probability of success? And is it given me a decent return relative to other opportunity costs out there? And if the answer is that it’s given me a good return, and it’s protecting my principal, and there’s a high probability of success, that’s something I want to go after.

Buffett has this quote, he says I want to step over the three-foot or two-foot bars or something like that. I’m probably messing up the quote. All this wine. But he says I’d rather step over a two-foot bar than to try to jump over a 10-foot bar. And that’s what he’s getting at with that quote is, I want to protect my principal, I will go after a decent return. I’m not chasing high returns with low probabilities of success, because that’s how you lose a lot of your principal.

Brian Rutherford  34:53

Exactly. Speculating versus investing. I think cadets generally don’t understand what they’re doing when they’re clicking the buy button, and I’m going to buy a block of stock.

Preston Pysh  35:03

And this is really getting to the essence of a thing we call patience. If you are patient, and you are trying to accumulate a lot of wealth over a lifetime, it’s a lot easier for that person to invest, than it is for them to speculate. These people that are speculating, these really anxious cadets, I mean, I was, I was one of these guys, you know, over a decade ago. So it’s kind of fun to talk about it because I remember being in that state of mind, where you want to do big things really early, you just want to jump out of the gate and get after it. And that’s where these guys are at. They don’t possess the patience. And I think for anybody, that’s going to be a large success in the market, you’ve got to have some patience.

Let me I’m just gonna look through my list really fast and see if there are any really quick ones that I have that we didn’t necessarily cover on your list. So the one that we talked about, and we talked about this a lot on the show, is really protecting your downside. And it really goes to what we were just talking about is protecting your principal. These guys who are the number one investors in the world across the board, you know, have managed billions of dollars or they have their own net worth of a billion or more. They always mentioned, protect your downside, you’ve got to protect your downside. So like we look in the current market right now. So a lot of people are chasing measly returns, in my opinion, that’s my opinion. I could be completely wrong. But my opinion is that based on how the market is currently priced, it’s at about a 4% return I think and the date is 9th of June when we’re recording this 2015, just so people know. So on 9 June 2015, the market, in my opinion, is priced at about a 4% return when you look at fixed income.

So you look at a 10-year treasury right. I think it’s bought two and a half percent 2.7% somewhere around in there. So those are the returns of people were chasing with their money. I don’t really think that those are very good returns. I think that you’re potentially setting yourself up for a liquidity trap. And I know we were talking a little bit about that before we started recording but it’s very important for you to think: am I in a position where the risk that I’m assuming in going after a 4% return is worth that potential liquidity trap the way that I am just defining it? Is it worth that? Is the downside risk of the market taking a huge correction worth that 4% gain? Yeah, I’m of the opinion that a lot of my money is not worth it. That’s my personal opinion.

Brian Rutherford  37:36

I completely agree, Preston. I mean, so to illustrate this, I had a good story about cadet coming in to talk about this company Lumber Liquidators. They sell flooring to millions of homes in the United States. And there was a story about three months ago, on 60 Minutes, about how a lot of their flooring was not meeting the code that was being stamped on the flooring. So it’s made in China and they had very high levels of formaldehyde and other carcinogens, and ethical concerns.

So the Wednesday before the Sunday 60 Minutes episode, the CEO came out and said, “Hey, there’s going to be a story run on Lumber Liquidators this Sunday and they put us in a negative light.” That day that, Wednesday, Lumber Liquidators stock went down by about 25%. So I think is that high about 70? So 25% run up on that day on that Wednesday, the story happens on Sunday. It comes out, it was maybe a little bit worse than what people thought so Monday, it takes another 25% to 30% loss. And I’m teaching a class on Tuesday. So cadets come in and they’ve read the news. And maybe they even watched the story and they said, “Hey, sir…” Again, looking at the chart first, saying, “Hey, this stock is down almost 50%. I should maybe be in this sort of thing.” And this gets to the point about understanding your downside risk. I said, okay, what is the downside? What is the risk here? Why would you make an investment today?

Preston Pysh  39:08

Why would somebody be selling even more?

Brian Rutherford  39:10

Yeah, what is your premise for buying today? And they said, “Well, because it’s gone down 50%,” like that is not a reason to buy, because you don’t know what your downside is, you know what, maybe potentially the upside is because you know what it was selling at trading at before. But now this new information comes to light, it’s assimilated in the stock price. And it’s down.

So I think at that point, the stock was about $40. And if you run the story forward, now I think it’s trading at 25 or so it’s down even further. It’s because more information comes to light and we the investors are understanding what the downside is, and they’re not touching it.

I have the opportunity to take some guests to Boston and talk to the CEO of Highfields Capital Management, one of the largest hedge funds in the United States, John Jacobson out of Boston, who famously shorted Enron about six months before it exploded. And made a lot of money there and has since done well. And so cadets ask him about Lumber Liquidators, he said, “We don’t have lots of models for what’s going on. We can’t even model what’s going on with that company right now. So we are not going to touch it.” And he is a person who likes to take a big position, whether it’s a short position, or whether it’s a long position, but it’s got to work in his models. And I’ll just believe that he has lots of smart people working for him. And they can’t model what the potential upside or downside is, then that it’s something that I shouldn’t be touching either.

