Aswath Damodaran - Making Sense of the Market Pt. 2 - [Invest Like the Best, EP.349]

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0:25 Operate smarter and stay ahead of the curve. See what Ridgeline can unlock for your firm. Schedule a demo at ridgeline.ai. Hello and welcome everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossis.com.

1:00 Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum or O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum or O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast. My guest today is Aswath the Motorin, who is joining us for a second time on Invest Like the Best. Aswath is a professor of finance at NYU Stern School of Business, and is often referred to as the Dean of Valuation for his clarity of thought on the subject.

1:46 This conversation picks up where we left off 18 months ago and covers a wide range of topics, from macro risks to NVIDIA, and the process of crafting a personal investment philosophy. Please enjoy this great discussion with Aswath the Motor. Mm. So Aswalk about a year and a half ago now we had our first conversation, which was, I think at the time our most listened to ever. So let's see if we can top it here today. To do that, we have to do a whirlwind tour of the world of markets and business and investing. And I thought I'd just begin by asking you for your state of the union on the market overall.

2:19 Just started kind of the last part of the year, the last quarter. been kind of a wild year last eighteen months. I'm just curious for your take on the general prevailing narrative as you see it of what's going on in markets today. I think there are two

2:33 Prevailing narratives. And one of them has to be right, the other one's going to be wrong, with profound implications. The first is that the last 18 months. is actually the aberration. Then we're going to revert back to where we were before that. That the Fed is gonna reimpose its power, rates are gonna go down, everything's gonna go back to the way it was. That's one perspective.

2:55 And a lot of people are doing mean reversion to the last ten years. That is the perspective they're taking is hey, you know what? This two shall pass and everything's going to be okay. The other is that maybe the last eighteen months are the norm, not the exception, and what we saw in the decade leading into that. was actually the aberration. And you know what, there's a pretty good argument that the latter is in fact the more reasonable assumption.

3:20 And here are the implications. You look at a four and a half percent rate, you're shocked. Especially if you're twenty five and thirty, you're saying T bond rates at four and a half percent. Nobody's seen anything like this before. Not true, we've seen much worse than this. But I think because you had a decade of low inflation, low interest rates. Complete access to risk capital.

3:41 It kind of altered, it skewed our perspective in psychology of how we frame what we're looking at is huge. And for people who are framing the last eighteen months in terms of what happened the previous ten years, it looks odd. But we frame it in a larger perspective looking back over time. This is

3:59 Perhaps more closer to the norm than what you saw in twenty twenty one and twenty twenty. So I think as we look at where will we end up after all of the shakes out, recession, inflation. I wouldn't be surprised we ended up Where we were in two thousand seven, four percent rates and three percent inflation and a market that reflects that.

4:19 What are the biggest market and business implications of that. New normal or status. Well, if that is the case. I think for those companies that got used to using six percent or seven percent cost of capital, it's time to let go. I know there are companies that still hang on to those hurdle rates, they said.

4:37 in the last decade saying, you know what, rates are low, therefore those costs of capital are not coming back. So the way we assess projects if your companies has to change the mix of debt and equity. When you have one percent risk free rates, your cost of debt is two and a half percent, your cost of equity is six and a half percent, the mix of debt and equity. Use as a company. is affected by that. That too is to be revisited. And in terms of dividends and buybacks, when you think about what you have to be to be able to give cash back to investors, and in fact everything about the way companies get run is altered when you have four percent rates as opposed to one and a half or two percent rates.

5:14 As investors. I'll tell you from a personal perspective, there's a very, very specific change I've noticed. And three years ago they asked me how much cash I had in my online brokerage account. I didn't know and I didn't care. After all, what was I going to do with the cash? Good in Tebels and make point zero three percent.

5:32 Today I'm acutely aware of cash when it's sitting around. That's something that people have become used not to doing. that you have to start because idle cash is losing cash. Because when you have three or four percent inflation, that cash is losing value. And you gotta get it into places. T bill rates might not stay at five and a half percent, but they're definitely not zero.

5:54 So some of the things we got sloppy on as investors in companies over the last decade, I think we need to revisit. The other and this has got to do with the risk capital question, which I think is a separate issue. Sometime in the middle of last year. We notice that risk capital went to the sidelines. Just to put it in perspective.

6:12 For a decade, risk capital was not just accessible, it was excessively accessible. I mean, I know that sounds like a strange word saying, How can you have too much? Risk capital. 'Cause when you have too much risk capital Companies are able to raise money too easily. So as a consequence Businesses that should never become businesses, with founders who are borderline sociopaths, were able to raise billions of dollars.

6:37 And then burn through them because risk capital threw money at them. That's hopefully not going to come back. So I think that There are things that you saw in the last decade that reflect the environment we're in, low rates, lots of risk capital. Then I don't think we're gonna revisit.

6:53 Even after We come out of this. downturn into a recovery. Can you explain why it's necessarily bad? Or that we don't want

7:03 borderline sociopaths with cheap capital trying crazy experiments. Because those experiments have larger consequences. You provide capital to, let's say, a bike app company. The line, the bird bikes, you probably saw them. And I remember looking at them saying This is a horrific business model. I don't see how this works.

7:24 But those buy cap companies raised billions of dollars of capital. They came into cities like San Diego, where I left. In a period of months, they destroyed an infrastructure of bike rental businesses that used to be in the city. They were able to do that because how can those bike rental companies compete against somebody who's giving away the product for free, which is what they were doing, because it's so much capital. Those bike rental companies are gone. They're not coming back.

7:51 And these app companies that replace them have now run out of capital because they're bad businesses. The only problem is we can't go back to where we were. So there is really economic damage created when you allow businesses that really shouldn't take off. To become large. and threaten the status quo. Could you riff a little bit on

8:11 the natural rate of interest, whether or not interest is ever really priced and set by a market mechanism versus by central banks or the Federal Reserve. I'll give you my simple rule. It's inflation plus one to one and a half percent. So expected inflation in the long term, not last year's inflation. Plus one to one. That's your natural interest rate. So then when people ask me where will interest rates go, I turn the question back and where do you think inflation's going? Because without answering the inflation question, interest rate question becomes a search in emptiness. You have really nothing to anchor it to.

8:44 And it's a rule I've followed even during the last decade when people told me the Feds had rates. I said, That can't be right. The Fed doesn't set rates. So I would say the natural interest rate I would expect to see would be, and that's why I said the long term, I see four percent T-bond rates and three percent inflation. Cause even though we might have broken the back of eight, nine, ten percent inflation. I don't think we're going to go back to the one and a half percent inflation we saw in the last decade. Talk more about inflation. We spent a bunch of time at the start of our conversation a year and a half ago talking about it. That was right at the beginning when it was very uncertain, like hard landing, soft landing, all these things that everyone was talking about. What is your updated view of

9:23 What is driving inflation to the past that it could go from here and anything that surprised you about the story and how it played out. Not at all. I think it's taken centre stage and like all stage hoggers, it refuses to leave. This is why when we talked a year and a half ago, I said, you know what? You let this genie out of the bottle, putting it back in the bottle is not gonna be easy.

9:44 And a year and a half later, guess what we're talking about? We're talking about inflation, the economy, and interest rates. And that's always been the case with inflation. It's not a macro problem that you can get a handle on quickly. That's why if you look at how little resolution we've had of uncertainty in this year. It's partly because one of the big uncertainties is inflation and getting resolution on it in terms of has it gone down, will it stay down? Takes a long time. So I wouldn't be surprised if this spills over into twenty twenty four. And we're still struggling with where will inflation end up.

10:17 And that's partly what's driving the Fed crazy is because until they have a handle on inflation. They're kinda stymied. You're someone that values by hand lots of different kinds of businesses. You're a dabbler in valuation and the king of valuation in academic circles. What has it felt like for you? Valuing companies With rates the way that they are.

