Learning From Chris Bloomstran

Whilst I’m a long-time avid follower of all of the Investment Masters, and I have to say a veritable devourer of their collected wisdom, there is nothing more valuable to me as an investor than actually speaking with these amazing people. Whether it’s a meeting at Berkshire, the odd telephone dialogue or even an interview, all of these interactions deepen my understanding of their unique views on financial and business matters and for that matter, the investment world.

Recently I had a wonderful opportunity to Interview Chris Bloomstran of Semper Augustus. Chris is a veteran of the Investment Fraternity and a recognised Master; The stocks in his portfolio have compounded at 4.7% above the S&P 500 since launching Semper Augustus more than 20 years ago. I’ve always valued what he has to say and our interview was no exception.

We covered many topics in the few hours in which we spoke, and I am incredibly grateful to Chris for being so open in sharing his knowledge and experience. I have collected the gems from our interview below.

Eclectic Value Investor

“For lack of a better nomenclature you’d put us into the value camp. Value is such a broad brush definition. We simply think of growth as part of the value equation. Growth is important. We are pretty eclectic in our process. We own compounders and we also own some out of favor, high-quality cyclicals; we’ll do the long side of merger-arb here and there. You can’t put us in a style box and I think that’s a big advantage.”

Dual Margin of Safety

“We are trying to find outstanding businesses at low prices to give us a dual margin of safety.”

Investment Time Horizon

“Having invested for 20 years at Semper Augustus and run money for thirty years, our process is very eclectic. We have businesses, such as Berkshire Hathaway, that we’ve owned since early 2000. For the duration of our owning it its been undervalued and it’s become an outsized position in a lot of our accounts. We’ve only sold it when mandate or need for diversification compels a sale. We’ve owned Mercury General and Washington Federal even longer, for the better part of twenty years, and have a history trimming companies like this when they’re rich and adding to the positions when they are cheap. We’ve owned things cyclically where we don’t have a long term horizon such as deep water drilling businesses. Today we own Subsea 7. It’s an engineering and construction company in Norway. We’ve also done things very opportunistically.”

Arbitrage Opportunity

“In 2008 we built a big position in the electrical utility Constellation Energy when it was to be acquired by Berkshire Hathaway. Although we ordinarily don’t like electrical utilities because of mediocre regulated returns, no pricing power and limited growth, we know how to price them. Generally they trade rich because investors are attracted to the dividend yield, which usually consists of most of profits. To us, Constellation was an attractive arbitrage opportunity and we traded the position actively as news broke again and again.

Berkshire offered to buy the business for $26.50 to keep Constellation out of bankruptcy. To effect the deal, Berkshire had to put in a billion dollars to shore up the derivative book of a merchant business Constellation owned in Texas. We had a bit of cash and the market volatility meant an attractive deal spread. EDF, who had a JV with Constellation to develop nuclear plants, ultimately made a counteroffer at $37 and Constellation accepted. As EDF was more of an unknown in the middle of the financial crisis, Constellation’s stock price tanked when Berkshire announced they were out. The stock dropped from $24 to $21 to $19 to $17 then $15 and we bought it at every one of those points except the last, when our final limit didn’t fill. It all happened fast. By the end of 2008 it was our second largest holding. We stayed in it until near the close, actually EDF bought the nuclear assets and the utility was ultimately sold to Exelon in Chicago. We exited in the mid $30’s.”

Position Size

The businesses at the top of my portfolio are not necessarily going to be the ones that perform the best over the long term but are the ones I know will perform. Generally we’ll start with a 1% or 2% position size. Then as we continue doing our homework, absent some underlying business deterioration, we prefer stock prices to decline which gives us a chance to add to the position size.”

Dealing With Market Turmoil

Being in the investment business for thirty years and knowing the businesses we own so well, is the best edge to deal with market turmoil. Because we have an anchor in the appraisals of the businesses we own and follow and we’ve done our homework - made accounting adjustments, drilled down to economic earning power and management quality - we don’t have to do a lot of work when price gives us an opportunity. For that reason, we are very non-emotional in times of stress.”

High Quality Companies

Sustainable returns on equity aligned with very high quality management teams running the businesses is how we define high quality companies. It’s taken a very long time for us to get to that. Leverage is anathema to our thinking. We are running a very unlevered portfolio in terms of the collective balance sheets of the assets we own. Cash largely offsets debt now. Our returns on capital are not far off the underlying returns on equity of the businesses.”

No DCF’s

We don’t run DCF’s. We think long and hard about the inputs [of a DCF] but we think the model lends itself to assumptions where you can get some crazy results.”

Owning Berkshire

“We’ve bought and still buy Berkshire at 15-20% position size, and it’s grown to 35% in some of our taxable accounts. BRK is unique to us and it’s the only business we would concentrate in that kind of size. We almost use BRK as a bond surrogate, really as our opportunity cost of capital, given a very predictable 10% ROE, which in a worst case could be an 8% ROE. To us, it’s a highly predictable, highly knowable business so for that we are willing to own BRK as a lower return business relative to the balance of the portfolio. It’s the most knowable thing we own. At a 10% unlevered ROE its undervalued by a lot, and if it trades closer to intrinsic we’ll earn something north of 10. If it earns 8 (ROE) for the next 10 or 15 years it’s fairly valued and we’ll likely earn 8.”

Company Issues Provide Opportunity

Investment Master - Chris Bloomstran

Investment Master - Chris Bloomstran

Usually company specific issues provide opportunities. My experience has been that when the whole market sells off and everything gets cheap, it’s hard to want to make changes because we already like what we own. We’ve also proven unwilling to trade down the quality spectrum during a rout like ‘08, even though you’re going to make way more during the recovery. That won’t change.”

Portfolio Turnover

“We’ve had on average about 15% turnover for the last 20 years. Our turnover in 2008 was probably 70%. We had about half of our capital in financials at the end of 2007 which included insurers. None of our holdings failed. In fact, some were rewarded for their conservatism with failed assets more or less given to them at fire sale prices.”

Thinking About Management

We have learned to think a lot more and spend a lot more time assessing management quality. We are spending a lot more time in the proxy statement than we used to. In our portfolio we only have about 20% of our businesses profits coming back to us in dividends which means management teams are retaining 80% of the profits. It is incumbent on us to work out how those people allocate capital. There are so many levers management can pull and we are very deliberate in assessing how well capital gets invested in the businesses we own.”

The Proxy Statement

We are spending more time with proxy statements. We try and tie in year to year changes. What we’ve learned by looking at the evolution of proxies over a period of ten or more years, by observing how compensation committees award and incentivise management, is that you can really ferret out underlying changes in the business.

As an example, General Mills’ bonus structure is tied to two yardsticks, none of which are capital related. One is organic sales growth and the other is free cash flow growth. Ten years ago they were using 3-4% organic sales growth as the hurdle for paying half the bonus. Over time that became 3%, then 2%, then 1.4% and in the last couple of years the hurdle has become negative. Think about that! Rev up the acquisition machine. Buy Blue Buffalo. You don’t count a deal in year one but if its a growing business you sure get your organic growth in the out years, regardless of profitability.

Many consumer packaged goods businesses are under-investing in their business and it’s evident in the free cash flow. It’s pretty easy to dial up free cash flow growth by cutting advertising and growth initiatives. I guarantee these people lay awake at night thinking about how to get supremely wealthy in the next five years and not how they are going to grow or protect the business over the next thirty years. If you don’t have a motivation to make decisions based on returns on assets or capital or equity you can get all kinds of nutso behavior. You might as well take a giant pile of money and light it on fire.”