Preston Pysh  40:36

So the part I like about this is it gets to the point that I really want the highlight, which is one of my big seven, and that is the appreciation for all the variables at play. And I think that a lot of people come up with a few talking points if you will. It’s like almost like their elevator pitches. They’re trying to sell you on why they bought whatever rand it’s so surface deep They’ve got three talking points and they’re like, hey, it’s a great buy. Because A, it’s a great buy because of B, and it’s a great buy because of C.

And notice how I said it’s a great buy, they never talk about the downside risks… It contrasts with whatever they think their upside is. And even if you did have three downsides, now you’re only dealing with six variables. And when you’re talking about some of these businesses, sometimes there are so many different variables at play. And I don’t think that a lot of people have an appreciation for that complexity of what they’re really dealing with. And I think that the better that you can define this, and Graham talks about this in “Security Analysis” a lot where, you know, he talks about the certified financial analysts, it is his duty to dig into all these different variables and then wait for them and figure out, “Hey, what are all the things that could go wrong? What are all the things that could go right?”

And that’s the people that you’re going against. So for some of these young investors that are doing individual stock picks, they might not have an appreciation for how involved some of those people are on the other side of the deal that is maybe selling or buying their shares. And I think that really kind of having that appreciation for all these different variables and really trying to shoot holes through.

Mark Cuban has a great quote, he says, “I always try to figure out how I could kick my own ass.” And I think that that’s a great way to look at things. Because when you’re buying stocks, if you’re buying something think, how could I lose? How could there be somebody that has the opposite opinion beat me at what I’ve got? I think when you look at it from that vantage point, I know Ray Dalio you know, biggest hedge fund manager on the planet. That’s why he has these boards. And he sits in these rooms with all these people. And it’s like, “Hey, here’s my idea. I want everybody in here to tell me why I’m wrong.” And then he tries to quantify that and figure that out. And I think that that’s one of the things you got to do as an investor. You’ve got to try to beat yourself up. Why am I wrong? Instead of just trying to sell yourself on why you’re right.

Brian Rutherford  43:01

And this is exactly… So to go back to the topic of this whole podcast is what are the mistakes that young investors make? And this is what they don’t do, right? You look for self-affirming information and you weigh that more heavily than something that could tear down your argument for buying something. And that’s what younger people do. I mean, they want to be right. You know, they’ve been right probably all of their life. They’ve done very well. They made it into the Military Academy. And now they want to make a good investment and they look for the information that supports the decision that they’ve probably already made, right? They probably click buy and then try to determine why they’ve actually bought it. “Oh, I bought Tesla because it was really interesting. And it was down 5% today, and Elon Musk is there and he’s, he’s amazing. He’s good. And he’s gonna bring it back.” Well, again, remember, not two years ago, he said $160 stock price feels a little bit high to him, right? So I think we need to take that into account.

Preston Pysh  44:05

Well, hey, so that’s all we got. I think that this was a fantastic interview. Brian, thank you so much for coming on the show. This was pretty exciting to be able to link up with you down here in DC. We did this… You should probably notice my voice sounds a lot different is because we’re using a little recording device in my hotel room. So I don’t have access to all my recording equipment. But I was so excited to be able to do this, just sit down, and share some of these experiences because so many people are in this same situation where they’re new investors, they haven’t had this exposure, they haven’t felt the pain of going through a 2008-2009 crash. And you know, when you go through something like that, you definitely look at the world through a different lens. And hopefully, we’re able to help people that if there is a market downturn in the next couple years, maybe some of this information will have been useful for them to maybe mitigate some of that risk.

Brian Rutherford  44:57

Yeah, thanks a lot, Preston, for the opportunity to come and talk and share what I talked with other people with. I believe some of these issues are what’s on a lot of people’s minds. Sometimes you don’t want to speak up and say, “Hey, I don’t really understand what I’m investing in.” But they could certainly do, and we have a good interaction. So I appreciate the opportunity.

Preston Pysh  45:16

So one question I got for you. And we ask every single guest that comes on our show this question if there was one book that you could recommend to anybody in the audience, and most people recommend an investing book, but it doesn’t have to be investing. Something that has impacted you tremendously. What would that book?

Brian Rutherford  45:32

Yeah, it’s my most recent read right now. And it’s Robert Cialdini’s “Influence.” I think that no matter what you’re doing in life, you are always trying to influence people, whether you’re in sales, or whether you’re a marketing person or whether you’re just trying to sell your idea to your boss and trying to get that raise. You’re always trying to sell somebody on something and understanding the keys of influence, absolutely recommend that book to anybody. Robert Cialdini, one of the foremost thinkers on influence.

