Notes & Quotes – Wealthtrack: Greenblatt Talks Investing

“I’ve been teaching for a long time and I would say that my most successful students are the ones who actually enjoy the process of figuring things out.”

―Joel Greenblatt

When I see Joel Greenblatt, for some reason, he reminds me of Benjamin Graham. I don’t really know why, but I guess it’s something in the way he behaves and talks and the wisdom he shares. And I don’t really know Graham himself much and what he looked like and the way he talked. I associate Greenblatt with Graham, let’s just leave it at that since it doesn’t really matter a lot.

Joel Greenblatt visited Consuelo Mack’s Wealthtrack on November 4, 2016. In this Wealthtrack episode discussions range from what makes a good investment, why the price you pay is crucial, return on invested capital, Warren Buffett and more.

Just to say it, my intention was not to go out and transcribe the whole interview. It just happened to be such a great one that I ended up doing it. Listening to Greenblatt when he discusses the different topics thorughout this Wealthtrack episode truly deserves the attention from every investor out there. So I hope you’ll enjoy it. And also, feel free to share it with anybody you think could learn from it.

The Secret to Investing

Consuelo Mack: Grenblatt has also written several books: You Could Be A Stock Market Genius, The Little Book that Beats the Market, The Little Book that Still Beats the Market, and The Big Secret for the Small Investor. I began the interview by asking Greenblatt to distill a lifetime of being a successful value investor. What is the secret?

Joel Greenblatt: If there is any secret I think there is in understanding what you’re doing. And most people don’t think of stocks, they think of them as pieces of paper that bounce around, and you put ratios on them or figure out difficult math problems with them. To us they’re merely owner-shares of businesses that we’re trying to value and buy at a discount. I think the people who are successful at it a) understand that, and b) really enjoy what they’re doing. I’ve been teaching for a long time and I would say that my most successful students are the ones who actually enjoy the process of figuring things out.

Consuelo Mack: So what does value mean to Joel Greenblatt?

Joel Greenblatt: Value means exactly that, figuring out what a business is worth and only buying it when it’s worth a lot less. Ben Graham said: “Figure out what something’s worth. Buy it at a big discount. Leave a large margin of safety between those two.” And that still the key to it. It’s not more complicated than that.

Consuelo Mack: You and your partner Rob Goldstein have devised a ranking system using just two variables. Is that correct? Return on invested capital and earnings yield.

Joel Greenblatt: Rob and I did a research project, and the very first thing we tested were those two concepts. Is it cheap? Does it earn a lot relative to the price we’re paying? And is it in a good business?In other words, does it deploy its capital well? So cheap was Ben Graham. His best student Warren Buffett made one little twist that made him one of the richest people in the world. He said: “If I could buy a good business cheap, even better.”

Consuelo Mack: So not just cheap? But, a good business cheap?

Joel Greenblatt: A good business cheap. And that was Warren Buffett’s little twist that helped him be so successful over time. And, we started out a project to test the concept that I’d been teaching my students, that Rob and I had been using for many years to make money, to see if we could prove those simple concepts worked very well. And the very first test we did of it ended up, I wrote a book about it called The Little Book That Beats The Market because the tests were so phenomenally good. That’s not exactly what we do now, in other words that was done, I would call that the “Not-Trying-Very-Hard-Method.” We used some crude metrics to simulate cheap and good. And those crude metrics worked so well that we said; “Well listen, we roll up your sleeve investors, we tear apart balance sheets, income statements, cash flow statements.” That’s what we do for a living. We’ve been analysing these for a long time. So, can we take these concepts and really and take them to the next level. The simple concepts work amazingly well. And so we sought out on a long project to improve on that. But, the principles are still the same.

jgbooks

Consuelo Mack: If I started tearing up a balance sheet and income statements and if I were looking for… Is my starting point return on invested capital and earnings yield? Is that… That would be my first kind of cut?

Joel Greenblatt: I think my first cut would be cheap. And that would be the earnings yield portions of what you’re talking about.

Consuelo Mack: Right.

Joel Greenblatt: You know I don’t live in Manhattan, but if I did and I had a three bedroom apartment. If it was available for $250,000, take my word for it, it would be a steal. At $50 million it would be ridiculous. The apartment, the quality of the apartment hasn’t changed. It’s the price that determines whether something’s a good investment. So you can’t invest without price.

Consuelo Mack: And the second part, the return on invested capital, that’s the good, whether it’s good or not. Could you explain how you find return on invested capital?

