MI384: Skin in the Game w/ Clay Finck & Kyle Grieve

24:00I'll read analysis from other investors. After that, I'll read things like 10Ks, 10Qs. I'll read letters to shareholders if the CEO writes them. I'll read and listen to quarterly Q &As, take a ton of notes, of course, and I'll read things like proxy statements and stuff like that. So if I go through that and the business still looks interesting, which not a lot of things pass through my filters to this point, then I'll start really digging in, seeing if I know anybody who works in that industry or maybe works for a competitor or just understands the industry better than I do and try to talk to them, ask them questions.

24:37Then after that, I like to look at competitors, see what they're doing, see what their numbers are, see why this business might be better or worse or equal. I also like understanding if the manager of the business that I'm looking at, I'd like to know more about their compensation. If they're making$10 million a year and everyone else in the industry is making$2 million, well, that's a pretty big red flag. Or maybe there's some superstar and maybe there's a reason, but I think it's pretty important to understand about the compensation and what they're also incentivized to do. After that, I'll start looking at my checklist.

25:08So I have a checklist. I think it's somewhere around like 130 items at this point and it just keeps growing. But I'll generally try to fill out my checklist in about say 60 to 70 % before I end up buying. I generally will end up writing every single answer to all my checklists at some point, but it might not be during the process because sometimes there'll be an opportunity that comes up that I might need to hustle because there might be some sort of catalyst. So during this entire process, I haven't mentioned valuation yet. So during this entire process, generally, I get an idea, looking at competitors, see what they're trading for, seeing the quality of the business.

25:47Is it really high quality? Does it have really high recurring revenue? Well, great. That means it's probably expensive and it's a high quality business and the market knows about it, which also means it's going to be expensive. And so at that point, I'll try to figure out if the investment makes sense. Can I actually earn a return? Of course, like Clay said, you can pay pretty high prices for some of these investments. And the traditional value investors probably not even going to bother looking at them because are just looking for PEs that are less than 10 or businesses that are trading at less than book value.

26:17But you can find really, really high quality businesses. And even though they're trading at these optically high multiples, they still end up giving a really, really good return. So yeah, so that's just to say, it depends. Some businesses deserve to be cheap and some businesses don't deserve to be cheap. So once I go through the valuation, I'll see if the price is above my hurdle rate. And if it is, then cool, then I'll start buying it. So my buy process has definitely evolved over the years when I kind of first started. And this was kind of, it's hard to adjust just from the times. During COVID, you had a lot of businesses that were really interesting and then they would go up in price really, really fast.

26:56So I kind of got scared to take this kind of slower approach because I'd buy something and then it would like double in a couple of months in it. So I kind of got used to being like, okay, well, I'm going to do the work and try to ratchet it up to, I'm pretty concentrated. So I might ratchet it up to eight or 10%, like right off the bat. But there were some problems in that because I felt like with the more and more experience I got, I understand a business really, really well once I own it. And so now I try to take a one to 3 % stake. And once I start understanding the business more, I'll add more.

27:32Will that mean I'm averaging up? Probably in some cases, but I think that understanding the business a lot better and averaging up is probably just a better strategy, at least for me. And then, yeah. So throughout the whole process, I'm trying to find some of the small nuances in the business, use different mental models to help solve a variety of different questions or problems that I might have on a business. And then as also part of the thinking process, I'll do destination analysis, which was popularized by someone, obviously, Clay highly respects, which is Nick Sleep and Kay Sakari from Nomad Partnerships.

28:04So if for listeners I don't know, destination analysis is pretty much where I'm just going to imagine where the business is going to look like in, say, five to 10 years. And this definitely requires some honesty because it's easy to really just fool yourself into thinking that you know what things are going to look like in the future. But as Clay already alluded to, the future is unknown and people who say they know what it's going to look like are usually not being completely honest with themselves. So you have to just admit that maybe you understand what it looks like, maybe you don't know what it looks like.

28:37And so for me, one thing that I've really found powerful is being like, okay, well, maybe I don't know what the business looks like in 10 years, but maybe I do know what it looks like in five years. And so if I know that, at least I know, okay, well, in five years time, if this business is still doing everything I wanted to do. Cool. Now I can look at it in another five years. But if I look out 10 years and I'm just completely off the mark, well, that might just give me signals to do things that don't make a lot of sense. And then with another section of my portfolio, it is a little more short-term oriented.

29:08So in that case, I might just be looking out like two years. And even I've noticed with a lot of my businesses that I think I can hold for a long period of time, I still probably have to bring it down to two or three years because I feel like I'm a lot more accurate than looking way further out. And then the other thing I also try to do during the destination analysis process is just finding out which KPIs are going to be most important that that business needs to hit in order for me to meet that destination. And then on the other hand, I also like to know what needs to happen for them to not hit those KPIs.

29:39And then I can actively look for that. So when I actually own the business, I know what to look for to make sure that, okay, are things going right or are things going wrong? And then that can also help improve my decision-making. To answer the other part of your question of what I'm looking for, I have two distinct buckets of investments. My primary bucket is pretty much probably exactly the same as what Clay already mentioned. It's high-quality businesses. I want businesses that can reinvest in themselves at hopefully very high rates of return and hopefully for multiple years into the future.

30:09I like businesses that have high returns on invested capital, preferably over 15 % and also a durable high returns on investor capital. I'd like them to have a history of profitability. I like pretty high insider ownership, hopefully even bought on the open market. I'd like to have a management team that has a history of value creation, whether that's preferably with the business that I'm looking at, but also it could be with another business that they've worked at previously. And I also prefer businesses that have minimal leverage. I do like serial acquirers and some of these businesses are managed by people that are so talented that it actually does make sense to have a little bit of leverage because you can just earn more profits.