The Macro

I wish we didn’t have to think about macro. We spend almost all of our time turning over rocks and looking at businesses, but, in my investing lifetime, we’ve seen aggregate debt levels systemically rise to levels we think are unsustainable. And that does enter our thinking. With on-balance sheet debt alone now at 350% of US GDP and 320% of global GDP, we don’t have room for a term structure of interest rates even remotely similar to where it was prior to the financial crisis. The days of 5-7% interest rates don’t work when debt is 350% of GDP.

The notion that debt levels are unsustainable and we are unlikely to grow our way out of what we think is excess leverage, lends to our thinking that interest rates will probably stay far lower for far longer than would be the case in a more normal, unlevered society. For that, you do allow for higher multiples somewhat than would have been the case historically. By contrast, we also think because the debt numbers are unsustainable we very much worry about long term stability in the financial system. The flip side of low rates driving higher multiples is that low rates are reflective of too much debt which goes hand in hand with disallowing growth. Therefore you can’t justify multiples that purely reflect low rates. Paying high prices for no growth won’t work out. Look at Japan for the past 30 years. We have small positions in two gold companies which are really just hedges against central banks doing bad things. Combined they are a mid to high single digit exposure.”

Anchoring - Mistakes of Commission

“Our single biggest error of commission was Ross Stores. We bought the position when small caps were cheap in 2000 for less than 10x earnings and 50% of sales. We loved the business and we loved the unit economics. We bought it as such a discount that during the 2000-2002 downturn which saw the S&P fall 50% we made about two and a half times our money over that period. When it traded for something like 20x we thought we could sell it at what looked like a full valuation and ease back into the shares at some point when valuations were a lot more attractive. I was probably anchored to having bought the stock at 10x earnings. It never traded at 10x again. It traded in the mid teens. After we sold the stock, it went on to be another twenty bagger. A gravely expensive mistake.”

Costco & Growth

“I learnt a lot about the growth component of the value equation by watching Ross Stores. A couple of years after we sold Ross we bought Costco, which has provided an invaluable education about how capital really works. Costco is the same deal as Ross Stores. We love the unit economics, we love the management. Costco had a similar number of stores to Ross when we first bought it. They’d just started paying a dividend. We bought Costco when their gross margin was about 14% and they were earning 11% on capital. We understood, having followed high quality businesses like Walgreens, Walmart and Home Depot for a lot of years, the embedded unit economics of Costco where lots of stores that have been opened recently and don’t reach maturity for six or seven years. Therefore the 11% return on capital was very much understated by the relative installed base compared to new stores that had been opened.

I paid 20x earnings. I was still a classic value guy and value guys don’t pay 20x for things. Fast forward today and Costco trades for over 30x, so you’ve made over 50% on the multiple expansion, but we’ve made over 10x our money on Costco because they’ve grown the store base profitably.

The gross margin has been driven down by from 14% to 11%. Wall Street typically kills a company for shaving gross margin, however Costco has taken the scale and purchasing power of the business and they’ve passed their cost savings through to their customers. Returns on capital have gravitated upward towards to the high teens or higher if you account for the cut in tax rates [Costco will likely be one of the first companies to compete away the tax cuts]. Our returns over owning the business for a long time have gravitated toward the underlying return on capital of the business.”

Most Valuable Lesson

I look at the amount of money we made on Costco and we could have paid 35-40x earnings at the time. Everything they do as a retailer is best in class. You just can’t get anchored to classic valuation pricing methods even if you call yourself a value investor. This is probably the most valuable thing I’ve learned. The extension of that is, if you own a business that really is a true genuine compounder where you have a ramp to grow and particularly for re-investment at high rates of return, don’t sell it, and definitely don’t sell it all. I get cute with a lot of other things that aren’t your classic compounders but any time I’ve sold shares in one of the handful of businesses that I think we can own forever it has proven to be a mistake. ”

When Compounders Mature

The durability of compounders is really only obvious in arrears. There are very few that are knowable. The risk is when you own a compounder and it matures and starts to face its own competition. Walmart for example, having killed retailers in small towns started facing competition. First from Costco and the like and then internet retailing. Look at Coke for the last 20 years. The core business weakened at the same time it traded for a nosebleed valuation that was awarded because of a glorious past.”

Price Matters

A great business at the wrong price can be a disaster.

Long Term Focus

We have stocks that have some common threads. They have all suffered in one form or another. We’ve been able to look through the short term suffering which is just that, it’s short term. Richemont is a great example. We’ve owned it for a handful of years. Richemont owns Cartier and Van Cleef & Arpels in jewelry. They have ten or so very high end watch brands including Vacheron Constantin, IWC and Jaeger-LeCoultre. Then they own some one-off brands like Peter Millar and Purdey shotguns. The Ruperts, the family that founded the firm had South African tobacco holdings which they sold to BAT probably 30 years ago. Within a holding company structure, they started buying up luxury brands. They’ve done a marvellous job preserving the brands and building them out and growing them intelligently.

Richemont’s watch business, when you count watches sold by Cartier, comprise about half the revenue, experienced a huge growth curve on the back of Asian demand. Richemont grew their distribution by using the store inside a store concept. Retail outlets were located in the best zip codes in Hong Kong, Macau and the rest of the high end world. A few years ago two things happened - the Chinese cracked down on graft and travel visas which really put a dent in high-end watch sales. It gave us the opportunity to buy the stock.

We watched how the CEO, Mr Johann Rupert and the management thought about the long-term viability of the brands they own. Mr Rupert talks about being a temporary steward of Vacheron which was founded in 1855. When sales declined, management recognised an excess of inventory in the retail partner channel. The first thing retailers do when sales slow and they have excess inventory is mark it down. The last thing you want to see happen if your customer just paid $20,000 for a watch is to see it sell six months later on on the grey market for $15,000. Richemont approached their retail partners and bought back a whole bunch of inventory and in some cases physically melted down the precious metal content of the watches.

Richemont is a 65% gross margin manufacturer. Initially I presumed the value of a $20,000 or $200,000 watch was largely in the precious metal or jewel content. Far from it. The higher up the price point, the higher the gross margin. On a $200,000 watch the gross margin can be ninety percent plus. It’s the brand. So to preserve brand they destroyed watches.

They also didn’t want to be in a situation where retail partners could kill the brands so they built out more of their own distribution. They spent a lot of money building out their own bricks and mortar. They sacrificed operating margins for the durability of the brand. The watch business is a good business but will likely only grow 4-6% organically, above nominal GDP, but it’s the fashion jewellery business where the upside lies. Fashion jewellery is very early, it’s maybe 10% of all the jewellery sold and there is a long curve to teach wealthy families about the appeal of high end jewellery lines. Once you’re into a line you’re kind of hooked on it. They’ve now fully bought into the internet. Control of distribution is a common theme across several names in our portfolio.”

Disruption & Change

Disruption is happening at a much faster pace which makes investing that much harder. What looked to be a durable brand or franchise can get dislocated in a hurry. Things like cutting out wholesalers and middlemen and going direct to consumers, I think we are in the early innings of it.”

“If you get fundamental change on a compounder and you bought it at a high price, the combination of the fundamentals deteriorating and then the multiple revaluation downward can be lethal.”


