Forensic Account: The Bubble No One is Talking About | Anthony Scilipoti

Transcript from https://podmenti.com/t/9443b0a3dcbb0b71

I hate calling things bubbles.
But I think we're in a period of
Extreme euphoria.
Where
You read
And speak to investors, and they say that the numbers don't matter.
And the financial statements no longer matter because this is changing the world. I say well, I've sins before.
You know I saw
That Nortel
Was changing the world and Lucent and Cisco and Three Sixty Networks. They were building out the infrastructure of the internet that we're using today.
But those companies don't exist anymore.
Anthony Shilapati is a forensic accountant who saw what others missed.
Predicting the collapse of both Valiant Pharmaceuticals and Nortel long before it happened.
He spent decades reading what companies don't want you to see.
The footnotes.
Now he's spotting familiar warning signs in today's AI boom.
What are the red flags you look for? It's not red flags, we call them flammable items.
Це три стадиї процес. Фер ста.
This episode of The Knowledge Project is for informational purposes only. The views and opinions expressed by Shane Parrish or our guests are solely their own.
Nothing in this conversation should be considered investment advice, financial guidance, or a recommendation to buy or sell any security.
Always do your own due diligence or consult with a qualified financial advisor before making investment decisions. It's time
To listen and learn.
I wanna start with how you got into forensic accounting.
I was an accountant and I was uh working at Arthur Anderson.
Doing the normal audit.
Sort of preparatory work.
And
I uh found it unfulfilling.
Uh, because the work I would do I would find interesting or concerns with the accounting or otherwise and
The clients it didn't end up
ending anywhere. So
uh what ended up happening was the there was some due diligence work to do where we could do actually look at transactions
companies calling us to say
you know, we want to spin out this business or we wanna make this acquisition. And then I asked, put my hand up, said listen, can I do that sort of work? And then I started doing it and I loved it. I s saw some huge fulfillment.
And then it's all about people you meet. I met a j uh a gentleman named Mal Rosen and he was the head of accounting at York University.
And he was a forensic accountant. He had his own practice. He taught uh taught us to pass the the the UFI at the exam or the CPA exam at the time. And um I said, you know, I'd like to work with you and he said, Well, you get your CA work done and then
We'll think about it. And uh that's what I did. And so then I tutelaged under him.
for some four years and uh that that really uh made it happen.
You weren't on the Enron file, were you? I was not on the Enron file. I left Arthur Anderson in uh nineteen ninety seven.
Couldn't even spell Enron at the time.
And uh it's it's a very sad thing what happened. What did happen at Enron?
They essentially had a number of off balance sheet
exposures. So they would enter into derivative type contracts where that were tied to an energy price, for example, or even the company's own stock price. And it'd be like this debt only comes due
If the stock price falls to X.
This debt.
only comes due or this derivative transaction we'd entered into and run was an energy trader.
Um you know, so if the price of
electricity in kilowatt hours rises to a certain amount, well then their this debt is no longer due.
If it falls to this level, then there they have to pay
uh some counterparty and so those were those those risks were essentially off balance sheet.
So those were not sitting on the company's liabilities.
They were all contingent. And at the time, the accounting rules were such that the this these numbers were not included.
on the liabilities. They were just in the notes.
And so
All of a sudden so people weren't paying attention because nobody read but reads the notes.
And so then all of a sudden things started to happen. There was a change in movement in commodity prices. Okay, this is now we're dealing with the dot com. There was a lot of pro a lot of changes that happened in the economy. We we had a we had a r a uh a recession in the early two thousands, right? And so that led to a lot of movements in commodity prices.
That triggered the derivatives.
Surprise, surprise.
They can't make the payments.
It's done.
And they weren't required to reserve or put away in reserves any amount of it.
And and why the implication to Arthur Anderson, which I think is important and then it's near and dear to my heart, is
You know, the auditors at Arthur Anderson they're working on the file.
They ended up signing off on all these things.
Well, when
Essentially the
Proverbial hit the fan.
All of a sudden they were asking questions and the regulator asked for the working papers of the auditor, that the papers of which they would support the audit work, and they knew perhaps that they didn't do enough work, so they shredded the documents.
So all of a sudden they became guilty.
Because of their actions. And so it was found in the courts.
um upon appeal
that uh Arthur Anderson was not guilty.
But that was way after the fact because Arthur Anderson was already was brought to its knees and it was over.
I became a scapegoat for everything wrong with
Uh with with accounting at the time.
And uh look, change needed to happen.
Arthur Anderson was full around the world all the partners were folded into the other firms.
What are the limitations on audits?
The limitations? Yeah, well, the limitations are you're hired.
To be a
Independent.
to give your independent opinion.
And a test.
that the financial statements present fairly in all material respects in accordance with
some set of accounting standards and or standards that's associated with a contract, for example. And the challenge is
Time.
Because you have to do this quickly.
Pressures on costs.
And
Essentially, think about it this way. It's like
I tell you
Look, uh I just prepared my report card.
I got an A.
I now hand it to you and say, look.
It's an A.
And if you
Say that it's an A.
I'll pay you.
X amount of money.
So look at your situation.
You come back and say, Well, it's actually not an A.
It's kind of a B plus.
Uh how much am I paying you again?
Yeah.
What do you mean it's a B plus? Do you think that question that that way I answered that question couldn't have been this way or the other way?
You know, and this is it it ties into so many things, you know, AI and so forth. Business is judgment.
People run companies, they don't run themselves.
the decisions associated with a business transaction
end up being reflected on those financial statements.
But
when the group that's making the decision
in the business to do something.
Well, then they come back to the office and show up in the ac in the accounting department and say, Hey, we just did this. You know, can you guys figure out how to account for it? And all of a sudden the accounts are like, Oh, what do I do now? How do I do this?'Cause then
They wanna and by the way, when you do this I want it presented as
As you know, as bright as possible so that our investors and all our stakeholders are really excited by the results. Like don't present it badly.
You you said a lot of people don't read the footnotes or the financial statements. Is that changing in a world of AI where you can sort of like download the financial statement, pop it into AI and say, What do I need to know?
I think
It's actually
Exacerbating the situation. Oh, spend a few beats on that. Because
Now read the financial statements, Anthony. I just put it into AI.
I asked Chat GPT to tell me that
What about this?
Look for that, look for that. And there's there's all the instances of those things. And then I just read it and it's all there. Well, did the AI miss it?
Did the AI understand the linkages between each of those sightings? If I'm if I'm looking at, for example, I was looking at a company recently
And I was looking at it was capitalizing costs. Okay. This is a REIT. And if it capitalizes costs versus putting them through the income statement, uh if it goes through the income statement and makes their operating earnings
Look poorer.
Lore.
And their uh net EPS ultimately. But if they put it on the balance sheet
Well, you know, that's an investment in the future and everything looks okay.
Right?
And so there's a gray area. Was it an operating expense or was it a capital item?
And so I was first thing I looked for was capitalizing. That's what gave me all the quotes. And then capitalized costs, and gave me all the quotes.
So then you think that that's enough.
But you have to then uh and I and I was showing one of my guys this so then let's go to the income then let's actually pull up the statements where it told us to go'cause AI made it faster. I now no no longer needed to flip.
the three hundred pages, but it it gave me where to go. So now I went there
And now I could say, Well, that means if that is what's happened, then we need to look at this other note.
to see what you know the implications of that. And then we gotta look at the cash flow statement to see how it's actually impacting what ends up being reported as as cash flow. And so those linkages come it the AI makes me get to the answer perhaps more quickly.
But it's my if I don't already know where I want to go.
Then AI just gives me information.
But that information doesn't help my decision if I didn't start with
Where I want to get to.
And it sounds like that information doesn't help your decision if you don't know the second, third, fourth order consequences.
This is I love it. If that's where investors go and that's where they're going, everything's going to AI.
the the bottom level
of being an analyst
The junior analyst is is gonna be replaced by an AI.
The one that said, find me all the references of you know where the company capitalized costs.
That the AI can do.
I get it.
But
You need someone with experience to know what which of those references matter and to what that means to the business.
And this brings about a number of challenges because well if that junior person doesn't learn
doesn't get on the in on the ground floor, they'll never learn
To be able to make all those connections.
And the only way to learn is sort of like being in the weeds and not being in the
In fact, it ties to so many things I I with my own children I've seen growing up
when we went to school and we were in el elementary school, we would be
You know, w we'd have to do the math
Tables.
And and recite them. Yeah. Two times two is four and so on. I remember I was struggled with my with my nine times table and then my twelve times table. And so I had to memorize them and get them going.