10:38 relative to the last decade or so. What are the things that you've noticed as themes when you're value in companies, let's say in the last year. Quite a while ago. Well before the low interest rate environment even kicked in, I decided I wanted to make my valuations as insulated as I could. From macro.

10:55 And the reason is very selfish. If you're spending all your time thinking about inflation and interest rates and economic growth, you don't have time to think about the company value, whether it's Coca-Cola or InstaCard or Facebook. So the way I've constructed my evaluation models is to make the macro variables cancel out. Let me give you an example. Now, in the last decade, low rates allowed every company to have low cost of capital. It's the truth. You can't override and say, I'm going to use a high cost of capital. I don't like these low rates. I used a low cost of capital. That's a benefit. If you think about having a low cost capital, it should push up value. But here's the counter.

11:30 Those low interest rates also told me that there was gonna be low inflation and low real growth in the future. So when I projected out growth for these companies for the long term. I also push the growth rate down to reflect those same views. No, so the same low inflation that pushed interest rates down also meant my growth rates were lower, my pricing power was lower. The effects in a sense offset.

11:55 That's why my valuations don't change dramatically. And that's why I'm not surprised the market hasn't imploded. 'Cause if you left everything as is and kept the same cash flows you had two years ago. And you raise the discount rate by two or three or four percent, which is what we have. Stock should be down forty or fifty percent, they're not. And the reason for that is companies are flexible, they're adaptable. As inflation comes through, guess what they do? They pass that inflation on.

12:23 to US customers and the companies that are better suited to doing that. are more protected against inflation. So when I design valuation models, I try to keep my focus on the company and not get distracted too much by macro variables. Not because they won't affect my value, but because they affect everyone's value. My job is to assess the value of the company given where the market is now and given macro conditions now. And I tried to stay in that here and now.

12:50 As much as I can. What macro variable or trend? most has your attention. Not today. When I look at all of the macro variables, my worry is more about

13:02 political risk and crises coming through. The last one here is one of the dark sides of globalization. Is everybody's problem is everybody else's problem. The biggest macro issue to me. It's China.

13:15 'Cause China is in trouble. And the problem is Unlike Russia. If China goes down, it takes the rest of us down. With it.

13:24 We need the second largest economy in the world. And you created interconnections. With every big multinational in the world. troubles you have as a country spill over into every company. So to me that's going to be the country to watch.

13:40 And the biggest macroeconomic risk. And that macroeconomic risk could become a political risk. And I am not looking forward to the kinds of damage that'll create. or investments, for uh companies, for businesses. Around the work.

13:57 Do you describe the nature of the trouble? That they're in as you see it. I think that In a sense, to see why we're all in trouble, we've got to go back twenty years and look at why companies jumped into China. With both feet without even thinking through.

14:12 One of the big selling points for China was we can tell you what policy will be. Not just for next year, not just for the next five years. But for the next four years. I've talked about Would you rather as a business invest in a democracy or in an authoritarian regime? And the answer that many businesses often give is

14:33 Democracy is chaotic. People change their minds, government change, policies change. I'd much rather go with an authoritarian regime which can give me the guarantee that policy will not change. And that barget worked out in their favor for many of those twenty years until uh perhaps three or four years ago.

14:52 It was viewed as an unmixed blessing. In fact, companies in trouble often use the China card. Look, we're in China and all of a sudden their price would pop up five percent or ten percent. But we're now seeing the dark side of being an authoritarian regime, which is The same forces that make things predictable can Create What I call discontinuous rest.

15:12 Overnight. And you saw this first with big Chinese tech companies, Alibaba and Tencent and J D. for a long time were rewarded because Beijing was viewed as being on their side. And suddenly, magically in two thousand nineteen, Beijing said No, we're not on your side. We are adversaries.

15:30 have the value of those companies because effectively If Beijing is your adversary and you're a Chinese company, you really are stymied in almost everything you do. So I think the China problem is the same government that guaranteed predictability is now going to be fighting for its political life. And in the process, they're gonna make decisions and create policies that are going to cut against everything they told you they're gonna do for the last twenty years. And companies are looking at that saying, Well, what will that mean? They're trying as fast as they can.

16:04 To move. their production from China, but even if you moved all of your production to China, which will take a long time. China is still one of the largest markets in the world. How do you walk away? From one point four billion people.

16:17 And that's where twenty percent or thirty percent or fifty percent of your growth is going to come. So this is going to be a dilemma that not just Chinese companies, but multinational, big companies around the world are going to face and as investors in those companies. We're gonna have to face as well. Do you think that it's a situation of mutually assured economic destruction given how intertwined Everything is that they're both manufacturer and consumer.

16:40 Partners to so many companies in the world. No, I think I'm less worried about the US China political tension than I am about companies finally coming to the recognition. That China is a mixed blessing. I think even if you took the US China political relations and put them to the side and say, we can deal with that. I think the gloss is off. I mean, companies now recognize the dangers they've exposed themselves to because some of them took a f made a Faustin bargain.

17:09 to enter China. They set aside everything they told us they believed in, whether it's Apple or Nike, because the market was so big, they went into the market saying, We're okay with that Fousting Bargain because look at how big the market is. And now they're looking at that bargain and saying, Maybe it's not worth it for us. So

17:28 To me, this is I think a much bigger issue than getting the politics fixed. This is something which is going to lead to withdrawal from China of many companies, the question is where they're going to go is going to drive the next big market. To look at whether it's India or whether it's Vietnam or Brazil. I think it's going to be a question of where will all that money go, whether it's investor money or company money. And that's going to be a big factor in where you're going to make money as an investor and where you're going to make money as a business.

17:57 There used to be this chart that would float around a lot that was this rolling ten or twenty year return chart comparing the S P five hundred to like M S CI EFA or something, showing US versus international. And you got this very nice back and forth pattern. There'd be a period of US dominance and international dominance. And it went back and forth a few times going back to the seventies. And then you got this just straight line up for the US just completely dominating the equity markets internationally for a really long period of time.

18:24 How do you think about that relationship going forward? as investors look for interesting things to do that are not the same as everybody else, do you think that international equities which have become completely ignored for a lot of investors are a place of interest now. I think it largely reflects the fact that the US has been

18:43 The country that benefited most from the shift. From a twentieth century economy to a twenty first century economy. You look at the ten largest market cap companies in the world. You've got five of the six fang stocks other than Netflix, the other five are all on there.

18:59 And then you got NVIDIA and you got Tesla. And in a sense the US in spite of all of its faults has created at least an environment where the companies that are most suited for the twenty first century economy are most likely to grow here. They're definitely not going to show up in Europe.

19:17 In fact, you can almost guarantee that the next great company is not going to come out of Europe because it creates an ecosystem. that makes it almost impossible to challenge the status quo. So the same things that worry us about the US, the chaos, the fact that you really can't keep control are what's allowed these companies to explode in value. So as you look at that straight line of the US I wager that almost all of that gain came from these big tech companies.

19:44 But we know. that the fangam stocks alone accounted for one in six dollars of market cap created. across all US companies in the last decade. a kind of like eight to ten trillion dollars of value just in those six companies? That's mind boggling.

20:01 The question to ask then at looking forward is is that big run over? Probably for those six companies. But I'm not sure the next six won't come from the US as well. Now we can debate which the next six will be and maybe Nvidia and Tesla two of the six. But we really have no idea. But I think in a sense

20:18 the kinds of companies that benefit from the uncertainty from the shifting status quo that you've seen in the twenty first century are exactly the kinds of companies that are most likely to grow and develop in the US. Not in the rest of the world. So I wouldn't be surprised. if the US maintains its lead in that return table.

