[00:03:13] Kyle Grieve: So to kick it off, let’s discuss why you called your fund ZIG. This might seem inconsequential, but there is a good reason why you invest this way. Please break down why you ZIG where others ZAG and why this gives you an advantage. 

[00:03:26] Tobias Carlisle: That’s a great question and I like the contrast of the Acquirer’s Multiple and Concentrated Investing because really they are two very distinct strategies, two sort of distinct styles.

[00:03:36] Tobias Carlisle: Even though they’re both value, they are very different. And the difference is Acquirer’s Multiple, so the first book I wrote came out in 2012, it was called Quantitative Value and I did some Investing I had a co author in that, Wes Gray, who’s done a PhD at Booth, good quantitative school. We found every bit of academic and industry research that we could on value investing, fundamental investing, credit drives, stock price returns, what causes companies to fail, what causes businesses to fail, what causes them to succeed, what causes returns to work, like lots of anything we could think of.

[00:04:13] Tobias Carlisle: And we went back kind of 80 years, something like that, maybe even more. I think we went, you know, security analysis is 1934, but then we were looking at some of the old, there are these old statistical sort of research papers that were done on, in the very early days when they could do like a regression analysis, linear regression, they were doing this stuff, like Pencil, and they were doing like least squares method to work out with the variables that were impacting some of these things.

[00:04:39] Tobias Carlisle: And what they were looking at was manufacturing companies and what made them fail, and they’d come up with these like long string of, you know, days, inventory, or days receivables, outstanding inventory, like all of these sort of things, inventory turnover, and then they’d stick a coefficient beside that, which was the, that’s what those overly squares sort of regression analyses look like.

[00:04:59] Tobias Carlisle: Does that continue to work today for companies that were not manufacturing companies? And we tested it and surprisingly, the intuition is pretty good because a lot of what it found was the just common sense things. If you see payables blowing out, probably they’re having trouble paying. If you’re seeing receivables coming out, they don’t have a lot of money coming in.

[00:05:17] Tobias Carlisle: If there’s negative cashflow too much, like all of it is just, most of it is pretty intuitive. And so we found a lot of the studies in the papers were like that. They’re pretty intuitive, even though they’re sort of set up in a quantitative way. And finance papers are an absolute nightmare to read because they love all of the algebra and all that sort of stuff.

[00:05:34] Tobias Carlisle: And you got to figure out what you’re reading. It’s a nightmare to read them. But then once you sort of plug it into a computer and you narrow it down to one line, does it pass or does it fail? Then it’s a pretty simple process. And it’s trivial now to build that into a modeling system. So we took all of these ideas, we modified some of them because, so something like Piotrowski’s F score, which a lot of people are familiar with, that’s the fundamental score, so the idea was Piotrowski went and looked at the cheapest of the cheap in the price to book value bucket, and then he said, which ones of these are the ones that are likely to perform, and all of the things that he’s looking at are the business fundamentals improving, is it sort of fundamentally strong, and then he looked at, do they issue shares, or do they buy back shares.

[00:06:14] Tobias Carlisle: And so he was looking at purely at share issuance and as you know, there’s some, you can have a buyback going or he was looking at buybacks and you can have a it’s quite common these days for there to be a lot of share based compensation could be like 15 percent of the market cap in share based compensation.

[00:06:31] Tobias Carlisle: And so they’re buying back 15%, which looks like a pretty hefty buyback, but they’re issuing it on the other side. So your net buyback is nil. And so we just tweaked a few of the things to capture stuff like that. We tested this thing. As you’d expect, in a back test, it looked really good. I think that it is still, I think it is a very good way of investing.

[00:06:50] Tobias Carlisle: So this is Quantitative Value. The big muscle movements out of Quantitative Value were clearly mostly the price ratios. They drive a lot of the return. And provided your portfolio is big enough to get over the fact that you’re going to step on some landmines, that you’re going to make some errors in there.

[00:07:08] Tobias Carlisle: It’s a very good way of consistently investing. And the real magic of it is that value can have very long periods of underperformance. And this thing doesn’t care, like it just keeps on going. You’re seven years into underperformance, doesn’t matter, it’s still ruthlessly applying the same method. And then it turns out that there are these very long cycles that sort of, people get very upset when, cause they’ve heard Buffett say, there’s no such thing as growth and value are tied to the hit.

[00:07:34] Tobias Carlisle: There’s no valuation without a growth component to it. And that is true, but then the industry and academia divided into two, and it’s just that the reason that the academics do it is they say if something is very expensive on a price ratio basis, because the market has this idea that there’s, you know, the efficient market hypothesis says there’s no arbitrage gains available.

[00:07:56] Tobias Carlisle: So therefore it must be implying a very high rate of growth to justify that valuation. That doesn’t work. Paying expensive prices with implied growth tends to underperform paying very low prices with low or negative implied growth. So we understand that as a sort of general principle, that’s always the case, but then you could look more specifically at the growth rates.

[00:08:16] Tobias Carlisle: And it also turns out that growth tends to, so you look at the growth rate of the revenues or whatever it might be. cash flow, whatever. And it turns out that growth also tends to fall apart. Through all of this research that we did, it became pretty clear to me, and it was something that I had understood on an intuitive basis from reading a lot of this stuff, but it really sort of became clear in Quantitative Value that something very counterintuitive happens.

[00:08:40] Tobias Carlisle: And it makes complete sense to me when you think about the fact that everybody in the market is trying to chase these excess gains. That’s what everybody’s here for. You could get a market. You can get spy, go to the beach. So everybody who’s participating is trying to beat the market. And clearly that’s an impossibility, particularly after trading and cost most people are going to want to perform.

[00:09:01] Tobias Carlisle: So how do you outperform? yOu have to be where other people aren’t. You have to be, you have to have some variant perception. As Michael Price calls it, you have to be doing something distinctly different from what everybody else is doing, and one of the ways that you can do something distinctly different is to go into those things that are particularly scary looking, either because it looks like they’re going out of business, or the stock price has gone down a lot All revenues have been dropping and you buy those things when that has happened and what you’re relying on is that there is going to be this mean reversion.

[00:09:34] Tobias Carlisle: Mean reversion is just this idea that things go back to normal over time. There are cycles in business, there are cycles that take long, long periods of time. I don’t know how long a human can really understand a cycle, but once you’ve been doing something for three years and it’s been running against you for three years, it feels like you’re probably wrong.

[00:09:51] Tobias Carlisle: It’s time to give up five years, time to give up 10 years. Time to give up. Cycles are much, much longer than that. And so really all that I was trying to do with the acquirer’s multiple was show here’s a very simple price ratio, which is, it is the best one because it just, it has a lot of information in the acquirer’s multiple.

[00:10:09] Tobias Carlisle: So what it is, it’s EBIT operating income. compared to the enterprise value of a company. And the enterprise value of a company is the market capitalization. And then you include any debt because that would be what an acquirer would have to take on if they acquired one of these things. Then you get any cash that they have.

[00:10:26] Tobias Carlisle: So you deduct that from the calculation. And then you look for other things that are debt like quasi debt or that sort of stand in front of the equity. So preferred stock gets paid first, often has a dividend attached to it. A minority interest would have to be carved out. And so on. So you get this that’s the true price that you’re paying.

[00:10:44] Tobias Carlisle: And then the EBIT operating income is kind of what’s flowing back in. It’s not a cash flow measure, but it’s a pretty close cash flow measure. Cash flow has its own problems and cash flow is reconstructed from the income statement. It’s not looking at actual cash flow. So I just use EBIT because it’s a simpler measure to calculate.

[00:11:02] Tobias Carlisle: You can start at the top of the income statement. So as you go further down the income statement, there’s more and more discretion for management. There’s decisions that get made. So you could have two identical companies that could have different bottom lines just because of the way they’re capitalizing expenses or whatever they happen to be doing.

