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What if you could peek inside the minds of the greatest investors in history?
People who've beaten the market not just for a few years, but for decades.
From Warren Buffett and Charlie Munger, to Peter Lynch, Nick Sleep, and John Neff.
These legends didn't just make money.
They reshaped how we think about investing business, life and decision making.
And today, I'm breaking down timeless lessons that helped them do it.
In this episode, I'll share what Buffett's honesty and transparency can teach us about long term trust and opportunity.
How Graham's margin of safety still applies in a world that's completely dominated by intangible assets.
And how Peter Lynch used incredibly simple observation to uncover billion dollar companies that were hiding in plain sight.
We'll also explore Philip Fisher's scuttlebutt method for gaining an information edge, John Templeton's contrarian genius for finding value where just no one else dared to look, and John Neff's flexible definition of value that just went beyond low PEs.
Then we'll dive into the mental frameworks that helped make some of these great investors just so extraordinary.
We'll look at things such as Howard Mark's second-order thinking, Nick Sleep and Kay Sakaria's art of holding on to winners, Monique Pabrai's eye for hidden value.
And then finally, Charlie Munger's philosophy of a win-win relationship in business and in life.
Each of these lessons is heavily shaped the way that I personally invest and think.
And I'll walk you through the key takeaways that you can apply right now, whether you're running a business, managing your portfolio or just simply trying to become a better decision maker.
So if you're an investor looking to sharpen your edge, a lifelong learner just fascinated by what drives consistent excellence, or someone searching for practical ways to think more clearly and act more rationally, this episode is just for you.
You'll walk away with tools and stories that have stood the test of time, insights that separate the true legends from just the good.
Now, let's get right into this week's episode on my 10 lessons from investing legends.
Since 2014, and through more than 180 million downloads, we've studied the financial markets and read the books that influence self-made billionaires the most.
We keep you informed and prepared for the unexpected.
Now for your host, Kyle Grieve.
Welcome to the Investors Podcast.
I'm your host, Kyle Grieve, and today I'll be discussing 10 lessons from value investing legends.
Since I spend so much of my time trying to uncover subtleties that legendary investors have employed to achieve their incredible results, I thought it would be a good idea to maybe break down one major lesson from each of them.
I've intentionally chosen ones that I think have impacted others and myself, but might not necessarily be the most obvious choice in some of the cases.
I could easily spend an entire episode on any of these investors, and I have done so on nearly every investor I'll discuss today.
But today I'm going to focus on these 10 timeless lessons that I think I've learned from investors just at the apex of their profession.
Now, the first person I'm going to cover is none other than the GOAT himself, Warren Buffett.
So it was hard to choose what exactly I wanted to share from Buffett, because when it comes down to what I've learned from Buffett, I can't help but think of that great Jim Sinegal quote.
He was asked if he learned a lot from Sol Price about the retail industry.
And Jim replied, no, that's inaccurate.
I learned everything.
I have learned nearly everything I know about investing from researching Warren Buffett.
But the lesson that I chose from Buffett is just how to succeed with maximum integrity, honesty and transparency.
You see, Warren Buffett isn't admired just for his monumental gifts in investing and value creation.
He's also admired for his character.
He's a person that you can genuinely trust to put shareholders' needs above his own, to be honest about his mistakes, and to not hide or sugarcoat things when it's obvious that he's made a mistake.
The thing about Buffett's honesty and transparency is that I believe they really contributed significantly, if not entirely, to his success.
Without his honesty and integrity, I think it's unlikely that he would have continued to receive fantastic opportunities in private businesses, which he's added to Berkshire's list of fully owned companies.
Warren certainly has a history of being out there and searching for ideas.
But he's also so well-liked and admired by others that people will go out of their way to make introductions on Buffett's behalf.
And they do this simply because he's just built such an excellent reputation over the years that making a deal with him can be very easy if you're very well aligned with how he thinks.
Now.
One notable example of this is a little-known subsidiary of Berkshire Hathaway called Forest River.
An RV manufacturer.
So picture this.
It's 2005.
Warren Buffett is relaxing in his office, poring over annual reports.
A two-page fax arrives at his office.
Warren curiously reads the fax from a man named Peter Legal.
He explains that he'd love to sell his RV manufacturing business to Berkshire Hathaway.
The price?
$800 million.
Warren Buffett didn't know a thing about the RV industry, but given what he learned from the fax, he began doing some due diligence.
The next day, Buffett made him an offer.
And within a week, Legal was in Omaha to shake on a deal after a 20-minute meeting.
Legal said regarding that agreement, it was easier to sell my business than to renew my driver's license.
Now, there just aren't that many people on earth who conduct business in this way.
And I think it's a significant reason why Warren has been successful over the years.
Business owners know that when Berkshire acquires them, they can remain in control of the business without worrying that Buffett's going to come in and lay off half of their workforce or massively change their culture.
They also know that Warren's very likely to hold onto that company forever.
And if the business requires additional capital, Warren will gladly provide it, assuming the returns on investment are adequate.
Transparency and trust offer additional benefits that aren't discussed very much as well.
For one thing, trust, just like a good business, compounds over time.
Every cent you drop in the trust jar today will be worth multiple times its worth if you continue to add to that bank.
Warren has always been a trustworthy person, even back in his 20s when he started the Buffett Partnerships.
And that trust has evolved into its current state.
And it's not an advantage that competitors can easily attack.
Another interesting point about transparency is that it can really save a company a significant amount of money and headaches.
A good example of this is Warren's own shareholder letters.
So since he has nothing to hide, he's written them the entire time.
And they're always full of a lot of honesty and transparency.
If he had things to hide, he might be forced to just hire a PR firm that can charge exorbitant fees to clean up any of his messes.
And then lastly, his high levels of honesty attract just like-minded individuals, which is why Berkshire Hathaway has so many CEOs that are just absolute superstars in its ranks.
Talent just attracts talent, and people are well aware of this.
Lou Simpson is an excellent example of a tremendous investor with an incredible track record and a long history of working at Berkshire Hathaway.
However, there's been several high performing individuals who have worked or currently work for Berkshire, and I'm sure there'll be several more.