30:48After reviewing some of my past mistakes, I think I personally have thought maybe a little bit too highly of my ability to forecast what exactly is a quality business, especially in regards to into the future. So I'm still definitely making enough good decisions that I still want to have quality businesses in my portfolio, but it also just opened my mind to another possibility. And this was something that I learned from my first actual podcast guest on Millennial Investing, which was Paul Andreola, and that was undiscovered businesses. So the second bucket I have, I like to call just inflection point businesses.

31:20So these businesses share a lot of similar traits to the quality businesses, but they tend to be really small. They're generally less than$50 million in market caps, and they don't have a long history of profitability, which I usually demand for in my quality compounders. So I'm looking for businesses that maybe have only been profitable for like two quarters. So that's why I call them inflection points because they're inflecting into profitability. But with these businesses, there obviously are a lot of risks. So with these businesses, I basically demand like no debt. Pretty much you got to have as little debt as humanly possible.

31:53Because again, I want to make sure I'm not getting a zero. And then the reason I think that this works is that because these businesses are undiscovered, because there's pretty much no analysts, there's no institutions really seriously looking at them. So you get all these crazy, crazy mispricings. And it's not uncommon for me to find something trading at a single digit forward P multiple, but also growing top and bottom line at 50 % or more. So these are just opportunities you don't find in businesses where like Amazon, everyone knows what Amazon is. Every single analyst in the world knows Amazon.

32:26So you're not going to see these huge discrepancies in price and value. And so just a little food for thought. So in 2024, my inflection point business is at 44 % returns versus 15 % for my quality businesses. So it's kind of a constant struggle in my mind if I should be allocating more to inflection point businesses or what. But it's definitely been a big realization. This was especially in 2023 that a good investment can be made at any level of quality. So I just want to highlight kind of three different investors that I highly respect. And two of them I've interviewed. Scott Barbie, he's kind of your traditional value guy.

33:05This guy's beaten the market for 25 years and he just buy businesses that are trading well below book value. So kind of your classic Ben Graham-ish type investor, and he's done it to amazing degrees of success. Then you have someone like Paul Andriola. And this guy, he has probably as many multi-baggers as anybody I've ever spoken to. I mean, he's probably forgotten more multi-baggers that he's had than I know exists. And a lot of these businesses are ones that despite being large multi-baggers, no one even knows they exist. And so again, this is kind of where I've cloned a lot of my inflection point businesses.

33:39I would consider them to be lower on the quality spectrum, but a lot of them are businesses that are inflecting specifically because I think the quality of the business is improving. And then lastly, you have someone like Chuck Ackrey. So Chuck Ackrey invests literally only in very, very high quality businesses and hopefully businesses that he can hold for extended period of time. He's written extensively about how selling your winners is probably the biggest mistake that you're going to make as an investor into high quality businesses. So the point being here is that all three of these guys have been just so successful and they have very, very different strategies and they own very different businesses that are different in quality and they're different in market caps.

34:19And so this is a really big concept that I've spent a lot of time thinking. And so I just want to mention here as well, Monish Pabrai has mentioned that his strategy has altered over time based on what the market was offering him. So I can't really guarantee that the strategy I'm using now is going to be the exact same in 10 years, but I can guarantee that I'll definitely consider quality all the time in all the investments and all my investing frameworks. Yeah. I imagine those inflection point. I mean, obviously you have to pay close attention to any business you own and are investing in. But those inflection point ones sound like something that you're kind of probably monitoring much more closely than your typical, like to be cliche, quality compounder that has so many recurring revenues and so many moats that you can kind of go to sleep at night and you don't have to worry about whether people are still going to be buying iPhones.

35:07And then I found that really interesting too, that destination principle you talked about, because it's sort of like Munger's inversion principle where you're thinking with the end in mind and imagining, if this stock is going to get me a 20 % per year return over five or 10 years, what has to happen five years from now to get that 20 % return? Is that all that coming from 20 % growth and free cash flows? Is it coming from dividends and buybacks? Is it coming from an expansion and the PE multiple? It grounds you in reality because it's easy to think, oh, I'm buying Apple. This is great. It's going to come down at 20 % a year for like it has for whatever, how many ever years it has in the past generated excellent returns.

35:47And then you're thinking, are they really going to sell 20 % more iPhones? Who are they going to sell them to? Who's buying these iPhones? And so it's an interesting way to think about things. But I want to talk a little bit about having skin in the game. Obviously, we're all podcast hosts here. And that means we talk publicly about investing and even on our specific portfolios, as you just have, Kyle. But there are some obvious and less obvious conflicts of interest that can arise from that, I think, for starters. And I don't think anyone could accuse you of this with your portfolio, Kyle, but there is a temptation to cover the most popular stocks and markets just to get more eyeballs on our content, even though the Teslas and NVIDIAs of the world are probably not the best investments for long-term investors when they're in the middle of some hype cycle.

36:32So I really enjoyed an interview you did with Brian Stoffel of The Motley Fool, who talks about what it means for him to work in media, but be transparent about his track record while also having skin in the game as an investor. Here's a clip from that conversation. Let me start with why it's so important to be transparent with it. I was a writer for The Motley Fool for a number of years, and anyone who follows me knows that I'm heavily influenced by the work of someone named Nassim Nicholas Taleb, who's written a lot of books that are very influential, especially for myself. One of those books is called Skin in the Game.

37:06And in it, he talks about how, especially if you're someone who is giving advice about anything, that you need to be exposed to downside risks if you're wrong, if you're going to make a living off of giving advice. And I really took that to heart. And so, I read that from him before he came out with his book, Skin in the Game. And I've actually interviewed him twice. So I've had a chance to interact with him. And when this happened, it was probably around 2017, 2018, that it kind of hit me that I was like, huh, I'm not doing that. Because as a writer, I wanted to write about stocks that were really, really popular.