Joel Greenblatt: Sure. Well, the example I gave in my book, the little book, which I really wrote for my kids to explain it. I gave two examples. I said “Think about you building a store.” Well, you have to buy the land, you have to build the store, you have to set up the displays, you have to stock it with inventory. Let’s say all that cost you $400,000. And every year that store spits out $200,000 in profit. That’s a 50% return on tangible capital. Every business needs working capital, every business needs fixed assets. How well does that business convert the working capital and the fixed assets into earnings? Then I gave another example, and remember it’s for my kids. It’s another store and I call that store Broccoli. It’s a store that just sells broccoli. Not a very good idea. But you still have to buy the land, build the store, set up the display, stock with inventory. It’s still gonna cost you roughly $400,000. But because it’s not a very good idea to just sell broccoli in your store, maybe it earns somehow $10,000 a year. That would be a 2.5% return on tangible capital. So I would simply say: “I would like to own the business that could reinvest its money at 50% returns than 2.5% returns.” And if you read through Warren Buffett’s letters he doesn’t use that term return on tangible capital, but that’s what I called it in the book.

Consuelo Mack: Talk to me about your strategy of choosing stocks, specifically for the diversified long-short hedge funds that you are running now.

Joel Greenblatt: Sure. It’s probably disappointingly simple what I’m gonna tell you. But basically we look at the 2,000 largest companies in the U.S. And we rate them from 1 to 2,000 based on their discount to our assessment of value. Stock number one gets the biggest weight in our portfolio. Stock number two gets the second biggest weight. Same on the short-side. The most expensive stock relative to our assessment of value gets the biggest weight on the short side. And the second gets the second biggest weight. We own roughly a little over 300 stocks on the long side, and 300 stocks on the short side.

Consuelo Mack: So there’s 300 in each extreme?

Joel Greenblatt: Yes, they’re not equally weighted but we own over 300 on each side. And so what we have to do is be right on average. And we’re pretty good at average. We’re not always right, but we’re pretty good on average.

Consuelo Mack: And why couldn’t I just duplicate that?

Joel Greenblatt: I wrote another book it begins, it’s called The Big Secret. And it’s still a secret I say cause nobody bought it. So I’ll just tell you what the secret is.

Consuelo Mack: Yes, please do.

Joel Greenblatt: The secret is really patience is in really short supply. I give a few examples in that book, one of them is really telling. I looked at the top performing managers for the decade of 2000 to 2010. I looked at the top quartile managers, the ones who ended up with the best records.

Consuelo Mack: That’s after the tech crash?

Joel Greenblatt: Yes, 2000 to 2010. Inclusive of the tech crash.

Consuelo Mack: The “lost decade” some people call it.

Joel Greenblatt: Right, the market was actually flat during those period. But the top quartile managers, here are there stats. 97% of those who ended up with the best records spent at least three of those ten years in the bottom half of performance. Not a surprise, but it’s almost everyone.

Consuelo Mack: In the same decade?

Joel Greenblatt: In the same decade. 79% of those who ended up with the best ten-year record spent at least three years in the bottom quartile of performance. And here is the stunning statistic. 47% of those who ended up with the best record spent at least three of the ten years in the bottom decile of performance, meaning they were in the bottom ten percent. So you’re pretty sure that none of their clients actually stuck with them to get the good returns. And to beat the market you have to do something little different than the market. You gotta zig and zag a little differently. But clients are not very patient. I also wrote a study about institutional investors. Two actually academic studies, and both studies concluded the same thing. There is only one metric you need to predict the institutional cash flows. And that metric is “How did the fund do last year?” If it did well it gets all the inflows, if it didn’t do well it gets all the outflows.

Consuelo Mack: Where were you during that decade? I mean, did you meet those statistics? Where you… I don’t know, how many years were you in the bottom decile, or bottom ten percent?

Joel Greenblatt: Sure, we did measure it. We had a year, I would say our worst years were 1998 and ’99 during the Internet Bubble.

Consuelo Mack: Sure.

Joel Greenblatt: The market didn’t agree with the way we were valuing companies. And then the market plummeted in 2000, it wasn’t that we became geniuses all of a sudden. We were doing the same things we were doing in 1998-99 when it wasn’t working. And we got paid of in 2000 when the market became more sane.

Consuelo Mack: What are a couple of the cheapest companies right now that you’re holding?

Joel Greenblatt: Well, there’s one called Towers Watson. It’s a cheap company. It really does all kinds of work for companies, keeping track of their employees and everything else. And it’s a very steady business, and now with the health-care reform I think they’re gonna have continued growth going forward. So that’s a nice business. VeriSign registers most of the domain names in the United States.

Consuelo Mack: So that’s another one that’s again one of the cheapest two by your evaluation?

Joel Greenblatt: Sure, it doesn’t have a lot of growth. It’s still growing about 5% a year, but it’s a very steady income, big cash flow generation. So it’s a, you know, good and cheap.

Consuelo Mack: Right. And what’s the turnover in your portfolios these days?

Joel Greenblatt: Well the way it works is that, you know, if we buy the company at the biggest discount to our assessment of value. Here is value and here is price. Companies on the little cheap… if I’m right in what I tell my students, companies are on a little journey towards fair value over time. And as a company moves towards fair value over time, it’s not as cheap as it used to be. It still could be very cheap, but not as cheap. So we’ll sell some of it down and reinvest that cash in companies that are cheaper. So that’s our process. But if you start at the beginning of the year in our long book, we probably have about 45% of the same names at the end of the year. But their allocation in the portfolio may change.