The common saying is that we are the average of the five people that we spend most time around.
Buffett knew this, so his nature allowed him to be surrounded by people who continue to push him and make him even better.
If you can adopt Buffett's traits of trust and transparency, chances are you'll attract some very high quality individuals into your life.
That will make you better too.
One such high quality individual who pulled Warren into his orbit was Benjamin Graham.
And while I wanted to get fancy with a lesson from Graham, that wasn't super obvious, just his bedrock principle of margin of safety was just too hard to pass up.
So the margin of safety is a simple principle.
Buy assets for less than they're worth.
It's such a simple lesson, but surprisingly few investors actually use it to help avoid making big mistakes and taking on too much risk.
While the few investors who do consider margin of safety assume that margin of safety is embedded in things like assets and boring, capital-intensive legacy businesses, there is definitely a margin of safety in many areas of investing, not just in these boring companies with outdated business models.
So while Graham loved using a company's balance sheet to find a margin of safety, there are more areas inside of a business that you can use to search for a margin of safety.
Earnings predictability is one way of looking at it.
You can have a capital light business that has a ridiculously high book value and the company can still have a very large margin of safety.
So let's take a simple example here.
We'll call a business fast grow to illustrate.
So let's say this company is in the growth stage of its development.
But the company also has a loyal customer base and very high switching costs.
The business is expected to grow its earnings per share by about 26 annually, with good visibility for the next three years.
So the company currently has an EPS of $1 and trades at only 10 times earnings.
Now, this implies a share price of just $10.
In three years, the company is expected to have an EPS of $2.
Let's also note that the business has very low tangible assets and trades at five times book value.
It also has negative working capital.
So, using Graham's traditional margin of safety of looking at net working capital, this business is not interesting at all.
But we know a few things.
So a business growing this fast probably shouldn't trade a 10 times earning multiple.
What should it have?
Probably something higher than the market.
As of August 7th, the PE of the S&P 500 is around 29.
So let's say 30 is a better number.
Now that we have a better idea of a terminal multiple, we think the business is going to be worth about 60 in three years time.
The business converts 100% of earnings to cash just to keep things simple.
So using an 8% discount rate, this business is worth $47.
So we're achieving a massive margin of safety without considering assets at all.
Now, in this case, if we can buy the business for $10, we have a massive, massive margin of safety.
And that margin of safety allows the company to make several hiccups and screw ups and we still won't lose any money.
Now, what might some of those mistakes look like?
So I came up with three hypotheticals.
So let's say the terminal year comes around, the market turns bearish and we have to use a lower terminal multiple.
Let's say it just stays at 10 times earnings.
In that case, the business is still worth $20, double our initial buy-in.
Heck, even if the multiple cuts in half, we're still breaking even.
Second is the business's growth stalls.
So let's say EPS growth gets cut in half to just 13%.
In three years, the EPS is now about $1.50.
Perhaps now the PE of 10 makes a little more sense and the business is now worth $15.
We still haven't lost money.
We actually made 50%.
Now, worst case scenario is the whole growth thesis just completely falls apart.
Let's say the business is not growing.
It's taking on debt to just stay afloat.
Let's say EPS halves to 50 cents and the PE multiple contracts to five times, as it's just no longer seen as a growth business.
Now yeah, you're losing money, as the stock price is trading for just a quarter of what you bought it for.
So these are just a few scenarios that could happen to a business that aligns a lot more closely with what I specifically look for and how I view a margin of safety.
So traditional value investors such as Graham would argue that fast growth has no margin of safety simply because its tangible assets are so low.
However, we live in a market where intangible assets simply reign supreme.
And examining the margin of safety in the way that I just outlined is an excellent way to measure the risk involved in any bet.
One interesting aspect of Benjamin Graham was that he was a highly quantitative investor.
Factors such as switching costs, network effects, economies of scale or even brand can all make a business far more valuable than its financial statement might indicate.
Or what about culture?
Over the long term, a business's actual value will depend on the culture that has been established within it.
A culture of innovation and excellence will always outperform one that stifles innovation and pushes out its top performers.
Let's suppose you were to find two businesses today with similar margin of safety.
In that case, chances are, the business with the excellent culture probably has additional hidden variables and further increases its margin of safety.
The company with the poor culture may look cheap on paper in the short term, but over the long term this is the business that's most likely to deteriorate.
Now there's an additional valuable lesson from Benjamin Graham that I really wanted to share as well, which is crucial to understand.
And that's his experience of just holding Geico.
So Geico is fast. the majority of Graham's net worth.
There's no way to know for sure, but I've read that Geico's stake made up over 50 of his net worth once he retired.
Now, the most interesting thing about Geico was just that it was at odds with many of the investing tenants that he put forth in The Intelligent Investor.
I came up with three here.
So the first one was broad diversification.
So since Geico made up nearly 50 of his net worth, he wasn't really practicing much diversification at all when it came to Geico.
The second is just his reliance on investing in cigar butts.
Geico may have started as a cigar butt, but it really turned into a compounding engine, which wasn't traditionally what Graham was known for looking for.
And the third one here is just his principle of selling when price reaches intrinsic value.
So this one's a little bit tougher to say, because it's really impossible to find any data on what Geico traded for for the nearly 25 years that Graham held the business.
However, my assumption is that it's pretty impossible that Geico's price never exceeded its intrinsic value over 25 years.
I just find that hard to believe.
Now, here's what Benjamin Graham himself wrote about his thoughts on Geico.
Ironically enough, the aggregate of profits accruing from the single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partner's specialized fields, involving much investigation, endless pondering and countless individual decisions.
Are there morals to the story of value to the intelligent investor?
One is that one lucky break or one supremely shrewd decision can we even tell them apart?
May count for more than a lifetime of journeyman efforts.
So the lesson here is that you can be flexible on some of your core principles if the opportunity is right.
Next we move on to someone who taught me just so much about identifying new stock ideas, and that's Peter Lynch.
So the beauty of Peter Lynch is in the simplicity of one of his methods for just finding stock ideas.
And that's through simple, real-life observation.
The overarching point that Lynch made was to invest in what you already know.
This meant you didn't need to mentally overreach to understand a potential investment.