37:47And writing about a stock that is really popular and having an opinion about a stock that is really popular, guess what? That gets you a lot of clicks. And a lot of clicks means that you're more likely to stick around as a writer. And of course, the problem with that is that if I'm picking out a popular stock, more often than not, that's a risky stock. And if it's a risky stock and I'm saying, yeah, you should own it, but I don't own it myself. Think about the dynamics of that, where someone reads this and they say, oh, so-and-so says this is a great buy. I'm going to go out and buy it. And I get paid for that article.

38:25And I also get paid if it's a really popular article. But what happens if the stock goes down? And everyone who followed my advice, they lose money. And I gain money. And there is something that asymmetry, there's something that's just not okay with that. So what I did, Kyle, that was really eye-opening for me. Because at that point in time, I probably had about seven or eight years worth of articles that I had written. And so I went back and The Motley Fool does a great job of this. At the end of every article, you have to say whether or not you have a position in this company. And so I went back and I went over hundreds of articles.

39:05And you can tell I had a lot of time on my hands at this point in time. My daughter had just been born. And when she was asleep, I would just sit down and go through these numbers. And when I did, it was so clear. When I made a recommendation about a stock for Motley Fool's free site. To be clear, this was the free site. It's not their paid services. They did significantly better over the next three years when I owned the stock than they did if I said so-and-so is a good buy and I didn't own the stock. And that was really eye-opening for me. So all of a sudden I was like, huh, there is a problem with suggesting stocks and you don't even own them.

39:46And it's funny because a lot of people, and I get the argument that they'll say, Well, you're just writing about this company because you own it. And I understand that argument, but I would much rather take advice from someone that eats their own cooking than someone who's just going for clicks. That's why I think that sharing your record is so important. First of all, I think you have a moral obligation to do so, first of all, if you're in our line of work. And secondly, it makes me a better investor. If I know that my reputation is on the line, I'm going to take a lot more time to think about what it is I'm suggesting.

40:26Let's take a quick break and hear from today's sponsors.

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43:44That's theinvestorspodcast.com slash tip-finance. All right, back to the show. As someone who has invested in the public eye and earned double digit returns for a few years now, which at the time of recording comes out to a bit over 13.5 % per year, I think, since April 2020. Can you tell us about the hardest parts of managing a portfolio publicly, Kyle? Investing is already hard enough, so having a spotlight on your every move, I'm sure, can present some subtle challenges. Kyle Lerner Yeah. So I can definitely only speak from my own experiences here, but for me, it actually hasn't been that challenging about managing a portfolio in public.

44:24I mean, you made some points there about covering stocks specifically that people would find interesting to hear about. Whereas I'm telling you here that I like stocks that no one's heard of and stocks that are really boring. So there's a conflict there where I personally find those types of stocks, the ones that I own, the most interesting, whereas maybe the audience doesn't. So that's kind of hard. But there are enough businesses out there. I think Clay and I luckily have covered a lot of those on the podcast that we both find interesting, both from a quality standpoint. They aren't necessarily insanely expensive like the ones that you mentioned.

45:01And we also find them interesting. So that's kind of how I think we get around that one. But getting back to that clip that you just shared of Brian there. So I really, really resonate with his point there about how sharing your track record is kind of like a moral obligation. So I've always thought the exact same thing, even from before I spoke with him. And so that's why I've shared my own returns over the last few years. And I plan on continuing to share that into the future. So with social media, obviously you're just exposed to millions of people out there that are, especially in, say, for instance, financial Twitter, you got people that are sharing their tickers, they're sharing their portfolios, but you really have no idea if they actually know what they're talking about or not.

45:44For instance, a random person can go on Twitter and they can signal to their audience that they're a genius because they have one winner in their portfolio that maybe it's doubled in the last year or a couple months. But at the same token, they can just fail to admit that they also have nine other businesses that have dropped 50 % or more in their portfolio. So is that the type of person who you want to follow into other ideas? Well, I don't know. I'll leave that to our listeners here. But I just think that sharing a track record really signals to anyone who wants to listen to me that I'm transparent about what I'm talking about.

46:20I'm not going to sit here and say that I'm some sort of massive success, but at least you just know that these are my results, take it or leave it. So if you think that I'm not doing good enough, well, then you know that you probably shouldn't listen to me. Or if you think that I'm doing good enough, then cool. Maybe you'll find some insights from what I say. So I personally wish more investors did this, but I think that there's a lot of investors that just don't really track their returns closely. Or unfortunately, I think there's also some that just don't want to admit that they're underperforming the index and maybe they're ashamed to some degree of sharing those facts with other people.

46:55So for me personally, I don't know, maybe I have some unique character traits because I do value certain people's opinions, but there's actually not that many people, especially in the investing world, whose opinions matter that much to me. So, you know, like I might write about some stock that I like, and I might have some random person with some profile picture of Warren Buffett who comes and tells me that, you know, I'm, I'm an idiot or, or whatever. And, and that doesn't really bother me that much because it's some random person on the internet telling me their opinion and I don't know anything about them.

47:27So, oh, well, I mean, you, you kind of have to live with that for, for sure. If you have an online presence. So, you know, but then maybe, maybe I'll have someone who I know and I've invested alongside with on certain ideas or I've talked to them about my ideas and they know me well and maybe they think my idea is not good. So for me, I think it's probably good for me because I can go and find out if their logic for their conclusion is better than mine. And so with that, I think I borrow a lot from Ray Dalio where I'm just hopefully trying to come to the truth and not necessarily just pad my ego and tell people that I'm right.