Consuelo Mack: Right. And I’m gonna ask to the flip side of that. So what are some of the most expensive names in that universe of 2,000 companies that you’re looking at?

Joel Greenblatt: Well Twitter is a company that has a lot of users but not a lot of revenue and a lot of cash flow. And you know it’s losing money, so that’s not usually a good thing. You know growth has slowed down so it’ll be curious to see if they could turn that into a good business model. Zynga is a game company that loses lots of money and probably has seen its heyday. So that’s another short that we have. And generally we’re looking for things that are earning very little or losing money and destroying capital as they do it.

Consuelo Mack: What’s wrong with the old-fashioned way of value investing of just going long, of just buying companies that are really cheap and good?

Joel Greenblatt: Sure, there’s nothing wrong with that and for many years we pursued that.

Consuelo Mack: Right.

Joel Greenblatt: I think perhaps part of your question would be: “Why do most people who go out, especially professional mangers to go out to beat the market, fail?” And I think they have very diversified portfolios of companies, and it’s very hard to know in dozens, or 30, 40, 50, 60 companies very well and know them better than other people. So I think the way to go about it, following that kind of strategy, would be much more… at least one of the ways, would be in a much more concentrated strategy, keeping to what you know very very well and those companies are usually far and few between. So usually a handful of companies, and most managers don’t stick to just a handful of companies. It’s to volatile for their investors. They’ll have to underperform a lot of the time, so people don’t really pursue that strategy. But if you’re goal is to beat the market, that’s a good one.

Consuelo Mack: And speaking of running a concentrated portfolio, Gotham Capital the hedge fund that you co-manage with your business partner from 1985 to 1995. It did have a very heavily concentrated portfolio, I mean six to eight names I read somewhere. Why did you take that approach to begin with? Why be that concentrated?

Joel Greenblatt: Right. That’s a great question. And it really goes to the answer I just said. We couldn’t know companies very very well if we had to know 50 of them. We might have to go through 50 or 100 companies to find those six or eight that are at the biggest discount to our assessment value. But what comes with such a concentrated portfolio is that every few years and or two of ideas you wake up and they haven’t worked out, and you might loose 20 or 30 percent of your net worth in those few days. And if you have outside investors they are not too pleased about that. If you’re working with a partner like a have, Rob Goldstein, we understand what we own, we understand that’s it’s just at a bigger discount if we haven’t changed our opinion, and so we’re willing to stick with it. But not many people would. The problem with, I think, giving money to idiosyncratic stock pickers is that I think investors don’t know the logic that really leant behind each investment. All they really have are the numbers, the results.

Consuelo Mack: Right.

Joel Greenblatt: And unfortunately returns in the last 1, 3, or 5 years have very little to do with the next 1, 3, and 5 years. But that’s all people look at, so that they’re giving money to the people who have just performed the best, then they’re taking money from the people who have performed the worst. That’s actually not what’s going on. What you wanna look at is process. Are they evaluating and valuing businesses in a disciplined and effective way?

Consuelo Mack: Is there some Greenblatt golden rule or approach that enables you to invest in this, again it’s a very focused portfolio that got you these 30 or 40 percent annualised returns when you were running Gotham Capital?

Joel Greenblatt: Well sure. I actually wrote a book of war stories, things you looked at, You Could Be A Stock Market Genius. Probably one of the most poorly worded titles ever. But in it I tried to really explain how we go about doing things. So it was a compilation of war stories. And one of the things I said in there was: “If you don’t loose money, most of the other alternatives are good.” So that’s one thing to think of. But mostly the book was about special situations investing. In other words, looking for things that are a little bit of the beaten path, they’re a little complicated, or just a little different then what other people are looking at. Company going through extraordinary changes. Something little odd, something little complicated, something a little different. So I would not say to get those type of returns we had to be the world’s greatest analysts. We just had to look under a few different rocks where other people weren’t looking at the time. But it still all comes down to being able to value a business and buying it at a discount. It’s just that, why not turn the edge in your favour and look at places that other people aren’t.

Consuelo Mack: Do you have a special situation that you’re investing in now? That would exemplify your approach?

Joel Greenblatt: Well frankly, what we’re doing now in a very diversified approach is valuing businesses. And so about six years ago Rob and I my partner, we looked at each other and said… picking, doing an intensive work on just a handful of companies is a full-time job. Covering a whole universe of research universe of stocks, a few thousands of stocks, even with a nice analyst team and a very talented analyst team, is also a full-time job. And we couldn’t do both, and so we decided to go all-in here. And part of it was that it was a little bit different than what we had been doing for several decades. The other part was that there’s a number of ways to make money. One is to be very concentrated in something you know well. And that’s what we had done for a long time. And the other is to be right on average. The benefits of what we’re doing now is that, as I told you before, if… when we owned a stock portfolio of 6 to 8 stocks and two of our investments weren’t going our way, we might wake up and loose 20 or 30 percent of our net worth. Today with a more diversified portfolio our bad days are 20 or 30 basis points of underperformance. And so for most investors, the reason we decided to take outside money in again is our other approach was probably not appropriate for most investors really can’t take the kind of volatility that of that concentrated approach. And the best strategy for most people is the one they can stick with.