But let's get into some of the more specifics of how you can use this to your advantage.
So the first step is to do something such as looking at your shopping habits.
There are a few ways to take advantage of this.
First, you could just look at your monthly bills, find out where you're spending all your money and determine if you could easily stop spending money there or switch to something cheaper.
If you're finding that there's products or services that you just can't replace or just don't want to quit using, you might find an excellent investing idea to dig into.
That is, of course, assuming the business is publicly traded.
Second is just observing where you shop.
So, even if you don't shop for a specific product, if you're in an area such as your local shopping mall that has several different stores, just monitor which ones are the busiest.
One of the TIP Mastermind community members did this to find an idea, which was Dutch Brothers.
So every day he'd pass one of their locations and see just cars lined up literally going into the street with people who wanted to buy beverages from Dutch Brothers.
I've used this as well to find one of my biggest investing successes in Aritzia.
So when I first started learning about the business case for Aritzia, I would look in stores whenever I was near one.
And I began asking women I knew about their experiences at Aritzia as well.
And it was super helpful in helping me understand the strength of their brand.
I also use this as a monitoring tool.
So whenever I'm in a city with an Aritzia location, such as Hawaii or New York or Toronto, I always try to make it a priority to walk into the store to see how busy it is.
And I can honestly say that they're always busy, which is an excellent sign.
A few other points to consider when using this method that Lynch made sure to emphasize.
So first thing is when you travel, notice what stores are full and which ones are empty.
Another one is to make sure that you're looking for things such as long lines, new store openings, rapid shelf turnover.
And then lastly, just compare your observations with multiple locations to see if it's a real trend and not just a trend in a single location, which obviously isn't interesting at all.
So the next one I like to observe is how my wife spends her money.
So my wife loves shopping a lot more than I do.
So I'm constantly peppering her with questions about interesting products she's considering or even new e-commerce sites she's exploring.
And this can give you a vast range of options.
For instance, when I owned InMode, a facial aesthetics machine manufacturer, I recall my wife telling me that she knew one of her mother's friends who had used one of their machines and had a very positive experience with it.
Now, this helped me understand that InMode had a decent chance of continuing to scale their products, since at least one of their customers liked what they were offering.
Another great way my wife has helped me is just simply by asking questions about specific brands that she knows better than I do.
So I've already mentioned Aritzia, and my wife grew up literally five minutes away from the very first Aritzia location.
Additionally, she's been shopping at Aritzia for 20 plus years.
So she's a goldmine of information to just help understand how Aritzia has created this customer loyalty.
And on my own, I just would never have probably gotten these insights.
So it's really, really helpful.
Another way to find new investment ideas is just to observe the products and services that your children enjoy.
For instance, my son loves a few things.
So I got five here.
One, YouTube, which is owned by Alphabet.
Two, Disney, a publicly traded company.
Three, Hot Wheels, owned by Mattel.
Four, Lego, not publicly traded.
And five, Fisher Price, also owned by Mattel.
So with that information I can see if maybe there's an investment case for Alphabet, Disney or Mattel.
I could tell you right off the bat that Disney just doesn't interest me.
Alphabet could be interesting.
And I checked Mattel, but it has 10-year compound annual growth rates of revenue at 015 and EPS of only 22.
So that instantly tells me there's nothing to be interested in.
As for Lego, it's too bad.
It's private, because sometimes I actually wonder if I like Lego more than my son does.
Now I did a check on Lego anyways to see what kind of growth that it might have or what's disclosed, even though it's a private business.
Unfortunately, its metrics are also very uninteresting if they are indeed true.
So the numbers I found was that revenue actually decreased by 2% in 2023.
And in that same year, operating profits declined by about 5%.
So numbers like that caused me to have zero interest.
Now, out of all these, Alphabet would probably be the one that I find the most interesting.
However, But according to Reuters, YouTube could be valued at something like $500 billion.
Now, to be honest, if YouTube was spun out, I would probably have a very, very close look.
So not only does my son love it, but I also love YouTube and use it very often.
I also use it as a research tool as part of my job.
TIP is obviously also very present on YouTube.
You might actually be watching or listening to this on YouTube right now.
Let's take a quick break and hear from today's sponsors.
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Now, this transitions to the last area where I like to look for ideas, which is from your job.
So I use several services on a very regular basis.
And a few of these off just the top of my head.
I use Gmail, Google Calendar, Google Drive Slack LastPass, Riverside and Adobe Audition.
Now the owners of the first three are Alphabet, Salesforce owns Slack, LastPass and Riverside are private and Audition is owned by Adobe.
Now we've already covered Alphabet, so I'm not going to go over it again.
Salesforce and Adobe.
Looking at the 10-year keggers, for Salesforce, first revenue is 27, EPS 28 and free cash flow 31.
They have no debt either, and they're led still by their founder, Mark Benioff.
Adobe is buying back shares, has a 10-year kegger of 13% revenue growth and 14% earnings per share.
So out of those two, I like the growth of a business like Salesforce, but I will admit that I just don't know that much about the company.
Perhaps I should put it on the wait list.
However, before I would ever decide to invest in a business like Salesforce, I'd have to conduct pretty extensive research and due diligence, which brings us to our next investor, who I consider to be just the master of that area.
And that person is Philip Fisher.
So he wrote the excellent book Common Stocks and Uncommon Profits, which I discussed in a lot of detail on TIP 646.
And one of my biggest lessons from Mr. Fisher regards the power of Scuttlebutt.
So Scuttlebutt is just one of the most potent ways that investors can gain an information edge.
Scuttlebutt is simply learning more about a specific business by using alternative sources of information.
Everyone has access to things such as a company's public documents.
Therefore, reading them or other easily accessible information on the internet won't provide you an informational edge.
It's definitely required, but again, it won't provide you an edge.
But if you speak to other people who are involved in the business, the industry or even the company, the competition of the business, you can learn a heck of a lot.
So in the book The Sleuth Investor, the author discusses examining three different parties to sleuth within a company.
They are customers, employees, and suppliers.
So I'll zero in on customers here because I think that's the most critical area to look at.
So when it comes to customers, there are three specific types to consider.
There's the end user.