48:00So I think that this is just a really, really important thing to do in investing and constantly doing it. And it's hard, don't get me wrong. So the next area of sharing my portfolio publicly in terms of problems is definitely in terms of biases that I think it creates. So there's kind of four ones that I can think of here. So the first one is commitment bias. So ideas that we end up sharing with others publicly tend to keep us more committed to them. And so I've probably had this problem where maybe there are some ideas that I had where there was some, you know, maybe there's some factors that told me I was wrong, but because I felt committed and I'd been talking about it, maybe whether that's on social media or even when I had my own sub stack, I felt like maybe I needed to hold on to it longer than I should have.

48:44Then there's liking bias. You know, if I'm signaling to everyone following me that I like something in the market, and maybe I'm getting a lot of engagement or positive comments based on the idea, I may begin liking that idea too much, which can also cloud my judgment to any potential risks or adverse events that can happen. Then the next one, social proof. When you share an idea on social media, you often get a lot of other people who are just looking at tickers and they come in and they're like, oh, Kyle likes ticker XYZ and I like it. And they'll come in and support you. And it's really nice to feel supported.

49:18But on the other hand, I know of other investors on Twitter who they'll say they sell a specific name and then they get hate from from other people that own it being like, oh, why would you sell it and blah, blah, blah. And so, you know, and I know that that can affect people in a really negative way. And so again, you know, that social proof might also keep you into an idea that maybe you don't necessarily want to be in it anymore. And so the last one here I have is just excessive self-regard tendency. So I'm sure you guys are aware of that study that where everyone thinks that they're a better driver than they are, than they think they are.

49:52Whereas in reality, 50 % are better, 50 % are worse than the average. But I think that exact same concept can be applied to investing. I think everyone who owns individual stocks is inherently saying that they're decent at investing, otherwise they just buy the index. So I think, again, this just explains why I think it's important to display your track record. It's signaling, hopefully, that I have some idea that I know what I'm talking about versus someone who doesn't share it because of a variety of reasons that I've already shared. So I think that if you publicly share your portfolio, you definitely need to just try to be aware of the biases that may arise because they will arise.

50:33No one's perfect. Even Charlie Munger, Warren Buffett, they've made mistakes due to biases as well. And so I definitely don't make any recommendations. I don't think we ever do on the show. We're just sharing information with you and hoping that you find it valuable. And then on top of that, if I share something with someone, whether they buy it or not, it doesn't make a difference to me. And I think that that thought process definitely helps me fight off a lot of the commitment bias that some people have. When it comes down to it, I'm in investing to achieve financial independence at one point, not to get likes on Twitter or get more attention.

51:07So once I really drilled that down, drilled down why I'm investing, I think that really helped me figure out some unique ways to try and fight these biases. But I'm sure I'm I'm guilty of some of them as well. It's a constant struggle. And I think that maybe Buffett and Munger had the right idea of keeping their ideas to themselves these last few decades. I really appreciate the approach that you take and the transparency involved on it, and also the perspective of what actually matters and why we do what we do. But jumping back to you, Clay, as we talk about managing portfolios and trying to outperform the market averages, the elephant in the room here is passive investing.

51:43I'm sure there's a chunk of the audience that's listening to this and thinking, why even bother with all the trouble of constantly searching for new investments or maintaining and tracking a portfolio of companies? And given that we know most professional investors don't even outperform the S &P 500, at least after accounting for fees, I do think that is a pretty valid thought and concern to have. I want to go ahead and play a clip from your conversation with Eric Balchunas. Eric wrote one of the most thorough books out there on John Bogle, who was in many ways the founding father of passive investing by launching Vanguard a few decades back, which is one of the world's largest asset managers known for their very low cost index funds.

52:24Let's listen. The rise in the assets under management for Vanguard over the years is just astonishing. They started in 1975. They hit a trillion dollars in AUM in 2006. And today their assets sit at around 7.2 trillion. And it makes me wonder if you've studied the idea if there is an index fund bubble. We have these trillions of dollars flowing in index funds. These people are buying every month regardless of the prices of these stocks that are in the fund. So I'm curious what your general thoughts are on that idea. I try to break this down in a chapter eight called some worry with quotes, because some are worrying.

53:02And I think most of it's meaningless. Look, at the end of the day, all that's really happened over the past 20 years is people went from buying an active sort of, let's say, fidelity fund that owns the popular stocks, but maybe in weightings that are slightly different than the benchmark. But you're still owning JP Morgan and Apple and Amazon and AT &T. We call that closet indexing, where you're pretty close to the indexing, you charge 70 bps. All that's happened is people went from closet indexing to actual indexing. So they're just owning all those stocks for three basis points. The metaphor I use is the CD to the MP3.

53:34I think indexing and ETFs are similar to the MP3. They're just way cheaper and more flexible to get the same thing. It's not like indexing has invented stock investing, just like the MP3 didn't invent music. You're just buying whatever music you like in a better way, cheaper way. It's a format change. That said, index funds do buy stocks indiscriminately. If the stock has a higher market cap, it's going to buy it more because that's where it sits in the index. The market cap, though, is determined by active managers. And that's why the S &P 500 can have a stock like Macy's fall out of it and Tesla comes into it.

54:07The reason Tesla got into it is because active managers like Tesla. And the reason Macy's fell is because active managers hated Macy's. Active controls what's in the indexes. So the indexes, you are somewhat riding the coattails of active, but they are definitely dictating pricing. That said, let's say a stock like GE, which went to the gutter in early 2018, I believe it was, went down 50 % in like half a year because of the bad earnings report. And then ETFs and index funds, the LG took in a ton of money during that period, but it still went down 50%. Now, would it have gone down 52 % if it wasn't for those bids coming in from the index fund flows?