Consuelo Mack: Tell me why you and your business partner decided to close the Gotham, the heavily concentrated Gotham Capital fund, and give the money back to investors–the outside investors.

Joel Greenblatt: Sure. We had a great record for 10 years. So we opened up in 1985 and at the end of ’94 we had built up a great ten-year record. And we had done well enough to keep our staff and continued to run our money while returning  outside money. Part of it is that we didn’t wanna peg the principle our way of what we know how to do well. So we as your assets rise, Warren Buffett said; “The fat wallet is the enemy of high investment returns.” And so as you raise more and more money it becomes more difficult to get high returns.

Consuelo Mack: Especially in a very focused portfolio, or?

Joel Greenblatt: Yeah, especially in a very focused portfolio. At least that you have many more alternatives, as you run more and more money, and Buffett runs you know probably a $100 billion or so, you can’t look at a number of the smaller situations that you could before. And even if you could, you couldn’t put a lot of you money, a big percentage of your money in those. So I think we should start in the way of keeping our hurdles pretty low. You know, being able to look at more choices is usually better, and so we wanted to. And it was a very concentrated portfolio. So it was a combination of those things. And we really enjoy what we do.

Consuelo Mack: Explain the long-short strategy, and why you think over the long term that’s better than just being long.

Joel Greenblatt: Sure. Well, if you’re able, when you’re a long and short, long you’re picking the cheapest companies you could find. The ones that are at a discount. The ones you think could give you good returns over time.

Consuelo Mack: You are as a value investor?

Joel Greenblatt: Yes. And on the short side you’re gonna pick expensive companies that you think will come down over time, meaning they are overpriced, and the market will realise that they’re overpriced and come down over time. If you’re good at doing both you have two ways of making money. One on the stocks you like the best, and one on the stocks you like the least. So what we’re trying to construct is something that makes it easier to be a contrarian value investor. Buy things people don’t want, short things that people love to death at the moment. And that’s potentially a volatile market. We’re trying to make it as diversified and easy to take as possible. So it’s always tough to be a contrarian, and we’re trying to make it as painless as possible. It’s not always successful, but that’s the goal.

Consuelo Mack: How do you justify, I guess from a value investor perspective, the fact that you are investing in so many companies? They all can’t be the best. Doesn’t that bother you at all, I mean, you’re dealing now with numbers in supposed to individual companies that you know inside and out?

Joel Greenblatt: Sure. No, it’s a great question. The big picture is we’re excellent on average. We’re not right every time, we’re right most of the time however. And that’s all we need to be when we have 300 names. On average we get it right. And some things are inherently uncertain. A lot has to do with what’s gonna happen in the future. It’s been shown that Wall Street analysts aren’t particularly good at doing that. But when we’re using our metrics of valuation, both cheap and good, on average they work quite well over time.

Consuelo Mack: Last question. The one investment for a long-term investment diversified portfolio, I ask each of our guests what that should be. Obviously none of our guests can recommend their own founds. So what would you have us all own some of in a long-term diversified portfolio?

Joel Greenblatt: Well, number one for tax reasons, ETFs are a great structure meaning you don’t pay taxes until you sell them. So if you bought an ETF, a share in an ETF today and held it for twenty years, when you get dividends you’ll pay taxes on that but you won’t pay any taxes, it’s almost like a retirement account. You don’t pay taxes, if they’re well-structured, until the twenty years ahead when you sell them. I wrote a book saying that market-cap weighted indexes aren’t really the smartest way to go about investing

Consuelo Mack: Because?

Joel Greenblatt: Well, because for market-cap weighting, what that means is that you buy more of the bigger companies. The ones with the higher prices. And if a company is overvalued, what you tend to do is buy more of it because you’re being the ones at the highest prices. If a company is bargain-priced your owning less of it. So it’s really a systematic way to do the wrong thing at every stage. And that cost you about 2% a year. So your alternatives would either go to an equally-weighted index, an equally weighted S&P 500 and those work. And you make plenty of errors and you make them randomly so you get the 2% back, that you make the mistakes with a market-cap index. You could buy a fundamentally weighted index or what I would prefer is a well-structured value index but in form of an ETF so you have the tax advantages. And for most people most funds don’t beat the market over time. So the advice to buy an index, despite what I do for a living, is quite good. Just you should buy the right index.

Consuelo Mack: Joel Greenblatt, thank you so much for joining us from the Gotham Funds. It’s been like taking your class at Columbia Business School. We really appreciate it.

Joel Greenblatt: Thanks so much for having me. Appreciate it.

Links

 

Notes & Quotes – The David Rubenstein Show: Warren Buffett

“Investing is just about assigning yourself the right story.”

—Warren Buffett

David Rubenstein Talks to Warren Buffett

When I got home from work today I found this new episode of the David Rubenstein Show available, this time a talk between David Rubenstein and Warren Buffett.