[00:11:17] Tobias Carlisle: So I like to start with EBIT operating income because it’s revenues minus cost of goods sold gives you your gross profit. gross profit backing out just a handful of things that there’s not a lot of discretion on. You’re pretty close to getting EBITDA. And then you make a lot of other decisions and you get down to the bottom line.

[00:11:34] Tobias Carlisle: So that’s a very good metric. It’s a very simple metric. And when you run it, you can definitely see this mean reversion occurring in the stock. So I said, this is the idea. Here’s a very simple price ratio. And here is the reason why it tends to work because there is this mean reversion in undervalued stocks and mean reversion, what drives mean reversion is when industries tend to go together, they tend to, companies and industries, it’s cyclical, when business gets really tough, they either fold involuntarily, they get bankrupt or they leave because there are easier things to do somewhere else.

[00:12:06] Tobias Carlisle: Or the other way around, business gets really good, lots of capital flows into the industry, there are new businesses started, they can pay away some of the super economic profits. And so that’s mean reversion in really simple terms. So that was Quantitative Value. Sorry, that was the acquirer’s multiple.

[00:12:22] Tobias Carlisle: Explaining a simple price metric and the reason why it works and some of the people and I just added some stories to show here there’s activists that come in when this stuff is broken. This is the actual mechanics of in practical terms. This is what happens to turn these companies around. Concentrated investing, on the other hand, is a completely different approach.

[00:12:38] Tobias Carlisle: Same intuition, still trying to buy something undervalued, but there we went and we sort of worked backwards, we said, let’s find guys who’ve survived for more than 25 years in the markets, because that’s a hard thing to most fund managers, like Peter Lynch was in the market for 13 years. He ran that thing for 13 years.

[00:12:56] Tobias Carlisle: Not many guys, and you know, Bill Miller, he was about 13 years in the market. You go and look at these guys their periods of time when they invest are very short, and you can have a value cycle could go for 11 or 13 years, then you can have a growth cycle that goes like the last one probably ran from 2010 to probably say 2022.

[00:13:12] Tobias Carlisle: Maybe it’s still going on now. I’m not sure, like the fangs seem to be sprinting ahead, but the cycles are long, so you need to find someone who’s survived more than one cycle, really. So Buffett is a great example because Buffett has survived over and over again and thrived through cycles, but there have been long periods of time where he’s underperformed.

[00:13:29] Tobias Carlisle: So the late 1990s, I forget which magazine it was, but say it was Businessweek, have him on the cover and say, you know, is Buffett done? Same thing happened again in 2019, is Buffett done? You go back further. It just happens over and over again. They get these long periods of time where your strategy just doesn’t really work.

[00:13:48] Tobias Carlisle: And we wanted to find people who’d survived through a few cycles, so they had some ability to stay. And then on top of that, they weren’t just holding spy, they were concentrated value investors. And then what were they doing to allow them to do that? And we looked across, there’s a guy, Christian Siem, he’s done it in the oil and gas industry, which is a tough industry.

[00:14:07] Tobias Carlisle: That’s a really cyclical up and down industry. looked at Charlie Munger because he had invested, he was an investor before he was in blue chip Stanton with Buffett. We looked at Keynes, John Maynard Keynes, the famous economist who had been, he’s kind of an interesting character because he was, he’d won this very prestigious prize for being an economist and he was kind of a famous economist because he’d said something about the reparations that Germany was forced to pay to following World War I.

[00:14:37] Tobias Carlisle: And he had said, this will blow up in everybody’s face, which, and then of course, World War II occurred, and he was vindicated by that. And so he was incredibly intelligent, towering intellect, people were listening to what he was saying. And he started out using his superior economic insights to invest as a macro guy, and he got blown up twice.

[00:14:55] Tobias Carlisle: So if Keynes can’t do it, I don’t think many people can. He eventually became sort of a compounding Buffett style investor where he knew the market cap of this company buys this many cars coming off the line that’s cheap on this basis, so this car company is cheaper than this one or better than this one.

[00:15:13] Tobias Carlisle: He was a real long term hold and he survived for a long period of time. So we included him and some other guys who are still operating today. And what we found, we’re looking at I looked at the academia around concentration and diversification because that’s important. So if you’re an efficient markets guy, what you’re trying to do, you know, now it’s easy to put together a portfolio of cheap stocks because it costs you, you can Robinhood cost you nothing to trade.

[00:15:37] Tobias Carlisle: You could put together a market portfolio for virtually nothing, but at one point in time was exceptionally expensive to do that. thousands and that looks so expensive to do it that you couldn’t really do it practically. So what they were interested in doing, what the academics were interested in doing was how few stocks can we hold to give us the market return.

[00:15:57] Tobias Carlisle: And they’re assuming an efficient markets world. So they would say, And what they found, kind of an interesting finding, I think, that 20 stocks gets you like 90 percent of the performance of the index. This is just randomly selected. 20 stocks gets you 90 percent of the performance. 30 stocks gets you like 95 percent and then you keep on adding stocks on after that to get you the last little asymptotic down to a zero until you get, until you own the market and then you’re getting the market performance.

[00:16:22] Tobias Carlisle: But at some point through there, the cost of owning those marginal stocks starts outweighing the benefits you get. So they decided, sort of the numbers between 20 and 30. Benjamin Graham, who was a value guy, of course. did a similar experiment and his numbers fell out at about 20 or 30. So he found the same thing.

[00:16:39] Tobias Carlisle: And remember, this is not trying to beat the market. This is just randomly selecting to perform in line with the market. You’re just picking ping pong balls out of a bucket with tickers on them and putting those in your portfolio. So how do you then go about outperforming or how do you get a divergent performance from the market?

[00:16:52] Tobias Carlisle: I mean, that’s kind of a challenge now. One of the things you can do is, of course, you just start looking at price ratios by the cheaper things, and then that gives you this widely, wildly divergent performance, but that’s not always a good thing. So you spend lots of time underperforming, you spend some time outperforming.

[00:17:08] Tobias Carlisle: What the data says is that over the very long term, you tend to outperform. So these concentrated investing guys, they were doing something a little bit more again. Some of them were Kelly betting. So this was a, I think, kind of an innovation of Buffett’s. I don’t really know that it existed.

[00:17:21] Tobias Carlisle: outside of Buffett, but he understood the Kelly paper. So John Kelly, who was at MIT Bell Labs physicist had imagined this private wire where you got this information about some sporting event, baseball. I think you knew the outcome and you could bet on it before everybody else could bet on it. If you have this inside information where you know the outcome, how much of your bankroll should you bet?

[00:17:45] Tobias Carlisle: And then he added some complications because it was Bell Labs. It had to be like a telecommunications based idea. So he said what if it’s a noisy line? And so sometimes the information is wrong. You’re not certain now. So you can’t bet 100 percent of your bankroll because if you’re wrong, you’re wiped out and we’d never want to wipe out.

[00:18:02] Tobias Carlisle: That’s what we’re trying to avoid. So what he ended up coming up with was this Edge over odds. So your edge is the private information, what you know, and the odds are what you’re offered by the bookmaker or the market implied odds. And then that tells you how big to size your bet as a proportion of your bankroll to maximize your rate of return in a geometric sense.

[00:18:22] Tobias Carlisle: It doesn’t make sense for some very rich person to be betting 95 percent of their capital on an almost sure thing. if it means that they’re going to go back to being, you know, they’re not going to be very rich at the end of that. So there’s clearly, there’s some limitations to this idea. That’s that the personal utility of the money.

[00:18:39] Tobias Carlisle: But the idea is essentially that the opportunity is the more you should always bearing in mind that there’s some risk in it and you don’t want to wipe out. I think that Kelly’s very hard to use because The market implied odds are hard to calculate. Is how good is your edge really? And then Kelly was really developed the way it worked best was if you’re sitting at a blackjack table and you’re getting these hands in series, one after the other, and so each time you get to bet some portion of the bankroll, but that’s not the way you invest in the markets.