There's the person who decides whether to sign a check or to purchase a product.
And then there's the check signers themselves.
You can also look at things like current customers, former customers and potential customers.
Speaking to any of these people will yield very high value information about the relationships that customers have with the business.
The primary purpose of Scuttlebutt is to gather non-financial information about a business.
So it enables you to learn about factors such as competitive advantages, management quality, growth prospects and potential risks.
Other great people that would be interesting to talk to would be suppliers, who can just reveal the company's bargaining power payment, reputation and reliability.
You can talk to competitors, who are often the best critics, as they have no problem highlighting where a company is going to be strong or weak.
You can talk to employees, current or former, which can provide incredibly valuable insights into things like culture management, effectiveness and innovation.
And then lastly, people like industry experts, who can offer a lot of context about trends, regulation and market dynamics.
So I try to stay informed about all of the businesses that I own, but I must admit that it's pretty challenging.
A CEO of a company is likely to know who all of their customers are, but they're very unlikely to share that information, as that's an action that's frowned upon.
Suppliers can also be very tough to find, simply because it's not obvious who the suppliers are for a specific company.
Competitors are probably the easiest to figure out, because anyone involved in the business won't have a problem sharing that information with you.
When you look at current employees, personally, I find it nearly impossible in my experience.
People just don't seem to want to speak about their own business, probably just to avoid getting into any trouble.
Industry experts are not hard to get information from either.
So industry experts can be found just all over the internet, but you have to understand some of the incentives of the industry experts.
Generally speaking, they're incentivized to talk up the industry.
So if you find one to talk, remember that very, very closely.
I recall finding a coal expert who was widely available on the internet.
Guy was all over YouTube and podcasts.
And while he always appeared to be very thoughtful, given his various positions within the industry in terms of investments, it was evident that talking up the commodity was in his best interest.
So our next lesson comes from Sir John Templeton.
And that's to fish where there's just no fishermen.
My idea came from this when reading the book, The John Templeton Way.
So Templeton began investing in Japan in the 1950s, nearly three decades before the major bubble began to form.
And he was investing in Japan during a time when just nobody was willing to touch Japanese stocks with a 10-foot pole.
But John saw incredible value at this time.
So in the early 1960s the Japanese economy was growing at an average of 10 and the US economy was growing at an average rate of only 4.
In other words, the Japanese economy was expanding two and a half times faster than the US economy.
But many stocks in Japan cost 80% less than the average of the stocks in the United States.
So in a written report in 1960, there were two reasons why foreign investors refused to invest in Japan, despite these cheap valuations.
The first one was that there was too many fluctuations in the stock price.
And the second was that there just wasn't enough information.
So this really got me thinking.
You know, where could other investors in today's markets find areas of the market that have large amounts of volatility and lack information?
And if you look hard enough, there's always areas of the market like this.
My personal choice has been microcaps.
Instead of looking at the massive US market, I stick with my home country, Canada.
And in Canada, specifically, I look at microcaps.
So whenever I'm speaking with members of the TIP Mastermind community, they often ask about microcaps and how I research them.
And it's ironic because one of the main impediments I hear from people is that they specifically don't research microcaps specifically because there's a lot less information out there on them.
So if you look at the popular news or you know analysis sites such as Seeking Alpha, you're going to be very disappointed at what you find when trying to research microcaps.
And that's because barely any analysts cover microcaps, because they know that funds or the readers just can't or don't want to buy them.
So that is why, when you look at a business such as you know, Alphabet or Amazon, you're never going to learn new analysis which can help inform you and give you an edge over others.
But the problem with investing this way is that you're investing in very well-known businesses and there's just less inefficiencies.
I'm never going to say that there aren't inefficiencies in large and mega caps, you know.
Consider meta for further proof of that.
But I will say that there are areas of the market where there's just these massive inefficiencies and they occur a lot more often.
And, in my opinion, the part of the market that I think I can understand that is regularly inefficiently priced are microcaps.
This is also backed by research.
In the book What Works on Wall Street by James O'Shaughnessy.
He writes between 1964 and 2009 If, as a Compustat scenario one illustrates, you required stock prices greater than a dollar, but put no return limit and allowed for stocks with missing data to be included, then the portfolio earned an average compounded annual return of 28.
Yet when you require that all stocks have share prices of greater than a dollar and have no missing return data and have limited monthly return to any security to 2000 per month, as we see with scenario two returns declined by approximately 10.
And the portfolio earns an average compounded return of 18.2%.
So this second number, even though it's obviously a lot lower than the first one, was way higher than other market cap deciles.
Now I'm sure that some investors have identified other, maybe rare, aspects of the market that are inefficient to exploit.
And if you look close enough, long enough, you're probably going to find areas that you can find very easy to understand but might not be understandable by the average investor.
And that's an area that you could exploit.
So the key is really in understanding where to fish, where there are no fishermen.
There's four of them.
So the first one is to find areas of the market where information is just hard to find.
The second is that the higher the volatility, the better.
The third is that if you can't find any analysis, you're probably on the right path.
And fourth is Try to find a community of people who specifically try to exploit some of these mispricings.
Today.
There's tons of communities out there that specialize in pretty much anything that you're interested in.
If you can find and get access to those communities, you can usually access pretty small groups of people trying to find inefficiencies in the market together.
John Templeton in his time just didn't have access to this, so he had to do it all by himself.
I can reach out to many, many people to find interesting ideas and microcaps.
And since there's just so many ideas, the idea flow just never really ends.
The interesting thing about inefficiencies is that they rarely last.
Microcaps tend to grow through cycles of popularity and unpopularity.
In Templeton's case.
Once the rest of the world started catching on to just how much of a bargain Japanese stocks were, they began bidding up the prices, which removed that inefficiency.
But by that point Templeton was long gone.
You must keep your ear to the ground to observe when they are disappearing.
Otherwise, you risk holding the bag.
And if you're holding the bag, you either break even if you had the right entry point, you lose money if the cycle goes down more than you thought, or you have to wait a multi-year time period until that cycle changes to make a profit.
Now, the next investor I want to highlight is John Neff, who I just released an episode about on TIP 747.