20:42 But Only if you invest across the board. So if you're a US investor who's invested in Coca-Cola and Washington Post for the last twenty years, guess what? you haven't seen that straight line benefit that you've seen by investing in US stocks collectively. So I think you gotta be careful about not being diversified, about not spreading your bets because This isn't just a betting on geography, it's betting on a subset of that geography. In this case, it's tech in the US that's carrying us.

21:10 Have you seen anything? Like the recent results from NVIDIA. In business that you've covered. On a percentage basis, yes. On an absolute basis, no, because you added seven hundred billion dollars of market cap in one year, that's

21:25 Astounding. No, you to do it that fast. Tesla maybe it in early twenty twenty one and added a half a trillion. I think that it reflects the fact that it caught the mood of the moment almost perfectly. Which is AI. Been for all the talk of AI.

21:42 and chat GPT. NVIDIA is one of the few companies that actually has a tangible business. In AI. twenty five billion dollar market now for AI chips. The estimate could be as large as three fifty billion.

21:55 NVIDIA has an eighty percent market share. And if it preserves a large market share of that three fifty billion dollar market. That is a huge market on which it makes almost fifty percent operating margins. So there is a story for why it took off. Whether it justifies the amount of market cap added is different because as you probably know, I did try to value the AI piece of NVIDIA. I double the value of NVIDIA as a company with AI in there.

22:23 But I was still forty percent below the market price. So I think a market's gone a little over the top in terms of reacting to the AI aspect. But I think that Captures what happens if your

22:36 the right place at the right time as a company and invariance in the right place at the right time. It feels like AI is this year's inflation for you and I to discuss. It's pretty amazing that Almost all of the AI storyline has happened since our last conversation, like the models that have gotten everybody so excited, ChatGPT and Dolly at Midjourney and all these things. I'm just gonna step back and get your broad take on the technology, the implications. The pros, the cons, everything.

23:02 We ask people when did AI start, they probably trace it to the first news story they read about Chat GPT, which was just about a year ago, year and a half ago. The reality is AI is a culmination of two trends over the last twenty years coming together. The first is big data. data collected, not just the fact that you can collect and put data online, but data is collected.

23:24 on our personal lives by apps all coming together. So that's been building up. The other is the building up of computing power. Where As chips get more powerful, computers are getting more powerful.

23:36 Big data plus Powerful computing power. is effectively AI. So AI has been building up for years. What chat GPT did was it brought that to the public consciousness because people could see the effect on their daily lives.

23:51 I remember my wife coming back, she's a fifth grade teacher and saying, You know what? Now I use chat GPT to send emails to my parents because it writes a very good email. So chat GPD, which is really low tech AI, if you think about it. It's been the door that opened that people say, Oh my God, there's a whole Would there

24:11 of how things could change in the future. So I think AI has been building up to where it is. It's not something that happened last year, last year and a half. It's something that's been building up over the last 20 years. That said, though, the question is what exactly will AI deliver over the next decade. We've seen lots of these buzzwords come and go. For instance, the metaverse. Remember how hard it was for a while? Nobody talks about the metaverse anymore.

24:39 And I'll confess I was never excited about the metaverse because unless you're a twenty five year old who loves virtual reality glasses. Nobody wants to spend the rest of their lives in a virtual universe. This is not healthy. So the metaverse never struck me as something. The cloud business, great business, but you can see it's a niche business.

24:59 It's not a business that most of us can relate to as individuals or even as companies because it's a service provider companies. I do think AI offers The promise. Or the thread. of changing the way we live and work.

25:15 In fact, I'm lucky enough or old enough to remember four big ships in my lifetime. They are being the fourth one. The first was P Cs, I came into a world where

25:27 I actually did my first valuation on a ledger sheet. With a pencil and a calculator. So I did my first valuation before PCs and Excel. The PC business changed the way we work, changed the way we compute things. So the PC's really made a difference, not just

25:44 to businesses, but to individuals. The second big shift was the internet. The internet broadly brought together online retail and if we The third was smartphones and basically what that created in terms of changes in the way we Interact, the way we do business.

26:01 An AI offers that promise A thread. Of changing the way we live and work, that it could have an effect. You notice it's screenwriters. One of the big

26:12 issues that they were fighting over was Will you let AI write scripts for you, or are we guaranteed that we're still going to get paid to write scripts? So you could see this is permeated. Every aspect. I wouldn't be surprised the order workers, one of the things and their demands is an AI component as well. So AI you can see is come into people's consciousness where they're aware.

26:35 Whether true or not, that it could change the way. The work and let The question though is what will it do to us as an economy, as markets, as a society? There, I'm a lot more muted than some of the biggest AI advocates. Their conviction is this is going to be amazing. Life is going to be so much better with AI. And the reason I'm skeptical is I've heard this before.

26:59 They told us that PCs would reduce the mechanical stuff we did. They would take this grunt work of entering numbers in a calculator and therefore free us to be creative and thoughtful. Not true. It actually made us more mechanical. We were told the internet would give us this incredible reach in terms of being able to get information.

27:22 Instead we drowned in data. They told us social media. We'd be able to keep our friendships alive with people who are further away. It actually's destroyed friendship as we know it, because everybody's got a virtual friend and very few people seem to have real friends. My point I'm making is every one of these changes is a dark side.

27:43 With AI, we see some of the dark side up front, which we didn't with the others. But I think it will have a dark side for every winner, there will be losers. For every disruptor there will be disrupted. So as I listen to all of these sales pitches for how great Chat GPT is and how much AI will do for us. I keep thinking ten years from when we look back, what will be the net effect, there will be a few big winners.

28:07 There'd be a lot of wannabes. And there'll be quite a few big losers. You just have to hope you're not on that loser's side because Every big movement creates losers. I'm a little more cynical about the AI pitch than most people are. I understand that it's going to be a big business. I understand that companies like Nvidia

28:26 And perhaps Microsoft that can make money on this business. Collectively as a society or as an economy, are we going to be better off because of AI? I'm not so sure. Have you tried to value any of the big AI companies like OpenAI or something like this in the same way that you did NVIDIA? Understanding there's less information. It's not even that there's less information. You need a business model.

28:48 to value a company. Unless you tell me how you plan to make money. You're not a business. You're just a movement. So if your business says that you're going to create the subscription model, then we're ready to talk. If you're saying, look, I'll charge per transaction, I'm ready to talk. But A lot of so called AI

29:07 Businesses are not businesses yet. They're AI movements, AI ideas. And until they start to take some form, you're buying an option. There's no reason why you shouldn't buy an option. Maybe open AI is a great option to be part of a business, but you're not buying a business. Do you think that investment firms will change a lot and trends of investment firms will change a lot as a result of the interest rates and AI and other big trends like One thing that pops to mind is private equity firms that have relied on very, very low cost debt for a long time to earn fantastic returns.

29:40 Obviously that picture has changed. Maybe that affects private equity at large. that or other trends like in the investing world. Institutional investing world specifically, anything that comes to mind for you that you're thinking about? But the question that every active investing group P V C

29:55 Mutual funds is asking is Will this Check. the slide because let's face they've been on a fifty year ride. Yeah.

30:04 they've been disrupted, they've lost market share. to passive investing, to automatic investing, to mechanical investing. And I think each new movement they looked and said, maybe this is what would stop the slide, maybe this will bring us back. And I actually think it's gonna make the slide worse. 'Cause let's face it, eighty to ninety percent of all active investing, including PE, including V C, including

30:28 Mutual fund investing. is mechanical. And it's mechanical, a machine's gonna do it much better than you can. I mean, that's part of the reason that over the last decade Active investing lost so much money to pass investing, you could create an ETF to replicate what mutual fund managers did.

30:44 But just watching that. And he's got to be able to do that almost effortlessly. Everything you do is going to be replicated in milliseconds. So you made money as a high frequency trader by trading quickly, a little more quickly than everybody else.