There are reasons we will stop the investment process. We start with either unknowability of industries or industries we don’t like because the economics don’t work for us. They would be the easiest decisions (e.g. Electric utilities without growth and the complexity of pharmaceuticals).

When I think back to the branded pharma companies we’ve owned, despite making a bunch of money, we really didn’t know what we were doing. It’s the unknowability. We’re not scientists and I’m not sure the scientists inside those companies know what’s going to go through the FDA or the EMEA. We don’t have an edge. Being lucky is not a replacement for understanding.”

Business Fundamentals

“Once we get past knowability, it’s onto the blocking and tackling which is the business fundamentals, management quality and how they’re compensated, price & volume, the durability of product lines and all the myriad accounting adjustments we make.

If we have an edge it’s adjusting every business’ GAAP numbers. Most businesses overstate what they earn. We are very good at getting to economic earnings from GAAP or IFRS which is just the starting point.”

Waiting for Price

“We’ve built a working list over the years of c450 companies that we track peripherally. We try and update our thinking on them through the course of the year. We maintain a rough intrinsic value target. When we get a stock trading south of that number we might get interested. It’s a function of sitting around and waiting for price. In the meantime thinking about where you are wrong on the valuation or the fundamentals. Price is then kind of the last thing we look at. When we have done work for 20 years on a business and the price now makes sense it’s very easy for us to put 1-2% to work. To the extent we’ll have to do more work we’ll do it. If we get comfortable we’ll make the position size even larger.”

Circle of Competence

“I would tell my younger self, ‘your circle of competence is way more narrow than you think it is’.”

Independence of Thought

From a psychological perspective, you need independence of thought, but not to a fault. You need an understanding that the crowd at the extremes is wrong, but for a long time they can be right.”

Client Alignment

Client expectations are never aligned. Clients expect results and if you’re not racing ahead when markets are, nobody likes to get richer slower. We spend a fair amount of time with process over the years, and telling the same story. It still doesn’t make it any easier. Human nature doesn’t make it any easier. Most people wrongly view the stock market as a casino, and it’s not. It’s a joy and refreshing to find clients who get it, who think about the long term, that are realistic about expected returns and think about what can go wrong and right. It makes way more sense to focus on long-term business performance and not short-term stock price performance, but that’s really hard for most people. It’s easy to see the stock price. You have to work to understand the business.”

Free Cash Flow

We’re looking for businesses that have an opportunity to invest and build out capacity. We are looking for retail concepts that can grow units over time on an accretive basis and expand returns on capital. Can I build a plant or distribution facility and earn high returns on the investment? Free cash flow in that setting is a terrible concept. It’s a great yardstick if you are in a business that is mature and isn’t going to grow. There are all kinds of flaws with various pricing metrics. It would be easier if maintenance capex was a disclosed number. It’s not. So you’ve got to talk to management and get a sense of what it really takes to replace your capital stock.”

Listen to Transcripts

“We read the transcripts but we might also listen to the transcript to see the nuances, to hear how something is said. The value might be in the Q&A and listening to what was asked and how management has answered the questions.”

Value Line vs Broker Research

We read and see very little sell side research. We do read Value Line, both the large cap and the small and mid cap editions every week. It allows me to cover the gamut of a lot of companies and industries very efficiently. Thirteen editions. It’s not in-depth but you see each company and industry four times per year.”

Questioning Management

We don’t want to talk to management about quarterly earnings. We are trying to get to the durability of the business franchise. I want to understand why an insurance company can raise prices by 6.9% but not 7%. That answer is meaningful for me. It’s not something discussed in a SEC filing. But there’s value in knowing that stuff.”


Chris also suggested some book titles he has read and recommended to others. These include: Sol Price, Merger Masters by Kate Welling, Economics in One Lesson, Freedom’s Forge, The Forgotten Man, Shoe Dog, Railroader, and The Bare Essentials. He gives copies of The Richest Man in Babylon and The Intelligent Investor to lots of students. All of these tomes include fascinating and valuable insights into both business and investment worlds.

Chris is a Master. Even with more than twenty years of my own in investing, Chris still manages to teach me things that add value to my own thinking. He is humble and was very generous with his time, and I am grateful for the opportunity to have spoken with him.

Further Reading:
Chris Bloomstran: The New Super Investors - Investment Masters Class
Chris Bloomstran - Annual Letter [Part II] - Investment Masters Class
Chris Bloomstran – What Makes a Quality Company – Invest Like the Best - Podcast

Semper Augustus - Investor Letters

Join our Investing Community for daily insights on Twitter: @mastersinvest


Learning From Chuck Akre

One of the traits that sets the Great Investors apart is the ability to be grounded - to remain calm under pressure and sensible when things get hairy. All the Masters have it but none more so than Chuck Akre.

Grounded: Mentally and emotionally stable, admirably sensible, realistic, and unpretentious.

And ‘Grounded’ quite possibly is the perfect word to describe Chuck. If you’ve been an active reader of our blog over the last few years, I’m sure you’ll remember our post on Chuck Akre and his Three Legged Stool. Like Buffett, he prefers to work away from the noise of Wall Street. His office is based in a small Virginian town that boasts a single traffic light. His humility and expertise are synonymous with those we call Master Investors and Chuck has been kind enough to give of his time to us on a number of occasions. He is someone we follow avidly.

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Chuck was recently interviewed on one of our favourite Podcast series: ‘Invest Like the Best’ with Patrick O’Shaughnessy. O’Shaughnessy typically has a great line up and as usual, he delivered big time on his recent talk with Chuck. Chuck’s explanations and investment approach are refreshing in their simplicity. Over more than fifty years of investing experience, Chuck has distilled the essence of great investing into three key criteria which he refers to as his ‘Three Legged Stool’. And while Chuck might be reluctant to disclose insights into his favourite stock positions, he does share a key insight in the Podcast which took him decades to appreciate. The podcast gets to the core of what great investing is all about. The Podcast is replete with pearls of wisdom and anecdotes, all straight from the legend’s mouth. It’s the perfect mental detox to remove the daily noise we get caught up in as investors.

Following are some of our favourite quotes from the Podcast:


I spend a lot of time reading. That’s how ideas bubble up in my universe. Mostly it is a serendipitous, non-quantitative approach.

Imagination & Curiosity

“In my career I’ve literally run across thousands of people who were very very bright, but not necessarily good investors. Pure knowledge, in and of itself, is not a ticket to being a good investor. Imagination and curiosity are what’s hugely important. We’ve discovered things over the years purely by being curious and continuing to keep involved in the search process to find these exceptional businesses.”

“I find that curiosity has been useful to me in searching for investments. Relating real life experiences allows me to pursue lines of thought to find a stock that might be interesting.”

Curiosity and imagination go hand in hand in being creative and identifying businesses.”

Education & Smarts

“I had no background whatsoever in the business world; I was an English major and I’d been a pre-med student and had no courses in business whatsoever. So I had a clean canvas and a willingness and a desire to learn and so my voyage was: ‘What makes a good investor, what makes a good investment?’”

Stocks Outperform Long Term

“I examined early on, and continue to do so, rates of return in all asset categories and made the observation that rates of return in common stocks over a long period of time was higher than anything else on an unlevered basis.”