But
Then my children came along and they were using a calculator. And apparently that was okay.
I went bananas.
I said, You're not gonna use the calculator. You need to learn it without the calculator, and then you can use the calculator, which is the same with AI.
You need to understand how the financial statements are prepared, understand the linkages, developmental models so that when the AI gives you information,
M you can you can digest it.
And make decisions.
reminds me of this funny story when I started university, uh, I ended up in first year calculus.
And for whatever reason the professor who was supposed to teach that class
couldn't teach it. So the dean of the math department took over.
And on the first class, in the first like minute.
He said there'll be no calculators in this class.
Oh.
Nobody, of course, listened to him.
'Cause graphing calculator, you're like, Oh my God, this makes my life so much easier. We show up to the final exam, which is like I think eighty percent of your final mark. Yeah.
And on the front page is no calculators.
And
He did not grade that on a curve.
And it was not pretty for most students. I taught at university for about uh fourteen years.
At York. And uh
Truly f one a a very fulfilling time.
uh my life and uh
I still love doing uh guest lectures.
I remember I I I would always start to c the you know, I would go over the outline and I and I would tell the students, I said
So
Assignments are due at the beginning of class.
If they're handed in after
The eight thirty start time?
It's a zero.
It's a zero.
And invariably
At some whether it was the first and usually the first or second assignment, somebody would show up and hand it in late and I would say it's a zero.
Yeah and they would whine and say it's how can you do that and you're so draconian and I said, Well, you think in the real world
When an RFP
is requireed
And you've signed with the contract with a client that they demand the report by nine AM on Monday and you show up at nine oh five.
How's that look?
And somehow it's okay.
So it wasn't okay in my class. And and ultimately I think you you build respect because people see there there's a rule.
And it has followed.
And then people have respect for the rule.
There's this sort of like weird dichotomy, I think, with students right now, and dichotomy is probably not the right word. There's this weird
path where students are coming out and they're more powerful and capable than ever because they use AI by default.
And so they can get more output.
than somebody who's maybe been in their career fifteen
twenty years. And I I I use my fourteen year old as an example.
You know, in a world where he never had to show up to work.
He's a mid level employee at most companies based on output. If you never saw him.
He can give you
the the exact same output that a mid level employee is gonna give you if everything goes right.
But the minute something goes wrong.
He doesn't quite understand all the nuances and all the and AI the I guess the race for him is like will AI catch up?
quicker, you know,'cause he uses AI by default.
And I sort of think about this as like making a recipe, right? Like if I pull out a cookbook
And I make a recipe and I do everything perfectly, you wouldn't be able to tell the difference between me and the chef. Like the food, maybe it's not plated as well, but it's gonna taste great. It's gonna taste the same. You'd be like, This is amazing. But if something goes wrong, if the oven's too hot, if
I don't stir enough. I don't put enough salt in. I don't know why.
it didn't go right. But the minute a chef, the chef who created that recipe, who's got all the experience, who did the
You know, who's made it hundreds of times. They taste it. They're like, Oh, your oven said three seventy five, but it's actually three fifty. You stirred this too much. You let this boil. You they instantly know what went wrong. Yes. And I wonder if in a world of AI
That's the nuance. And I I was talking to Steve Schwartzmann about this in a different context.
But he basically said, you know, a lot of the analysts coming up
They know the numbers, but they don't know what the numbers mean. Correct.
Experience teaches you judgment.
And and you talk about this in your book. It's all about the mental models. I I I believe that strongly.
The experience teaches you what the numbers mean, as we've spoken about. And when you have experience you say
I've seen that before. And a lot of the things I see happening today.
link back to things I've seen
when I started my career over the last thirty years.
And I think that's something that the AI can't quite do.
Unless you tell it where to look.
Because it doesn't know the link board that I'm thinking about. Right. But if I if I can make the b initial stage, it can help me.
Get there quicker.
And more accurately.
But if I don't a if I don't already have a model of what I'm looking for
It's not gonna get there. What are you seeing today?
We're talking now equity markets, is that
Yeah.
I think we're in uh what seems to be
You know, and I I hate calling things bubbles.
But I think we're in a period of
Extreme uh euphoria.
Where
The numbers.
the fundamentals and
Fundamentals is thrown around in the investment industry, like the the word love is thrown around among humans.
You know, the fundamentals. Well, someone looks at the chart and sees that you know it did a double bottom. Well, that's the fundamentals. And someone else says, you know, that they're looking at the RSI or some other things, or someone else says they're just looking at cash flow, or someone's looking at the multiple related to earnings, and those are the fundamentals.
Well.
At the you know, historically and if we follow what what Buffett says, the company is the present value of its future cash flows. And the how do you develop those cash flows? Well, you need to do a forecast on what it's what it what it's gonna drive the business. And so that's what I think the fundamentals are. And so when a company today is not generating
Much in free cash.
impact negative and yet the market wants to trade it at a multiple of its revenues.

Well then
the company's valuations is extracted from its current fundamentals and trading
based on some future expectations. I've been asked you know if you could have anything, what would it be? And I'd say tomorrow's newspaper.
Because then I'd know.
What was gonna happen and I would be able to invest on that.
And so we're all trying to do the most the impossible, figure out what's gonna happen tomorrow.
And
All I know is I've seen that when
You read
uh and speak to investors and they say that the numbers don't matter
And the financial statements no longer matter because this is changing the world. I say, Well, I've seen this before.
You know, I saw that Nortel
was changing the world and Lucent and Cisco and three sixty networks. They were building out the infrastructure of the internet but we're using today.
But those companies don't exist anymore.
They built what they built, and that still exists.
But they no longer exist.
Either bankrupt or folded into other companies.
Cisco still exists today, but has never traded at its p at its historical mul uh valuation. And yet it's a it's it's a multiples bigger than it was back then.
And by earnings and by revenue.
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I guess what you're saying is the same as
We know this is the future, but it's also the same in that we don't know who the winners are going to be.
That's right. And and I think
Right now.
the reason why I think we're in a b in a very high risk situation is because the cost of the risk is priced
Very low.
And that's when the risk is highest.
And so how do we look at that? When you look at the uh the high yield bond spread, the spread between the ten year bond and the high yield bond in the US.
Okay, that's the non investment grade bonds. Well, that's the tightest, near the tightest it's ever been.
Mm. Which means that
Investors are willing to lend money

non investment grade companies.
at a spread over what a
government bond is at a rate in which is the
Tightest it's been practically in history.
So there's no risk priced into the bond market. And then in the equity markets
We use Vicks.
which is a measure volatility of the t of the S P five hundred. And that
is trading.
At a benign level. It's not the lowest it's ever been, but it's at a benign level. So in essence, what investors are saying is there's no risk.
Everything's fine.
Isn't that the age old w wisdom of like don't fight the Fed though?
For sure.
The future is is pretty
clear at least in the short term, but the implications of that are we I I don't proclaim to know, but interest rates are coming down. I mean all the governments want interest rates down.
Right, they they want interest rates down because because debts have have b continued to balloon.
in a period which has been
Relatively buoyant.
uh by historical standards.
And interest rates, uh they perceive interest rates are gonna go down. That's gonna keep on the buoyancy. Well
The central bank, and if you followed Powell uh despite all the pressures coming from Trump to cut rates,
I mean Powell is gonna cut rates because
He's concerned about either
The employment situation.
Right.
Or the economic situation.
More broadly.
More political pressure.
There's supposed to be a separation. It seem you're right.
But it seems like he's actually noticing that because the now all of a sudden we've seen some some more strain in the in the employment market.
And that I think is what's leading him to believe, okay, now it's time probably to start cutting rates.
What happens when we cut rates and markets are at all time highs?
It could become a situation of where you sell the news.
because everybody was moving the market up.
In anticipation of it happening because the belief is as we when we cut rates, we provide more c lower cost capital to companies, they put that capital to work and it generates return.
Every company is only as good.
or as stable or as strong as its customer base.
And if we're seeing that the customer base of
uh you know, let's call it the average Joe.
And I call that Joel Six Pack.
Uh, he's a buddy of mine.
We all have a buddy, Joel Sixback.
And so if Joe Six Pack is struggling
then
Ultimately, how is everything gonna trickle down and create growth? You know, I have a hard time reconciling this, right? Because the
the the territory, the boots on the ground.
Is
A lot of people are struggling. Seems like more people than
At least in my adult lifetime.
Uh with the exception of maybe the two thousand and eight financial crisis.
And we have markets at all time highs.
Yeah.
And we have
inflation, core inflation actually going up.