[00:19:09] Tobias Carlisle: In the markets, you’ve got an unlimited number of investments that you could make at any given point in time, including you could have a treasury bill, which is a pretty certain return, but a low one. And you could have something that’s quite speculative that is a very uncertain return, but a very high one.

[00:19:24] Tobias Carlisle: And you could have them both available at the same time, and it could be that you’re sizing both. at more than 50 percent of your bankroll, in which case you’re risking ruin if one of them doesn’t pay off. And so that’s, that doesn’t work. So you have to apply it differently. But the idea is the intuition of it is kind of sound that you should size up better bets, size down less certain bets.

[00:19:48] Tobias Carlisle: And I think what really stood out to me from reviewing the whole book was The ones that are best to size up, and I think this is what Buffett does, it’s not so much the ones that offer the greatest return, it’s the ones that offer the most certain return, that seems to be it. Buffett’s approach. And I really think that’s the key to what Buffett has done, that he never risks ruin.

[00:20:07] Tobias Carlisle: He’s looking for things that are almost certain, even if the return is, you know, modest, he would prefer a modest certain return to an uncertain high return. And that sort of means that under most circumstances, he’s got a great line, which I just, I can’t think what it is at the moment, but he says something like, the problem is that most people set their course.

[00:20:29] Tobias Carlisle: In the markets, assuming that most of the time I get pretty good returns and every now and again, these very rare events come along and they’re essentially they’re wiped out. But he, what he does is he sets his course assuming that these rare events are going to occur all the time at any given point in time, and he’s going to survive that rare event, and so then he does well, and that’s sort of the cycle thing that I was talking about before, where he goes through these bad cycles for himself, he gets a bad magazine cover, but at the end of it, he’s still alive, he’s still going.

[00:20:57] Tobias Carlisle: So that’s sort of, that’s, those two books are a pretty good example of the range of value, I think, and the way that I think about investing. And I think you, you look at any given opportunity somewhere on that spectrum from cheap statistical value and you should do something like that and every now and again.

[00:21:15] Tobias Carlisle: I’m mostly a cheap statistical investor, but you know, I do believe that you get these like 20 punch cards over the course of your life. You get a punch card, you get 20 opportunities, probably over the course of an investing life. It’s one every two or three years, something like that, that you should think about sizing up.

[00:21:30] Tobias Carlisle: And I just think the more you do it, the better you get at identifying these things because you see the reasons why things fall apart. the reasons why things don’t work. And that’s why investing is really one of the few things that you can get better with at age, which is one of the reasons that I like it.

[00:21:47] Kyle Grieve: So there’s an interesting Credit Suisse research article that was released in 2013. In it, they had some interesting findings on high quality businesses. So they determined that there was little evidence of mean reversion for a company’s operating performance. Companies in the top quartile remain there over extended periods of time.

[00:22:04] Kyle Grieve: Great businesses remain great. Only 9 percent of the top quartile moved to the bottom quartile, and 79 percent of the top quartile remained in that top half. Poor businesses continue to report poor performance. 6 percent of these had a chance of moving from the bottom to the top quartile. I’d love to get your thoughts on this research piece, given all the work you’ve done on Regression to the Mean.

[00:22:26] Tobias Carlisle: If it’s Credit Suisse, it’s probably Michael Mavison. Was it a Mavison? Mobison has done some research where he says, he looks at 10 year rolling periods and he divides, he ranks all these companies on return on invested capital. So this is one of the little, when we’re talking about quality, there are lots of different ways to measure quality and return on invested capital is sometimes used as a quality sort of metric.

[00:22:51] Tobias Carlisle: And I think it is a quality metric. It’s just that it’s, it could also be a profitability metric and profitability can be a little bit mean reverting. Quality could be quality of the balance sheet. quality of the earnings, recurability, predictability of the earnings, all of those sort of things. So I do think this, it’s certainly the case that there is some momentum in earnings and some of these businesses that do tend to do very well will continue to do well.

[00:23:16] Tobias Carlisle: If you’ve got a good niche where you’re making money, you’ve got money flowing in and you’ve got a sensible management team that’s not over levering the company or doing anything silly like doing silly acquisitions or something like that. They’re just focused on what the business is and they keep on doing that.

[00:23:30] Tobias Carlisle: That’s what Buffett is hunting for. You know, ideally they’re kind of returning capital rather than sort of it’s going to slower return investments, which sometimes that tends to happen because they get a bigger universe and they get a bigger empire if they do that. That is the case that there are a lot of these things that are excellent businesses that just keep on doing that.

[00:23:48] Tobias Carlisle: The problem is that on a risk adjusted base, on a valuation adjusted basis, you don’t want to be, you can still overpay for a company like that. It may be the case that a really good quality company, you can overpay a lot and the quality of the company will bail you out eventually that it’ll catch up.

[00:24:04] Tobias Carlisle: But I have seen it happen enough times that, so in the late 1990s, everybody remembers the late 1990s as a dot com bubble. And it certainly was an element of it being a dot com bubble, but really what it was a large cap growth bubble. And the companies that were, we all agreed that they were high quality companies.

[00:24:20] Tobias Carlisle: So we’d be talking about Microsoft, Walmart, I can’t remember the rest of them off the top of my head, but they were, you know, they’re all big recurring revenue companies that are very stable. And from 2000, at the peak of the bubble to 2015, when they sort of, it took them that long to work off their overvaluation, they were still growing most of the time through their like extraordinarily high rates, still being high quality companies.

[00:24:44] Tobias Carlisle: It’s just that the stock did nothing. for that period of time. You’re not trying to find the best quality company. You’re trying to find the best handicapped odds. So you’re trying to find the thing that, you know, you go to the racetrack, you’re not trying to find the winner. You want to find the show or the place at good value.

[00:25:01] Tobias Carlisle: And that’s how, I don’t know, I don’t want to say that’s how professional racetrack bettors do it, but that’s what I would do if I was a professional racetrack bettor. You’re trying to find the best return for the unit of risk that you’re taking on or the best return. I think that’s right. The best return for the unit of risk that you’re taking on.

[00:25:16] Tobias Carlisle: I do think that it’s certainly the case that the underlying business can do very well, but as an investor, that’s only half of the equation. The other half is trying to find good value and good risk adjusted returns. And so the ideal scenario is that’s really what Buffett is doing is he’s got that list of very high quality companies that compound and grow with great management teams.

[00:25:36] Tobias Carlisle: It’s just that they don’t ever get cheap enough for him to buy, so he sits there not buying them, and then he waits until that scenario happens where either it’s a systemat you know, system wide collapse, the market collapses and all of this stuff gets cheap, Or there’s something that happens specific to that stock that doesn’t impact the business, it’s just that the stock gets knocked.

[00:25:56] Tobias Carlisle: So American Express with its salad oil scandal in the 60s is a good example of that where it famously went and sat beside cash registers at restaurants and saw them, you know, the consumers were still presenting the cards, the restaurant was still accepting the cards, it hadn’t impacted the most important part of the business from his perspective.

[00:26:16] Tobias Carlisle: The salad oil scandal. I don’t know if your listeners know that story, but I’ll tell it very quickly. It was basically, there was this guy, Anthony, Tiny DeAngelis, who was a speculator in salad oil, in soybean, I think it was soybean oil, something like that. And he was trying to corner the market, which is where you buy more, you buy up a whole lot of oil and you squeeze anybody who’s short.

[00:26:36] Tobias Carlisle: And then when they come to buy, they can only buy from you at a very high price. He kept on buying oil and the price went against him. And so he ended up coming up with the tanks had to be stored somewhere. So he had these warehouses that store the tanks and he used seawater to make the tanks look like they were more full than they were.