30:58 You were able to do it for two years. the middle of the last decade, you might be able to do it for two months now. Active investing is only going to get more difficult. And when you say P E and B C benefit from low interest rates, they did, but collectively. It wasn't a good decade for either.

31:14 The average V C investor. The average PE investor. made about as much money as the average S P five hundred investor. Course, there were winners. There's a selection bias with PE and B C, we look at the winners. One of the talks I gave is Who put the smart?

31:30 It's smart money. Because I've look for forty years for the smart money, money that presumably gets in before everybody else gets out. For everybody else. There is no group of investors that I can point to and say that money

31:42 The smart money. It's just greedy money that ultimately runs into a wall sooner or later. So I think there's going to be more accountability sooner with higher interest rates. But collectively as a group? I don't say

31:56 groups benefiting or paying a price because the average is still the average. What parts of your own valuation process remain outside the reach of automation. I'm not sure and I keep asking myself that question because I'm open to the possibility. When I teach, one of the things I tell people is look, I want to make myself

32:16 unnecessary dispensable. That's the essence of good teaching is you want to make yourself Not necessary. We've taught people. a way to think where they don't need you to think through a problem. Every year before I start teaching, I say, Is this the year I need to stop teaching? Can I

32:32 Basically say, Hey, I'm not necessary anymore. And I ask the same question as an active I'm not married to active investment. If next year I discover that What I'm doing is really doing nothing for me. I don't make a living on active investing. I don't have to put on a front

32:51 It works even when it doesn't. So if it doesn't work, why would I want to waste what's left of my life trying to value stocks and invest on that basis? But it's really not giving me any payoff. So I'm open to the possibility that a lot of what I do can be mechanized. I've passed on all of my blog posts to a friend of mine who is an AI Specialist.

33:13 And he's trying to create an AI engine that can replicate what I do in my blog post. And he said, Would you have a problem with it? I said, Not at all. If you can do it, all the more power to you. I'd love to see a blog post valuing ARM or Birkenstock, which is what I'm working on right now. With your AI engine. It's not quite there yet.

33:33 Thank God for that. Could it be there a year or two from now? Absolutely. And I'm open to that possibility. Do you think that there is a natural end state equilibrium for active management and its role. Obviously we need some of it.

33:46 Someone has to price securities. What do you think? That end state. might be or when it might be. It's actually a good question because

33:54 One of the most famous papers written in the nineteen eighties was a paper titled This Was an Efficient Markets were at their peak. The paper written by Sandy Grossman and Joseph Steglitz won the Nobel Prize called On the Impossibility of Efficient Markets. And they made a very simple case. If markets are efficient, you create the seeds of inefficiency because nobody's looking for information. Nobody's looking for mistakes. Markets don't become efficient.

34:20 automatically they become efficient because people look for mistakes They catch them, try to make money on them and in the process they drive mistakes out. So you're right, there is going to be some floor on active investing where It ebbs and flows. My guess is it's going to drop too low. There are going to be too many mistakes. Active investors are going to come in. But here's what I can say, the steady state number.

34:43 of active investors is gonna be far lower than the number we see out there. There are far too many active investors and we're gonna see the numbers drop off. So all those buildings that Fidelity and State Street and T role price fill up. are going to be only one quarter as full.

35:01 In steady state. Because so much of what's done there. It's just creating noise. It's not adding value. You said earlier I can't remember the number used, let's say ten percent of investors that

35:12 or successful in terms of beating simple benchmarks or something like that over the longer term. Have you noticed anything in common between those investors? I've been type. class I teach called investment philosophy because I started that question.

35:26 When I started looking at it, I assumed they're all the students of Ben Graham. The old legend is And I discovered that when you look at the most successful investors over time, consistently successful investors over time. Get a mixed bag. You've got value investors obviously who weren't buffet.

35:45 from that group. You've got growth investors like Peter Lynch. You've got Traders like George Soros. George Soros I've never seen George Soros talk about the value of a company, it's a macro trade. So as I looked across these investors, what I noticed is there's no one pathway to greatness to God.

36:02 There are multiple ways in which people seem to win. So then I start looking at what do they have In common. Two things. One is They have a core philosophy. That remains unchanged over there.

36:16 Investing lifetime. Now I've had disagreements with Warren Buffett on things he says, but here's what you gotta give him credit for. He has a core philosophy, you know exactly what it is, and it guides every strategy. He adopts. So there's a core philosophy built around beliefs about markets and data that make sense. The second is They have personalities

36:38 That match up to that philosophy. We talk about everybody wants to be a long term value investor, especially after you read three books on Warren Buffett. Of all those people who try, very few people succeed. So you said what goes wrong? Because to be a long term value investor, first you've got to be incredibly patient, which often is not under your control. Warren Buffett has insurance capital is investing. You and I might be investing our own money or clients' money. So we've got to be able to be patient.

37:06 And second, you have to be able to withstand peer pressure because you're often moving against the crowd. Those are psychological factors. If you're naturally impatient. And you're swayed by the crowd. I don't care how many books about Warren Buffett do you read?

37:20 You're not gonna be a successful value investor. When I teach that class I tell people, look, there is no right investment philosophy, but there's one that's right for you. And to find that philosophy The person you've got to understand. Is you.

37:34 Not Warren Buffett, not Peter Lynch. Spend less time. Reading about other successful investors. Spend more time looking inward at the things that make you comfortable and uncomfortable. 'Cause that is at the heart of building a successful investment philosophy that you can stick with in good times. It's easy.

37:53 But also in bad times. Which is not that easy. What were the important Episodes of your own path to finding the investment philosophy that's right for you.

38:03 Couldn't agree more with the alignment of personality and style and commitment. But it's always helpful to hear an actual story about how that came to be because it sounds simple. When you say it, I think it can be quite hard to actually pull off in practice. I think with each big movement I talked about with PCs, with the internet, with social media, what I realized

38:23 as I went further and further in is the tools I came in with. And the beliefs I had coming in. Pushake. So When I came into the dot com, boom, I came with the old time value invest route.

38:35 You need earnings, you need cash flows, you need them now, you need them on the balance sheet. And the more you went through that dot com boom, I started looking at that and saying, maybe that's not right. We have to start to think about cash flows for growth companies, but there's very little here. So with each big shift where I've been wrong for an extended period. There's a point in time you have to make the judgment. It's not the market that's wrong. It's something you're missing that you have to start to incorporate into your philosophy.

39:05 Doesn't mean you abandon the way you think about markets. I still believe value matters and have to invest based on value. But the way I estimate value, I've got to be pragmatic enough to Expanded. I'll give you a very simple example. The first time I valued Uber. I valued it by looking at the car service business as it existed then.

39:26 car service business when Uber came into the market was composed of taxi cabs and limousine companies And I went around the world, added up all of those, came up with a total market of about a hundred billion. And he said that's the total market. I ended up giving a value to Uber based on the total market. And uh Bill Gurley very rightly pointed out that I was missing something very critical that these disruptors, in addition to taking share away.

39:51 from existing players could actually change the size of the total market. He said, You know what, there are people who are not taking car service now. who might start taking car service Even Uber becomes ubiquitous. And he was absolutely right.

40:07 And in subsequent valuations of Uber, I had to factor in the reality that this is a company that changed the size of the car service business. It was too late for me to fix my two thousand and thirteen mistake, but and I valued Airbnb. I brought that learning into the process. When I said how big can the market for hospitality be?

40:27 And I used to market three times the size of the hotel business. So again, sometimes accepting the fact that you're missing something significant. in the way you're approaching some aspect. Of your investing can be a learning. People talk about this all the time. One of the reasons I like writing my blog is. I'm accountable because I can never say I never said that because it's right there.

40:53 Then two thousand and fourteen, this is what you said. And it's also become a place where I can confess my mistakes, not because Confession cleanses my soul, but But because it's in the process of saying I screwed up. that you can start thinking about what can I do differently going forward.