Preston Pysh  46:02

Stig and I did an entire podcast episode on that book. That was pretty neat that you said that you liked that book. By the way, that’s Charlie Munger’s favorite book, who’s the vice-chairman of Berkshire Hathaway, who’s a billionaire. So, we will have a link to our interview that we did on the top five points of “Influence.” We will also have a link in the show notes.

If you want to download our executive summary of that book, if you don’t have time to read it, or you don’t have time to go out and get it. We wrote an executive summary of that book, you can download that executive summary on our show notes. Also, if you sign up on our mailing list, you can get all of the executive summaries that Stig and I write for all the books that we do, but awesome recommendation. That’s probably one of my top five favorite books of all time. So that’s pretty neat to hear you say that. Thank you so much for coming on the show. It was awesome to have you here.

Brian Rutherford  46:53

Thanks a lot, Preston.

Preston Pysh  46:55

Okay, so I hope you guys really enjoyed that interview with Brian. This is the point in the show where we’re going to go ahead and answer a question from a member of our audience. And this question comes from Frank Borgia. And he has a great question. So we’re going to get and play that right now.

Frank Borgia  47:07

Hey, Preston and Stig. I know you guys are really big into accounting. So my question is accounting related. How does a company like Tesla continue to operate with negative net income and negative free cash flow since 2007? How does it even continue to keep its doors open? Thank you so much.

Preston Pysh  47:30

All right, Frank, this is a fantastic question. And I’m just surprised you haven’t heard of the money tree, that they just go out to the money tree. And I know, obviously, there is something that’s a little funky going on, because it doesn’t make any sense. And I think for a lot of people that are starting off, they’ll see that and they’ll immediately say that none of this stuff makes any sense because a company can’t keep its doors open if they have a negative flow of income, year after year, but that’s not necessarily the case. And so, Stig is going to answer this one because this is a hard question. So I’m gonna throw it over to Stig.

Stig Brodersen  48:04

Yeah. So, you know, I really like this question, Frank. And that is also something I think that a lot of people that invest in this called tech stocks or on new issues, or they might be meaning to. So it’s really great to hear that you are on the right path here. So basically, there are two ways to do this, if you want to operate a business, and you can sustain that business with the net income.

The first one is debt. So basically, I just pulled up some numbers when I heard the question because I found it was really interesting. And I can see that back in 2010. Tesla had 72 million in long term debt. Today, or by the end of 2014, they have 1.8 billion in long term debt. So that’s, that’s one of the secrets of why they can still be operating.

The other thing which is not debt, but a kind of debt is that they’re issuing more shares. So actually when they issue shares and when they get more shareholders, the kind of just owe that money to the shareholders, which in turn, of course, will dilute the shares of the existing shareholders. And so just to give you an idea, again of some of the numbers, they’re actually gotten more than 1.7 billion raised in additional equity from the capital markets since 2010. So, this is not me saying that Tesla is a bad business, anything. This is just me saying that. It’s definitely not a Warren Buffett type of business. It’s not one of those stable companies where you buy into the earnings and you would just see steadily, money flowing back to you. It’s definitely another type of business.

Preston Pysh  49:45

So Frank, the best way that I can tell you to help you solve problems like this in the future, because whenever I was first starting off, the thing that helped me the most was trying to always relate something back to my own personal life from my own personal experience. So I would ask myself in this situation, how could I continue to not make money and have enough to get by from day to day?

So the easiest way to answer that question is, well, I’d have to go out and I’d have to get more loans than what I have right now. Or I’d have to have people lend me more money. And then the last scenario that Stig talks about is basically diluting the equity of the business or selling more shares on the open market to raise cash. And that’s really the best way I found to really kind of solve these difficult accounting questions, is how would this relate to me as an individual person or individual investor, if I was in a similar circumstance.

And when you do that, and you go through that mental gymnastics, you’re sometimes able to solve the problem a little bit better, but Stig’s answer was spot on and hopefully, that really helps everybody crack this problem. So, Frank, we really appreciate the question, we’re going to go ahead and send you a free signed copy of the Warren Buffett Accounting Book.

And for anybody else out there if you want to ask a question like Frank and get it played on the air and get a free signed book by us, go to asktheinvestors.com. And you can record your question there. And hopefully, it’ll get played on the air for you.

51:05

So that’s all we have for you guys this week. We really want to thank Brian Rutherford for coming on the show and giving us a fantastic interview. I really hope that that helps people think about those difficult problems that they may be overlooking, that are potential risks as they continue to invest in the market. So thank you so much, Brian. And thank you, Frank, for the question. And we’ll see everybody next week.

Outro 53:20

Thanks for listening to The Investor’s Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit stage.theinvestorspodcast.com. Submit your questions or request a guest appearance to The Investor’s Podcast by going to www.asktheinvestors.com. If your question is answered during the show, you will receive a free autographed copy of The Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application.