One of my favorite aspects of John Neff was that he was an investor with a very value-based approach, but he also wasn't afraid to buy businesses that I think most traditional value investors wouldn't touch.
So Neff considered himself a low PE investor, and that's definitely where the bulk of his money was made.
However, he also understood that flexibility was just crucial to achieving superior long-term returns.
He owned names like Home Depot that traded over 20 times earnings and even owned names like IBM, Xerox and Intel during the latter part of the nifty 50 years.
So Neff wasn't afraid to take positions in businesses where he found value.
Now, this is a valuable principle to consider for investors who might limit themselves to a single investing strategy.
If you're only looking at businesses with single digit PEs, for instance, there will be boom and bust periods in your opportunity set.
It's totally okay to invest that way.
People like Bob Robadi have made a career out of investing in this manner.
However, I think you really broaden your horizons if you view value the way that Neff did.
And that's to find undervalue assets rather than focusing exclusively on low PE.
And this is a lesson that I've tracked for nearly my entire investing career.
While I do enjoy investing in stocks with single-digit PEs, I'm also attracted to businesses that might have a PE that exceeds 30, but for good reason.
Some businesses are just so exceptional and resilient that they simply deserve to be priced higher than a lower-quality alternative.
A sticky SaaS business that is growing its recurring revenue at 30 per year and has nearly all of its revenue as recurring revenue, deserves a premium, versus a cigar butt that is trading cheap based on its assets.
So let's dive into this topic in some more detail.
So let's make up a hypothetical cigar business.
We're going to call it Ugly Duckling or just Ugly for short.
So Ugly is a discount shoe retailer that buys leftover inventory from failed brands and resells it in outlet style stores.
So its competitive advantage is just it's cheap and it has no loyal customers.
It's got no in-house brand.
Since the business is a low cost provider, its gross margins typically range in the 15 to 20% range.
But the company is struggling to grow because its operating results just aren't strong and banks are very hesitant to lend it any money.
Going to the capital markets is an option, but their growth prospects are so dire that it just might not work out the way management wants.
However, if you examine the balance sheet, they don't require much debt to operate.
They own a significant amount of their stores and they have substantial amounts of inventory.
So if you were to look at this on a balance sheet basis, as maybe a liquidation play, you would make money just by selling all the business's assets, rather than keeping the business running.
So what's a business like this worth?
It might trade at five times earnings, attracting value investors to the company.
Perhaps the catalyst would just be some sort of liquidation event of the entire business.
Or maybe a new leadership could come in and improve the business and identify new ways to expand.
The point is the business is cheap and I think kind of deserves to be.
Could this business be worth 10 times earnings, resulting in a double if they maybe strung together a few good quarters?
I doubt it.
Let's look at a business we'll call CloudNest.
So this business is a cloud-based collaboration software for small businesses.
Customers pay a yearly fee for project management, file sharing, and communication.
The business has 95% of its customers on multi-year contracts.
Revenue is about as predictable as the sun rising and setting, and gross margins are 75 and climbing as the business onboards new customers and tests out its pricing power.
Customers are extremely loyal with retention rates of about 98%.
The market is just massive as they've only penetrated about 1% of small businesses in North America.
Additionally, the company is developing new modules that current customers are willing to pay more for as they expand their offerings.
The business is hugely profitable, boasting 25 net margins, and net income has grown at a 30 kegger for the last three years, showing no signs of slowing down.
Now, do you think CloudNest has any business trading at a five times earning multiple?
10 times seems like an absolute steal.
Heck.
A business like this, trading at 20 times its value, could still yield excellent results if it can continue growing at those rates while improving its margins.
So let's say this business can continue growing net income at 30% for the next three years.
That means EPS will more than double over a three-year period.
So if you bought it at 20 times earnings, your investment should double, with absolutely no multiple expansion needed.
However, a business like this can easily justify 30 or 40 times earnings.
That would add a substantial amount to the investment.
This is why growth should be factored in to any investment and reflected in its stock price.
Now let's move on here and imagine that the year is 1999 and Howard Marks is at a quiet dinner in Midtown Manhattan.
The Nasdaq has just tripled in the last three years and the air is just thick with the optimism of innovative technology.
Everyone at Howard's table is eagerly discussing dot-com stocks, young billionaire founders, fast-moving IPOs and the fortunes that were made in a matter of weeks.
Someone leans over to Marks and asks, Howard, may I ask what your hottest tech pick is right now?
Mark slowly smiles, shrugs, and says, none.
It's a baffling response to To most people in the room.
Not owning dot-com stocks is complete madness.
But this is why Marks has been so successful for so long.
He doesn't think like everyone else.
Instead of asking what everyone else was asking, which was what stock should I buy?
That will continue going up in price.
He was asking what happens when everyone else buys a stock and I don't.
So the question everyone else was asking is an example of first order thinking.
It's a simple and direct way of thinking.
Growing rapidly in terms of revenue, or those even with just an idea that revenue would increase in the future, were the ones that were becoming these market darlings.
Therefore, they were the ones that people should buy.
But second order thinking is much more complex and requires more mental energy.
Marx would look at the problem this way.
Since everyone knows the company is growing fast, there will be significant buying pressure.
As buying pressure increases, the stock price will rise.
So the question wasn't, is the company any good?
It was, what is the best decision to make, knowing that everyone is piling into the stock?
Marks wasn't looking at the surface question.
He was peering and looking at an extra layer, deeper examining factors such as the expectations embedded in the stock price, which gave him a much more accurate view of the market psychology.
Let's now look back even further and go back to the mid-1800s.
When thousands of people rushed to California to live out the American dream by finding a very precious resource gold.
So Americans headed to California in droves, carrying pickaxes and shovels.
And they did this with visions of glittering fortunes.
They were thinking in the purest form of first order logic.
Gold is valuable.
Go to where the gold is and find it yourself.
Now in 1853, a Bavarian immigrant arrived in San Francisco.
His name was Levi Strauss.
Instead of thinking about gold like everybody else, he noticed a need that was missing for all gold diggers.
This was a pair of just good pants that wouldn't rip after a few days or weeks after digging.