41:11 So it's been useful for me to be able to verbalize when I miss something, say, this is what I missed. This is how I'm going to try to fix it. Because it's on the record that I've made a mistake and that I'm trying to change the way I do things. I love the exercise of valuing non traditional things. How do you go about valuing something like the Washington Commanders or an NFL franchise? The value of a sports franchise now is almost entirely as an entertainment business. Why? Because fifty years ago or or seventy years ago if you bought a football team or a baseball team.

41:44 Most of your revenues came from people coming into the stadium. and what they spent in the stadium. But T V changed that with T V contracts. Increasingly high percentages of revenues at these teams come from the media contracts. Like that's one reason why the Oakland Ace. have to leave the Coliseum. It looks terrible on TV. It's a terrible reason for leaving, but

42:09 when your entire revenue stream is based on how you look on T V, you can see what Teams are actually going to build smaller stadiums that look better on TV. Fenway is a great stadium on TV. Accidental because they didn't build it for TV. So if you ask me to value a sports franchise, I would project out the gate receipts, I'd project out the merchandising.

42:31 And I project out The media revenues. No, you could value it as a business. But two things. One is Teens can sometimes

42:38 alter the magnitude of those revenues by actions they take. Let's take the Golden State Warriors. Fifteen years ago, the Golden State Warriors were a mid level NBA team in terms of visibility and value. Then there are two strokes of luck. One was in signing Stephen Curry to come and play for them. And the second was their ownership shifted to a group of tech people who decided that If this was a game about streaming and getting a higher profile, the Golden State Warriors are now the second or third most valuable NBA franchise. 'Cause their revenues in terms of media and streaming reflect

43:14 the fact that they're now a national team. Taylor Swift alone has probably increased the value of every NFL team by Fifteen or twenty percent. 'Cause she's bringing in women viewers to T V who are gonna increase The value of streaming

43:30 So if you ask me to value a sports franchise, I can value it, but I can also tell you almost before I do it. that what people will be willing to pay is a price for that franchise. is going to bear no resemblance to that value. It could be two, three times why? 'Cause if you look at the owners of many of these sports franchises now.

43:50 This is not the art Rooney Pittsburgh Steelers world you live in. The Rooney's among the Steelers. For them it is a business. They need to make cash flows. In fact it is probably ninety five percent of their wealth. Same thing is true for the Mars.

44:05 Much of the wealth is in the giants. Or the Steinbreaders. The only problem is the rest of the franchises in the league are held by Billionaires. private equity investors, V C investors, Steve Bomber.

44:19 Why do they want to franchise? Because it's a great toy to have. I remember valuing the clippers when Bomber bought them for two billion. And I came up with a value, even my best case numbers of about one point two billion, allowing for higher TV ratings and revenues. And then I said, You know what, I'm not going to keep trying to push my value up because clearly Steve is not buying the steam because it's a business. He's buying it because he wants an expensive toy. What better toy can you have, especially if you're Steve Cohn, in part of all of his successes as an investor.

44:53 We ask him which investment he tracks more closely. It won't even be close. This guy's been a Mets fan since he was a kid. He now owns the team with all the pain and the gain that comes from it. So increasingly sports franchises are being bought as toys. What does that mean?

45:11 The pricing is going to bear no resemblance to value. And if you try to explain the pricing based on fundamentals, it's all gonna come apart. As long as the number of billionaires exceeds the number of sports franchises, I'm afraid this game is done. We're playing a pricing game. Which means what these franchises do will also make no sense from a financial perspective.

45:33 I'm going to sign Shoe Kotani. For six hundred and fifty million, even if he never pitches again because Think of the Japanese viewers I can get on my streaming with them on my team. Think of how much more lucrative my toy looks. When I have the best baseball player in the game. So I think that it's not always good news as fans.

45:56 As people who follow sports, you're going to see strange things happen. In this sporting world now that it's billionaires owning toys? A wonderful adjacent topic is the world of entertainment. Real large, you mentioned streaming and That being a key component of those businesses. I would love you to talk for a while about

46:13 how you see the world of entertainment as a business, as a cultural phenomenon, as a business model, and how that's shifting. What do you think about media and entertainment today? Let's take a component of entertainment where in fact the damage has already been done, the disruption has happened, which is the music business. The music business, if you're old enough, you remember was structured very differently. Yeah, studios.

46:36 The studio sent out talent scouts assigned stars and Those stars were effectively signed to long term contracts by the labels. who then put out albums where You were required as a consumer to buy an album with sixteen songs, even if you wanted one. It was a business that was built around bundling and studios controlling the entry and exit parts.

47:00 That's how the m market business look like. in the early nineteen nineties. Then along came Napster. Napster, of course. was a barely legal or potentially illegal operation, but With stream music.

47:13 For free. And of course the music studios shut it down. They managed to get the legal apparatus behind them. And I'm sure there was heaves of sighs relief across music studios in the late nineties when Napstore was shut down. But what Napster did was it revealed the weaknesses in the business. Why make somebody buy sixteen songs when they needed only one?

47:34 An apple iTunes stepped into the bridge. And the disruption continued, especially with the coming of Spotify and Pandora. In two thousand and fifteen, the revenues of the music business had halved relative to nineteen ninety nine, in nominal terms, the business had become half what it was. There's been a bit of a comeback, but not in real terms, in nominal terms. And the business now looks very different. The biggest play are the streaming companies, which includes Spotify, but also includes some of the big tech companies, Apple Music, Pa Amazon Music.

48:07 If you look at the landscape, it's entirely different. The way music gets produced, the way it gets sold, who gets the rewards is entirely changed. Movies and broadcasting. Put off that disruption. Netflix, of course, started the process With original.

48:24 content and so until 2012, until Netflix created its original content, they thought they still control the process. A process that was created over a century. built around movie theaters Now, if you remember you produced a movie, you got Gate received the movie theaters. A few months later, you released it to Cable. So there was a sequence that Studios If not perfect it had worked at that work for them.

48:48 The Netflix. Rock the book. They rock the board because they change the way content gets produced. Because Until Netflix came along, the way you created new show, if you remember the old days in the networks, new show came along, they'd allowed the show to create three episodes. The episodes work, they'd have a season, the season worked, you signed for a second. Everything was done in pieces because you don't want to create hundreds of shows and have three work. It's too expensive.

49:15 But Netflix said, no, we're going to produce a hundred shows, throw it against a wall and hope something sticks. Why? Because people judge us on the number of subscribers we have. They're not judging us based on revenues and earnings and cash flows. And when it first happened, I remember talking to somebody at a movie company, they said, This is not going to work. This is stupid. Look at what Netflix is doing. They're going to go bankrupt. Seven years later Disney joins The Netflix bandwagon.

49:39 They start spending thirty billion dollars on content as well. And of course COVID along the way. appended the process as well because if you remember during Covid Some studio started releasing movies directly to streaming and bypassing movie theaters.

49:57 the entire structure on which the movie and the broadcasting business was built, which is theaters and networks and Cable are coming apart, we're replacing it with streaming. The only problem is people are not sure how to run a streaming business. Netflix with its make a hundred shows, throw it against the wall, hope something sticks is trying. Disney with It's huge big budget shows built off existing franchises. The Mandalorian, Star Wars, or whether it's uh Avengers is trying.

50:27 HBO kind of is this internal conflict of what it is. The old HPO model was just made big by the Game of Thrones model. But now you got it connected to Warner and you don't know where it's going, but Everybody here is trying. And nobody has a sense of what's going to work. It's not a good place to be.

50:46 You're an entertainment company. And it's at this stage that the writers and the actors both walk out, you're effectively taking a business that's already on the precipice. And you're risking pushing it over the precipice. Here's one thing we can guarantee. We consume entertainment. We need entertainment as consumers.