And we also have governments
uh with high unemployment pushing interest rates down.
And we have this this really I don't make macro predictions, but we have this really interesting setup. And then on top of that, like just from my like how I sort of approach things, you have the greatest investor of all time.
Who is built up
Uh I don't know. What's the four hundred billion by now? Or three hundred and fifty billion.
His largest cash holding as a percentage of market cap, I think, ever.
I struggle to reconcile all of these things into some coherent view of like
The the thing about
The markets.
And companies is they'll continue longer than you and I will be alive.
And so
When
You're investing.
It just depends on your horizon.
And
I think
What
Happening today.
Is
investors have learned
And Rayby Sol
That every time the market falls it rallies back.
Hm.
And
I like the comment you made, Shane. I I'm not here to predict markets. Uh it's a fool's game.
Uh I don't know w you know, I I wish I knew then I just buy futures and make tons of money or short them.
But what instead I know
Is I'm looking at the underlying companies and except for some of the Mag Seven that are growing the earnings.
the smaller and mid caps are not.
When Walmart is telling you that there's a problem with
It's
sales forecast and Target is struggling and Lou Lemon can't sell the same number of pants.
And Starbucks's
considering to changing some of its pricing and some of its its business model. You know, this is
Joe Sixback.
And
And Stevie Winebox.
that stepped up from Joe Sixback, you have Stevie Weinbox in the middle. Um, and I think they're the ones that are struggling. And so it tells me that
This can continue.
And and markets can continue going up for for
uh any number of amount of time because it's a function of how much liquidity is in the market as well.
People have are if investors have lots of cash.
They'll continue to invest.
The people that you're seeing that are making the most money today
um are not those that historically necess in general I'm speaking.
the ones that you hear about that have made money historically. We talk Ray Dalio, we talk about you mentioned of course Warren Buffett.
And there was a there's a quote that was that I that I learned uh over time and it says during raging bull markets
Knowledge is superfluous.
And experience.
Is a handicap.
Because
If you have the the benefit of knowing what happened in all the other blow ups.
You know how painful it can be.
But if you've never experienced it and every time something went wrong
It just rallied back like nothing happened.
Well.

You think it's gonna continue.
I guess the argument against that is this time it's different, which is what we always Which is the most dangerous
Words in in life.
And in finance.
When they want to write a book that's that ma that marries
Finance with
Life.
Because it's it's it's it's one and the same.
I remember this interview Alice Schroeder did
She hasn't done many interviews.
And one of the most illuminating things that I remember from that interview
is that Buffett when he was looking at patterns, he wasn't trying to identify what's different this time.
He's trying to focus on what's the same. Yes.
Talk to me about that.
And so
What I see is the same.
We actually put
you know, our uh I I transitioned the the forensic accounting knowledge and and skill set into what is today Veritas.
And so that's an independent equity research firm.
And then later into a also an asset management arm. And uh all of that started because we wrote a cell report on Nortel.
In in two thousand.
And people thought we were crazy and you know, at the time I was twenty nine years old, so
I didn't realize
What I was actually doing. It's amazing. When we're young.
But you didn't realize the impact of what you were doing. I didn't un like what you knew the accounting. I knew what I was looking at, but didn't realize that if you drop said pebble into the water, what happens? And then when John Roth gets quoted in the newspaper that we're hurting his ability to raise capital and clients are canceling
And
you know, employees are contacting us upset because of the things we're saying and it's like
I didn't mean to hurt anybody. I'm just
Saying the truth.
Hence the name Veritas.
So let's link
To
What?
I think s some of the the the linkages from the past.
So
At the time.
You had Nortel.
And you had Cisco and you had Lucent and they were building out various components parts of
The Internet.
And what they would do was
They needed customers. Well, the customers needed to raise money'cause if you're gonna build infrastructure, you're not gonna generate cash flow for some time. So they would raise money from equity holders.
A and eventually get some debt. But
B
powers that be at Lucent and Nortel would also offer them, so they would say, buy this ten million dollars worth of product and
Why don't you pay me?
over
Some extended period of time.
Oh, and by the way.
Will give you a line of credit so that
You need ten million from us of

Uh, but will you can also you need to buy some routers from Cisco, you know what will give you some line of credit so you could do that.
Because Norto could borrow money, could could had a great balance sheet, could raise money, whatever.
And so
That's what was happening. Well, ultimately when the equity market started to wobble
And there was no one left to continue to make sales to.
Right?
Well then now all of a sudden
Nort Nortel didn't get paid on its debts.
And
The wheels came off.
And then the three sixty networks and J D S unifase and et cetera that were the customers of
The big
Three that I just mentioned.
They went by the wayside.
And so
What ended up
Sort of now let's take that and think about
What's happening today.
So you have
the likes of
The Nvidia of the world and let's say Microsoft.
And you have open AI and such.
And
NVIDIA is
Investing.
in open AI.
Mm-hmm.
And Microsoft.
Is an investor.
in open AI.
Microsoft
Offers.
Cloud services.
To open AI.
So it's a customer.
So open AI becomes a customer.
of Microsoft. Well Microsoft gave it the money
So that could actually pay it back.
NVIDIA invests in open AI.
And NVIDIA is
A c a a supplier of chips too.
Open AI.
So
It's all circular what's going on here.
There's a new uh company that just went public earlier this year, Core Weave.
Who is its largest customer?
Core we've provides data transaction like analysis of on chips, right? It's a data farm.
for the large uh AI users like Microsoft, its largest customer is?
Microsoft.
Microsoft hasn't invested in it.
But
NVIDIA supplies.
Pretty much all its chips.
Well, NVIDIA is a large or is a meaningful investor in
Core wave.
Core weave goes public.
It's trying to close its its equity its uh financing on the last moment.
NVIDIA buys two hundred and fifty million dollars worth of shares of core weave.
So that it could close the deal.
These are you know
JP Morgan gives them a loan so that they could uh just before they go public and then they go public and repay the loan to JP Morgan.
Who's the le one of the lead underwriters? JP Morgan.
No one's doing anything bad.
No one's cheating.
It's just these are all the same type of symptoms of things that were going on.
Way back some twenty five years ago.
All these things don't mean anything.
Nothing means anything until it means something. I say
You know, the things that we're talking about right now, these little things
If you will.
You know,
In the time of two thousands, just like we talked about Enron that didn't have the disclosure.
So the key wrinkle.
Two
Everything I brought up, and that's why now I want to take it to the accounting, is the financial statements of Nortel didn't show
that long term
Lone.
as a part of current assets.
It showed it as part of long term assets. So when
Mm.
the simple calculation of current ratios, they would only take well current assets. And so this long term asset, that wouldn't show up as part of the liquidity calculation. It also wouldn't show up as part of operating cash flow. And if it's not part of operating cash flow, then operating cash flow looks better.
And no one would look at
long term receivables. And
What they would because they're taught in their CFA how do you calculate free cash flow.
Operating cash flow less capex.
But this is the problem with
When you just
create the ratio and invest by ratio.
The ratio needs to be adapted.
To the company.
The life cycle, the industry, the business model. If the company's selling things at a long term receivable uh for over a period of extending beyond one operating cycle, but it's part of its normal operations, that should be part of operating cash flow. And in fact, after an a after Northel
Fazbey changed the rules and then long term receivables became part of operating.
And short term and and and current assets. And that's something we wrote about. We said, this is wrong. You need to the free cash flow is actually negative.
Because this number needs to be shown. So they're extremely vulnerable to something going wrong.
If the customer can make payments.
And today, now let's look at the accounting today, NVIDIA.
would make that investment in
In Corweav, it's such a small, meaningless dollar amount.
to the balance sheet of NVIDIA.
Mm that the num amount of disclosure is irrelevant. It'd be it's a it's a related party.
Now we only own five percent, so that's not material.
to to NVIDIA and the dollar amount to NVIDIA's total balance sheet is also immaterial. So
It doesn't matter.
But
If this is happening
Over hundreds.
Of
transactions where it's making investments like this.
In its own customers.
Then
What ends up happening if
All of a sudden it runs out of the ability to get cash, or the customers end up having problems selling
Services with the chips that it buys.
Then kind of things start to fall uh

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Again.
It is
It is fantastic business savvy.
You want if I'm trying to create
A new
Paradigm, which is AI.
then I in order to foster
That paradigm?
I need to invest in it as the as the key player in it.
And
What ends up happening if you see that my name
as a key investor and and a leader in this industry, is making an investment in this company. Well then what does everybody else do? Warren Buffett tells you he's buying something, what does everybody do? They go buy it.