The interview is about 25 minutes and I spent the time on my back in my bad watching and listening, just having a good time. A spoiler here… There was no talking about Wells Fargo. The subject wasn’t even brought up. I don’t know at what date the interview was recorded, but it’s not unreasonable to believe that the interview was taped before the Wells-Fargo scandal hit the headlines.

Topics discussed range from pinball machines, Harvard Business School, Benjamin Graham, Columbia Business School, Washington Post, Bill Gates, smartphones, computers, and philanthropy, bridge, search among others.

When watching and listening to an interview that I find especially interesting, I’d like to put down in writing the things I enjoyed the most. I do this to share with the readers of this blog, but also to archive it in a place I know I can go back to later on. 

Below you’ll find the parts transcribed by me. Hope you enjoy it.

The Best Business: The Pinball Machine [01:59-02:39]

David Rubenstein: You grew up in Omaha, but then you moved to Washington when your father became a congress man. How did you start you business career in Washington, with various pinball machines or golf businesses?

Warren Buffett: Yeah, I was like that with a couple of businesses going. The best business we had was the pinball machine business, which was the Wilson Coin and operated a machine company, and it was named after the high school me and my partner went to. But, we had our machines in barber shops, and the barbers always wanted to put in the machines with flippers which were just coming in. But those machines cost 350 bucks, whereas an old obsolete machines cost 20 bucks. So, we always told them we’d take it up with Mr. Wilson, this mystical Mr. Wilson. He was one tough guy, I gotta tell you.

Going to College as a Way to Please Dad [02:40-03:05]

David Rubenstein: So, when you graduated from high school you weren’t as interested in the academics, I assume, at that time?

Warren Buffett: I was not interested.

David Rubenstein: And your high school yearbook said he’s likely to be a stock-broker, but he’s very good in math. Why didn’t you go to Wharton? And why didn’t you wanna stay two years there?

Warren Buffett: I didn’t wanna go to college, and… But my dad wanted me to go to college. And we didn’t have SATs then, but he practically would have done the SATs for me. So he… and the truth… I always wanted to please my dad. He was a hero to me and still is.

Working for Benjamin Graham: The Hero [04:55-05:40]

David Rubenstein: You worked for Mr. Graham and his partnership, and how did that work?

Warren Buffett: Well, it was terrific in the sense a was working for my hero. But Ben was going to retire in a couple of years. And, so I was only back there a year and a half. But, every day I was excited about being able to work for him.

David Rubenstein: So, what you were good at where picking stocks according to his formula, which is to look for stocks that were undervalued, now call value investing. Did you realise that he had some principles that were very unique, and is that why you followed his guidance?

Warren Buffett: Well, by the time I went to work for him I probably could have recited the words in his book better than he could. I’d read his books multiple times, and so it was more a question of being inspired by him than it was learning something new from him.

The Reason For the Success [08:12-08:42]

David Rubenstein: What would you say is the reason for your ability to do this? Is it that you study the companies more than anybody else? You’ve stuck to your principles? You were smarter than other people? Or people were just caught up with fads, and you didn’t get caught up with fads? What would you say is the reason for the success?

Warren Buffett: Well, the first two to quite an extent. We bought businesses that we thought were decent businesses at sensible prices and we had good people to run them. But we also bought marketable securities in Berkshire. Over time the emphasis shifted from marketable securities over to buying businesses.

The Railroad [08:42–08:52]

David Rubenstein: What was the theory behind buying a railroad? Cause people thought they were kind of fossils, these businesses.

Warren Buffett: The railroad business had a bad century, the kind of like Chicago Cubs. Everybody has a bad century now and then.

The Washington Post: A Bargain Price [09:01–11:29]

David Rubenstein: Over the years you’ve bought a number of companies and had stakes in companies, one of the ones I know very well is Washington Post. How did that come about?

Warren Buffett: Well, in 1973… the Washington Post Company had gone public in 1971, right about the Pentagon Papers time. But in ’73 the Nixon administration was through Bebe Rebozo who was a pale of Nixon, they were challenging the licenses of two of the four television stations the Post owned. So the stock went from 47 down to 16. Now at 16 there were about five million shares outstanding. So the whole Washington Post company was selling for 80 million dollars, and that included the newspaper, four big TV stations, Newsweek, and some other assets, and no debt to speak of. So, the Washington Post Company which was intrinsically worth four or five hundred million dollars was selling for about eighty million in the market. We bought most of our stock at an equivalent of 100 million in the market. And it was ridiculous, I mean, you had a business that unquestionable worth four or five times what it was selling for. And Nixon wasn’t going to put them out of business.

David Rubenstein: When you’re doing these analyses, then and now. Do you have computers that help you? How do you actually read all materials? And how did you in those days get the materials to read about the Washington Post? How do you do it today?