54:43Maybe. So I think if anything, index and the rise of indexing might put a little bit of a baseline on stock sell-offs because there's a bid coming in. But overall, I think anybody over the past couple of years can see with meme stocks and Tesla and Peloton that indexing is not controlling prices here. Otherwise, we wouldn't see some of these stocks go up and down. So until we stop seeing that, I'm fine with this. I mean, indexing is a great way for people to get the value. Also, keep in mind, indexing is not uniform. The S &P 500 actually has criteria to get in. There's a human committee that has absolute discretion over it.

55:16That's why Tesla was late to get in. And then the Russell 1000 has their rules. Then there's like, oh, I'm going to own maybe a total market. That's different. And then there's different indices within mid-cap and small-cap. And then you get to international. Some hold, now some hold China, some don't. Indexing isn't really all uniform either. Just like active isn't that active either. So in the book, I sort of try to explain to people that the real trend here isn't active to passive because some act is very passive and some passive funds are pretty active-ish. It's not broker to RIA, which is also another big trend.

55:47And it's not mutual fund ETF, which is a trend. It's high cost to low cost. Within every one of those categories, you just see people, I call it the great cost migration. So I try to explain it. That's really what's happening here. So that was a bit of a longer clip, but I really like how Eric Bouchounis breaks things down. There's been this huge pull to passive index funds in the past few years, and yet active investors are still fundamentally the ones who are driving the market. They're the ones on the margin deciding whether stocks are fairly valued or not, but there's something to be said too for how trillions of dollars worth of indiscriminate buying can distort the structure of markets by, for example, normalizing higher and higher average price earning valuations on the S &P 500.

56:30So it's something I go back and forth on a lot. And that is on the one hand, I know that the odds are stacked against you to outperform the market with a more active approach. And I don't want to be just blindly contributing to buying index funds that are sort of forming a passive investing bubble. After having spoken with Eric and now having chosen to not use index funds, I'm curious to hear how you think about it, Clay. I'm sort of joking here, but is there some part of you that chooses to invest actively so that you're contributing to fairly valuing companies rather than being a passive investor?

57:01Or do you do it because you believe you can truly beat the market? Or is it just sort of a passion for you and life is short and you want to enjoy the craft of investing? Clayton Yeah, it's a really interesting question. I think it ties into a comment that Kyle just made actually. So I don't really think about investing in terms of should I go passive or should I go active? I mean, that's one way of thinking about it. But what I really think about is what vehicles are going to help me hit my financial goals. And my main financial goal is achieving financial independence. And I'm reminded of yet another lesson I kind of picked up from Chris Mayer.

57:35I had mentioned to him in an interview that the goal of probably most active managers is likely to beat the market because that's what their investors are likely benchmarking them against. And he mentioned to me that it really isn't his goal. His goal is to essentially just compound capital as fast as he can without taking unnecessary risks. So he also made the analogy of trying to invest and beat the market is like trying to be happy. It's like focusing on the outcome instead of focusing on the process itself. So none of us can really control what the index is going to do. But with an active strategy, we can control the companies we buy, the managers we choose to partner with, the business models we expose ourselves to, and the valuation we pay.

58:18And I'm also reminded, I was just chatting with Stig yesterday about how the index fund, especially the S &P 500, has performed over time. So when you look at the 1990s, there was nine straight years where it was up. And the average return in the 90s was 18%. So I'm sure people in 98, 99 were like all about index funds, like this is the way to go. And then from in the 2000s, it had actually a negative return with dividends reinvested. So I sort of feel like we might be at some sort of similar period. I'm not making any projection on what I think the S &P 500 is going to do over the next decade, but it's been really good since 2010.

58:55It's been north of say 14%, something like that. So I personally think that the passive investing crowd can sometimes take it a bit far when stating that, just pointing to that statistic that says that most active managers underperform, while it might be true, it overlooks some of the shortcomings and limitations of a lot of active managers. So for example, I'm not going to own more than 50 stocks in my portfolio like many active managers do. And some managers only buy large caps or they only buy US stocks and they have all these limitations. And they maybe can't size up their best ideas as much as some of us can do, or an individual investor can do.

59:34And they might have pressure to put up short-term performance and they feel like they need to beat the market this quarter or this year. And so in some ways, I think individual investors can actually have a pretty big advantage over institutions. And that's not to say that it's necessarily easy to do, of course. And I also can't help but just think about how the S &P 500 and a lot of these indexes are just becoming more and more concentrated into the Magnificent Seven, let's call it. And yeah, it kind of makes it hard when people kind of ask you what they should invest in. What would I tell a close family member where they should put their money?

1:00:09Historically, the S &P 500, I felt pretty comfortable with that, but it's getting harder and harder just with, call it 31 % of the index being in the top seven names. And then I also have to recognize that most people just don't want to analyze businesses. They don't want to read all these books on Buffett. And yeah, it's easier for me to do since I enjoy it and I enjoy the process. And it's honestly part of my job to some degree. So with time, I've just found some businesses that I would personally much rather own than an index. And even if there's the possibility that they might underperform for the first one, two, three years, hopefully they will over the longer run.

1:00:46And I know that you mentioned, you know, trying to find these mispricings that kind of contribute to the active side of things. And I think a lot of people mentioned taking emotions out of investing, but I can't help but feel some sense of connection to some of the businesses that I own, which can introduce a lot of biases. But it honestly makes investing a little bit more fun for me. So hopefully I'll stay invested for long periods of time. Whereas for the S &P 500, it's more systematic. You're just mindlessly buying a basket of stocks. And I'm honestly not sure if it's a rational way to look at it, but it certainly does make investing more fun for me.

1:01:21And I think about how many value investors own Berkshire in their portfolio and they've owned it for decades. And they know Berkshire isn't likely to vastly outperform the market, but they feel some sort of connection to Buffett and the way they sort of operate. So I feel a similar connection to some managers out there that I feel are just exceptional of what they do. Another interesting stat I recently read, I'll be chatting with Rob are not on the podcast here soon. And he put out some research that indicated that the typical S &P 500 company gets a markup of around 40 to 50 % on their multiple for those that are included in the index.