Compound Returns

“Thomas Phelps, wrote the book, ‘100 to 1 in the stock market’ in 1972, and to this day it remains inspirational to me and fundamental to me in terms of thinking about the issue of compound returns.”

Return on Equity

A return in an asset will approximate the ROE [FCF return on owners capital] given a constant valuation and given the absence of any distributions. You get that from your quantitative background. There are no constant valuations so you work hard to have a modest starting valuation.

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If our goal is to have above average outcomes we need businesses to have above average returns."

“We try to identify businesses that have had high returns on the owner’s capital for a long time and we spend a lot of time trying to figure out why that’s so and what caused that. What’s does the runway ahead of them look like? Is it broad and long? Do they still have the opportunity to earn above average returns on capital?”

“Rate of return is what drives us. Did I understand that implicitly thirty years ago or fifty years ago? No! Stuff that is right in front of your face sometimes doesn’t reveal itself in terms of its importance for a long time. I carry a coin in my pocket that says, ‘I am a chartered member of the slow learners’. And that’s in fact the case.”

‘Three Legged Stool’


“Leg one [of the three-legged stool approach to investing] is the quality of the business enterprise. Leg two is the quality and integrity of the people who run the business and the third leg is, what is their record of reinvestment and what is their opportunity for re-investment? Once we have those in place, we say we’re just not willing to pay very much for these businesses. Those are the three legs of the stool.”

Disclosing Positions

We try not to talk very much about the companies in our portfolio and we certainly never talk about ones that are coming in and going out.”

In March of 2010, Chuck added their first position to MasterCard. Due to regulatory concerns, MasterCard and Visa were selling at 10 or 11 times. In regards to return on capital, Chuck noted “there isn’t a word in the English language superlative enough to talk about them. You could cut the margins in half twice and you’d still be above average for an American business. So clearly something extraordinary is going on there. It also tells you there is a big target on their back; everybody wants some of that. It tells you they are probably jamming everything they can in the income statement to try to reduce how good the margin is they are showing. We think we know what causes that and we’ve quit talking about it. If you read any research from Wall Street, and we read very little, there is no-one who talks about rates of return they are earning on their capital. Because Wall Street, in general has a completely different business model than we have. Our business model is to compound our capital. Wall Street’s business model, generically, is to create transactions. What is the best way to create transactions? Create false expectations, they are earnings estimates. We call it ‘beat by a penny and miss by a penny’. That gives us opportunities periodically.”

Keep it Simple

Everything should be made as simple as possible. Lots of very bright people can build really intriguing complicated ways to find out why something is cheap or expensive. We try to keep things as simple as possible.”


“[The managers we have owned] don’t have a screen in their office showing them the price of their stock. And lots of them do. Sometimes you find it in the lobby of a company and sometimes you find it on the CEO’s desk. That doesn’t interest us. Their focus is on the wrong thing, in our judgement.”

“We have an expression, ‘Our experience is that once a guy sticks his hand in your pocket, he’ll do it again’. So we just have no reason to go there. We constantly find people’s behaviour which is antithetical to our interests.”


“We explore, we learn and we observe; we think a lot about the businesses we have sold. Was that the right decision? We’ve concluded in a number of cases is was not. But who does it perfectly?”

Right Once or Twice + Long Runway

“Here’s an important notion: You only need to be right in your investment decisions once or twice in a career. The challenge is how do you identify that? Typically you want something that’s small.”

Collect Data, Form Judgements

“A pre-med major, an English major, someone involved in the investment business - they’re all the same. They are about collecting data points and forming judgements around them. It’s all the same.”

Not Selling Exceptional Businesses

If we own exceptional businesses, one of the hardest things in the world is to not sell them. All businesses have hiccups in their business operations and all businesses have things occur that are unplanned for. Nothing is perfect. Not selling maybe is one of the hardest things to do. Maybe one of our greatest assets is our ability to not sell.”

Read Biographies

Reading business biographies you learn about people’s behaviour. Sometimes you see it through the eyes of a biographer who has a rose tint to the glasses, sometimes you see it through pure actions.”

Career Advice

Follow your passion. That’s the most important thing. And read like crazy and be curious about everything. It’s relating real life experiences.”

Pricing Power

I’m always looking for ways to understand pricing power because pricing power is key. What is the source of their pricing power? Think about MasterCard and Visa; we have our notions and we don’t talk about it anymore. And you’ll notice the company never talks about it.”

It’s Not all Quantitative

If this business was susceptible to purely quantitative approach, they wouldn’t need me and you would just a punch a button and it would solve for all your problems. That hasn’t happened.”

A Question for CEO’s

“One of the questions we like to ask [the CEO particularly] is, how do you measure if you’ve been a success managing this business? As you might expect some say the price of the stocks goes up, or we hit our earnings target, or we delivered on all the things the board asked of us. It’s a rare occasion that the CEO articulates an idea that shows he understands the idea of compounding the economic value per share. Why is that so? Because they’re trained to run businesses. They’re not trained to think about compounding the intrinsic value per share, which is really the single most important thing.”


Whilst Chuck has continued to out perform the Index for many years, it is interesting to note that his recent above average performance has been done entirely without any of the FAANGS. Many of the Masters cannot say the same; the likes of Google and Apple and Amazon feature in many of their portfolios. Chuck says it was simply because he ‘wasn’t smart enough or quick enough to figure them out.’ Humility indeed. But that said, it doesn’t say he’s not open to considering them.

Everyday is a learning day and we have to figure out which of those businesses [FAANGS], if any of them are truly attractive, and not subject to rapid changes in technology or governmental intervention or retaliatory issues relating to different countries in different parts of the world.”

Curiosity and Reciprocation

Chuck tells the story of how curiosity, observation and imagination led him to a tyre company with a history of very high returns on capital, a company called ‘Bandag’, which had done well for a long period of time. Chuck arranged a meeting with the company and when he walked into the CEO’s office, the CEO had his feet up on the desk and was eating an apple … “we got a different feel right off the bat,” Chuck noted.

Bandag’s returns were three or four times the competitors. Chuck’s goal was to go meet them and figure out what business they were actually in. Bandag was a tyre company that dealt with independent tyre dealers who retreaded Bus and Truck tyres. Bandag had taken the savings generated when key input costs fell and distributed the windfall to their dealers on the basis the dealers had to use the money in their business, ‘They couldn’t buy new Cadillacs, but they could buy a new store.’

As all the Bandag stores were franchised, each was an independent dealer who worked long hours compared to the competition. In contrast, employee dealers had no share in the profits and worked shorter hours. Bandag very wisely shared the wealth with their dealers instead of passing it all onto their shareholders. As a result they built a huge loyalty network of independent dealers, who continued to use the Bandag products instead of the national tyre companies. This resulted in much higher returns on capital than other tyre companies.


Just like successful athletes develop strategies to mentally prepare for the emotional rigour of a race or big game, investors can do the same. I find setting aside some time early in the day to re-visit insights from the great investors, be it Akre, Munger, Buffett, Lynch or others, keeps me grounded and mentally prepared for when volatility strikes.

Chuck’s ‘Three Legged Stool’ criteria for identifying great investments is beautiful in its simplicity. His lessons and mental models on other aspects of business and finance are incredibly handy to have at your disposal.

You don’t have to have a major in business to succeed, nor it seems do you need to be the quickest of the mark. It’s Chuck’s innate curiosity and imagination that have allowed him to spot great companies that quite often others have missed. We’re glad to have him in our community of Master Investors and we look forward to many more inspiring lessons.