Instead of joining the gold finding frenzy, he decided to make his fortune by supplying the prospectors with just strong pants that could withstand a lot of punishment.
And this is how Levi's jeans was born.
So Levi Strauss was thinking in the second order.
And instead of taking the risk of finding gold or just going completely broke, like many people did, he simply just supplied the diggers with the equipment they needed to attempt to find their own riches.
And in the process he built an incredible business that remains in existence today, 172 years later.
Now we get back to Marx.
So the people at his dinner most likely ignored his comment.
They went all in on the dot-com bubble.
And a year later, many of these people were seeking a new career or employer, as their funds and fortunes had evaporated.
Marx, by contrast, would continue to compound his investors' capital successfully for many more decades.
And Marx did this by investing in the less obvious deals that everyone on the street didn't love.
And that's really the lesson in Marx's brilliance.
Don't just ask what will happen, but continue to ask what will happen after that.
Just do that for a few decades and you're bound to find some incredible investments with just large margins of safety and a more than adequate upside.
So my favorite use case for this is determining whether I'd be taking too much risk by buying an investment at a given price.
So purchasing an expensive business means the business is just priced for perfection.
And when a company is priced that way, it must continue to meet sky-high expectations.
The problem with this line of thinking is that businesses will stumble.
You know, regulators will get in the way, the economy will throw a curveball or management will face some sort of crisis.
So I like using second-order thinking to determine if a business's expectations are set correctly.
Poor quality businesses are likely to fail to meet expectations.
High quality businesses tend to beat expectations alarmingly regularly.
I also employ second order thinking to observe enterprises that don't meet expectation in the short term but are likely to improve in the long run.
Next, we encounter two exceptional investors in Nick Sleep and Kay Sicaria, who founded the Nomad Investment Partnership.
These two made an investing career out of riding just three key stocks and doing as little tinkering as possible while holding them.
And the lesson here is simple, but not easy to put in practice.
And that's to treat your winners as businesses that you keep, not ones that you trade in and out of.
And these aren't investments you just look to double your money, then run to the next idea.
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Sleep and Zakaria spent their entire investing career looking for a very specific business model.
These were what was called scale economies shared.
It states that when a business grows, it passes on its scale benefits to its customers rather than retaining them for their own use.
The three businesses that they rode were Berkshire Hathaway, Costco, and Amazon.
Now I've tried to grasp whether this is a business template that appeals to me and I concluded that I would never say no to a business model like that.
But I'm also not going to go out of my way to exclusively search for business models that fit the scale economy shared model that Nomad was obsessed with.
Instead, I search for businesses that I can ride for hopefully multi-year and maybe even multi-decade time periods, and businesses that are likely to just increase in intrinsic value over my holding period.
This is what Sleep and Zacario were trying to do.
They basically whittled down all of their decisions to these three stocks that I just listed.
And the stocks were just so good that they were able to extend their holding periods for longer and longer periods of time.
And even since they closed their fund in 2014, they still hold the vast majority of their net worth in these three names.
But they didn't reach this conclusion overnight.
They invested in other businesses that even shared the same business model, but didn't quite make the cut.
So there are other companies AirAsia CarpetRight, ASOS that were in the portfolio at one point, along with several other classic value investments trading at a fraction of liquidation value.
But over time, Sleep and Zakari observed that the businesses that were at the top of the rung, even within the ultra-specific business model, were the ones that deserved most of their capital.
I enjoy reviewing my top three businesses and noting if they exhibit any specific characteristics.
So my top three positions make up 42% of my portfolio.
And to be honest, they don't really share a business model between the three.
And I'm perfectly fine with that.
So, even though I find Nomad's approach interesting, it's not the actual business model that taught me the most significant lesson.
It's simply to find businesses that you can ride for extended periods of time and make sure to hold them as long as they continue to perform well.
And in that sense, yes, I think I'm doing that pretty well.
All the businesses in my top three generate a significant amount of cash.
And when I think about them, they do actually share a few similarities.
So I came up with five.
So The first one is that they don't pay a regular dividend.
Second, they don't meaningfully buy back shares.
Third, they consistently invest more and more in growth.
Fourth, they don't allow cash to grow excessively.
And fifth is that their moats are continuing to expand.
Now, these are all characteristics of businesses that can compound value, simply because they can reinvest all of their cash flow back into their business at high rates of return.
So, while their free cash flow numbers may not look amazing, I'm actually okay with that, because they're constantly using that cash to reinvest into their business at very high rates of return.
So this is a business model that really attracts me the most.
While many value investors are looking for businesses that are growing, maybe in the high single digits or low double digits, they're also accepting that returns are going to come from things like multiple expansion, buybacks or even dividends.
I just prefer to not rely on them as much to give me returns.
While I love buying businesses on a cheap multiple, one of the great benefits of compounders is just the steadiness in which they can compound capital.
So for that reason, they tend to carry higher multiples and maintain those higher multiples.
As of today, the forward earnings multiple on my top three businesses are 29 times, 41 times and 90 times.
So the third business, which I won't name, with the 90 times multiple, is pretty distorted by the fact that it's growing so rapidly, which penalizes it very significantly under IFRS due to significant depreciation and amortization.
So the multiple gets cut significantly when I make a lot of adjustments, but it still is a pretty high ratio.
So you'll notice that the first four points mean businesses are just optimized for growth.
They aren't trying to grow a steady dividend to draw in capital.
They know that the best use for capital is to invest in the businesses that they're already in.
The risk of owning businesses like this relates purely to just the future and the unknown.
Once the market no longer believes that these businesses will grow at high rates, they will no longer be given a premium multiple.
This is my most significant concern.
My primary maintenance tasks are basically tracking growth and observing the direction that things are moving.
I learned this the hard way with Evolution AB, an iGaming business.
So this business was one that I expected to grow but just failed to meet the market's expectations.
So any business that is expected to grow but fails to meet the market's expectations is going to experience a pretty big price drop.
The key is to just try to stay ahead of the market.
Let's suppose that you think a business is in maybe some sort of structural decline.
In that case, I'd rather exit early, potentially foregoing profits, to avoid the mass exodus that's probably going to follow once it's well-established that the business is in a structural decline.