Well, if NVIDIA's buying something
What do all the private equity firms do r looking around? Well, we that's a good one.
There's another one, it's not Corey Tenterweave. Like the AMD equivalent, which is private now. Yeah. So I'd imagine they would all exactly. You got it. Yeah.
This Nortel report, I wanna come back to this for a second.
And
You happen to be
Correct.
What responsibility you know, remember the Superman quote with great power comes great responsibility. I tell yeah, and Spider Man.
Spiderman. Spider Man. Yeah. I love that quote. And I wonder about these things like when you're right.
It's great. But what about when you're wrong? And that's one of the things, uh you know, we're celebrating our twenty fifth anniversary this year and uh
I developed ten uh rules, investing rules.
They they relate to life as well.
But that one of them is
Being
Negative.
Sounds intelligent.
Being negative.
Typically is looking at facts.
It's looking at numbers.
It's presenting them to you in a way that says, Wow, that seems really compelling.
If I want to sell you something.
That is, you know, that so that's the negative side. If I want to sell you the positive side, well then I gotta sell you the dream.
AI is gonna change the world.
People are gonna be no are no longer gonna need to work.
We're gonna it's gonna replace jobs, margins are gonna go higher. There's gonna create you know, it's it's gonna uh improve healthcare services, all the all the the phenomenal things that
could potentially happen. And so you'd see that, and then you're willing to invest. It's you're buying a dream.
But if I tell you
Yeah, but a lot of this is based on
all these intricate transactions where there's no disclosure about, you go, ah, that doesn't matter, Anthony. Look, we're changing the world, buddy.
I like to say none of these things matter.
Until they matter.
And then when they matter.
They matter a lot.
You know, with great power comes great responsibility. You're right.
This should not be interpreted as I'm telling that something's gonna blow up.
I'm just saying that there are some linkages.
Things we've seen in past euphoric times.
Things could continue for
Any number of
Period. I d I don't know.
But we're getting to a point, as I said earlier, where r there's very little
Cost.
To risk.
Today.
What are the ten investing rules?
Oh.
Yeah.
Now you're gonna put me on the spot. I I I don't I I don't remember all of them.
Uh, the number one
rule and I borrow this from from Warren.
And so if you ever
pay attention to listen to me, but I did reach out
to him, his number one rule is don't lose money.
And my concern with don't lose money
Is
Any investment.
requires uh the absorption of risk.
And so if you're not willing to take some level of risk, which means potentially to lose money
You won't
Make money either.
So you don't want to invest with a from a from position of fear.
You wanna invest, I think, so my number one rule is avoid embarrassing loss.
You want to avoid the loss of a company potentially blowing up.
If the company might, you know, if it looks like it's a little bit expensive and it might and it might go potentially go down five percent or something or ten percent or twenty, okay, you can deal with that. But if you're investing in a company where if something goes wrong
You could wake up one day and it's down twenty or fifty percent.
That's the one you don't want to have in your portfolio.'Cause investors will never invest with you again.
And you'll also be scarred.
Because
People make investments.
This is why it's so difficult to be to be a long term sound investor.
Because emotions get in the way.
Which is one of my rules.
Emotion.
Has no
Please.
In investing.
Another rule is uh don't trust management.
I'm sure there's many management teams and I run my you know, we're a operating business uh private company and it's not that they that you know, you you shouldn't trust anything they say, but again, it's it's a mindset.
Up everything you do.
is is about how you pos you you present your your mindset going in.
And so if you go in with the mindset of don't trust, then you'll be curious.
Then you're gonna ask questions. It's not that you you think that they're bad people. I didn't say they're bad people. I said just don't trust.
Verify.
And then trust.
And then another rule would be
That you have to read the notes to the financial statements?
First before you actually read the statements, the notes to the financial statements tell you
How
The company
modified the accounting because it changing choices. We decided to account for
this these type of transactions in this way. So then when you look at the financial statements, once you know how they're prepared, you can better interpret them.
Accounting is a language.
if I said to you tomorrow you're gonna speak Spanish. Oh, you know, you could do AI and you figure it out and you're gonna learn it.
But the nuances of the language
An individual who did a PhD.
In that language, they're gonna understand way more about the language than you are.
The same like reading the financial statements. The more you understand of what went into them and how they're prepared, the better you're going to interpret them.
What are the red flags you look for?
I like the way you you pose the question.
Because it sets up.
What I we've learned over time.
The problem with red flags is it gets to your point that you started at before.
Where you don't want to be crying wolf.
And so I've learned to temper
Because you could be wrong.
Mm-hmm. It's not red flags. We call them flammable items.
Okay.
So this goes to the pro our process, it's a three stage process that we use and we teach.
'Cause one of our um we have Veritas View.
And so we teach investors how to make better investment decisions. And so the the first stage is you understand the business
And a control environment.
Okay. Again.
understand and understand the accounting that's being used.
So that when you
study the financial statements, everything else. They all make sense.
And you understand
sort of the the the structure, how is management compensated.
What stage of their life cycle are they at? Because those are all sort of constraints.
and opportunities within the business.
So then you look for a flammable item.
For example.
companies generating negative cash flow.
That could be by itself.
A red flag in the normal way.
This this type of I would call
Forensic analysis is taught.
Unless you know so if a company's generating negative cash
It may actually be a fantastic thing. They're investing in
an AI startup that is going to be a huge opportunity and they've shown over time that their return on invested capital is in excess of twenty percent or fifty percent or whatever it is. And so they're investing in something.
Yes, it's negative cash flow today, but I'm not investing for the cash flow today. I'm investing for the cash flow tomorrow. So you see that as a red flag, you don't invest in it.
And
Unless you understood the first part, which was
the fact that where they are in their life cycle type of business, et cetera.
That
Is now
Not a red flag. It's just a flammable item.
By itself?
Not a problem.
It depends.
And then you get to the third bucket, which is
The spark.
And so you're always looking for a spark.
Because
Let's use that same negative cash flow.
Well
If all of a sudden
A new competitor.
comes into that.
Companies.
Operating space.
Okay.
And is able to
Take market share.
Now all of a sudden the negative cash flow.
is a problem if you notice in the financial statements when you look at that
negative cash flow the company's taking on very expensive debt.
Again, very expensive debt by itself doesn't mean anything because if the potential return on invested capital is higher than that cost of capital,
It's all good.
But if a new peer comes in play
Now all of a sudden that model may not work.
And now
You have a blow up.
in my podcast, uh the fact finders I
I interviewed uh an individual who we've used before, this private investigator, and he's the one that got me onto this
This way of this mental model.
And uh
He says, you know, if the CEO
Oh.
Beats his wife.
And uh r run stop signs, kicks his dog, doesn't get along with the neighbors.
Probably could be a problem.
But that's not gonna show up in the financial statements. That's not gonna show up in any interviews. You gotta kinda foll things that are going on.
What is that?
organization stand for.
How are they operating? What are their values?
But not just what they write down.
The culture and the values are not what you read.
on the financial statements and in their in their press releases, we wrote about Valiant. We said sell Valiant. Okay? We're the only sell.
on on Valiant in twenty uh twelve.
Twenty thirteen. The company didn't blow up until twenty fifteen.
Okay.
But
They and they would talk about their integrity and their, you know, how they were changing the world with the m with the drug reformulations they were doing and so forth.
But if you look deeper, they were just
Manipulating the accounting.
And changing the pricing on on drugs.
And creating a fraudulent network of uh online pharmacies.
Valiant's a good one because there's a lot of
uh well known ambassadors in that
Yeah.
How
did so many well known, well respected investors
go wrong. People who are known for their due diligence, people who are known for their legwork.
I sat with them.
Talk to them before the cave before
It's a situation where someone
is such a masterful
A spinner of a story.
And
is Are you telling the CEO is the CEO and the management team sold you had Mike Pearson and was executing
And you know, he comes w he came from a great pre pedigree.
He was not taking uh a salary and everything was tied to the stock price.
You know, he he was you know, four tireless tirelessly working in the company.
And
He proven.
Because
What ends up happening is price
Creates narrative.
Mm-hmm.
So all of a sudden you don't believe it day one.
But then you see that they made an acquisition. It didn't seem like it was gonna work, but then it works and the stock price goes higher.
And then they do something else. And it kind of seems a little bit strange. And then they change their accounting and that and they change the way they rec they they present their op their uh non gas gap metrics, which is things we noticed like
That's another huge flammable item. The company says, you know, they're reporting their
They use an adjusted
Iba and they calculate it in a certain way. And then the following year they calculated a different way.