Berkshire Meeting: Omaha 2019

Berkshire Meeting: Omaha 2019

Source: Invest Like the Best’ Podcast. Chuck Akre interview with Patrick O’Shaugnessy. 2019. Apple Podcasts.

Further Reading: Chuck’s Three Legged Stool’, Investment Masters Class.

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Guesses & Forecasts

If successful investing was as easy as acting on the headlines of the financial press or the latest stockbroker bulletin, we’d all be wealthy indeed. Very wealthy and very successful. Imagine how easy it would be to simply read headlines such as: ‘USD to rise’, ‘Gold to Break $2,000’, ‘Stock Market Crash Imminent’, ‘Company XYZ a BUY, Price Target $152’, and then upon taking action, turn those forecasts into success. Every single time. Sound too good to be true?

Unfortunately it is.

Forecasting is an art, not a science and as such, its incredibly hard to be accurate 100% of the time. Actually, when you think about it, its hard to be right even part of the time. Forecasting, at best, is just a considered guess, and when you look at the actual definitions of those two words, you’ll see there’s actually not much difference:

Forecast: “predict or estimate (a future event or trend)”.

Guess: estimate or conclude (something) without sufficient information to be sure of being correct.”

In the end, they’re both estimates, yet we’re often led to believe that the person making the estimate must have some foresight we don’t. Unfortunately the truth is, ordinarily they don’t.

If investors demanded those publishing the forecasts to include their track record, life would be much simpler. I’m not suggesting forecasting is easy, but the confidence and precision portrayed by so-called experts reminds me of the charlatans who peddled their ‘miracle cures’ before medicine became a science.

“We always read ‘I think the stock market's going to go up.’ We never read ‘I think the stock market’s going up, (and 8 out of my last 30 predictions were right) or ‘I think the stock market's going to go up (and by the way I said the same thing last year and was wrong).’ Can you imagine deciding which baseball players to hire without knowing their batting averages? When did you ever see a market forecaster's track record? “ Howard Marks

"The greatest folly is to accept expert statements uncritically" Garrett Hardin

In over a quarter of a century in the finance industry, I’ve pretty much seen it all. Consider this recent forecast in Barron’s … 'Tesla is headed to $10 a share under a bearish case—or $391 under a bullish one, wrote [an] analyst this week’. The stock was around $200 at the time. I thought to myself, $391, that’s rather precise. No rounding required? Maybe $400? And the downside as low as $10? Yet that outcome seemed unlikely. Not because it was too bearish, but a glance at the debt load suggested to me that if the bearish case developed, the light will bypass yellow and go straight to red from green. And the analyst range of $10 to $391? I’m not sure how to make money out of that one, but given the possibility of losing everything, maybe it’s a stock to avoid?

The above statement can be best described as a guess. When we look into the future that’s what we’re all really doing. Guessing.

William Stewart, the founder of Stewart Asset Management, has bettered the S&P500 by a remarkable 4.3%pa net for 40 years! In a recent Graham & Doddesville interview he proffered:

“This is not a science but more of a guessing game. We try to make the best guesses we can.” William Stewart

“What you’re really doing is laying out your decision tree and adjusting it. You can come back saying, I think I got this a little high, or that a little low. It’s not fixed. In essence, we’re always operating with the best guess we can make. If it changes weekly, it changes weekly. It doesn’t usually change weekly, but it could. Nobody’s got a lock on what’s right, a model is only a model and it’s not fixed in stone. Sometimes, nothing’s changed but you changed your mind. That’s good. The purpose of the process is to bring out our best guesses. Everything we do is guessing. I think we all get a little carried away with the science of the matter, because there are lots of formulas, whereas you’re essentially making a guess.” William Stewart

Because we don’t have perfect information and because we can never know the future, a model capable of predicting an exact target price is fiction; even a 5,000 line spreadsheet model! Because businesses are unpredictable, some more so than others, asset price targets or intrinsic values can’t be set in stone; regardless of what their makers and promoters hope to convey.

We won’t know if a stock price was a reasonable reflection of a company’s value until some future date. So today, a stock price is just a fictional analog of the underlying company it represents.

The benefit of approaching investing with a ‘guessing’ mindset is that it removes the shackles of perfection. It provides for the possibility of being wrong and in doing so, it helps avoid confirmation and commitment biases.

"You need humility to say 'I might be wrong'.'' Seth Klarman

"Every day I assume every position I have is wrong." Paul Tudor Jones

William Stewart‘s quote took me back to one of my favourite books, ‘Super-Forecasting’, by Philip Tetlock. Tetlock’s observation about ‘guesses’ is an apt one.

“Probability judgements should be explicit so we can consider whether they are as accurate as they can be. And if they are nothing but a guess, because that’s the best we can do, we should say so. Knowing what we don’t know is better than thinking we know what we don’t.” Philip Tetlock

I’ve included some of my favourite quotes from Tetlock’s book below. I hope they’ll help guide you the next time you’re presented with an ‘expert’ forecast, or even if you’re attempting to develop your own.

Check The Forecasters’ Record

“Every day, the news media deliver forecasts without reporting, or even asking, how good the forecasters who made the forecasts really are.

Many have become wealthy peddling forecasting of untested value to corporate executives, government officials, and ordinary people who would never think of swallowing medicine of unknown efficacy and safety but who routinely pay for forecasts that are as dubious as elixirs sold from the back of a wagon.”

“The list of organisations that produce or buy forecasts without bothering to check for accuracy is astonishing.”

“Consumers of forecasting will stop being gulled by pundits with good stories and start asking how their past predictions fared - and reject answers that consist of nothing but anecdotes and credentials.”

“Far too many people treat numbers like sacred totems offering divine insight. The truly numerate know that numbers are tools, nothing more, and their quality can range from wretched to superb.

Most Forecasts Are Quickly Forgotten

Old forecasts are like old news - soon forgotten - and pundits are almost never asked to reconcile what they said with what actually happened.”

More often forecasts are made and then .. nothing. Accuracy is seldom determined after the fact and is almost never done with sufficient regularity and rigor that conclusions can be drawn. The reason? Mostly it’s a demand-side problem: The consumers of forecasting - governments, business, and the public - don’t demand evidence of accuracy. So there is no measurement.”

Forecasting is Often Impossible

“It’s misguided to think anyone can see very far into the future.

“It’s a rare day when a journalist says, ‘The market rose today for any one of a hundred different reasons, or a mix of them, so no one knows’.”

Uncertainty is real. It is the dream of total certainty that is an illusion.”

Limits on predictability are the predictable results of the butterfly dynamics of non-linear systems.”

“If you have to plan for a future beyond the forecasting horizon, plan for a surprise.”

“The past did not have to unfold as it did, the present did not have to be what it is, and the future is wide open. History is a virtually infinite array of possibilities.”

Stay Open-Minded, Curious and Self Critical

Super-forecasting demands thinking that is open-minded, careful, curious, and - above all - self critical. It also demands facts. The kind of thinking that produces superior judgement does not come effortlessly.”

“The strongest predictor of rising into the ranks of super-forecasters is perpetual beta, the degree to which one is committed to belief updating and self-improvement. It is roughly three times as powerful a predictor as its closest rival; intelligence.”

Seek Dis-Confirming Evidence

“Scientists must be able to answer the question “What would convince me I am wrong?” If they can’t it’s a sign they have grown too attached to their beliefs.”