[00:26:52] Tobias Carlisle: And he had these little devices where when the inspectors came and put a little dipstick in to check that there was oil in there, it just went into a little tube and the rest was seawater. And then he also had some pipes that he moved the oil around. That was very clever, kind of. The amount of effort that went into the fraud, if only he’d found some way to do it.

[00:27:09] Tobias Carlisle: non fraudulently, probably would have been very successful, but eventually the soybean oil market collapsed because they figured out that this guy’s, somebody pointed out he had more oil in his tanks than there was in the entire world, which meant that was not possible, and so he got liquidated, it wiped out some of the banks, and then American Express had this business where they would give these warehouse receipts, which is how you turn a commodity into something that you can trade or borrow against, and so it was American Express who had said, yes, he does have this oil in his tanks and it turned out that was not the case.

[00:27:38] Tobias Carlisle: And so they went and sued everybody they could think of, the brokers and everybody, including American Express and American Express had the deep pockets. And so American Express could have been on the hook for, it was like 60 million bucks or something like that. Buffett looked at it and figured out it was unlikely to be as, the payout was ultimately unlikely to be as big as that.

[00:27:54] Tobias Carlisle: But even if it was, it’d be like a one time dividend that they wouldn’t collect. And it would keep on going provided that the business franchise wasn’t impacted. And that was why it was so important that he went and sat and looked at people were still handing over the card. People were still accepting the card that likely was going to work.

[00:28:09] Tobias Carlisle: So he put 40 percent of the business in. He was at that stage and much more deep value investor. And so he was really just playing on the crisis, expecting that he would buy it and it would bounce. And then he would basically get out. And so he did that and he made some good money doing that. But then he revisited it when he was running Berkshire.

[00:28:25] Tobias Carlisle: So this was when he was running the partnership and he revisited it when he was running Berkshire Hathaway. And it had grown enormously over the period of time that he had been out of the stock, whatever it had been 10 or 20 years. And he used it as an example, or he learned from it himself that you buy these things when they have that little moment of weakness, and then you just never sell.

[00:28:43] Tobias Carlisle: You just let the underlying business chug ahead. And that’s how you get your great returns. Ultimately, that’s where we’re all trying to get to that kind of investment style, but it’s a very long process, I guess, to get there. You talked 

[00:28:55] Kyle Grieve: a little bit about uncertainty and there was a really good quote in your book by Seth Klarman, which was quote, high uncertainties frequently accompanied by low prices.

[00:29:02] Kyle Grieve: By the time the uncertainty is resolved, prices are likely to have risen. How do you relate this quote to courage 

[00:29:10] Tobias Carlisle: in investing? That’s something I’ve been thinking about a lot. So courage is not something that you want in an investor, I think, because I get these, I get particularly through, you know, the whole 2020 stock market bubble.

[00:29:23] Tobias Carlisle: And even now, when we’re back everybody’s pretty bullish at the moment, maybe less over the last few days, but pretty bullish. I sometimes, you know, I look at things that say when Nvidia ramped, like I would say, you know, if you just look at this on a fundamental basis, this is probably likely very, this is too expensive.

[00:29:39] Tobias Carlisle: It’s crazy. It’s just, there’s so much growth implied in this valuation. And I’ll get all of these people come in who are much more brave than I’m, I absolutely love that quote from Klemen and I just think it’s such a true there. There are these times in the market where the market goes down a lot and it comes through Twitter and it comes through the news and it just, I can talk to people and I get a little contact high from looking at Twitter.

[00:30:03] Tobias Carlisle: I get the, I can feel the adrenaline of people, I can feel how nervous everybody is, and you can tart when a portfolio is whipping around then. That’s often the best time to be investing. And so rather than rely on courage to kind of charge in and spray money around in that, I like to just, it’s, I think the simpler thing is just to remember what you’re trying to do and to focus on the valuation rather than the price.

[00:30:28] Tobias Carlisle: And you get this, you can say, yeah, I could, it’s possible that I’m buying too early and I’m going to get a better price if I just wait. But it’s also possible that the price just bounces from here and I completely miss it. You just look at the opportunity set that you have. Klarman has another quote where he says, the best investor is a contrarian attached to a calculator.

[00:30:47] Tobias Carlisle: And that’s kind of the way you need to think. Not so much. I know in my Twitter profile picture, I have something like contrarian, but I mean it in the sense that I use that word specifically because it’s, there’s a, there are two very famous papers in investing. One of them is The paper by Fama and French, where they talk about the efficient market hypothesis, and they also talk about the factors, and one of the factors is value, which they define on a price to book value basis.

[00:31:13] Tobias Carlisle: One of them is size. Then there’s the market. And then I think that was the initial paper. There are only two or three. What am I missing there? Size, value, maybe momentum. I forget what the, what’s in that first paper, but pretty hot on its heels. Another paper comes out by LeConachick, Schliefer Vishny called Contrarian Investment.

[00:31:29] Tobias Carlisle: And their idea in that paper was, it’s not, the market is not perfectly efficient. The market is filled with people who make behavioral errors because they extrapolate. So he contrasts these two investors. There’s the extrapolation investor who looks at earnings going up or stock prices going up and just sees that keeps on going up forever and ever.

[00:31:49] Tobias Carlisle: And then he contrasts and he calls those night or they call them naive extrapolation investors. And then on the other side is the contrarian investor who expects men reversions. And so expects the very high rate of growth to slow down or the earnings going down or the value being compressed to turn around at some point.

[00:32:06] Tobias Carlisle: Clearly, it’s better to be the contrarian investor. The contrarian investor gets better returns. I mean, it’s objectively, empirically better to be the contrarian investor. So that’s the way that I use that expression. But the point is that you’re not so much. It’s not a brave step to go in and buy those things.

[00:32:21] Tobias Carlisle: It’s just an application of the same thing that if the market collapses tomorrow, it’ll make no difference to the way that I invest. I always do the same thing. I’m always because I’m, I have the funds that are running both long only there’s long only fully invested all the time. And I’ve looked at lots and lots of different ways that it doesn’t intuitively.

[00:32:40] Tobias Carlisle: I don’t like being fully invested all the time. I would much rather carry cash. It’s just that my inherent bearishness makes me want to pull back all the time. And I think you better off. And this is where I, when I’ve looked at it and I’ve looked at lots of different ways of trying to time with a little bit of cash in there, just none of them work properly.

[00:32:56] Tobias Carlisle: The only thing that you can do. is give yourself a, you know, Buffett says you can have, I think he says you can have a smooth 12 percent or a lumpy 15%. And that’s basically what I’ve found. Like you can quantitatively demonstrate that you can have the smooth 12 percent or lumpy 15%. And the difference is really when you’re remaining fully invested or holding a whole lot of cash.

[00:33:16] Tobias Carlisle: And so I, of course you want the lumpy 15 percent if you’ve got a long time horizon and you don’t want to use that money. So I remain fully invested all the time. I don’t try to time the market. If it collapses tomorrow and we’re down 50%, I’ll still go through my regular rebalance, I’ll buy whatever’s cheap and I’ll keep on going.

[00:33:34] Tobias Carlisle: It won’t make any difference at all. So there’s no bravery in it for me. It’s just implementing the same program all the time, whether it’s high or low. 

[00:33:43] Kyle Grieve: So one common feature of the investors that you looked at in concentrated investing was that many of them had permanent sources of capital. This volatility, like you just discussed, without worrying about capital exiting.

[00:33:57] Kyle Grieve: Why do you think most other investors with permanent sources of capital don’t take advantage of this? 

[00:34:02] Tobias Carlisle: There’s not a lot of, Buffett describes it as an inoculation. I remember reading the Buffett book by Roger Lowenstein, The Making of an American Capitalist, and just thinking, and I hadn’t really, I didn’t really know anything about the markets.