Well, that's a non audited number. It's a n it's it's whatever management wants, and you know, the markets just believe it. And so
That's something that Valiant was notorious about. But
Didn't matter.
Because the stock price just kept going higher.
And as the stock price keeps going higher, it's very difficult
Okay.
Ma in in the money management industry.
When you're underperforming
It is so difficult.
To stay
The course.
Mm you saw this, you know.
In the financial crisis.
that movie about you know the big short.
Like those individuals were became clients of ours. Like I know Porter Collins, if he ever listens here, and and Danny and so forth. Like
We we befriended each other during during this time of madness and afterwards.
was like they were crazy. Like you end up looking at yourself going, I'm crazy. I'm seeing this and nobody cares.
It becomes so difficult.
When you're on the other side now, you're
trying to make money and raise money from clients because investors now are saying, Well wait a minute, you're up five or you're down five, market's up twenty, you don't know what you're doing, what are you doing?
And you know, y it's hard because that's how you earn your living.
That I think becomes the
becomes the problem.
And with Valiant it just went on for so long.
And you need to look at
the market conditions at the time.
Because
The people are running a business.
But the business is operating.
In a certain economic environment.
Well
You had
Brand new
Bond market activity.
H we.
No one ever heard of QE before the early two thousand or two thousand tens.
The bank the the central banks were buying long dated bonds to keep interest rates low.
Well now all of a sudden what does that do to a company like Valiant that's making that's growing through acquisition and needs
Capital.
Well, they can borrow money at very low rates.
And if that's the case, then their IRR, cost of capital, et cetera, their hurdle rate is very low. So they look really great.
All these transactions that may not have made made any sense in other time periods when risk free rates were not.
you know, in the one or two percent range.
All of a sudden they make sense.
If I had to go back in time
We should have said buy valiant.
At the beginning.
Because
We had studied Biovale.
So Bio Valiant bought Val BioVale and BioVale was a Canadian company that was run by Eugene Melmick.
And we
wrote a cell report on on that company in in the early two thousands.
And and the company ended up being a a figment of its former self.
And but it had something. It had some formulations.
for of drugs which were long dated.
in their uh release. So they they would buy a drug and then repurpose the the the formulation so there'll be slow release, et cetera.
And then they and they also had phenomenal tax structure where they were set up in Barbados.
And Barbados is like heaven.
So the more money you make as income.
You pay a lower percentage tax.
Imagine that?
So what Valiant did was they bought that structure.
When they bought uh BioVail.
And so that allowed them to
Екстракт о
The cost of tax.
So many interesting things they did. They set up their head office in Quebec.
Province in Canada.
French speaking.
Well,
The case.
Which is
The largest one of the largest
pension plans in Canada, right? Their mandate
is not just to make money for its pensioners.
Okay.
And there are this is the civil pension fund, one of the and it's I think second largest in Canada behind C P
And one of their mandates is to invest in
Quebec based companies.
And foster growth it's a phenomena. I used to think it was a problem.
But actually, I've changed my way. I think CPP should do the same. CPP should be encouraged to invest.
In Canada.
The US pension plan should buy
US companies encouraged to do that. Anyway.
So in this case, you set up in Quebec, you know you got a set flow of capital that's gonna come from this Quebec based pension plan.
And I remember
Meaning
With the
With the leaders at the case at the time talking about this and they're like, We don't want to own it. We're we we agree with you, Anthony. We're worried about all this stuff.
But these are the subtleties.
That you need like everything again, when you see it's a flammable, you didn't even know that was a flammable item unless you know from the first page, oh, they're set up in Quebec. And you go, Well, why did that happen?
Which is part of the mental model of being curious to say
Nothing happens without a reason. If you notice something and you go, that seems really weird.
No one else does that.
And most people just say, Well, it's okay.
Doesn't matter.
Well
Actually.
That's what matters.
It's complicated just in general, like a red flag for you. I remember Buffett and Munger got entailed with something with the SEC in the early seventies, I think it was. Yeah their structure was just
It was uh legal, it was rational, it was
Not transparent.
If I recall correctly, it was incredibly complicated.
And they ended up simplifying it, but they weren't doing anything wrong.
So again,
I've you know sat with management teams
And you go through their ten K.
And then you see a list of all their
operating subsidiaries.
And you see the different places that they're operating. Again, thing about investing today is there's so much pressure.
On the analysts to cover more stocks.
The money management fees today
Or a fraction

Even a decade ago.
So
The companies that are doing the investing, the fixed cost of doing investing, like paying the audit.
doing the back office
All that stuff.
Yes, it's come down a bit, but it's still there. Yeah.
All that's been squeezed.
Is
The c the cost of the money management. So they're having to look for shortcuts.
And that means just give me the number, Anthony. Just give me that one number.
I just want that one number.
And then you get the one number.
the management gives them.
And then they just accept that and move on.
I was talking and I'm not gonna mention here, I was talking to a well known CFO once
About earnings management.
Yes.
And they said, you know, we would call
Analysts after
The earnings call.
And we would
you know, legally, but we would definitely lead them
uh to what numbers to expect for the next quarter, even if we were
And we would sometimes manipulate that if we wanted to. And I I always thought that that was a bit nefarious, but I mean this is how people work and how the world works. And so just being c you know, to I think you asked the question is being complicated.
Okay.
A problem well
It's just
Why is it happening? And you go back to nothing happens without a reason, then you point to some company operating in the British Virgin Islands.
That's listed on the list. And what does this company do?
Yeah. And management starts sweating.
And so why are you asking that?
I don't know.
You have your answer before you ask a question.
Do you get to a point where things are like too complicated, people don't even know what's going on? Like it it always starts with like this one thing makes sense and but over, you know, thirty, forty years you end up with a structure that nobody even internally probably understands. You know they they interviewed um
Fast Andrew Fastow, who is the CFO of of Enron, and he's done many an interview on this. Also I I w because when we do our training we have a few of these interviews that we that we quote.
Companies don't start out.
Yeah, it's
being crooked. They have to convince someone to buy a product.
Okay, or a service. So money comes in.
to the company in some fashion or time.
And then gets converted into something that adds value.
The problem becomes outside stakeholders come in and say, Well
I need you to make X.
Because
You want my money.
Well, I'll give you my money so long as you give me this return.
Well, that works.
Until there's a problem.
And now
There's no CEO that wants to disappoint.
So it's very simple. The CFO comes to talk to me. I'm the CEO and he says, Look, I know uh Anthony, we were gonna make a dollar, but we're coming in on ninety five cents.
And I say one.
You get back to your room.
And find me five cents.
Yeah.
You like your job.
You like your kids going to private school, you like your stock options how much they're worth. You see all these employees we have, they we give them stock as a part of their compensation every quarter.
Like that's a problem.
We can't disappoint.
And then it starts.
And it starts slowly. It always starts slowly. And look, there's that was what Andy said in in the I think those interviews. Like, you know, it started with a little bit and I figured next quarter I could bring it back.
And it's just
You know, that's the thing. Uh uh life is a dangerous thing this way. Whether we've pushed something even in life, right? You know, well, look if I
smoke a bit or drink a bit or tell this little lie
You know
No one notices and I'm I'm okay. Well then
Maybe I do a little bit more of each one of those things and
No one noticed this.
And then
It's all good, right?
But then

Pushing gears a little bit, do companies that report free cash flow on their press releases or in their financial statements tend to outperform?
I don't have that data? What would be your guess?
It's not a common metric to report. My guess is I would say not necessarily. No, I would say no.
What do you think of Ibada?
Ibad Da is the
Mother of all
disastrous
measures.
Why?
Because of what
investors want to believe that it is.
And that it's something that is cashable.
that it's something that can be compared to
D total debt.
And it is not.
It is purely a operating road.
Performance metric.
calculated before interest.
Panics.
Appreciation.
And amortization.
That's it.
No.
What runs into a problem is well what do I do with stock options?
What do I do with joint venture games?
What do I do with gains on investments that I made that I happen to sell this year?
What do I do with the
charges that I took on that acquisition that I bought this year that I included in my IBT, the profits, but at the cost that are associated with that.
operate that transaction, should I include that in butt?
Aren't those one time costs? If making acquisitions is part of my business model
Oh, I think that's no longer one time costs. This gets us back to we have a course called The Secrets of Free Cash Flow.
And that's been our most
watched uh and taught course. And that's because it started, we said it earlier. We said free cash flow is operating cash flow.
Less Capex.
But it's not.
It depends.
Every every answer that someone asks you, what is what should it be? Well it depends. Depends on the company. You got it.