So what Sleep and Zakaria really nailed was that the businesses that they chose were just so good that, even if they grew at lower rates, they still maintained a reasonable valuation, because it was just common knowledge that these businesses had near impenetrable moats and had high, high levels of customer loyalty.
To execute Nomad's strategy on yourself, you must have active patience.
I first learned of active patience from Ian Cassell, who wrote The longer I invest, the more I realize you get one or two great opportunities every few years.
The rest of the time is spent wondering if you'll ever get another great opportunity again and convincing yourself to own mediocre opportunities while you wait.
Mediocrity is the price you pay for impatience.
Nomad did an exceptional job avoiding impatience and practicing active patience.
If you want to learn to improve the skill of active patience, focus on three areas.
So the first area is developing your temperament.
This is done by managing your emotions and understanding your default reactions to things like risk losses and volatility.
By journaling on your decision-making, you can build awareness to help anticipate emotional triggers and respond intelligently, rather than relying on things like impulse.
Second, find your principles.
Clear principles provide a north star for evaluating opportunities.
Create things like a non-negotiable checklist of criteria that you just refuse to deviate from.
This helps filter incoming ideas to further help remove mediocrity.
And third is just commit to your principles.
Once you know temperament and principles, the hard work really comes in.
So the hard work is just staying true to your rules and avoiding the temptation of good enough.
You can try to reduce noise by doing things such as improving your investing environment and saying no firmly and often.
Monish Pabrai has evolved as an investor very similar to Sleep and Zakaria, moving from cheap cigar butts to businesses that are a little higher up in quality.
But I think it's important not to only focus on where investors like Pabrai are today, but also to learn lessons from their experience in managing smaller sums of capital.
So let's imagine we're in 2012.
Monish Pabrai finds himself in quiet reflection in the evening, scanning financial news using his usual mild skepticism.
But a specific car company gives him a jolt.
In Monish's mind.
The financial press is sharing fears of the business, with headlines such as fiat teeters on the brink of bankruptcy.
Monish gets interested as he checks the price of fiat and sees it trading at the very bottom of the bargain bin.
But even though it's cheap, how can a business in just this bad of a financial situation be saved?
His answer comes in the form of Sergio Marchione, the man who had saved the company in the first place.
Monish begins conducting his due diligence on the business, and his skepticism slowly fades as he learns more and more.
Fiat Chrysler has a market cap of 5 billion but has annual sales of 140 billion, meaning the business was trading at less than 4 of its revenues.
Additionally, the company was still turning a profit, and a very good one at that, given its share price.
It had 222 in EPS and was trading at a price of around 4, meaning it had a PE of around two times.
Now, his eyes really began to widen.
But Pabrai does some more digging.
He knows not to fall for every business with low single-digit P multiples, because many of these businesses just don't deserve to be held by an intelligent investor.
Many of these businesses are on life support and aren't worth the hassle of trying to understand any deeper than that.
But Fiat Chrysler has an additional asset that the market is overlooking, and that's Ferrari.
At this time, Ferrari was a subsidiary of Fiat Chrysler.
He decided to deduct 40 of the 2012 purchase price as a value derived from Ferrari, and this is how he arrives at a PE of only one.
From there, the rest is history.
It's not publicly disclosed when he sold but within two years Fiat Chrysler was trading in the teens and low 20s, meaning there was a multi-bagger from that 4 price point which he reportedly started buying.
So my main lesson here is isn't actually that you have to find businesses that have a PE of one.
However, companies where you, as an investor, can just peer into the future, often have valuations that simply do not make any sense.
Whether that's a PE of one five, 10 or 20 or whatever number you want to use, there are businesses out there that are just significantly mispriced.
The key here is just in finding them.
They won't appear on things like traditional screens.
And, like Pabrai's research into fiat, additional adjustments to a business's financials are required in order to really get a clear picture of that business's intrinsic value.
That's where the opportunity exists in understanding the value of a company offers that is being overlooked by the market.
So when examining fiat, it was apparent to Pabrai that the market wasn't properly valuing the golden goose within fiat, specifically in Ferrari.
Once a few simple adjustments were made, the core fiat Chrysler business was even cheaper than the market thought.
So how can investors use this to their advantage?
You can look at a business as the sum of its parts looking at each segment of a business individually, valuing each and then adding it all together to come up with a more accurate picture of value.
This is a method that I've used in the past, but haven't always been very successful with.
Bosch Health was a business that appeared cheap on a sum of the parts calculation.
Still poor management ultimately just completely derailed the entire hypothesis, and investors just headed for the exit in droves once they realized that management was unlikely to help the market recognize its full value.
This experience left a very bad taste in my mouth regarding some of the parts investments.
As I evolved, the model still made sense to me, just in a different form.
So Monish was looking for a business where the future cash flow of the company provided the margin of safety.
Like I mentioned, with the evolution of Ben Graham's margin of safety principle.
This was a lesson that really helped me improve my thought process as an investor.
Instead of looking at a business as a sum of their assets, use the future earnings or cash flow to help you determine what a business is worth.
That would give you a very firm floor on your downside and a nice upside if the business had additional growth levers that it could pull.
In this light, if you look far enough into the future, really any business growing at a decent rate becomes a PE of one.
If a business today is trading at a PE of 30 and growing EPS at 25, then it becomes a PE of one in 15 years.
Now, I don't trust myself to assume any business can grow at 10% for 15 years, let alone 25%.
So, instead of using the number one, I like to see what I think the multiple will be just a few years down the road, based on its current stock price.
When I look at a business like Topicus, I think it will grow its owner's earnings by about 30 a year from now.
That means its future price to owner's earnings drops by about 23% in just a year's time.
And if it continues to grow at that high rate for a few more years, the multiple will continue to drop precipitously.
And that's my opportunity.
Since the market won't allow that number to continue to fall, I make money simply by owning it and letting my conviction and their ability to compound their cash keep me as a shareholder.
And as long as I have conviction that the future cash flow can grow at a given rate, then I have my blow PE stock.
So, instead of looking at a business with a PE as just a single target, I view PE as more of a moving target.
And this is how I can justify owning some of the higher price businesses in my portfolio that I believe can continue to grow at rates the market just doesn't expect them to grow at.