1:01:59So with that in mind, I think there can be some sort of an advantage to hunt elsewhere for a similar quality business that doesn't have that markup. It might be just due to their size or due to where they're based or whatnot. And of course, I don't necessarily recommend that for everyone. It's just an observation I've had personally. And recently, a member of our mastermind community mentioned to the group that the group generally likes to talk about individual stocks. And it sort of made me realize that different people are coming at investing from a different perspective or different angles.

1:02:34We all have different experiences and whatnot. So for somebody who's financially independent many times over, oftentimes their number one concern is going to be wealth preservation. And I think that makes index funds a great vehicle because the bad companies automatically get filtered out of it, the up-and-comers get put in, and it's never going to be a zero, essentially. So I'm still on my road to financial independence. And I think there's something about hunting for the next five or 10 bagger or whatnot. And just one or two of those could make a significant difference for me. But for other people, it might not make any difference at all if they put a few percent in a stock and it goes up 20X.

1:03:11They're still financially independent either way. So yeah, it sort of depends on your life situation, your financial goals and whatnot. And I just have found some investments that I think will give me a good shot at achieving my financial goals and then find some assets that I'm comfortable with. And for some people, a passive approach is probably the route to go. So just found an approach that suits my skillset and my temperament. Yeah. Now, to your point on, people asking for, hey, what should I invest in? It's a question I get a lot too. And it's like, on the one hand, like you said, I want to tell them the S &P 500.

1:03:45And then there's all that concentration in the S &P 500, as you pointed out. And then my next bet is, okay, buy a Vanguard total world fund and just invest in the entire world. And then you realize 63 % of the market value of all of the world's stocks traded everywhere is US companies. So the, want to call it a bubble in US stocks or just the kind of rich valuations in US markets has led over and really consumed a disproportionate share of global financial markets. So even if you think you're buying a total world index fund, you're still having a massive exposure to the US, basically three times what the US's share of global GDP is.

1:04:26And then within that, you're heavily concentrated within the S &P 500. So I'm not sure that there's an easy answer to it. But as you said, it depends a lot on your perspective and where you are in life and what you're trying to do and the risk you're willing to take. And that brings me to, I know we all admire our colleague, William Green, who's the author of Richer, Wise, or Happier and a host of podcasts of the same name. And I think we all agree that that book is an instant classic. It's a book I always come back to, especially when I want to learn more about specific investors, since William Green does such a great job profiling so many of the investment legends I know we all look up to after having spent time with a number of them personally, including folks like Charlie Munger and Manish Babrai.

1:05:10I want to go ahead and play a clip from William when he was last on Millennial Investing. What led you to study the best investors, not just to discover those investing lessons, but also to learn how to live a better life as well? I started off originally, I just wanted to make money. I didn't like the idea of working for a really annoying boss who I had to take orders from. I was always a little bit subversive and independent-minded, even as a kid. And so, I think when I discovered investing in my 20s, I kind of thought, this is this miraculous thing where if you think well, you can achieve a degree of financial independence and security is difficult to achieve any other way.

1:05:54So, I had this tremendous advantage because I was working as a journalist. So, when I started to want to invest and make money off the stock market, I could actually go and interview all of these great investors for magazines like Forbes and Fortune and Money and Time, all these magazines that I ended up writing for. And so I would do things like I would go off to the Bahamas and spend a day with Sir John Templeton, who was probably the greatest global stock picker of the 20th century. And so I initially, I was looking at these guys thinking, this is so cool, they can kind of teach me to become rich.

1:06:26And then gradually what happened, much to my surprise, is I figured out, God, these guys are really interesting. These really strange characters who are very incredibly thoughtful. And I think what I gradually figured out is that they were almost like practical philosophers. They weren't just thinking about these really obstruse esoteric questions like, does this chair exist? And do I exist? They were thinking about these really practical philosophical problems like, wait a second, so the future is unknowable. So how the hell do I make a good decision about the future, about anything. And so what occurred to me when I look back now on 25 years of writing about these famous investors is that the reason they have to think that way, they have to be very pragmatic, very philosophical in terms of thinking about the future and how to make good decisions is because they have skin in the game.

1:07:20If they screw up, they actually get really punished for it. You can lose tens of millions, hundreds of millions, billions of dollars in the case of some of these investors. So I think that makes them very good thinkers. And so my interest kind of deepened over the years. So it starts off really just being about money. And then I start to think about all of these issues that they're grappling with. Like, to give you an example, someone like Howard Marks, who I write about in one of the chapters of this book. Here's a guy, multi-billionaire, managing something like$160 billion at a firm called Oak Tree.

1:07:52He's literally grappling with this problem of the fact that the future is unknowable. As he puts it, everything changes. When he was a youngster, he went to Wharton, and he was a very good artist and he wanted to study art, but they were like, no, you're a finance student. There's no way you're allowed to study fine art. They kick him out of the class. He has to find another class to study. He goes to this Japanese studies class and discovers this Zen Buddhist concept of impermanence. The word for it in Japanese is mujo. And this has become this kind of defining idea of his life is, okay, so if everything is impermanent, if everything is changing, what the hell do I do?

1:08:29How do I deal with the future? And so one of the things that he does is he says, well, you have to accommodate yourself to reality as it is. You have to say, well, I'm not this master of the universe. I don't know what the future holds. I don't know what can happen. All I know is that everything is changing. Everything is inconstant. And so I have to adapt myself to circumstances. And so this sounds like kind of an esoteric, hairy fairy idea, but it's actually really practical because you think about how it applies both to financial markets and to life. William Green is such a wealth of wisdom.