How should I calculate it? Well, it depends. What decision do you need to make. You always start with
The facts before you think about a transaction and how you're gonna account for it. It's all about the facts.
The constraints.
And the objectives.
Right. The facts determine
What did I sell, what did I buy, from who, at what cost, under what terms, et cetera.
So those are the facts.
Broadly.
Then I have
The constraints well
I'm a private company.
Who uses the statements? Well just me and my partners.
Who cares where I put it. It's less.
Less important.
But if there's an outside onlooker on this, well now it matters because they're looking at it. I now have outside investors.
I have debt.
I have a debt covenant.
All of those things I'm public. Now I have the SEC. Those are all
Constraints. I operate in the US. I got Fazbeat.
PCA will be.
I operate in Canada.
I have IFRS.
I have CPAB.
And the last is the objectives.
I wanna sell my business this year.
And my business sells on Ibata.
Buddy, I'll tell you how I'm gonna account for it.
My business investors want free cash flow.
I'll tell you how we're gonna account for it.
It's those three points.
When I teach accounting.
I teach those three things.
Yeah.
That's fascinating.
I wanna talk stock options for a little bit. You brought that up. I wanna come back to this. Like
How should investors
Think about stock options today.
And then how would you change accounting rules to better account for stock options? Two separate questions, but
Seeing you're good.
I hate them personally, in in public companies.
However I I understand why companies want to use them. I mean my take is they're
You know, if you look at most buybacks, they're just covering up stock options. Correct.
Very good.
So that's an expansion. I think that uh stock options
What they do.
Everybody it it comes down to human motivation.
So
If I am gonna compensate you on
The stock price.
Then you're going to
Make decisions.
That move the stock price.
In my
early classes when I t
Um I w I always say that
Economy.
And economics, reality.
Is way over here, as far as I can see with my hand.
And the accounting?
is way over there.
As far as I can go.
With my hand.
Because
If for example
You know, I'm gonna take a very simple manufacturing company'cause everybody understands that. We make pens
We drive pens, we're making a thousand pens an hour.
And
I sell the pen, you sell, you know, today we made, you know, in over eight hours, we made eight thousand pens. One of my salespeople sells a thousand pens.
Well
How do I calculate
The cost of that thousand pens.
Do I just take the eight thousand pens that I do?
divide, take one thousand over eight thousand, that's the total cost, and then that's what I allocate, right? The reality is I sold them a thousand pens and it was the last thousand.
Дувай стоп до прес.
figure out the cost of that last thousand.
Do I average it? Do I even though I sold them the last ones, do I
Calculate the cost of the first thousand, which may be a little bit higher because there were some setup costs to change my machine to make the thousand.
All of those three options I gave you a business reality for what the accounting is, five full, lifel, or average cost. So the reality is I sold them the last
Thousand.
The accountant said
Well, we want to show high margin.
So we're gonna abuse the average.
And that's all good.
That ties that point. But I wanna get to your question because I I don't think I I I got on a sidetrack and I want to answer your question about stock options.
So
I think stock options should be an expense.
And if they're not an expense I I borrow from Buffett and even the chair of the counting uh has said things like this that that uh if it's not an expense then what is it?
You can choose to pay someone in stock options or you can choose to pay them in cash.
So if I pay all my employees, you pay you have the same company, you're we're a competitor, you pay all your employees with stock options, I pay them in cash, I have a lower EBITDA.
I have a lower EPS, your stock trades higher than mine.
Stock price goes down.
All of a sudden all your employees leave.
And they want to come work for me.
And all my guys are pretty happy.
They don't care.
So you should include it as an expense.
Taking this one step further to and why I brought up
Reality
And accounting.
is that
as an employee at any level.
Even the CEO and CFO. Sure, the things they say, the things they do will affect
markets perception of the company.
Perhaps in the near term, perhaps in the medium term.
But in the r in the longer term, in the in the fullness of time, the results will prove what's gonna happen.
But
the management and and the the guy on the shop floor, even the sales manager, may have no impact.
on what actually happens in the stock price.
Yesterday
Powell cuts rates. So that moves the company's price.
All of a sudden as an employee I'm better off or worse off, but I had no effect on that. I had no nothing to do with that. A new peer enters the c enters our business uh in in our in our as a new competitor. I have no effect on that. All of a sudden GDP slows down.
My business isn't even affected because the GDP is tied more to consumption problems.
My business is a B2B business that's totally outside of being affected by current G GDP movements, and my stock price price falls.
I had no control over that.
So I think it it incentivizes what I think the wrong thing is and makes people make potential decisions.
Which can manipulate.
Which may or may not be good for the company.
So do you adjust, I guess, for options? You just consider them an expense of you.
I I think that
You know, options are are super interesting because a lot of companies
The report profits aren't actually
Profitable.
If you factor in the stock options.
And
I had a friend who actually put me onto this about ten years ago.
And I was visiting his factory. He doesn't give a stock options. I was like, Well, how do you compete? He's like, Well
I I mean I hire the best people and you know, they tell me they they have stock options at their company and it's a public company. I'll give you the options on their company. Oh, on their stock. On their stock, not my company or my stock. And I'll pay you in cash and I'll give you a cash bonus.
And so this is how you recruited all the best people. Wow.
And one of the interesting things about this was after that meeting, I was like, I wonder where if I went fishing, like you talk about fishing in a pond, right? Yeah. And if I could increase the ratio
Of
what I'm looking at to be solid. And so I look for companies that stopped stock options.
And there's not many of them, but when you find one, it's usually like a good place to start looking for an investment.
Yeah.
That's uh that's a good point.
What do you think of other incentives in inside companies?
Such as
I don't know, like what else drives sort of like a lot of
either good or bad incentives. Like what do you you if you only had access to financial reporting
Uh, management reporting and conference calls. Like what are the things on the call that you would look for? What are the things
I'm gonna look for
Okay. So for to answer your question is about what are what incentives do I think are are make sense. Well
You look at what the key measures of success are for the company and do those align with investors' interest. So investors are conc are care about the company's longevity, its ability to generate cash, its ability to grow.
And sustain itself.
And
Yeah.
the company's incentives aren't linked to that. So if they're not tied to
you know, cost control, if they're not tied to uh driving revenues from an organic standpoint, not just from acquisitions. Um if they're not, you know, if they're if they're tie if they're m driven by acquisition but with no care to what's going on on the balance sheet.
Um that's a problem. I would say you know, it's it's not easy to say that just I hate I'm sorry, but the one here's the one thing and it's gonna work.
But I think it it's one where
Is it consistent that it change?
Did a company say, you know, we're gonna pay management on X performance metric if they hit it.
they get a hundred percent if they don't
They get some graduated scale.
Well then management doesn't hit it and they change the the metric and management still gets a bonus.
I think that's a problem. Oh, totally. Yeah. Because now what that does is it says that's that everything's okay.
And you know, it's hard again.
Now I'm aboard.
See the the more you learn and the more experience you have, you understand more about
what you don't know and that there's a lot of things to learn. Well the board is making these decisions.
And everybody say, Oh, the board's bad and boards are bad. It's like Well, no, the board wants to retain the CEO.
And oftentimes, you know, that could be a very significant personality.
And
that personality, maybe m you know, there's other companies that want
that individual to work there. So they have to retain them.
And
Oftentimes money is is is retaining. That's something that becomes a a problem. What is the role of the board?
The role of the board is to embrace
The
Position
Uh and and the and the viewpoint of the shareholder.
And or the stakeholder, I we always always focus on the shareholder, but stakeholders, stakeholders, employees.
Uh customers.
the communities the company works in.
The competitors
And embrace each of those.
And ensure that the company is making decisions or that the executive is making decisions in the best interests.
Of those.
Stakeholders.
Often times
They just focus on, you know, shareholder value. Well w what is shareholder value? Is that just something that we can calculate on the financial statements or calculate into the stock price?
Or is that that they've built a vibrant employee base?
that is growing and everybody and then it has a great culture

regardless of what's going to happen in the stock price, they're going to get through it.
Are they
focused on uh you know in the in the communities in which they operate and ensuring that they sustain themselves because if they're just milking that community or that environment wherever they're working, well then what happens when they've finished milking it? Are the is that business going to be able to continue?
And so
It's something I've spoken on before. This and I so I think it's more than just
Shareholder value calculated that way.
How do you think most board members get selected?
oftentimes uh by relationships.
Going back to humans run companies.
I'm gonna ask you to be on my board if I like you.
Think you're gonna agree with me.