Warren Buffett: Well, I… pretty much the same way except there’s a few more opportunities now. But I met Bob Woodward back, and he’d just come up with all the presidents men, and all of a sudden at thirty years of age he was becoming quite wealthy, and we had breakfast or lunch over at the Madison Hotel. And he’d say: “What do I do with all this money?” And I said: “Investing is just about assigning yourself the right story.” I said imagine Ben Bradley this morning said to you: “What is this Washington Post Company worth?” What would you do? You’d have to write the story in a month. You’d go out and interview TV and brokers and newspaper brokers, and owners and just try to value each asset. I’d said: “That’s what I do. I’d assign myself the right story.” And it’s nothing more than that. Some stories I can’t write. If you ask me to write a story on whether some glamorous but non-profit business is worth, I don’t know how to write that story. But if you had asked me to write this story about Potoma Electric Power or something like that, I can write a story. And that’s what I’m doing every day. I’m assigning myself a story and then I go out and…

David Rubenstein: So you get the annual reports, and you read them. Just like other people read novels, you read annual reports?

Warren Buffett: That’s right.

David Rubenstein: And then, do you do the calculations in… what things are worth, in your head?

Warren Buffett: Sure.

Computers, Bridge and Search [11:30–11:42]

David Rubenstein: Do you use a computers to help you?

Warren Buffett: No. If you need to carry something out to four decimal places, forget it.

David Rubenstein: Today, do you use a computer today, even?

Warren Buffett: I use it to play bridge, and I use it to go to search… a lot.

The Highlight of Deals [15:25–16:31]

David Rubenstein: What would you say are some of the highlights, the deals that you’re most proud of? Let’s take one that you did recently. The biggest deal you’ve ever done was Precision Castparts, about 47 billion dollars.

Warren Buffett: Yeah, it was between 42 and 43 billion of cash, and then we assumed about four billion of debt.

David Rubenstein: Okay, so how much… for to spend 47 billion, you spent a year studying the company?

Warren Buffett: No.

David Rubenstein: How much time did you spend with the CEO?

Warren Buffett: I met the CEO, I think on July 1, last year. And he happened to be calling on certain shareholders, and one of the fellows in our office had had a position for some time. It was an accident I met him. If I’d been out playing golf or something it never would have happened. When then I liked him. I heard him talk for thirty minutes I then said to the fellow in our office: “Call him tomorrow and say if he would like to receive a cash bid from Berkshire Hathaway. We would supply one, and if he didn’t like to receive one; forget we ever called.”

David Rubenstein: That was it? Did you hire any investment bankers to help with the analysis?

Warren Buffett: No. No.

David Rubenstein: Do you ever hire any investment bankers to help analyse a company?

Warren Buffett: No. Not to help analyse a company.

Acquisitions and Mental Filters [17:41–18:05]

David Rubenstein: Now, people must call you every day and say: “I have a deal for you. It’s perfect.” And how often do any of these deals pan out?

Warren Buffett: They don’t call every day, and we’ve made our criteria fairly clear. So there’s relatively few that call. And when somebody calls I can usually tell within two or three minutes whether a deal is likely to happen or not. There’s just some half a dozen filters, and it either makes it through the filters, or it doesn’t.

Click here to see the whole interview.

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Columbia’s Bruce Greenwald: Are Corporate Profits Sustainable?

Here, an interview with Bruce Greenwald who’s being interviewed by Michael Ricciardi, the CEO and Managing Partner of Mercury Capital Advisors. In this interview Bruce talks about why he doesn’t think that corporate profit margins will be reversing to the historical mean.

Transcription made by me.

Michael Ricciardi: Bruce Greenwald is the professor of economics and finance at Columbia University, the Robert Heilbrunn professor of economics and finance. Bruce has also been recognized across all of Wall Street as the Guru to the Gurus, and so we are delighted that he’s here with us today.

So Carl Icahn has said that what’s going on right now is in effect a replication of what took place in 2007-2008, and in fact the market is about to go off a cliff, and that people are going to find themselves and dramatically worse shape going forward than they did at that point in time. And I want to have you about that?

Bruce Greenwald: Okay, so let’s talk about that in detail. The first thing is that the valuations are actually not as rich as they were in 2007.

Michael Ricciardi: That’s based on PE?

Bruce Greenwald: Yeah. Second thing is that the craziness where nobody thought there was any risk, so that for example in 2007 you could buy credit default swaps on Dubai sovereign debt, the riskiest region in the world dependent on the most unstable commodity in the world, which is oil, for four basis points. Which is 1 in 2,500 years they’re going to go completely under. So that craziness is not in the market. The real issue is the earnings power of these companies. So that if you look at people like Jeremy Grantham who has been now for 9 years doing the Carl Icahn story. Their view is that these earnings levels are not sustainable. And what you’ve seen is that as a share of total U.S. income, corporate profits which pre-1990 were about 8.5 percent are now around 13.5 to 14. So there’s been this huge increase in profits. If that increase in profits is sustainable, and it’s likely to continue, then we may have a flat market for a while, we may not have the kind of increase in prices that we’ve had, but we’re probably not gonna see the kind crash we saw in 2008-2009. Now, I think that profits are gonna stay where they are, and I think that’s the important thing to understand. And then I’ll talk about the downside is that people are gonna have to get used to.