[00:34:15] Tobias Carlisle: Mom and dad weren’t like stock market people. I didn’t really come from a market background. And I read that book and I was like, Oh, this is interesting. There is kind of a, there’s a method to this. And also I like the fact that he was, you know, he talked about honesty and character and I had always thought business is about being ruthless and being aggressive and that didn’t really appeal to me much at all.

[00:34:33] Tobias Carlisle: But I like the, you can try and do the right thing and that’ll be a good way to invest. So when you read through it’s not just value, the way that Buffett and Munger are doing it, there’s something else going on in there as well. And it’s, once you sort of start down that road, Buffett’s so far ahead down that road, it’s funny, the number of times that I go back and read his 1979 letter or whatever it is, or his 65 like partnership letters, and I find something in there that I think that I’ve come up with this idea myself originally, and I go back and I find that he’s looked at it, decided that it doesn’t work and dismissed it, you know, that I’ve done that more than once, many times, and I’ve read those letters lots and lots of times.

[00:35:12] Tobias Carlisle: I read all of those letters many times. And so it’s in there and I’ve read that same sentence 10 times and just not understood actually what he meant when he was saying it and then think I’ve found something, go back and find that, realize he’s already considered it. So he’s always working through this same idea and I think that it’s basically what we’ve just discussed.

[00:35:30] Tobias Carlisle: Be conservative in your estimates of what the business is going to do, try and invest at a pretty big discount to that, try and survive, don’t get too over levered, all those things. And so you get, after a while, you sort of soak this stuff in and it governs the way that you do everything you think about, the way you think about investing.

[00:35:47] Tobias Carlisle: But the number of times that he, when I started reading this, I think I read that book when I was 17, something like that, 17 or 18. And then I went and practiced law and I practiced law as a corporate advisory, which is like you do mergers and acquisitions, anything from mergers and acquisitions to reviewing annual reports to whatever it might be, whatever the company needs, whatever the corporate needs you to do, you go in and you sort of help them do that.

[00:36:11] Tobias Carlisle: And then I moved out of that into an activist firm where we’d approach these small cap mostly that were just being run very badly. And often we’d say to them, you know, why don’t you do a buyback? Because you’ve got all this, you sold this business, you’ve got all this cash, you’re very undervalued. Why don’t you buy back some stock?

[00:36:27] Tobias Carlisle: And this will be the effect. And they just never considered it before. They’d never had anybody say, because they came from an engineering background. They’ve invented this product. They’ve had been very successful. They’ve listed this company. They’ve done very well. They sold off some sideline or something like that.

[00:36:41] Tobias Carlisle: And they’ve got some cash. They just don’t think in those terms of, they don’t understand fully the mechanics of the business. And I just found it strange. I found it ama they’d be paying a dividend and raising capital at the same time. So they’re just, all these silly things going on that just didn’t make any sense.

[00:36:57] Tobias Carlisle: And I’d come from this, you know, reading Buffett when I was 17, and I just think, this is just obvious, right? Why would you be doing all these silly things? And if you understood really what was going on, if you thought about what was going on, you wouldn’t, nobody would do any of this stuff. It’s One of the positions that I like now that I talk about a little bit, they’ve got exactly the same thing.

[00:37:14] Tobias Carlisle: I’ve seen the manager, I’ve seen the CEO interviewed and he says, why would I go and buy back stock when my competitor just bought back stock and this stock price has gone down? You know, it’s gone down further. What’s the point? You’ve misunderstood what’s actually going on here and you’re thinking far too short term.

[00:37:28] Tobias Carlisle: It’s not their fault. They come from their background as in inventing something. They’ve invented this product and it’s working pretty well. There’s a little bit of weakness in the market and they could go and buy back some stock and do very well. They just have to think in a longer term. And then to the extent that people are taught about these things, the way that they’re taught is the efficient market hypothesis and they’re taught all of that stuff.

[00:37:47] Tobias Carlisle: I did law, I did a business degree. First, my undergrad is business management and that included a lot of finance in addition to some other softer stuff, but there’s a lot of finance in there. And they teach, they did when I went through, they were teaching, they were still teaching Efficient Markets Hypothesis, they’re teaching Beta, that nobody is really teaching this stuff, and I don’t know why, because it’s, Buffett and Munger have been around for so long, they’re so well known, they’re clearly, they’re very successful guys, they’re clearly very well known, they’re, I think the best MBA that you could get, really, is just reading Buffett’s letters.

[00:38:17] Tobias Carlisle: Beyond that, I don’t really read Buffett’s letters. Go through the Buffett archive. That’s an incredible resource. I think CNBC’s website’s got it. You can see all the questions that they get asked at general meetings in the afternoons and their responses in there, they explain, you know, they’ve started businesses.

[00:38:33] Tobias Carlisle: And they, so they’ve been entrepreneurs as well. They’re not just investors. They’ve started businesses and those businesses have worked for the most part. So that’s interesting. And lots of businesses fail. And then they’ve got other businesses like See’s Candy and they talk about, you know, why don’t you expand See’s Candy?

[00:38:48] Tobias Carlisle: And they say, we’ve tried everything that we can think of for decades to expand it. It’s just that it doesn’t travel. That sort of explains why Buffett liked Coke so much. Cause he said, holy cow, here’s this product. It’s just like the See’s Candy. People like the brand. They’ll pay a little premium. And guess what?

[00:39:02] Tobias Carlisle: Everybody in the world knows about it. This is kind of a sure thing. I don’t really know why. I mean, I guess I do know why. There’s a few things. One of it is just lots of people don’t know. And the other one is that it’s sort of slightly against everybody’s way too short term, particularly CEOs of businesses like that.

[00:39:18] Tobias Carlisle: They’re looking forward one quarter, most of them looking forward one quarter, looking forward to the stock price tomorrow or as soon as they possibly can get it back up. And if it doesn’t work, it doesn’t work. And it’s so funny to say all that stuff because that’s what Buffett and Munger said when I read this stuff when I was 17.

[00:39:33] Tobias Carlisle: I’m 44 now. I’ve been doing this for a long time. Nothing’s changed. I don’t think anything’s ever going to change. I think it will be exactly the same, which is a good thing because it means, you know, if you can stay in the markets and learn over time, nobody else, like the market itself doesn’t learn.

[00:39:47] Tobias Carlisle: That’s the most amazing thing. I remember the 1999. I was a student. I wasn’t investing. I didn’t have any money, but I remember the stock market running up and I had read the Buffett stuff and I was looking at all this stuff thinking, this is funny. This is really crazy that this is going on. Not expecting that it would collapse, like not really understanding anything and then seeing it collapse.

[00:40:07] Tobias Carlisle: And since then, I’ve seen 2000, you know, the run up to 2007 and then that collapse and I’ve seen the run up to 2020 and that collapse and whatever we’re going through now, the cycles just keep on coming and no, the market doesn’t learn anything, but if you can hang around in it for a little bit with a good theoretical framework, which I think Buffett and Munger give.

[00:40:27] Tobias Carlisle: And you can learn and you really can, the market gets easier and easier to invest in because people just keep on making the same mistakes. And you personally can learn, you know. 

[00:40:37] Kyle Grieve: So for investors who are interested in concentrating their portfolio, you gave some great advice to maintain a margin of safety with a few positions.

[00:40:44] Kyle Grieve: Investors can find a strong margin of safety by searching for protection from either, quote, assets or by a strong franchise and an unlevered balance sheet. I want to focus on the balance sheet part of this equation. Since a concentrated portfolio will be very sensitive to a position going to zero, having a healthy balance sheet becomes very important.

[00:41:02] Kyle Grieve: What areas of balance sheets should investors focus on the most if they intend on running a concentrated portfolio? 