And you know, look, we we have uh
uh board.
a found a board in our foundation and
I wanna bring on people that are going to make us better.
Mm.
That might mean that some conversations are not always Yes, Anthony, yes, Anthony. I I like I actually don't want that. I I want even in my my own partners and my own employees. I I welcome. Please come in, the door's open, tell me what I'm doing wrong.
We're not gonna get better. I'm not gonna get better if someone doesn't tell me I'm I'm I'm doing something wrong. That is an uncommon view.
But
It's the only way to progress, I believe.
I'm not saying that
We're gonna
decide what you said, but I want to hear it.
If you don't and and then
And the danger they say, Well, if you listen to it and then don't do anything about it, then it's like you disregarded it. I said, No, you listen to it.
And you go back to the person, Thanks for the input. Here's what we've decided to do as a result of what you've said. Yeah. And then they feel like they were part of it. What do you think of the rise of indexing?
I think it's what are they uh I don't know the exact stat, but the a huge percentage of money now is is passively invested in
ETFs of one form or another.
And we've never seen this concentration invested in say blindly, because I mean indexing works though, and it works. It has worked over a long period of time. Again, you know.
the price creates a narrative.
And so if indexing works, then why not do it?
The danger I think we're having
Of the
index or investing, passive investing.
In essence, all that is is momentum investing.
Because
It's a your buying index which is market cap weighted.
So the money that you're investing is going to the largest market cap companies?
Those companies continue to grow.
They drag the index higher.
You know, there's really two indexes. There's the Mag Seven and the Sloppy Four Ninety Three.
And it's well, if you look at the earnings expectations of the slot before ninety three for this year, there's virtually no growth.
But if you look at the growth of the Mag Seven.
It continues to go higher.
And so
I think
That the the danger is
But if that reverses
I'm not saying it's gonna reverse, but if that slows
Ти Оливаса.
What's been dragging the index higher.
will drag the index
Lore.
In the same veracity.
Hm.
Because they are the largest cap.
So if
You know, if one of the large if if Microsoft were to miss, and I'm not saying they're gonna miss anything.
But if they if the earning growth slows.
All of a sudden the stock falls.
Like we saw this in April, right? We saw this huge drawdown in a very short period of time. You know the thing about those drawdowns, because each of the drawdowns
That drawdown occurred because Trump put together a tablet.
He came down from Mount Olympus.
brought down a tablet, right? I have a picture of it that I use in my presentations and showed how much the t the t tariff he was gonna charge on all these countries.
And
That created immediate fear in the market.
Right?
costs of companies were gonna go up.
Transaction w were gonna go down, revenues get hurt, margins get hurt, stock prices get hammered.
But
What the the second third level thinking on that is well wait a minute.
These haven't been enacted.
Yeah.
There's still time.
Maybe they don't happen.
And if they don't happen.
Well, maybe all this drawdown doesn't mean anything.
Yeah.
So it's like an exogenous
impact on the market. It wasn't something that the market fell on itself.
What I think would cause
A uh a more
A a a downturn.
similar more like what happened in O eight or
even even in the early two thousands. Like
People forget that in the early two thousand they say, Oh, the two thousand crash. Well, actually the market was lower in twenty th oh three than it was in two thousand.
But everyone thinks that it happened in two thousand. It actually didn't.
It began.
It's like that's when it started. Right. Kept going for years. And the other ones have been relatively fast. Even in the financial crisis. That one that one actually the peak was in oh seven.
In September oh seven, that was the peak, and the bottom was March oh nine.
That's a lot of that's a lot of pain.
That's eighteen months of pain.
If you look at what what I think could make this one be a a a longer one if it if something were to occur, is it comes from earnings slowing down and earnings growth slowing down.
That's
would be something that would take longer to repair, especially when a lot of the earnings
are interconnected as I talked about. Because the companies are dealing with each other.
It's not like one thing you can
You know, you have this band aid, you rip it off. It's like the slow Yes.
Yes.
No, we've seen
meaningful changes that are going on here, right? Like Lululemon is trading at a low much lower price today than it was last year. Let's talk about stock buybacks.
ShareCount doesn't necessarily go down, but buybacks are happening. It's the same as
Stock options.
In a sense.
And the disparity between reality, economic reality, and what's going on
in the accounting.
So
When you
buy back stock
The company is making
A
Investment.
In a
Security. Mm-hmm.
Which it partially has control over what it does.
But it
doesn't have full control over what happens.
to that investment ba value.
Whereas
If it takes its cash
and buys an an operating asset that expands its current
Production.
And if it's already generating a meaningful return
Then that return should continue.
And expand.
So to me it's a this it's a point that says I have no other investments.
In my business.
That would
generate a return.
higher than my cost of capital.
And so I'm going out
And buying my stock.
And I think
That is very risky.
How should investors look at that or account for that?
I'm not so concerned about the accounting. Well that stock buyback. So if you're saying they should invest in it though. I understand. Yeah. So I I think what they should do
is they should look at
Earnings.
On
A
Pre EPS.
So look at the earnings that the company's generating before you've divide it by the number of shares. Okay. To see is that number growing.
Oh.
To the revenues.
Right.
Because now you're seeing a uh
Is it or is it just coming from a reduction of stock price number of shares outstanding? And if the company's taking on debt.
Here's the classic example.
Company generates
Uh the company borrows money.
To buy back stock.
Why?'Cause
Because it's such an uh a high
perceived value company and generates cash. It can buy borrow money.
and at a very low price and invest it in the in its own stock, which has historically generated a greater return than how much it has to pay in debt.
Well, this works.
Until it doesn't.
Because
If for some reason the business
changes or just slows its growth.
Which could be just a natural evolution. Like part of this is the law of large numbers.
Okay?
And if this happens.
Then all of a sudden
That debt doesn't go away.
And what looked like a very low cost.
is now a meaningful cost.
That doesn't leave.
And they look at Apple.
And this is what concerns me.
Revenues aren't growing.
Minimal.
And yet
It generates meaningful cash.
Because
It has a brand.
People are still willing to pay.
eight two thousand dollars for a new phone.
There's a lot of competitors.
And I'm not sure.
That that will continue forever at the same rate. In fact, it's already slowing.
And that debt that they've taken on to buy all back all those shares to generate that EPS growth.
That could end up being a problem.
If they instead took their money.
And went out and bought
Businesses.
operating businesses within its network that would ensure its sustainability. And it's been doing some of that, but continually do that.
Imagine if it if it just kept the cash.
And all of a sudden.
The business that it w always wanted to buy suffered a bad quarter.
And he bought it.
It's very difficult when you have a lot of cash, cash is king. Cash is power.
You know
We've been talking and again it goes to one of my rules about
Being negative sounds smart.
When if the market falls.
uh or or suffers some kind of setback.
You shouldn't be concerned.
You shouldn't be
You shouldn't be scared.
In fact, I I did a trip to China.
Uh life changing practically.
earlier this year. I'd never been before.
And um when I went to China
I the if you go in the in the uh and I um met with analysts there and taught them
our training.
Process.
And if you uh when they when they look at their screen
Stocks that are down.

Stocks that are up.
Are red.
That's how you should re jig your

If you look wake up every day and everything's red.
And you like did we lived this in a weight, right? It went lower and you thought, Okay, I'll buy some now and then it went lower.
two early two thousand and then went lower until you don't know what that feels like until you go through it.
But imagine if every day it was green.
You cool.
This is interesting.
And if every day it was going up, it was red, you'd go, Hmm.
I'm not sure. Is this okay? Is everything okay?
It might be.
But it's just everything's a mindset, right?
They talk about
You know
The uh
Uh uh habits, right? Developing habits and that and of course that famous book. I I I love that.
And you know, you w you want to do small things, right? Develop by put your shoes over there so you remember
to put them on there and then put beside the shoes something that you need to shine the shoes right there, but that way you shine them before you leave.
Why do you think so few people
Like everybody talks like Buffett and then a a situation like two thousand and eight comes along.
And people were paralyzed. He had cash. But he wasn't paralyzed. Why could he act and other people
To me it's it's uh
It's it's w goes back to something we've already touched on, and that is the natural
agency issues related with uh money management industry.
My investors.
Give me their money.
So I can make a return.
That is hopefully better.
Then they could make
Investing passively.
If it doesn't end up being that
They decide to take it away from me.
Mm. And then I don't have any money.
Buffett.
has built a business
that generates cash. So he has operating businesses.
Gay Cole.
Pralom, et cetera. These generate cash.
He takes that cash and invests it when he wants to invest it.
in the way that he wants to invest it.