Michael Ricciardi: So, to the extent that profits do stay where they are. Is your expectations that the market will stay in a range?

Bruce Greenwald: I think that’s right. I mean, I think it’s pretty fully valued at these profit levels. It’s not they’re screaming bargains out there. Things fluctuate, and I think for various reasons interest rates are gonna have to go up, and that’s gonna make the comparison to fixed income a much tougher comparison. So it’s not going to be so easy to buy equities on margin and leveraged equities, and you really will.

But let’s talk about what’s really going on with profits. We are in the middle of a transition that’s comparable to what happened in the depression. In the depression what happened is that agriculture died. So, you know the third of the U.S. population that was on the farms had their income fall 80 percent. That what happened then in the depression is all the countries with big agricultural sectors tried to save those sectors by exporting. You had the kind of imbalances that you have now where everybody try to export, nobody wanna import, and the problem was that when you added up overall countries, the surpluses and the deficits have to be zero. So, it was a very long-term problem until the adjustment got made in the course of the Second World War and they got everybody off the farms. What’s happening today is that manufacturing is dying, and everything is going to services.

Michael Ricciardi: U.S. manufacturing?

Bruce Greenwald: Global manufacturing. That’s why the Chinese are going down the tubes, and that’s why the Japanese have gone down the tubes. I don’t know if you remember, but when you got out of business school the Japanese were all the rage. Everybody was studying the Japanese.

Michael Ricciardi: One square foot of property in Tokyo cost, you know, million dollars.

Bruce Greenwald: Million dollars. Everybody was going to be dressed up as Mickey Mouse entertaining Japanese kids at Disney Land. Didn’t happen. And that’s because they concentrated in the sector which is manufacturing, which is just going away. And it’s going away for the same reason that agriculture went away, which is productivity growth is 5-7 percent and demand growth is like 2-3 percent. And so employment is going away, value added is going away. And you see that going on. What that means is that everybody’s trying to save those sectors. Everybody’s trying to export. You have these huge imbalances where the Germans who can control the appreciation of the market now that they’re part of the Euro, where the Japanese who control their currency, where the Chinese who control their currencies. Where they all basically maintain their currencies to maintain exports are exerting extraordinary deflationary pressure on the world. That’s the bad news, and that’s not going away. Nobody is talking about getting rid of manufacturing sectors. On the other hand there’s a good news side to this; everything is going to services. Now, profits come from either fair returns on assets or barriers to entry, which is protected markets. What barriers to entry look like is guys dominating markets and keeping everybody else out, which is economies of scale of various sorts. Whether it’s network effects, whether it’s just fixed cost, or whatever, coupled with enough customer captivity so the guys who wanna enter can’t come in and steal their market share.

Big global markets, which are the manufacturing markets, which are the commodity markets, are very difficult to dominate. The markets that you can dominate are local markets, either in product space, so that if you look at the people in the personal computer industry have made all the money. It’s not the IBM’s and the Apple’s who originally dominated it. It’s the Microsoft’s who did only operating systems. It’s the Intel’s that did only CPU chips. It’s the Oracle, it’s Google and so on. Or in geography, which is how Walmart made all that money. They dominated geographies, they kept other people out, and they made a ton of money. As you move to services you move to local markets. The other thing about these service markets is they’re incredible stable. It’s not like you have a replacement cycle the way you always had with capital goods. Or you have these huge price swings, the way you have with commodities. So you’ve got very stable and safe sources of income increasingly that are not dependent on investing a lot. So actually, the thing that’s going to keep your kids at home to til their 55 years old cause they can’t get jobs which is this transition out of manufacturing…

Michael Ricciardi: This is supposed to be the good news?

Bruce Greenwald: Is really good for companies. So I think in those terms that you’re not gonna see some big reversion to the mean to historical profit levels. So, and because of the stability, I think you’re not gonna see things like the housing market or any other markets that are overextended, and again as I say, you don’t see those levels of no fear in the options markets that you saw in 2007.

Bill Gates on Warren, Bridge, Business Analysis and Tennis

“He was the first person to really ask me about software, and software pricing, and why wasn’t IBM with all of their strength able to overwhelm Microsoft. What was gonna happen in terms of how software would change the world?”

—Bill Gates

David Rubenstein Talks to Bill Gates

This morning I found out about a brand new interview series available via Bloomberg called the David Rubenstein Show. The first episode was broadcast on October 17, 2016, and contains and interview with Bill Gates.

Over at the Bloomberg site the show is described in the following way.

“The David Rubenstein Show: Peer-to-Peer Conversations” explores successful leadership through the personal and professional choices of the most influential people in business. Renowned financier and philanthropist David Rubenstein travels the country talking to leaders to uncover their stories and their path to success. The first episode features Microsoft co-founder Bill Gates. (Source: Bloomberg)

The interview is about 25 minutes and is time well spent. To be honest, there’s not much of news here. But, listening to Bill is usually very interesting. Topics discussed range from Microsoft, Harvard, bridge, Warren Buffett, and philanthropy, among others.