51:04 So that part is not changing. But ten years from now if you ask me what will that structure that provides content look like? I really have no idea and I don't think people at the entertainment companies have any idea. Will there be movie theaters left after this? There isn't a single healthy movie theatre company left in the world. Half of them are bankrupt, the other half are run by CEOs.

51:26 who seem to think that their job is to run a mean stock rather than a company. I'm not sure where this game is ending. But I think for the moment I'm looking for entertainment companies that are adaptable because we don't know how this model will shake up. You want either a status quo company that's able to adapt to the streaming world.

51:46 or a streaming company that learns enough. From existing movie makers that they can be a little more disciplined how they produce content. But we're in motion. I don't know how this will play out. But we're gonna be watching it play out. I'm fascinated by this. Do you think any of them

52:01 A really amazing businesses because It's interesting that there's unlimited demand for the products. And yet Here we are talking about how

52:10 Maybe none of them are Ensured a great Right, business future with lots of free cash flow. Right now none of Netflix might have the highest market cap.

52:20 The analogy I give is Netflix is like a hamster on a wheel. Because it's created a model where it's got to create more content to keep its consumers and still more content and It's trying by moving its content outside of the US. Ninety percent of the shows now in Netflix or Spanish or French or Indian. But I think from the perspective of actually being a good business model, Netflix doesn't have it nailed down.

52:44 Disney clearly it doesn't. I mean its struggles reflect that. And every other company in the status quo space is actually in worse shape than Disney. I cannot think of a single company where I can point to that company say. Those guys have a model that They've actually figured out.

52:59 So I think everybody is in motion right now and none of them is a solid business model right now. What are the best business models you've ever seen? Take a movement model like Patagonia, I've said. Look, I don't believe in ESG. But Patagonia in a sense plays within its limits. It recognizes that it has a particular agenda to push, but it also keeps things scaled down.

53:21 I have respect for companies that essentially create businesses that reflect the vision. And stay true to it. When I'm valuing Birkenstock and one of the things I find impressive about Birkenstock is how well they've nurtured their brand name. while growing and being profitable at the same time.

53:40 I mean they've actually turned away partnership models because it think it puts the brand name at risk. I mean along the way, of course, they benefited from being lucky, but everybody does. I'm sure nobody planned for Barbie to be wearing pink book and stock. But create a buzz that pushed up their revenues thirty percent over the summer.

54:00 But I think if you look at the company and you say this is a business model that's internally consistent. where the management and the company is acting consistently With the story they're telling us. It's what's always impressed me about Amazon.

54:15 When Jeff Bezos ran it. Is this a company that was built around a story. I called it the field of dream story, which is if we build it, they will come. And in every step in the process. They stayed consistent with that story. They acted consistently. So what I'm looking for is

54:32 Companies that have a narrative about themselves where their actions are consistent with the narrative. That's actually rarer than you think. A lot of companies tell stories, but then they act very differently from their own stories. So if you're looking for uh good companies, that's what you're looking for, companies that have crafted a narrative that they stay true to. And sometimes that means turning away growth and turning away profits because it doesn't fit into The narrative they've structured for themselves.

54:59 What did you think valuing Instacart? And what do they teach you about online delivered groceries and just that entire market, which has been extremely controversial amongst investors of private and public investors as to whether or not this business model is a long term viable one or not.

55:16 Sometimes asking common sense question about the business can help us plumb through the depths and get away from the tunnel vision. Ask yourself, do you want to shop for your groceries online? all the time. And the answer you will get from most people are not homebound. or who have issues with their health is Grocery stores are usually close by and it's one of the few sh areas of shopping where you'd prefer to do it yourself.

55:44 It's not that you're impulse buying, but you want to make sure the eggplant you put in your cart Not all eggplant is created equal. I mean, that's the essence of shopping. I think that Even at its height.

55:56 Of course, with covet we all were forced. to shop online. But even at that height, you could look forward and say, this is not steady state. This is not what the world is going to look like. This is a niche business. And what I saw when I valued InstaCard is how easily people can let loose or lead their senses

56:15 In the midst Uh something happening in the case of COVID. The reason you saw thirty nine billion dollar pricing is for whatever reason. Sequoia and

56:26 Pedarity and T Row Price, I think they were the three big investors in the$39 billion pricing, managed to convince us that half of all Americans. But from this day on the grocery shopping online. And what we're discovering is in hindsight that was clearly Over God.

56:43 But I think we knew it was overwrought then if we'd step back and had some perspective. The other thing I did note with InstaCard and this goes back to the point I made about VCs and PE investors being a lot more average than we think they are, is I did track Every V C round. in InstaCart going back to two thousand and twelve, it's a company that has had a seed round and rounds that go from A through I. So lots of V C rounds, two point nine billion dollars in venture capital.

57:11 And I looked at the returns you'd have made as a VC investor if you invest in two thousand and twelve, two thousand thirteen, two thousand fourteen, two thousand fifteen, all the way through twenty twenty one. And what I saw was every V C investor since two thousand and fifteen, that's I think series C. has essentially done worse than the S P five hundred. put that table out to show that we see investors are bad. I put that out to kind of counter the notion that BC investors is somehow smarter than the rest of us, better gauges of businesses.

57:42 Much of this is pricing and you get caught up in the mood of the moment, you can push up the pricing these companies well above what they should be. And I think at eight or nine billion dollars, Instacard is valued as a niche business. Where about ten to fifteen percent of Americans will stay with online grocery shopping for one reason or another? Of course it could be an option on the next pandemic if you want to make a bet on it. But I think that as a niche business, I'm okay with eight to nine billion.

58:10 But not with twenty or thirty or forty pen. What has been in the last year or since we last talked. The most interesting company or thing that you valued. I did value the Dani group.

58:23 The Downey Group is an Indian infrastructure company. And of course was targeted. in the short selling being hindered but targeted it. of fraud and self dealing and manipulation So I did value the Adani group.

58:37 It's an infrastructure company that trades at about a eight fifty to sixty times epidemic. Doesn't Get priced like an instructor. And as I valued it, you could see how We talked about being in the right place at the right time.

58:50 The reason Adani's stock price were up was it had two things going for it. One is it's an Indian company and India is the next China in many investors' minds. And second, it's an Indian infrastructure company, which is the biggest missing ingredient in the Indian story. So they're the infrastructure companies can create the airports, the ports, the physical infrastructure that'll make India into the next growth destination.

59:14 And it's got a third connection, which made it a fascinating company to value. It's a company with connections, political connections, government connections. Something we don't talk about explicitly in valuation, but could be a source of Value. So one of the fascinating things about Valingadani was the interplay of politics, markets, and economics in a company valuation. You can't avoid it.

59:37 You got to bring in all of those factors in and as a consequence It made valuation more uncertain because your valuation is conditional who will win the next election. And that is not a great place to be as an investor, but it is the reality that you face. So I actually found it to be a fascinating company to value because it's got Good things going for it, bad things going for it. And on top of this you have this issue of

1:00:01 has it committed fraud and what can be the consequences of that. on investing. curious what kinds of companies, maybe even one specific company that you feel falls in the too hard pile for your method of valuation. So if you had to think of the landscape of decently well known companies in the world, Is there one or two that pops out as like ah I wouldn't even bother?

1:00:21 trying to apply my method to it and I'm curious the reasons why, if so. I mean I'll take a come like Madonna. I will steer away from valuing a moderna because I mean what it has going for it is a technology that it has proprietary rights on M the M R and A technology.

1:00:38 But knowing what that technology is going to be useful for and what kinds of things it can come out of it that can create revenues are beyond what I know about medicine and And I could sit there and price Moderna like everybody else, but if you want to do an intrinsic valuation of Moderna, it's gonna be really difficult to do. Perhaps impossible with what I know about. medicine and health care.