We rarely seek out evidence that undercuts our first explanation, and when that evidence is shoved under our noses we become motivated skeptics - finding reasons, however tenuous, to belittle it or throw it out entirely.”

People can be astonishingly intransigent - and capable of rationalizing like crazy to avoid acknowledging new information.

“Social psychologists have long known that getting people to publicly commit to a belief is a great way to freeze it in place, making it resistant to change. The stronger the commitment, the greater the resistance.

“Super forecasters may have a surprising advantage; they’re not experts or professional, so they have little ego invested in each forecast.”

Beware High Confidence

Declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily the story is true.”

Screen Shot 2019-07-17 at 8.55.59 pm.png

People trust more confident financial advisers over those who are less confident even when their track records are identical.

Intuition is Pattern Recognition

“There is nothing mystical about an accurate intuition .. it’s pattern recognition. With training or experience, people can encode patterns deep in their memories in vast numbers and intricate detail - such as the estimated fifty thousand to one hundred thousand chess positions that top players have in their repertoire. If something doesn’t fit a pattern, a competent expert senses it immediately.”

Wrong Outcome Doesn’t Imply Wrong Forecast

“If the forecast said there was a 70% chance of rain and it rains, people think the forecast was right; if it doesn’t rain, they think it was wrong. This simple mistake is extremely common.”

& Vice Versa

“People often assume that when a decision is followed by a good outcome, the decision was good, which isn’t always true, and can be dangerous if it blinds us to the flaws in our thinking.”

Words, Numbers and Time Matter

“Study after study showed people attach very different meanings to probabilistic language like “could”, “might,” and “likely.”

“Forecasts must have clearly defined terms and timelines. They must use numbers.”

Fuzzy thinking can never be proven wrong. And only when we are proven wrong so clearly that we can no longer deny it to ourselves will we adjust our mental models of the world - producing a clearer picture of reality. Forecast, measure, revise: it is the surest path to seeing better.”

More People ≠ Better Forecasts

“Aggregating the judgments of many people who know nothing produces a lot of nothing.

Models are Models

No model captures the richness of human nature. Models are supposed to simplify things, which is why even the best are flawed.”

Forecasts Are To Foresee

“The point of making forecasts is not to tick all the boxes on the ‘how to make forecasts’ checklist. It is to foresee what’s coming.”

Sample Size & Randomness Matter

“Someone beats the market six or seven years in a row, journalists profile the great investor, calculate how unlikely it is to get such results by luck alone, and triumphantly announce that it’s proof of skill. The mistake? They ignore how many people were trying to do what the great man did. If it’s many thousand, the odds of someone getting that lucky shoot up.”

You Can Get Caught by Stories

It’s natural to be drawn to the inside view. It’s usually concrete and filled with engaging detail we can use to craft a story about what’s going on. The outside view is typically abstract, bare, and doesn’t lend itself so readily to storytelling.

Test & Debate Views

Super forecasters constantly look for other views they can synthesis with their own. There are many different ways to obtain new perspectives. What do other forecasters think? What outside and inside views have they come up with? What are the experts saying? You can even train yourself to generate different perspectives.”

“For super forecasters, beliefs are hypotheses to be tested, not treasures to be guarded.”

“If forecasters can keep questioning themselves and their team mates, and welcome vigorous debate, the group can become more than the sum of its parts.”

Assume You’re Forecast is Wrong

“Researchers have found that merely asking people to assume their initial judgement is wrong, to seriously consider why that might be, and then make another judgement, produces a second estimate which, when combined with the first, improves accuracy almost as much as getting a second estimate from another person.”

Practice Forecasting

Learning to forecast requires trying to forecast. Reading books on forecasting is no substitute for the experience of the real thing.”

“Our expectations of the future are derived from our mental models of how the world works, and every event is an opportunity to learn and improve those models.”

Revisit Forecasts

“To learn from failure, we must know when we fail.”

“Unfortunately, most forecasters do not get high-quality feedback that helps meteorologists and bridge players improve. There are two main reasons why. Ambiguous language is a big one. Vague terms like ‘probably’ and ‘likely’ make it impossible to judge forecasts. The second big barrier to feedback is time lag. When forecasts span months or years, the wait for a result allows the flaws of memory to creep in.”

Hindsight Bias

“Once we know the outcome of something, that knowledge skews our perception of what we thought before we knew the outcome; that’s hindsight bias.”

Stay Humble

Underlying super-forecasting is a spirit of humility - sense that the complexity of reality is staggering, our ability to comprehend limited, and mistake inevitable.”


The front pages of yesterday’s financial papers and brokerages bulletins are littered with stock recommendations that resulted in permanent loss of capital. Why? Because for most forecasters, it doesn’t matter. It’s wasted ink not money. New Price target 50% of Old Price Target. Has the model been changed? The old model didn’t work?

When you don’t have a position, you just have an opinion. It’s for this reason I prioritise information from investors with skin-in-the game and long track records of success.

The next time you’re presented with a forecast, take the time to consider the forecasters track record of success, and also why they might be making such claims. Remember, if their guess is right, they’re seen as a guru; if they get it wrong nobody remembers anyway.

I’ll let Morgan Housel have the last word on this topic:

“You don’t get on TV, or invited to industry conferences, or big book deals for predicting average outcomes. Pundits get paid for sitting three standard deviations away from sane analysts.”

Source:Superforecasting: The Art and Science of Prediction’ Philip Tetlock, Dan Gardner, Broadway Books, 2016.

Further Reading: Investment Masters Class Tutorial - ‘Forecasting

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Learning from Sol Price

Walmart, Costco, Home Depot. You’ve heard of them no doubt? Together, they’re recognised as the world’s largest retail and hardware chains and believe it or not, all three owe a great deal of their legacy to the same man.

Sol Price.

Walmart’s founder, Sam Walton, noted in his biography, "Most everything I've done I've copied from somebody else." Later he divulged, "I guess I've stolen - I actually prefer the word 'borrowed' - as many ideas from Sol Price as from anybody else in the business."

It’s the same story for Costco. It’s founder, Jim Sinegal, had one mission: ‘clone’ Sol Price’s retail business. Jim also had the credentials to do so. At the age of 18, Sinegal started his retail career as an employee of Sol Price and three decades later he left to start Costco. A reporter once asked Jim: “you worked for Sol for so many years, you must have learnt a lot?” To which Jim replied “No, that’s inaccurate, I learned everything from Sol Price.” Sol Price was his mentor and as he put it: ‘The smartest businessman I ever met’.

Similarly, there’s every chance that Home Depot wouldn’t exist today if not for Sol Price. Home Depot’s co-founder, Arthur Blank, went to see his friend Sol after he was fired from a hardware chain called Handy Dan Home Improvement. In that meeting, Sol encouraged Arthur to forget about suing his ex-employee and instead start a retail business. Which he did.


As the son of immigrant parents, Sol Price grew up in the Bronx, before relocating to San Diego, where he met his wife Helen. While pursuing a career as a lawyer, Sol’s father-in-law passed away leaving a property which needed to be dealt with. Sol ended up trading the property for a vacant retail property in need of a new tenant. Sol sought advice from a good friend and client who’d opened a few jewellers stores in San Diego. The friend explained how the jeweller’s highest volume account was a business called Fedco, a membership retail store which catered to federal employees in Los Angeles. As a non-for-profit corporation, Fedco was doing a brisk business with customers coming from as far as San Diego.