[00:41:09] Tobias Carlisle: The guiding rule should be it’s not your biggest position shouldn’t be the one that you think you’re going to make the most money on. It’s the one that you are most certain you’re going to make money on.

[00:41:19] Tobias Carlisle: The safest position in the portfolio should be the biggest position. And so then if you’re just thinking in terms of safety, you would want a liquid balance sheet. You want cash and you want lots of assets that God forbid you actually have to sell them on some sort of fire sale. That means your analysis is probably wrong in that instance.

[00:41:37] Tobias Carlisle: I don’t know how much downside protection assets really provide. I think that what you want is liquidity. I mean, not a lot of debt. The number of times that I’ve seen debt damage really otherwise good business. Number of times that businesses get taken over and they get leave it up, or they get taken private and they get leave it up, or the company just pays a special dividend and leaves up to do it.

[00:41:58] Tobias Carlisle: It’s amazing that it still goes on, but of course it still goes on. Look at most companies, they’re too, there’s too much debt because most big companies that, Any of the consumer staples that have very stable earnings have had, for the most part, because, and it may be an anomaly that they have looked like that, because the world was once, there was one television set that everybody watched, and there were a handful of channels, and then you went into the supermarket, there was a finite amount of supermarket space, and so it was very valuable to have Colgate advertising, Colgate sitting there in the supermarket, you could buy it.

[00:42:31] Tobias Carlisle: Now it’s not like that at all. You buy You scroll Instagram and you find something that you like and you buy it off Instagram. And so the entry, the barriers to entry are much, much lower for those consumer staples, but you go and look at those consumer staples balance sheets and they’re all trash.

[00:42:46] Tobias Carlisle: They’ve been financially engineered to tweak the last little bit of growth out because it helps the manager. You’re a manager, you go in there, you’ve got a big options slug. You’re going to be there for three or five years as CEO, you know, lever it up, jack up that share price and sell off into the sunset with a big payoff.

[00:43:03] Tobias Carlisle: And that big pile of debt is the next guy’s problem. You know, and then there’s so many examples of that. It’s hard to find companies that don’t have that. So that would be the first thing that I would say. You don’t want a whole lot of debt. You want a whole lot of cash. And then you want a management team that’s, I think it’s really simple.

[00:43:18] Tobias Carlisle: Basically, you want a management team that is like Buffett and Munger, and you’re not going to get that. So you just discount as you go down, you get some, there are lots of good guys out there. There are lots, I should, it’s not that you’re not going to get that. It’s just that that’s an extreme example of super smart guys doing the right thing for a very long period of time who really understand how to run a business.

[00:43:37] Tobias Carlisle: But then everybody else is a sort of slight discount to that. And so you discount for that reason. They’re just not quite as good. I would have said John Malone for a long time with that liberty complex, but gee, that liberty complex got complicated. And to leave it and cross holding it’s too complex to kind of figure out.

[00:43:51] Tobias Carlisle: So complexity is an issue. So I’ll tend to avoid complexity just because. The number of frauds that I have seen that were basically using complexity to cover up the fraud makes me suspicious now of complexity, because I think why be this complex? I Don’t think my lines are fraud, I think they’re using it for tax purposes, they’re trying not to pay tax, which is fine.

[00:44:13] Tobias Carlisle: but the complexity is an issue and it just, it’s always a little red flag. So more cash than debt, simple balance sheets are great. Good businesses that throw off lots of cash. And then you want a management team that’s reinvesting sensibly, mostly in the same business, but making bolt on acquisitions when it makes sense, buying back stock when it makes sense, all of those things.

[00:44:34] Tobias Carlisle: I think it’s very common sense. I really don’t think that the business analysis and company analysis is sort of almost a commodity. Being able to, you can go and find any number of websites that will do it for you quantitatively and go to Seeking Alpha, you can go to Guru Focus, you can go to any of these sites, like finding something that’s undervalued with a good balance sheet, all of those things is pretty trivial and I think quantitatively that’s what I try to do, I’m just trying to buy all of those things because I know that if you hold a basket of those, you’ll do very well over time.

[00:45:02] Tobias Carlisle: Every now and again, you’ll find one though that’s, that the part that is hard, the judgment at the very top to size something versus something else. That’s really hard to learn over a long period of time, and I don’t know that necessarily that I have that even now for as long as I’ve been doing it.

[00:45:15] Tobias Carlisle: I’m very wary of that. I think you can fool yourself that something is better, but the longer you do it, the more obvious things become. One example I think was Meta, when Meta sort of got cheap last year, Meta possessed all the things that I like in a business, even though it’s a Even though it’s sort of a, it’s newer, it’s hard to see, there’s some behavioral changes all the time and people keep on using the blue website, everybody accessing it through Instagram, do people transition over to TikTok?

[00:45:42] Tobias Carlisle: The numbers seem to be pretty good. At its root, that was a high cash flow generating machine where Zuck was, Zuck’s the owner, operator, founder, He knows what he’s doing and he wants to win. He’s competitive, but the stock price was going down because TikTok’s a competitor and all these other things are going on.

[00:46:03] Tobias Carlisle: You remember all that stuff that went on, but I thought this is a pretty good example of this is about as good as it gets. I think that I would size a position up like that. And that one that did work out has worked out so far as a good position. But I think that the thing that was holding it back mostly was the amount of money that metaverse.

[00:46:23] Tobias Carlisle: And at some point, Duck’s competitive juices got turned away from investing in the metaverse to buying back the stock. And at that point, that was a, that was basically a no brainer, I think. 

[00:46:33] Kyle Grieve: So my favorite case study from Concentrated Investing was John Maynard Keynes, which you discussed a little bit. I really enjoyed learning about his evolution from kind of an arrogant trader who relied on his quote, superior knowledge of economic cycles, all the way to a long term buy and hold investor who placed a heavy emphasis on business.

[00:46:52] Kyle Grieve: and didn’t bother attempting to time the market regardless of his economic conditions. So what were your takeaways from his evolution and how do you try to limit the roadblock of ego in life and investing? 

[00:47:03] Tobias Carlisle: There are lots of interesting things from that because he invested through the Great Depression and he was running endowments through the Great Depression where he was responsible for their investments and it was King’s College and things that he cared about.

[00:47:14] Tobias Carlisle: So he was really trying to get them through. And he had these, I think one was an insurance company and one was the endowment, and he, everything was way down, everything had been smashed to smithereens, just an unbelievable devastation of those portfolios, like they were down 80 or 90%, which was basically the market was down that much.

[00:47:31] Tobias Carlisle: And one board was so shell shocked, they just wanted to liquidate and get out, and the other one was feeling the same way, and he said to them, look, we’re at this point where if everything goes to zero, it’s not going to matter whether we’re fully invested or not, but if everything recovers, then of course we want to be fully invested here, so he managed to talk one into remaining fully invested, and he didn’t talk the other one in, and of course, everything did rebound over time.

[00:47:56] Tobias Carlisle: And it worked out ultimately. The number of times that I have come across couples who are in their early 60s, this was in 2000, after 2009, in sort of 2015, 16, 17, 18, the number of times that I ran into couples who were in their early 60s who had made a whole lot of money, but who had pulled out of the market in 2009 and were waiting for that moment to get back in.

[00:48:15] Tobias Carlisle: It was just every week I’d go and meet somebody who was like that. And so that just sort of seared into my mind that you’ve got to be prepared to pull the trigger when the market goes down, because you just, otherwise you just never get another chance to get back in. So you have to do that. You have to find a way to be fully invested at the bottom.

[00:48:30] Tobias Carlisle: And sometimes that means you’ve got to be fully invested at the top. Unfortunately for me, that’s what that means for many other people. You just have to know that it’s time to get fully invested. The ego thing is tough. I think that if you spend enough time in the market, you will see enough bulletproof companies go to zero, that you just know that everything has within it, the seeds of its own destruction.