This method works exceptionally well in some of the smaller businesses I own, which can grow their bottom lines at 30, 50 or even more in a year.
When a company can double its income in a year, the trailing PE shown to the market isn't an accurate reflection of what that business is likely going to be worth in a year's time.
So let's say a business will double its profits in a year, but only has two quarters of profits.
So its trailing 12-month PE may not even exist, since the earnings from the last two quarters don't actually cover the losses from the two preceding them.
Therefore, many investors will examine these businesses just very briefly, conclude that it's not profitable and move on.
However, if you examine the business more closely and determine that it can sustain its momentum in sales and high profit margins, then profits are likely to continue growing into the future.
And if future quarters are anything like the previous two, then the business can grow very quickly.
So let me just use a straightforward example here.
So let's take a business, we'll call it XYZ.
It's grown its revenues at 50 for the last three years, but has only inflected positively in net income in the previous two quarters.
In the last quarter, they had 1.25 million in profit.
The business doesn't require any dilutive financing or debt.
The company is valued at about $10 million today.
So let's assume that they can continue selling while keeping costs controlled.
And if we annualize the profits, we arrive at $5 million.
And the business is trading at a forward PE of only two.
Now, this happens more regularly than you think.
You just have to be willing to go and look for the opportunity.
So finally, here we get to Charlie Munger, the person who may have had the most considerable impact on me, not only in investing, but in life.
There are so many lessons I've learned from Charlie, but I've chosen one that I've started really leaning into more and more lately, which is to invest in, and surround myself with, people who offer win-win outcomes.
So I believe this principle is most effective in personal relationships, which I'll discuss further shortly.
But it also obviously applies in investing.
And the business that Charlie invested in that best exemplifies this is Costco.
So it's hard to find a party that just doesn't win from being part of the Costco ecosystem.
The prime parties that come to mind are customers, suppliers, employees, and investors.
Let's start here with customers.
So what do I get from shopping at Costco?
I get things like the lowest prices that I'll find on essential items.
I may have to buy larger quantities, but the pricing is just unmatched by most stores because they just can't match Costco's buying power.
Costco has also developed deep trust with customers due to their exceptional return policy.
I also occasionally enjoy the extra perks such as Costco cookies.
Next up are suppliers.
So suppliers gain added stability and reliability from working with Costco, which is a trusted long-term partner in the market.
If a business wants to grow and scale, then partnering with Costco is just a great opportunity, as it has the ability to put your product in front of many customers and help build your brand.
Since Costco has been partnering with suppliers for such a long time, they're also very, very reliable.
Now, when we look at employees, employees at Costco are very well taken care of.
Since Costco can buy their product for cheaper, it allows it to spend more money elsewhere, such as on its employees.
This enables them to pay above average wages and offer great benefits, extending them to part-time workers as well.
They also do a great job of promoting from within.
As a result, they have lower turnover rates compared to their competitors and have built a very solid reputation among employees.
Lastly, we have investors.
This is a pretty easy one.
Since Costco's inception as a private business in 1985, the stock has returned nearly 3800 to shareholders, which is about a 20 kegger.
And the returns just keep on coming.
So if you look at the last five years, its CAGR has been 25%.
The business is resilient through economic cycles and pays a steady and growing dividend.
They also have growth opportunities as they expand their store network.
So, as you can see, Costco is one of those rare businesses that truly creates win-win outcomes across the board.
That's why Charlie loved it.
Because it's not just profitable, it's fair, durable, and trusted by nearly everyone involved.
But here's the thing.
While I admire this dynamic in business, I've actually found the principle is even more powerful in life.
Businesses may come and go, but the quality of your relationships determines the quality of your life.
And, just like Costco, the best relationships that I've had are the ones that everyone walks away better off.
All my best relationships are with people that I can hopefully try to provide as much value as possible to.
But there's no way I can offer the right amount of value to everyone, which is why I think you can only maintain a very limited number of very high quality relationships.
However, the key is to ensure that the relationships you do have are mutually beneficial.
So what exactly constitutes a win-win relationship?
I think it's reciprocity that multiplies.
Whenever I try to give value, I often find that I receive it back multiple times over.
A hidden benefit of win-win relationships is just the exposure to serendipity.
When you have people in your life who want to provide you with value, they often surround themselves with people looking to do the exact same thing.
And this allows you to tap into their network, further enhancing the power of win-win relationships.
Then, most importantly, I derive most joy from relationships where I'm just excited to be around that person rather than dreading it.
Win-win relationships must be nurtured.
One thing I've noticed as I've gotten older and taken on more and more family responsibilities is that maintaining relationships is a lot more difficult than when I had fewer responsibilities.
Since I have a lot less time, I'd rather eliminate toxic people from my life as my time is precious.
Now, by focusing my time and effort on people that really bring me joy, I build a self-reinforcing cycle of support, generosity and opportunity.
When it came to toxic people.
Charlie Munger once said the great lesson of life is to get them the hell out of your life and do it fast.
And I think that's very key.
I've come to learn that people just tend not to change their mindsets.
If people are stuck in an entitlement or scarcity mindset, it's very doubtful that I, or anybody else for that matter, will change their minds on that.
So toxic people have a way of offering win-lose relationships where you put in value and you receive none in return.
The simple removal of these relationships is just a massive boost to the quality of your life.
Ultimately, a life curated around these win-win relationships is just one that's filled with higher quality interactions, deeper fulfillment and significantly reduced exposure to negativity.
And that, to me, is the essence of the win-win principle.
Invest deeply in people and relationships where value flows both ways and be quick to cut out all the ones that don't.
In investing, that might look like Costco.
In life, it looks like surrounding yourself with people rooted in trust, generosity, and abundance.
In both cases the rewards compound over time, not only in terms of wealth, but also in terms of happiness and meaning.
That's all I have for you today.
Want to keep the conversation going?
Follow me on Twitter at IrrationalMRKTS or connect with me on LinkedIn.
Just search for Kyle Grief.
I'm always open to feedback, so feel free to share how I can make this podcast even better for you.
Thanks for listening and see you next time.
Thank you so much for having me.