Sol tried to convince Fedco to join with him to open a Fedco at his vacant property. Fedco declined. Henceforth, FedMart was born. Fedmart was started as a ‘membership’ retailer, allowing the business to circumvent the strict Fair Trade Laws applicable at the time; laws which gave manufacturers the right to set minimum selling prices for their products.

Ultimately Sol sold FedMart to a European retailer, and remained in the business. Before long the new owners clashed with Sol and fired him. Sol wasted no time moving on. Sol started a wholesale cash and carry business he named the The Price Club. Unfortunately, it wasn’t all smooth sailing to begin, with initial sales well below budget. In response to lagging sales, Sol decided to open the business to a wider customer base. Sales grew rapidly. The Price Club concept grew into a 94 store enterprise before it merged with Costco.

While you’ll find references to Sol Price in Sam Walton and Arthur Blank’s biographies, Robert Price has written a biography about his father entitled Sol Price - Retail Revolutionary and Social Innovator. Once again, you’ll find many of the characteristics embodied in Sol in the other Master CEO’s we’ve covered; it’s no surprise, many took a leaf straight out of Sol’s book. Here are some of my favourite insights from the book.

Retail Innovation

‘As a retail revolutionary, Sol’s brilliance changed the way we shop, first with FedMart in 1954, the retail format copied by Walmart, Kmart and Target in 1962; and then, with the Price Club, the warehouse club format adopted by Costco and Sam’s Club in 1983.”

“Fortunately, most of us had backgrounds that were alien to retailing. We didn’t know what wouldn’t work or what we couldn’t do.” Sol Price

Look After Customers

“Our first duty is to our customers. Our second duty is to our employees. Our third duty is to our stockholders.” Sol Price

“[Sol] was never driven by the need to have the most stores or the most money, but by the desire to give the customer the best deal and to provide fair wages and benefit’s to FedMart’s employees.”

And Employees

“Employees [in San Antonio] were paying their employees 50 cents per hour. Sol knew that people could not live on 50 cents an hour. He decided that the wage rate at FedMart would be $1.00 per hour. Of course, everyone wanted to work at FedMart.”

“Sol’s approach to FedMart employees mirrored the relationship he had with FedMart members. He felt a responsibility -a fiduciary duty - to provide excellent wages, benefits, and working conditions for employees.”

In a bulletin to FedMart employees, Sol said: ‘We believe that you should be paid the best wages in your community for the job you perform. We believe that you should be provided with an opportunity to invest in the company so you can prosper as it prospers. We believe you should be encouraged to express yourself freely and without fear of recrimination or retaliation''.”

Innovate to Keep Prices Down

“Because Fair Trade Laws impacted so many products, including such staples as Tide detergent and name-brand liquors, FedMart developed a line of private label merchandise. FedMart purchased these products with specifications and standards as nearly equivalent to the national brands as possible and stocked the FM brand to demonstrate the savings.”

“FedMart’s low price merchandise, limited selection, yet breadth of product offerings had a major impact on the retail world.”

“According to Sol, FedMart was not a discount store. He described FedMart as a ‘low margin retailer’.”

“FedMart priced merchandise starting with the cost of the product and taking as small a markup as possible - consistent with covering expenses and a small product while giving the customer the best price.”

“The trusting relationship with members was reinforced by FedMart’s unique merchandise selection - limited selection and large pack sizes. Sol proved it was possible to do more sales with fewer merchandise items [stock keeping units - SKUs). He pioneered large packing size as a way of lowering prices.”

“The typical grocery or discount store carried about 50,000 different items compared to Price Club’s 3,000 items.”

“Price Club was different from other retailers - charging a $25 annual fee with large package sizes and extremely limited selection.”

“[Product] sampling increased sales both because members liked the products and because of the ‘reciprocity rule’, people’s subconscious desire when receiving something for free.”

‘The Intelligent Loss of Sales’

“One of the intriguing questions is: why does limited selection result in higher sales? Part of the answer lies in what Sol called ‘the intelligent loss of sales.Conventional wisdom in retailing is to stock as many items as possible in order to satisfy every customer’s needs and wants. The ‘intelligent loss of sales’ turns that theory on its head, postulating that customer demand is most sensitive to price, not selection. And low prices are possible only if there is integrity in the pricing combined with being the most efficient operator.”

“Because payroll and benefits represent approximately 80% of a retailer’s cost of operations, pricing advantage follows labor productivity. Put simply, the cost to deal with 4,500 items is a lot less than the cost to deal with 50,000 items.”

Empower Staff

Sol taught by example and he taught by engaging people in challenging discussions, demanding that they use their brains.”

“In return for providing a great workplace for FedMart employees, Sol asked only two things of his employees: that they work hard and that they think.”

A Customer Fiduciary

“Sol’s business philosophy was simple:

1) Provide the best possible value to the customers, excellent quality products at the lowest possible prices.

2) Pay good wages and provide good benefits, including health insurance to employees.

3) Maintain honest business practices.

4) Make money for investors.

Sol believed in building long term relationships with his customers. He described his business philosophy as the professional fiduciary relationship between the retailer and the customer. In his words; ‘If you recognize you’re really a fiduciary for the customer, you shouldn’t make too much money’.

The underpinnings of this fiduciary were consistently high quality merchandise and consistently low prices. Sol infused FedMart’s employees with the belief that they were representing the interests of the customer.”

Refund Policy

“Sol’s sense of duty to FedMart members was punctuated by FedMart’s refund policy: ‘Everything we sell is guaranteed unconditionally. We will give an immediate cash refund to any customer not completely satisfied with a purchase made at FedMart. No questions asked’.”

Pristine Ethics / Tone at The Top

“Sol’s business ethics extended to all facets of his business world. FedMart employees were prohibited from taking any form of gratuity from suppliers, even a free lunch. But suppliers were to be treated fairly.”

“Sol believed that fairness was a moral imperative. He would say that rich people would often think they gained their wealth on their own when, in fact, their success was the product of their teachers, along with government workers, service providers, and the employees in their companies.”

Membership Model Benefits

“There were a number of reasons for charging a membership fee of $25, a significant amount of money compared to the rather nominal $2 membership fee that members of FedMart paid. The most important reason was to use the membership money to lower prices by including the fee in the calculation of gross margins.”

“The $25 membership fee also operated as an incentive for the member to purchase more as a way to leverage the membership fee as a percent of purchases. In addition, the membership concept helped reduce operating expenses for the business because the membership psychologically tied the member to Price Club and eliminated the need to advertise.”


One of the things I find particularly interesting with Sol is that like with Warren Buffett, many people have benefited from the few. Thousands of investors have benefited from the lessons of Warren Buffett. They’ve recognized his success and copied it. Berkshire Hathaway itself has copied others.

“All Berkshire does is copy the right people.” Charlie Munger

The same can be said for Walmart, Costco and Home Depot. Even Jeff Bezos’ Amazon Prime membership model draws on the innovation of Sol Price. If the world’s largest retailers and hardware chains have all been influenced by the one man, and even further have emulated his practices in their own businesses, its hard to refute that the man was a genius.

Sol was a true Master.

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Disclosing Positions


Not many investors have been likened to Warren Buffett in their investment career. Besides numerous other aspects, you would need to have an incredible track record for one, and most of the Investment Masters, despite having enviable track records themselves, have found it difficult to match Buffett and his long history of success.