1:01:02 So it's a kind of company where I'm gonna say, Look. It might be a great company to invest in, but from my perspective I can't put a value on the company. No. So that's one group of companies, companies that are operating in the space, but I really don't understand the space well enough to be able to flesh out. The biggest item. I'm willing to value more traditional pharmaceutical company because there it's about blockbuster drugs and revenues and earnings and cash flows.

1:01:27 The other group of companies I put in the hoop. Too hard to value pile other companies where you have What I call discrete risk. When you come to me with a Russian now and say, Can you put a value in a Russian company? I'm not even trying. In fact, I've reached the point where I probably will not invest in a Chinese company anymore because

1:01:45 What you value when you value equity in a company is a share of the ownership of the company. But of ownership itself becomes a fuzzy concept. There's no legal protection for ownership. Then what exactly are you getting? You can get great earnings and cash flows. But you can't even tell me what your share of it is.

1:02:02 Which in Russia is effectively what's happened. You might have a company which has earnings and cash flows, but your ownership stake in the company was effectively eliminated if you're non Russian in twenty twenty one or twenty twenty two. And I would say that the more uncertain you feel about protection of legal protection of your ownership rights.

1:02:24 the less willing you should be to value a company and invest based in that value. So Chinese companies are getting rapidly moved into I don't want to value the company part not because I can't get a value for the company, but getting from that value to what my share Of that value is It's become a much trickier exercise.

1:02:43 Another huge storyline since we last spoke is banks, which might pull the other end of the interestingness spectrum or something. But S C B and related bank failures and crises was a huge storyline in the past year. What was it like for you watching that happen? How did it make you think differently about our financial infrastructure, banks as businesses, and so on? We talk about the effects of social media and the internet.

1:03:08 What I thought about as I watched S V B meltdown and the subsequent meltdowns in First Republic and Signature Bank. Is how those same issues that we talk about as social issues are starting to permeate how we think about economic issues. Hey, think about it. S V B.

1:03:25 Did things right. If you think about the lessons that came out of T. They didn't invest in risky stuff, they invested in T Ward. That should be safe, right? Did a duration mismatch made an L. But at the same time. But not the deposits are sticky. People don't pull money up.

1:03:41 But those assumptions fell apart in the case of SVB simply because we discovered that deposits are not that sticky, especially If you're Depositors all are homogeneous. They come from the same room and they talk to each other all the time. Almost every player in the bank was somebody in that

1:04:00 VC startup space. And guess what? They're the most interconnected group in history because everybody's on the phone with everybody else. So the space of two days the Bank went from being healthy. To effectively die. So after that happened, I actually wrote a piece on the stickiness of deposits. And I looked across banks and I said,

1:04:20 What are some of the things that are going to make me worried about a bank? Do you have younger depositors or older depositors? I want older depositors. Do you have depositors that are concentrated in one business on one geography or you have co deposit is spread out across the country. I want deposites spread out across the country. And

1:04:39 Are you a high growth bank or a low growth bank? I want a low growth bank. If you increase your deposits fifty percent, these are new people you brought in, they're l more likely to turn and run. If there's a problem. So it made me rethink about the stickiness of deposits and maybe our bank Rules have to be written in terms of

1:04:58 deposit stickiness. How much need to maintain as a regulatory capital ratio should be much higher if you have younger depositors all happen to be tech people. Maybe we need to keep track of what percentage of your depositors are on Twitter. The higher the percent The more regulatory capital sounds

1:05:15 Absurd, but in a sense we discover the things that drive deposit stickiness. Things that are not the old factors that we used to look at twenty or thirty or fifty years ago. I think That the rule writers have got

1:05:30 At least a period where they have a chance to do this before the next big run happens, because there will be one. It seems like the attitude towards ESG investing changed a lot in the last eighteen months. Do you think that in some ways some of the focus there was like a zero interest rate phenomenon to some degree, like an indulgence of sorts that

1:05:49 Has gone away in the last eighteen months. I think virtue is always good. Mountain to be on top of.

1:05:56 for ESE people as well, but look how much good we're doing for the world. So I will give them that starting point. The reality is when use virtue as your primary selling point, you get no debate because who wants to push back against goodness? So for the decade, ESG advocates got no pushback. And that was I think a problem because

1:06:18 They all were reached. They overreach and what they claim basically sold it as All cake, no calories. And I think in the process they missed a chance to actually develop a movement that was healthier. Because there is a market out there.

1:06:32 for people who want to invest in goodness, using whatever definition of goodness you have. And these investors are probably willing to give up returns. For being good. And if ESG had been crafted that way right from the beginning, we could be in much better shape.

1:06:48 So I think that it was long overdue and the reason the backlash has been so Harsh is because When it was sold, it was so oversold. I've turned my attention entirely from ESG because I think that it's an acronym that run its way, but I know that it's gonna be replaced. With something else.

1:07:07 Now I'm actually writing a piece on impact investing and that I'll give you the title of the piece because it's going to tell you a little bit about what I think. Good intentions. With perverse outcomes. And essentially where's the impact and impact investing. It starts with two presumptions. One is

1:07:23 that whatever the issue you're trying to impact is real. Climate change. Real. Let's accept it. And second presumption that your intentions are good. So I'm not going to question what you're fighting. I'm not questioning your intentions. I'm questioning your approach. Because impact investing. And you can say the same thing about ESG investing can take one to three forms. you can invest in good companies, but good is whatever increases the impact.

1:07:49 You can pull your money out of bad companies. Which in the case of climate change will be itself fossil fuel companies. The third is you can invest in the bad companies and try to get them to change. Doesn't three moment. What I basically did was

1:08:03 I looked at the impact outcome that is hoped for. So when you sell bad companies, here's what you're hoping. You will push down their price by selling them. By doing so you increase their cost of equity and cost of capital. By increasing the cost of capital, they do less exploration, less growth, so there's less fossil rates.

1:08:22 the weakest link in that argument, you can get ExxonMobil and Royal Dutch to do less exploration. But if the demand for energy is still there and that energy is being delivered from oil, somebody else is going to step into the breach. and do the expiration period in the last fifteen years, and we talked about in the context of ESC. It's been private equity investors, it's been people who've taken advantage of the seams and this argument to make money. So what we end up with is the same amount of oil being produced, but now being produced by different people.

1:08:54 With good companies, it's supposed to be to push their prices up and by doing so lower the cost of equity and allow these companies therefore invest more. So we got green energy companies. You can't tell me that not enough money has been invested in alternative energy. In fact, we've invested Tens of billion, perhaps trillions of dollars in alternative energy. But my question is where's the beef?

1:09:17 Where is the energy from this alternative energy? getting eighty two percent of our energy from fossil fuels. And the weakest link in that argument is you might be pushing the wrong alternative energies by supplying capital because you decided. that wind power was the alternative energy when in fact it might have been better nuclear power. The problem with trying to pump money into good companies and push their prices above where they should be as you're essentially giving them an artificially low cost of capital, too much capital to invest.

1:09:46 So what I do with each argument is look, I know this is the outcome you're expecting. But this could happen. And then I say, let's let the facts tell us where. So I take a fossil fuel business and I look at what's happened over the last 15 years. Initially. Fossil fuel companies dropped in value. You look at the stock prices.

1:10:06 But then they came back. Why? Because In the process of doing what you did, they pushed up the price of oil, you made oil again a valuable commodity to get out. So the price effect has gone away. You got private equity investors making tens of billions of dollars in their fossil fuel investments.

1:10:25 If you look at the evidence, the evidence is that the perverse outcomes are the ones that have come out of this rather than the good outcomes. Maybe there's a better way to do impact investment. But I think we need to have a healthy discussion of What are you impacting? Because the one thing I can guarantee impact investing will impact. Is ever touch?