I have transcribed the part of the interview where Bill talks about his relationship and friendship with Warren Buffett. This part starts at about fifteen into the interview and goes on for about 3-4 minutes.

DAVID ROSENSTEIN: When your mother first said: “I’d like you to come and have dinner with me, and Warren Buffett will be here. You should meet him.” You didn’t seem that interested. Why was that?

BILL GATES: Warren, I though was somebody who bought and sold securities which is a very zero-sum thing. That’s not curing disease or cool piece of software. And the idea you know of looking at volume curves, it doesn’t invent anything. So I thought my way of looking at the world, what I wanted to figure out and do to what he looked at, it wouldn’t be much intersection. And that’s why it was so shocking when I met him. He was the first person to really ask me about software, and software pricing, and why wasn’t IBM with all of their strength able to overwhelm Microsoft. What was gonna happen in terms of how software would change the world? And, you know, he let me ask him about why do you invest in certain industries, and why are some banks more profitable than others. Yet, he was clearly a broad systems thinker. And so it started a conversation that has been fun and enriching. You know, an incredible friendship that was completely unexpected.

DAVID ROSENSTEIN: He taught you how to play bridge or did you already know?

BILL GATES: I knew how to play bridge but I hade done it just… our family had done it. And then because it was a chance to spend time with Warren I renewed my bridge skill, at first really poorly. But both golf and bridge were things that we did in our hours that we got to goof off together.

DAVID ROSENSTEIN: You’ve given up on golf?

BILL GATES: Well, Warren gave up on golf a few years ago. So my primary excuse to play golf has gone away, so I’m golfing not much now. Tennis has become my primary sport.

DAVID ROSENSTEIN: Warren Buffett called you one day and said: “By the way, I’m gonna give you most of my money.” Were you surprised when he said he wanted to give you all his money from his wealth to your foundation?

BILL GATES: That was a complete surprise because Warren is the best investor, and he’s built this unbelievable company, and he was giving me advice about all the things I was doing. I was learning so much from him. But his wealth was devoted to a foundation that his wife was in charge of. And so tragically she passed away, and so then he had to think that his initial plan wouldn’t make sense. And much to my surprise he decided that a part of his wealth, a little over 80 percent would come to our foundation. So it was a huge honour, a huge responsibility, and an incredible thing because it let us raise our level of ambition even beyond what we would have done without that. You know, by most definitions, the most generous gift of all time.

Click here to see the whole interview.

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Peter Thiel’s Stanford Lecture Nr. 5: Competition is for Losers

«Escaping competition will give you a monopoly, but even a monopoly is only a great business if it can endure in the future.»

—Peter Thiel, Zero to One

Let’s Go to Class: Peter Thiel on Competition

Click here for slide deck.

A transcript of class nr. 5 is available here.

Also, Blake Master’s notes from the Thiel classes can be found here.

* * * * * * * * * * * * * *

«If I do my job right, this is the last class you’ll ever have to take.» 

—Peter Thiel

Additional Reading

Thornton O’Glove Talks at Google (incl. Slide Deck)

“Anybody who thinks the market is efficient should see a psychologist, they really should.”

—Thornton O’Glove

Quality of Earnings: Background

Background information below from Talks at Google:

In this talk, Thornton covers a wide range of investing topics, including the art of financial deviation analysis, the least complex and best way to invest in the stock market on a long-term basis, and an independent prediction about Berkshire Hathaway’s future and the bonanza that awaits its shareholders.

Thornton O’Glove is the author of “Quality of Earnings: The Investor’s Guide to How Much Money a Company Is Really Making.” His work is amongst the “must reads” by industry icons including Tom Gardener of the Motley Fool, and on Kuppy’s Book List as one of the top financial accounting books of all time. Thornton holds an MBA from Haas Business School at UC Berkeley. An investor from the age of 18, he went on to work as an analyst for some of the top investment firms in New York and became the President of the Reporting Research Corporation, who publish the Quality of Earnings Report. His work continues to influence students of finance and professionals around the world. Thornton is also an occasional commentator for the Motley Fool Blog Network and Barron’s Weekly.

Quality of Earnings: Slide Deck
Thornton O Glove Talks at Google
Quality of Earnings: YouTube Video

Hewitt Heiserman Talks at Google

Talks at Google Hewitt Heiserman authored “It’s Earnings That Count” and is finishing his second book, “The Checklist Investor”. He is a member of the Boston Security Analyst Society and CFA Institute. He has written for several investing publications. He graduated from Kenyon College and received the Faculty Award for Distinguished Achievement. He is an Ironman finisher, and is active in open land preservation.

In this Google Talk Mr. Heiserman talks, among other things, about how he thinks about business analysis, earnings, free cash flow and his growth investor’s checklist (see image below).

HH_slide1

The slides to pair with this talk can be found at: https://goo.gl/kg1BtL