1:09:05And I want to give you both a chance to share your favorite lessons from studying legend investors, either from directly talking with them or from reading about them in a book like William Green's. Kyle, I'll let you take a swing first if you want, but let me just say this could be really for anything. It doesn't have to only be about investing, life, friendships, whatever it is, wherever you want to take it. Yeah, sure. So one thing that William told me was that the book is meant almost as a tool to really decide who and what you want to clone. And so I think this is just a really compelling message for the entirety of the entire book, because he obviously He has all sorts of different kind of wide ranging concepts from each chapter.

1:09:42And you can just go through the book and pick and choose whatever you think is going to be most effective for you at this time and point in your life. So every chapter in the book was so good, right? But I think there's a couple big ones for me that really stand out. I mean, the chapter one on cloning was huge. I find myself really focusing on cloning people that I high respect all the time. It might be Buffett. It might be Munger. It might be Pabrai himself. They all have just these incredible traits that I think I, I, that I really admire and I want to try to emulate them in my life. And one, one interesting part about cloning that I've been focusing on is, you know, just focusing on cloning very specific attributes from people.

1:10:24You don't know if there's someone that you, you know, you respect, maybe there's, you don't like everything about them in their entire life and that's okay. You know, you can pick and choose what you want to clone from. You don't have to clone, you know, the entire person. So that's been a pretty key lesson for me. So a few character traits that I've emulated from some of the people that I highly respect would be Buffett, his inner scorecard, his concept of just doing business with people that you like and saying no to nearly everything. Those have been things that I've found a lot of value in.

1:10:53Charlie Munger, I mean, there's so many. Inversion, which we've spoken about already a little bit today. Thinking in a multidisciplinary manner. Thinking rationally. Just trying to be a learning machine and going to sleep a little smarter each and every day. copying other ideas from other people, reading biographies. I found that to be really beneficial and then just making friends with the eminent dead. And I think really focusing on understanding them at a really deep level. I'll say my mom, I've cloned a ton from her, especially with just how she treats other people in such a warm way. And that's been really helpful for me.

1:11:25Charles Darwin, I think he really taught me a lot about being open-minded, open-minded, staying true to the truth, even if it actually contradicts what you've maybe believed in in your entire life. I think that's a very powerful concept. Howard Marks, another person that's widely regarded and written about in the book. A couple of things I've cloned from him is just constantly thinking about the downside. I think that's really important. I think it's important not to get swept up, I think, in the euphoria, especially because as he's pointed out in the most important thing, it's during these most euphoric times that you're probably at the greatest levels of risk.

1:12:00Then a couple of other things that he's taught me is to focus on the process over the outcome. And then on luck, just embrace it. Embrace the fact that you're going to be lucky. And also maybe more importantly is don't mistake luck for skill. And then kind of another maybe just broad group of people that I found really interesting to clone is the Stoics. There's a couple of different Stoic principles that I try to live by that I think have made my ability to just deal with the unknown better. One of my favorite tools is just the dichotomy of control, which simply is that there are things in life that we can't control, and there's things in life that we can't control.

1:12:33And so I've tried cloning their ability to really put my focus on what I can control and accept the fact that there's going to be tons and tons of events that are completely outside of my control. And I think that really helps me try to deal with problems in a better way. And then this obviously directly is expressed in the markets. There's so many things in the market, like Clay was just talking about what's the market going to do. No one knows, like no one. And so if we know that well, then we can hopefully spend less time thinking about that and spend more time on, in Clay and Mai's case, just finding really good businesses that we want to put in our portfolio and make sure that those businesses are doing really, really well.

1:13:15And the rest of the stuff that's happening in the world, it is what it is. And there's nothing we can do to control it. So focus on what we can control. William's second chapter on investing being a very lonely pursuit was really, really insightful as well. I think this speaks to some of the points that I had about fighting biases. Us humans, we're really social creatures. We crave things like community and social relationships. So being a contrarian means you're going out and doing things that nobody else is doing. And that's a pretty tall order, I think, for most people. And I think most investors would prefer to fit in, do what others are doing because it's safe.

1:13:48And you feel like you have support both when things are going really well, but also when things are not going well. But John Templeton, he was your classic contrarian. He didn't invest this way. He actively looked for businesses that nobody wanted, or he just wanted ones that everyone hated because he knew that everyone's out of these and these are where you're going to get incredible bargains. But when you think about that, it's a very lonely proposition. If you're right, well, you're right and no one else is sharing in the fact that you're right. And if you're wrong, Everyone's pointing at you like going, ha ha, you're wrong.

1:14:21You didn't jump on NVIDIA or whatever's the hot stock of the day. So I really thought that was a huge insight. And in the same chapter, William wrote these six guiding principles for the non-tribal investor. And I really like how he worded that tribal part in there. And so there are some really good nuggets in there. The sixth one I thought was really good, which was super simple. Do not chase fads. And I think if you can follow this piece of advice for your entire investing career, you're probably going to perform a lot better. And most importantly, you're going to actually make it to the finish line.

1:14:52If you want to create life-changing wealth or become financially independent, you have to actually make it to the finish line. So I personally try to spend a lot of time trying to figure out where maybe I've been wrong in the past and where I could be wrong in the present or in the future. And this helps me identify where maybe some of my investments or some of the actions I'm taking are excessively risky. And then just circling back to Charlie Munger, one thing that I didn't mention was his study of failure and mistakes. I think that's just profound. I think this was one of Charlie's superpowers.