[00:48:51] Tobias Carlisle: And you kind of have to, as do we all, you have to kind of watch these things and know that any one of them could blow up. And so it’s a reverse, I call it, it’s like a via negativa is the approach. You go through and you look at these things and you just, all of the obvious problems, management’s not good enough, balance sheet’s too levered, cyclical business, all of those things, you just have to take those out.

[00:49:13] Tobias Carlisle: You can’t invest in those things that have those qualities, that have those properties. And you’re left with, at the end, this handful of things that you haven’t been able to eliminate for any other reason, for any other reason. And that’s the one that ultimately ends up in a portfolio and it’s sort of a reverse process.

[00:49:27] Tobias Carlisle: not trying to find things, but trying to eliminate everything you possibly can. And sometimes everything just gets through the filters. So that’s, for me, that’s the ego thing is also, it’s a very common behavioral error that people attribute their own success to their own skill and failure to outside.

[00:49:45] Tobias Carlisle: And so that’s one of the reasons that I stay quantitative. Mostly, and I rely on the model because I know that it’s all outside of me. If I have a good idea, so someone will say, you know, whatever, accruals is a great way of finding if you’ve had. Accruals are blowing out. That means there’s potentially it’s a great short because it means that they’re reporting more income basically than they’re earning in cash flow.

[00:50:08] Tobias Carlisle: And so that has to show up as an asset on the balance sheet somewhere and it shows up as an accrual. It’s a very common way of finding lots and lots of frauds. That’s a great idea. So I’ll go and test that and then I’ll put that into the model. And then the model, the next time it’s run, we’ll be looking for that kind of thing.

[00:50:23] Tobias Carlisle: That’s an example. I’ve always had accruals in there, but I’m just as an example of something. So it’s never me making the decision, good or bad. I don’t have really much into any construction or any portfolio, so if it’s good performance, it’s not me. If it’s bad performance, it’s also not me. Although, it’s probably, it’s, obviously, it’s my fault, but I think that’s one way of doing it.

[00:50:42] Tobias Carlisle: You just have to actively combat all of the behavioral errors that people commonly make, and getting to, I’ve tried to do that. You get too concentrated, you blow up. You buy stuff that’s too hot, you blow up. If everybody’s piling into something, it tends to fall apart. All of those things that are just obvious.

[00:50:59] Tobias Carlisle: I try to put in. So I think that ego is a problem. The number of times that I have seen two guys who, when they go very well, it definitely flushes you with something, you know, you feel good. You feel like you’re powering ahead and that’s often when people make their biggest mistakes when they’ve had a good run and it’s, the tragedy of it is that if you’re a guy whose size is up, you know, you want to be Kelly betting into something, your portfolio is up a lot.

[00:51:25] Tobias Carlisle: The portfolio is really big. You’re going to put 40 percent of an enlarged portfolio into a position and that position is the one that blows up. That’s how you wax more money than you’ve made at any point in the entire cycle. Not to pick on Cathie Wood, but Cathy has sized up some of those positions right into the face of the big drawdown.

[00:51:44] Tobias Carlisle: But that’s not unique to her. That’s basically the way everybody goes. They size up into these things. So I just equal weight my positions. I don’t know which ones are going to be the biggest ones and which ones are going to be the, and it’s, there’s so much noise. There’s so much randomness. You could be in a very good, you could tick all of the boxes, have dodged all of the bullets.

[00:52:02] Tobias Carlisle: It’s just something you haven’t thought of. The government changes some regulation completely changes the nature of that business. So there are lots of periods of time where Chinese reverse takeovers were very popular for a period of time and then they collapsed. But then shortly after that, there was this for profit colleges where they looked great on every metric.

[00:52:22] Tobias Carlisle: other than the fact that the Obama administration had basically decided to eliminate them. But they were all very cheap and they were good businesses. They made a lot of money. There was, it’s intellectual property. They get people in there, it’s recurring revenue and they got very cheap.

[00:52:36] Tobias Carlisle: They’re all gone. Basically, they’re almost all gone. There’s a handful floating around, but not very many. And so it would be easy to fill up on those things. So another way to do it is just to make sure you’re not too heavily exposed to any sector or industry or theme or however you define it. You just assume that everything that you’re doing has something wrong with it.

[00:52:57] Tobias Carlisle: There’s a crack in everything that you’re doing and any single part of it could fall apart and your objective is not so much to maximize your return in the short term. Jake Taylor, who’s my co host on another podcast, Value After Hours, he says this, if you look at the future value equation, it’s 1 plus r, which is 1 plus the rate of return, raised to n, which is the number of periods of time that you compound 1 plus r.

[00:53:25] Tobias Carlisle: And everybody focuses on maximizing the R. They want the rate of return to be as high as possible. And he says the real secret is maximize the N. Because if you can sit down and do that calculation, you know, if you can get If you can get 30 percent a year compounded for 11 years, that’ll give you a great return.

[00:53:45] Tobias Carlisle: If you can get 15 percent a year compounded for 50 years, it’s a vastly bigger return. The N is the secret, not the R. And so to the extent that you’re reducing your R to maximize your N, that’s always a good thing. So that’s what I think about. We’ve got to survive. I want to be in this business for a really long period of time.

[00:54:02] Tobias Carlisle: I love doing it. I want to go out feet first, toes up. I want to be sitting at the desk. It’s a nice thing. It’s not a physical business. You can sit in a seat and do it. You can do it evidently. Munger’s almost a hundred, so you can almost do it. You can do it to almost a hundred at least. Buffett’s in his 90s.

[00:54:16] Tobias Carlisle: That’s a long time. And I want to keep on doing it for that long. I hope that this interview comes back in 50 years time. And it’s me saying, I want to be doing this in 50 years time. Hope I live that long. 

[00:54:25] Kyle Grieve: So I’d like to discuss some lessons that qualitative investors can take from the quantitative side of things that you specialize in.

[00:54:32] Kyle Grieve: If you were talking to a qualitative investor, what accessible data sources are they ignoring that you think would give them additional valuable information? 

[00:54:40] Tobias Carlisle: I think there’s essentially there’s two ways of approaching investment. And I think that the two that you presented at the start are pretty good view of that range.

[00:54:47] Tobias Carlisle: There’s, you’re either starting with the valuation and then making sure that it’s a sufficiently healthy balance Or you come up with your list of names that you want to hold because these are the 100 best businesses in America or the 300 best businesses globally, and they’re all phenomenal businesses.

[00:55:06] Tobias Carlisle: The problem is they’re all too expensive. So you go through with your 300 and you have a valuation for each one of those, which you will buy at and probably go and put your market orders in. to buy at that price. I’m not market order. Sorry. You put your limit order in at that price or however you want to do it, but you kind of say that you will buy or you make a pact with yourself to buy these things at the right price.

[00:55:29] Tobias Carlisle: I don’t know that it’s so much data because I still, I really do think that the evaluation of these companies is largely a commodity. Everybody knows when something gets, everybody knew about Mesa when it got cheap, it wasn’t a secret. Everybody knew about Apple when it got cheap. Even after Buffett bought it, you had plenty of time to buy it.

[00:55:46] Tobias Carlisle: All of these companies, it’s not like they’re not known, it’s that when they become known, the problem, the reason why they’re now undervalued, also becomes known at the same time, and that’s the thing that scares people off. I see people do it on Twitter all the time. They say, if this stock gets to this price, I will back up the truck.

[00:56:02] Tobias Carlisle: And the stock gets to that price and they say wait a second. I know the reason why it’s got to that price. Like it’s the patents going to expire or something, whatever it is. And I think you’ve done all this research and you’ve done all of this work and here you’re not prepared to buy it at this point in time.

[00:56:15] Tobias Carlisle: Like what was the point of doing all of that work and all of that research? You should have imagined this possibility that there would be a problem or you should know what the problem is likely to be. when it comes to this and you should be able to make the decision. And sometimes the advantage that I have is a deep value guys.