1:10:44 In a bad way. Everything else. is up in the air. You were forced to fly in the face of something you said earlier, which is

1:10:52 Probably. active management is in a secular decline in terms of market share, maybe not in terms of absolute, you know, in absolute the market grows. So There's a countervailing force there, but I said there's some sort of hunger games or something, and you have to try to enter this contest to build the biggest possible investing firm that you could. How would you think about approaching that problem? I would actually change the starting point instead of making the biggest

1:11:14 I would want a firm that I can sustain, which often means settling for Smaller scale. looking for a portion of the market where I have something to bring to the table. And then not getting tempted. This is stuck to do, right? Because when you're successful, more money comes in.

1:11:30 Saying look. This is not scalable. This can be done only up to a ten billion dollar, fifteen, twenty billion dollar amount. I can't do much more. But that requires discipline. And I think the active investing that I see surviving will be active investors who found a niche, something special that they do.

1:11:50 And stay disciplined enough. To stay in that niche. So the Patagonia strategy we'll call that. Why do you think that There are still so many huge

1:12:02 Schools of capital. We'll call them LPs. writ large that pursue a mostly Active investment mandate. And strategy.

1:12:12 We don't have more of the guy from Nevada that just put it all on the S P five hundred or something. Hope springs a tunnel. In human beings. Who wants to be average? Everybody wants to be above average.

1:12:25 I don't think that search is ever going to go away and in a sense active investing takes advantage of the fact that You want to be better than average. So I think as long as that is part of human beings, you're gonna see people trying. And they'll be attracted by stories of winners. And that's why in V C and P the stories that are promulgated have that selection by some look how much money you could have made if you'd invested in Uber.

1:12:50 On the ground floor. Is there anywhere else that we have topics that we have not covered today where you feel like your opinion is the most off? consensus narrative today. No, probably something we talked about last time, which is the fat. I am so sick and tired.

1:13:07 of discussions that revolve around central banks. 'Cause I think it's become a reason for coping up. The reason for not dealing with fundamentals is the Fed will do it. Oh the Fed did?

1:13:20 No, how many active money managers I've talked to in the last few years? If you ask them why did you underperform the market over the last decade, their answer is the Fed did it. So fit. Or we say what'll happen in the future, the Fed's going to set rates? I mean it's very unhealthy because it means we're not talking about the things we shared.

1:13:38 But it's still the conventional wisdom. Every time there's an FOMC Meeting. The entire What? At least investing work comes to a standstill.

1:13:49 It's like watching a pope get selected, right? Smoke's coming out of the smokestack. There's a new FOMC policy. Let's see how the world will look. If I were to wish it's over the next decade. We stop talking about the fact. I mean there was a time when if you ask people who the Fed chair was. they wouldn't have been able to give you the name, or when the next FOMC be they had no idea what the FOMC even was.

1:14:12 This is A recent phenomenon. And it feeds into all kinds of conspiracy theories, which is the Fed and a few hedge funds and these smart money are all together in a room. And that the rest of us are essentially being taken advantage of by the Skabal?

1:14:28 promet conspiracy theories is you no longer take responsibility for your own mistakes. So If there's a page on which I am Entirely off the page. It would be in giving power to the Fed in determining what the future is going to deliver. I think the Fed is just as confused.

1:14:47 as everybody else in the market about where inflation is going. and where the economy is going and it terrifies them. Where do you think the ideal alternative would be? There is not. Markets are ultimately set by demand and supply. Inflation is not something that magically comes from above, it comes from

1:15:04 Are behavioral factors. So I think in a sense We have to give up expecting somebody up there to give us answers. The answers are in the market. And I think that if nothing else in the last three years we've recognized when experts and markets diverge.

1:15:22 It's the experts who are usually wrong. And every Turn and short. I have a new respect for markets after the last three years, in spite of all their mistakes and their foibbles. in terms of coming to a judgment on the big issues of the day.

1:15:37 What do you think you have the best taste in? And how did you come to that taste? leisure activity basically. I enjoy my walks to the beach. Live two blocks from the beach in San Diego. So What I find I enjoy doing the most is letting prompts clatter around my mind

1:15:55 Sit there, watch the ocean, try to think of answers. I have the luxury of doing that. I admit, I mean, most people have jobs that they have to go to and they have to get things done. I have nothing to do. I can sit there and think about issues and I'm I've often said we read Too much and we think too little.

1:16:12 I don't have that problem. I have lots of time. I know there's old saying an idle mind is the devil's workshop, but an idle mind is often where You get your best connections of ideas, your best thinking is done when you have nothing in your mind per se that you have to get done. So to me I think the advantage of not having a to do list on most days

1:16:33 Is I get more done when I've no to do list than when I do. Power of an open schedule. What are you most Looking forward to

1:16:41 studying, thinking about, learning in the next year. Something new. I mean, as I said, I'm a dabbler. I lose interest very quickly, so I'm always looking for what's interesting. For instance, Birkenstock, the reason I find the valuation fascinating is it's giving me a vehicle to talk about Intangibles.

1:16:58 This big issue with accountants. And often badly misused by praisers who use intangibles as an argument for adding premiums on. So with Birkenstock, I'm actually breaking the value down into how much of this is branding. Ah, much of this comes from the fact that you have Celebrities.

1:17:16 Steve Jobs Birkenstock just went on sale, I think, and sold for two hundred and sixteen thousand at some absurdly high price. of celebrities who essentially are your best brand carriers And you don't even pay them. This is not today's TikTok and YouTube celebrities. These are celebrities Who have roots basically reflect the history. How much of the value comes from that, how much comes from the Barbie butts?

1:17:39 There is a bus. You can't fight it. How much is the Barbie bus? And how much of it comes to the fact that they managed to find I mean, after all, this is a two fifty year old company. But all chronological age terms, this should be an old company. But ten years ago it got a new lease of life because the family let go of the company and essentially

1:17:59 hire an outsider to come in a CEO and the guys. I don't easily fall for management as great management, but he's actually done an incredibly good job. in keeping a balance between growing the company and preserving what makes the brand special. So I'm actually breaking down the value, asking how much of the value per share comes from each of these. 'Cause the point I'm trying to make is when people talk about intangibles, my response it's already in there.

1:18:25 And this time I want to be able to say, this is where it's indeed, this is how much it's worth. So it's keeping me occupied this week. But next week I'll be back to what will interest me next week, so who knows? Is there any other major difference in your mind between a financial and an accounting balance sheet? The biggest difference I think is the financial balance sheet is forward looking, the accounting balance sheet is backward looking. I am less concerned about breaking things down in a financial balance sheet. What I mean by that is I really don't need to know.

1:18:58 how much of Coca-Cola's value comes from the brand name. Why? Because it's not like they can sell off the brand name and keep what's left to the company because there'll be very little left. So I'm less concerned than accountants in deconstructing balance sheets levels of detail, which I think is the problem with accounting rules. is they want to get customer list, they want to get brand name, they want to get tech

1:19:18 That each of these intangibles Separately value. And in my view, that's an impossible task. you're going to create very artificial numbers for these. So I'm willing to accept aggregated values on a financial balance sheet.

1:19:32 Because I don't have to pass it by Gap or any other rule writers. All I have to do is be okay with it. And I'm okay with generically saying eighty percent of the value of this company comes from intangibles. A bunch of that. The case of Apple, its style, it's Brand name. It's

1:19:48 having your own operating system. Why does it matter to me what portion of the value comes from each one? Because none of that Is separable and for sale. That's what every time we talk, I love

1:20:00 hearing you as an example of someone in the investing world who is clearly passionate and curious about the thing that they're doing. I know in the next year you'll have another twenty five, thirty, forty posts of great interest, and I hope we can make this an annual tradition. Thank you again so much for your time. Thank you, Pat. If you enjoyed this episode, check out Join Colossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning.

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