1:15:21He really was able to, especially reading biographies, he'd go back and find out some of the biggest failures that ever happened, even from people that were really smart and tried to avoid these failures at all costs. And I think that the reason that a lot of people don't do this is just that when you think about popular media, the media doesn't necessarily talk a whole lot about failures, but they do talk a lot about successes, especially in financial terms. So if you're looking to them for advice, you're going to get inundated with all these stories about people being wildly successful, a lot of times, maybe even being successful while taking huge amounts of risk.

1:15:58And so people want to emulate that. And that's probably not what they should be emulating because what that fails to show you is that there was tens of thousands and millions of people who were maybe trying to do the same thing as the success story, but failed miserably. So I think that trying to figure out failure and mistakes that you should avoid is very, very powerful. And people should probably spend a lot of time there on that. I know I do. And as an added bonus, this obviously applies to everywhere in life, not just in investing. Clay, let me throw that same question at you. What surprising things from studying Legend Investors has most resonated with you?

1:16:32Yeah. That last comment you made, Kyle, was interesting where even with us on the podcast, interviewing investors who beat the market, there's going to be some survivorship bias there. And one thing I appreciate just about our show and Williams as well is being super selective and who we allow to shine a spotlight on. And I think one of the common traits I see is just humility in that luck played a factor and they don't know everything. They admit they don't know everything and luck is part of it, but also a lot of hard work, grit, and skill and whatnot. So there's a lot to sort of think about there.

1:17:07And I think we could probably do an entire episode on what we've learned from all these great minds. I'm reminded of Dan Rasmussen. Last year, I interviewed him and he mentioned to me that investing is like the intellectual Olympics. And that was a comment that just really stuck with me. And it's just one that recurrently just comes back to mind. And since investing is the intellectual Olympics and invariably attracts just some of the brightest thinkers in the world, as William highlighted in his book. And as a result, there's just so much to learn, not just in investing. If you talk to William, he'll tell you he's invested in a few index funds and he's invested with a few of his friends and he might own a couple individual stocks, but it's like a meaningless amount of his net worth.

1:17:48So he's studying these other aspects of these people. And Kyle highlighted chapter one. I love the title, The man who cloned Warren Buffett, of course, covers Monish Pabrai. And the practical lesson is that you can look at all these people and you might not like a lot of what they do or how they live their life or whatnot, but there's probably one or two things you could probably pick up and you can choose whatever suits you the best. And I feel like I have to mention chapter six on Nick's leap in case of Sicaria. So it's recognizing that the emphasis on quality isn't just about buying good stocks.

1:18:23It's also thinking about things like, how can I be a quality partner in business or in all my relationships? What's a quality day look like? What's a high quality decision in this moment? And you recognize that all of these things matter and they all permeate into our entire life. And I was reading up on the history of Costco this week and the man who essentially invented the Costco model, his name is Sol Price. And you study a business like that. And you realize that all of these quality decisions can really add up into just this one just magnificent thing that we all call Costco today, which is why both the business and the stock almost have this cult-like following that can't be replicated to any degree.

1:19:08So Nick and Zach, they looked at this example of Costco and just noticed how this business was so strict on always having ultra slim margins. And they decided to clone that and decided to charge an abnormally slim management fee to their investors. And when they shut down their fund, they simply told investors to go buy Berkshire, Costco, and Amazon. And there wasn't much else they needed to do. They could have milked that fund for the rest of their life and made money off their investors. But they just said, it's not the high quality decision, essentially. And then, of course, I have to mention Buffett and Munger as well, who Kyle and I discuss in-depth on We Study Billionaires.

1:19:49So Buffett, when I was just graduating college, I always thought about how he always encouraged people to pursue a line of work that they really enjoy doing. And that really inspired me to join TIP. And that was very impactful for me and just totally changed my life. So just very grateful for Buffett, just continuing to harp on that advice. And then another big lesson from Buffett is that the best investment that you can make is in yourself. It's so simple, but it's also so simple that it's easy to overlook. So many people, I think, will talk to maybe someone like us or someone that's into stock investing and just want to get the next hot stock tip, but they should probably turn and just look at themselves and invest in their own education.

1:20:29How can they find that themselves or how can they develop the skill sets to lead to a good investment? So most of the greatest investors are learning machines for a good reason, because there's just always more to learn. And that's the investment that pays the best and the biggest dividends over a lifetime. So I guess another comment is that Buffett and Munger, they just put a huge emphasis on the people you choose to surround yourself with. And that is also something that's just hugely important and hugely powerful and something that I think we can all always work on to some extent. And it's a challenge I'm also just always working through.

1:21:04It's been a ton of fun to chat with you both today. And it's sort of a trip down memory lane to listen to all these clips from past episodes and interviews that you both have done. So I'll just tell the audience, go and follow these guys on Twitter for more on them. And of course, make sure to tune into We Study Billionaires to hear more of their episodes. All three of us will be in Omaha this year for Berkshire 2025. And you can just email me at sean at theinvestorspodcast.com. That's S-H-A-W-N at theinvestorspodcast.com for more information on how to attend our meetups. But any last thoughts, guys?

1:21:39Nope, nothing from me. Thanks for having us. Cool. Well, with that, keep an eye out for the first episode of our new Intrinsic Value podcast next week, where I'll break down Madison Square Garden Sports, the publicly traded parent company for the New York Knicks and Rangers. It's not every day you have a chance to study a stock tied to major professional sports teams, especially one that is seemingly trading at a significant a discount to its intrinsic value. But that's for next time. I'll send you off today, as always, with a quote. This one is from William Green. He says, you get a lot of A's and B's in school, in the stock market, you get a lot of F's.

1:22:15And if you're right six or seven times out of 10, you're very good. See you all again next week for the debut episode of the Intrinsic Value Podcast. Thank you for listening to TIP. Make sure to follow Millennial Investing on your favorite podcast app and never miss out on our episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor's Podcast Network. Written permission must be granted before syndication or rebroadcasting.