[00:56:29] Tobias Carlisle: I’m always looking at stuff that’s busted. I’m always looking at stuff that’s got hair on it. There’s always a problem with the things that I’m buying and I’m relying on mean reversion for the, for many of them. I look at the same thing that everybody else looks at. It’s just that the valuation is so compelling at some of these prices that we’ve got a handicap.

[00:56:45] Tobias Carlisle: This thing’s not going to win the race, but it is going to show all place. And the price that we’re getting to show a place is so good here. It’s worth putting on this position. Having said that, I know that about half of them are going to be errors, so it doesn’t bother me so much that I don’t know which ones are going to be errors.

[00:56:59] Tobias Carlisle: Otherwise I wouldn’t put them into the portfolio, but I know that most of the, half the time the market’s right, half the time. The stock itself, the market is wrong and the payoff in the market is wrong. It’s so big that it’s worth putting these bets on. So it’s not so much finding additional data. It’s just being aware of the valuation.

[00:57:19] Tobias Carlisle: You need to be aware roughly of what there’s an implied return. There’s an expected return. at every given price for every given company. And so that expected return is basically, what is it going to pay you as a dividend? And what is it going to be able to reinvest in its own business? And then those are both perpetuities.

[00:57:36] Tobias Carlisle: You assume they’re both perpetuities and that gives you roughly what you’re going to earn from this business. Some of them, the numbers are just so noisy that you can’t really do that. And so that’s a cyclical way you’re expecting. You’re relying on some mean reversion, but for the better companies, that’s exactly what you’re doing.

[00:57:51] Tobias Carlisle: You’re looking at how much cash flow it’s throwing off. What are you paying for that cashflow? What is the company then doing with that cash flow? Is it paying it back to you as a dividend or a buyback or however else it gets it to you? Or is it reinvesting at a rate of return? How likely is it to continue earning that rate of return in the future if you can put those things together?

[00:58:08] Tobias Carlisle: That’s the evaluation. It doesn’t need to be more complicated than that. It’s something you can do realistically on the back of a napkin, having read through a few 10 Ks, probably 10 Qs as well. Understanding that you’ve got finite information. You don’t have all the information that you need. That’s the beauty of that Kalman quote.

[00:58:26] Tobias Carlisle: that he says, it’s the uncertainty that is the thing that scares people. And this is the crazy thing to this. You see this in the markets all the time that, so I had, when the Obama administration was bringing in the Affordable Care Act, and that was going to impact these insurance companies. And they had blocked a few of the insurance companies from merging.

[00:58:42] Tobias Carlisle: So United was the biggest. and then Humana and the other four underneath were combining together. And so combined, they wouldn’t be as big as United, which was the biggest at the time. And so I was at that point in time, something had happened to the risk arbitrage industry. So all the spread, someone had blown up in risk arbitrage, something strange had happened.

[00:59:03] Tobias Carlisle: The spreads were all very wide. And so for a period of time, I was a risk arbitrage through there, where I was long some of these names. Not pure risk arbitrage because I didn’t put the short leg on, but I had some options and some other things in there. And I watched that spread trade wide and what they were waiting on was a decision from the administration about whether they were allowed to proceed with the merger or not.

[00:59:25] Tobias Carlisle: And the worst case outcome was that they’re not allowed to proceed with the merger. During this period of time, United, which isn’t in a merger, the stock price just keeps on going up, but all these other ones with all the uncertainty, their businesses are still fine, it’s just whether they combine together or not.

[00:59:40] Tobias Carlisle: They were all trading sideways and down the day that the administration announces that it’s going to be blocked, which is the worst case outcome that everybody was worried about. All of these stocks leapt. It just doesn’t make any sense. But what it really showed me was that the uncertainty was worse than the worst case outcome.

[00:59:59] Tobias Carlisle: It doesn’t make any sense until you sort of understand that people really hate uncertainty. And so if you can find a way to operate through uncertainty. Knowing that sometimes half the time you’re making an error doesn’t matter because the payoff is so good when you don’t make an error or when you turn out to be right.

[01:00:15] Tobias Carlisle: So that’s where I think about it. It’s really finding a way to operate under uncertainty. That is the one of the keys to sort of outperforming I think. 

[01:00:23] Kyle Grieve: So in a recent discussion with the TIP mastermind community, you mentioned that value is an early cycle indicator when looking at economic cycles. I’d love to get a better understanding of how performance of value does in regard to economic cycles.

[01:00:37] Tobias Carlisle: This is an observation of mine. I don’t know how, I don’t know how empirical or how true this is really, but I have heard it talked about in other contexts. So at the moment, this is a current example. All of these small and value strategies are selling off while the rest of the market still seems to be okay.

[01:00:53] Tobias Carlisle: The FANG or whatever we’re calling it now, the Magnificent Seven is. It’s running ahead and it’s doing fine. It’s probably up today where everything else is down. But it’s been my observation that going into a crash, value tends to sell off first. And I don’t know why it’s, there’s already some uncertainty with these names.

[01:01:09] Tobias Carlisle: So people don’t want to be anywhere near anything that’s got any uncertainty in it. And then when the crash comes, the rest of the market sort of catches down to value, which is already having its crash. And then for whatever reason, value seems to recover first. So value bounces out of the bottom of the recession.

[01:01:24] Tobias Carlisle: Maybe because they’re cyclical companies and there’s some risk that they go into financial distress or go into bankruptcy and when it turns out that’s not going to happen, you’ve taken the risk, that risk off the table and so they bounce very quickly back to where they were beforehand or even a little bit higher and then early stage of the recovery tends to be value and then as the recovery goes on and it transitions into a normal market and then into sort of a more bullish where people have forgotten about the risk again.

[01:01:51] Tobias Carlisle: then all of the stuff that is growthier and more sort of glamorous tends to run at that point, value doesn’t participate, and then value sells off again at the end, so that seems to be the cycle that typically it’s, the better the market feels, the less, the sort of looking at the downside risk, the more value seems to not participate, because value is just not very glamorous.

[01:02:12] Tobias Carlisle: And then at the very blow off top end value sort of sells off a little bit because people are pulling money out of the value stocks that haven’t worked to stick it into the stuff that is working and then there’s the collapse and it starts all over again. Value bounces out of the bottom. That’s my observation.

[01:02:26] Tobias Carlisle: I don’t know. I think it’s John Hussman has, he describes it as, He’s got a name for it. I just can’t remember what the name for it is. But it’s basically that idea that weakness in small and value is sort of an indicator that there’s some problem with the underlying market. And on the other hand, strengthen them.

[01:02:43] Tobias Carlisle: So it’s more of a classic bottom of the market when value starts bouncing first. I think that is that’s sort of what I think is true. I’ve never sort of seen any study demonstrating that it’s the case, but that’s what I feel is true. 

[01:02:57] Kyle Grieve: Tobias, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about you, your books, and the Acquirers Fund?

[01:03:05] Tobias Carlisle: Thanks so much for having me, Kyle. It was really great chatting to you. My funds are ZIG, which is deep value, mid cap, large cap in the U.S. And DEEP, which is small and micro value in the U.S. You can go to the acquirersfund.com, has a link through to the websites, or you can go to acquirersmultiple.com, which has a screen.

[01:03:26] Tobias Carlisle: Has a free screen of large cap companies that are sort of meet these criteria of being cheap on an acquirer’s multiple basis and there’s links to the books. If you go to Amazon and you search my name, some books will come up and I have a, I do have a new book coming out sometime in the next few months.

[01:03:41] Tobias Carlisle: I’m just finishing it up right now. So I’m hoping to get that out in really it’s way, way overdue. So it’s coming. 

[01:03:49] Kyle Grieve: Okay folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon. 

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