You know, the average portfolio manager can't do that because they're tied to they have to like today in the investment management industry.
Portfolio managers
are measured like on a daily basis. There if you're investing in my funds, you can look right now and see how we're doing versus the index. Every second.
Yeah. Why you down three?
My you know, my partner that started the business with me says, I don't know,'cause there was uh more sellers than buyers today. I don't know.
Any number and and someone that tells you they can
phys know exactly why unless there was some announcement
And even when there was an announcement, it was the interpretation of the announcement that led to the stock price falling, not the announcement itself.
One of the things that we've sort of hit on here without naming it is how important structure is.
to investing. And part of the reason that Berkshire was able to do that and Buffett was able to act is that
Or Buffett's able to do what he's doing today is he controls so much of the shares. So he's got the structure to enable the strategy to play out.
Whereas
If you think about it.
You know, there's many times during a perk.
Brookshires.
a long career where
An investor, an activist investor would have come in
Demanded they return capital.
Demanded they take on debt to buy back shares.
And
the structure that's enabled so much success has also prevented that. I I think about structure a lot in terms of not only being positioned, so having cash and
You know, being the master of your own fate or what did Buffett say, I never want to rely on the kindness of strangers. Yes.
Uh, especially when I need them. Yes. And so like I think about that and I think positioning anybody looks like a genius when they're in a good position and even a smart person looks like an idiot when they're in a bad position. Yeah. And then you think about structure and how that aligns with the companies and what you're trying to do. And you know, like it's
Similar to how I invest. I don't have a fund. I don't have outside investors for I
'Cause I don't like that structure. I don't wanna answer to other people. I don't wanna
And if I want to save up money for three years and do nothing, then I can do that. And if I wanna chuck eighty percent of it into an investment, I can do that. Yes. So the structure enables my style of how I proceed with investing.
And I think that those are very underrated when we think of public companies,'cause you have a time a structure mismatch. So that's the first thing you look at. Yeah is the structure in the control environment. Yeah.
And so you have shareholders who have increasingly, you know, it's gone from years to probably seconds, quarter seconds, whatever you want to call it now.
Uh the average CEO tenure is
It's
Very short. Yeah.
Uh and I I sort of like
maybe the analogy is bad, but I think about this in the context of sports, right? Like if I'm a head coach, I'm going into an O and seventeen team in the NFL.
I'm going to take risks and I'm going to do things that
May or may not work out.
Uh but it's not gonna be status quo.
And I could leave the situation worse than I found it.
Uh, but what I'm not gonna do is just try to make it incrementally better.
I I I think your analogy is fantastic and it's and it's why, you know, I
I I I I played hockey and football in in in my life and uh
I I love hockey. I you know, big huge leaf fan.
And watch uh watch the games and so on.
But I watch more NFL. I will watch teams that I have
Zero interest in watching.
Um and not because of the not because of the betting.
But because
Any it's one game. They only play seven games. There is one semi final game.
And if they lose, they're done.
Yeah.
And their career could be over because the NFL career is so short.
Yeah. And and so whereas in hockey you got seven games.
Like okay guys.
You know, second period, we're down five.
Okay, it's game two. We're good. Okay, like we got this.
Settled down.
Let's get ready. We play in a couple of days.
So what I see happening in these situations is like
the new coach going into the bad team will overspend our free agents.
Yep. Uh they will leverage
The future.
Yeah, put themselves in a bad position salary cap wise in five years. Yep. And it's almost under the assumption that I'm probably not going to be the coach in five years. Yep. But this will make us immediately better. I can show tangible progress. And I have a hope of but I've screwed myself from year five to
A hundred percent. You know, forward. We talked about uh the impact of passive investing.
I would say
That
Passive investing has always been there.
Okay. What I think the more meaningful, important impact on investing today is the power of the retail.
I watched that movie called Stupid Money, was it called?
Uh with Hello Kitty and Oh yeah, yeah. That was great.
Um
That is you know, these are movies they're fantastic.
Yeah.
Because
And the w I love the word fantastic. We haven't yet said it yet, but'cause it's something supernatural. It's something that is both good and bad, and it changed something.
And so what that
really exposed is the power of the retail investor.
Yeah.
And today the retail investor as a component of total investment is the largest it's ever been.
And the other thing that's interesting is that the prevalence
Of
Oh
And how easy it is.
for the retail investor to have just the same information
And maybe even better, I don't know.
But to have access to both.
Technical.
technical looking at charts.
Fundamental.
looking at actual financial information, social media stuff.
access to that in any way that I could get.
Yeah. At very low cost.
So when I started in the industry in nineteen ninety nine
Okay.
And just think of Buffett. He'll tell you the story of he used to read the financial statements and he used to get the chart the old charts and look at them. And no one was doing that.
They weren't paying attention, even even institutional investors. And the retail investor was hardly paying attention. We were just learning on dial up. Oh, I'm and you could trade, but you'd you'd have to call in your trade, right? And wait in line for someone
Or and then it started online, but it was really slow and you didn't get good information and you didn't get great fills. Now you have interactive brokers. That
platform that you get is unbelievable. And all the other all the other com comparatives that are coming up that's empowering that retail investor. So
This is creating a significant
Short term.
Focus.
There are day options.
Okay.
Traded all the time.
Someone told me that in Tesla
There's more transactions on options than there are in dollar value.
on the actual stock. Oh, interesting. The option market is we could do a whole discussion.
on all the subtleties of the stock market that people don't know.
When an option is sold.
Someone has to sell it to them.
Well
That's typically the broker.
The market maker.
Sell that option.
They try to sell it off to somebody else, but if they can't get the other side
Well the then they uh stuck holding it.
Now
Most options expire worthless.
Until they don't.
If something actually happens and the price
rises on the stock and you've bought calls now the broker needs to sell like needs to act to make that money to pay you for that option.
And typically they're gonna start acting on the stock itself.
To hedge themselves.
Mm.
to buy the stock because if your calls are going up and the stock because the stock's going up, well, I want to buy the stock so that I'm hedged as the calls go up. I'm also hedged with the stock price moving. Well that just creates more momentum for the stock price to go higher.
And so
That is that that I think is also
causing big swings. Like you know, we're looking at on a daily basis during earnings season, stocks move
Like it used to be one or two percent. Now we're looking at twenty percent moves in a day. Oracle move twenty percent. That was like on I don't recall the exact number, but that move, though those were valuations of entire companies. It is almost forty percent. So you think about that.
And yet
We're in a period of AI.
Yeah.
There are drones.
Now for Oracle's business drones might not help, but think about Lululemon.
drones looking at at what's being sold, what's being w where traffic is. You're you have access to you can buy access to credit card data. You can get you can talk to suppliers. There's all these expert networks that you can talk to like
of th individuals working in the industry or used to work in the industry, they'll give you all this inside but not inside type information. And so yet all of that is happening and Oracle stock price moves.
Forty percent on news.
And we have access to in better and supposedly better information than we've ever had.
How does that make any sense?
If we had better information, then you know what stock prices on news would hardly move.
Everybody would already have known.
It'd be fully priced down. Correct.
So therein lies the interesting point.
Where
You know, they think that AI
is gonna beat us.
as investors.
I say bring it.
It's all good.
Bring it.
It's just a tool. We're still human. It's a tool. It doesn't have judgment.
It doesn't have the ability to
you know, make decisions on past links.
That
Unless it
Unless that link that it drew. But you don't even know what link it drew. Well, as of today, I guess the the potential is that it
It supersedes individual and collective intelligence.
And so it it gets to a point where it's able to do that.
I guess that's the
Maybe.
Yeah.
We'll see.
Yeah.
That's a great place to end this. We always uh end with the same question, which is uh a life question for you and a personal question, but what is success for you? Success is achieving something that
Uh I can share
With.
those that I love and care about.
My family and my friends.
and my and my employees and and and my customers I I think that's w that's the success, whether it's in sport
It's achieving something that I can share.
Um because if we can't share it.
You know, I I I learned a quote long ago that uh
Happiness can only be shared.
From uh my late pastor priest uh Paul Kusak, we'll give him a shout out. He was awesome. And so if you can achieve something and share it.
Uh, then it then it's real success.
And I think uh
winning has to be something that that is
Everything. It has to be it has to you have to be focused on on achieving something, then nothing else can get in the way.
Big shout out to that book winning.
Uh I'm sure you looked at that book from uh
Tim Tim Grover.
Uh that that's that's such a pivotal
Study.
This is a great way to hand this conversation. Thank you so much, Anthony, for taking the time today.
It's my pleasure, Shane.