UK based Neil Woodford has been likened to Buffett in the past, and for a while enjoyed both the financial success and the celebrity that came with it. Right up to the point where he didn’t. The recent demise of The Woodford Fund has been well-publicised and well-analysed, with a lot of reasons for its downfall.

‘The glittering career of Neil Russell Woodford, touted as the UK’s answer to legendary American investor Warren Buffett, lies in tatters. The UK financial regulator has turned on him, long-standing investors have collectively pulled billions of pounds from his funds, and a reputation built over four decades of front-line investment management has been ripped to shreds.” Barrons, June 2019

One factor that likely contributed to the downfall was Mr Woodford’s decision to publicly disclose all his positions. Now it has to be said that taken by itself, his disclosure would not have led to the downfall of the fund, but after the dust settled, it seems disclosure added to its woes.

“Woodford will publish only the top 10 holdings of his three funds while redemptions from the LF Woodford Equity Income Fund are halted, the firm said in a statement on Monday. The move is an abrupt shift from a longstanding commitment to provide transparency about investments; the fund previously disclosed all holdings at the end of each month.” Bloomberg, June 2019

Many managers release their letters publicly. While a letter’s purpose is to inform a fund’s investors, it can also be used to help clarify the manager’s own thinking. In many cases the letters are a marketing tool to help attract new funds. At times, managers use letters to explain how and why the fund’s performance differs from others. Some manager’s hope the information conveyed in their letters will encourage others into the investment, a catalyst to close the gap between an under-priced stock and its fair value.

Despite the many who do disclose, some choose not to publish letters, or if they do, they’re very hard to find. Others choose to disclose little about the positions that make up the fund.

Why is this so?

Front Run - Squeeze

Without doubt, The Woodford Fund’s woes were exacerbated by the market’s knowledge of the positions. For those unfamiliar with what transpired, the ‘star’ UK fund manager stopped redemptions after facing a multitude of problems; a cocktail of illiquid assets, poor performance, riskier assets and questionable management actions. This resulted in a mass exodus by investors. Market knowledge of the stock positions attracted predatory shorts which moved ahead of, or front-ran, the unwind of the fund. The UK’s FT noted:

“Mr Woodford’s ambition for full transparency on his holdings may have been enlightened, but recent weeks have shown the risks of such openness. Short sellers have been able to exploit his difficulties, driving down the prices of investments they know he will be under pressure to sell.

It’s one reason managers can be reluctant to disclose positions.

“Our Fund is concentrated in relatively few large positions and greater disclosure than that required could make it more difficult to deal when we are building or divesting from positions in the Fund, and enable other market participants to “front run” our dealing activity to the detriment of the prices we can achieve.” Terry Smith

And size positions appropriately.

“Being too large in an activity enables the rest of the market to pick you off or ‘gun’ for you. We once did an option trade that was so compelling that we built much too large a position. We found that as market participants sensed the size of our positions, they ‘ganged up’ on us. The options that we bought at cheap prices just got cheaper and cheaper, people anticipated our ‘rolls’ from one option to another, and every trading action we took seemed to increase our losses. As soon as we unwound the position to stem the losses, prices rebounded to near normal levels. It was quite an expensive lesson for people who were used to trading quietly in the market, rather than being the focal point for attack.Paul Singer

I suspect Bill Ackman knows that feeling all too well. In 2012, with much fanfare, he announced a $1 billion short position in Herbalife. Ackman opened the attack publicly with a three hour, 342-slide presentation at the New York Sohn Conference. Like a red rag to a bull, hedge funds, including Dan Loeb’s Thirdpoint, piled in on the long side, squeezing Ackman. Soon after, billionaire activist Carl Icahn whaled into a 25% stake, predicting at the time Ackman’s investment could produce the “mother of all short squeezes.” In 2017, when Ackman finally capitulated and closed the position, he’d dusted $500m.

Ackman survived the ordeal. But one of the most infamous funds that faced a ‘run on its positions’ and didn’t survive was Long-Term Capital Management. It almost took the US financial system down with it. Once highly secretive, as liquidity problems emerged, the fund was forced to seek capital, requiring a higher level of disclosure. Roger Lowenstein’s brilliant book, ‘When Genius Failed’, noted:

“As it scavenged for capital, Long-Term had been forced to reveal bits and pieces and even the general outline of its portfolio. Ironically, the secrecy-obsessed hedge fund had become an open book. Markets, as Vinny Mattone might say, conspire against the weak. And thanks to Meriwether’s letter, all Wall Street knew about Long-Term’s troubles. Rival firms began to sell in advance of what they feared would be an avalanche of liquidating by Long-Term. ‘When you bare your secrets, you’re left naked’.”

Knowledge of Long-Term’s portfolio was, by now commonplace. Salomon was, and had been, pounding the fund’s positions for months. Deutsche Bank was bailing out of swap trades, and American International Group, which hadn’t shown any interest in equity volatility before, was suddenly bidding for it. Why this sudden interest, if not to exploit Long-Term’s distress? Morgan and UBS were buying volatility, too. Some of this activity was clearly predatory. The game, as old as Wall Street itself, was simple: if Long-Term could be made to feel enough pain - could be squeezed - the fund would cry and buy back its shorts. Then anyone who owned those positions would make a bundle.”

It’s little wonder many manager’s are careful about publicly disclosing positions, especially shorts.

“As you are aware, we are guarded in disclosing our shorts to anyone.” Andreas Halvorsen

"The danger is you get squeezed on that short. Bob Wilson, a very famous short seller, famously said that nobody ever gets rich publicising their shorts. You want to get rich quietly. I don't go on CNBC trying to talk a stock up." Leon Cooperman

Commitment Bias

Ackman’s nemeses in Herbalife weren’t confined to the hedge funds that squeezed him. The enemy was also within. The fact he was on the record in a big way [342 pages!] and had committed tens of millions in research and publicity costs meant he was all-in. While Ackman recognised the ‘commitment bias’ in Wall Street analysts he may have missed his own short comings.

When one shares an investment thesis publicly, it can be more difficult to change one’s mind because the human mind has a tendency to ignore data that are inconsistent with a firmly held view, and particularly so, when that view is aired publicly. That is likely why Wall Street analysts continued to rate MBIA a buy until it nearly went bankrupt. And, I believe it is why analysts will likely keep their buy ratings until Herbalife is shut down by regulators or the company faces substantial distributor defections.” Bill Ackman

Many of the Investment Masters understand the risks of sharing positions, ideas and thoughts on the record. Talking up a big position can make it harder to change one’s view when contradictory evidence emerges.

“The more public you become with your positions the harder it is for your ego to let go of a position. You can’t let your ego slow you down when the facts change. Don’t talk openly about your positions until you are strong enough to change your mind in front of the crowd.” Ian Cassell

“When you pound out an idea as a good idea, you’re pounding it in.Charlie Munger

“I avoid letting my trading opinions be influenced by comments I may have made on the record about a market.” Paul Tudor Jones


Great ideas are few and far between. Disclosing positions can lead to unwanted competition, meaning higher prices or potentially better performance by a competing fund. Funds management is a competitive industry and most funds are seeking to attract capital, not give their competitors a leg-up.

Despite Buffett’s openness with regards to his investment philosophy, business and industry insights, you won’t find him talking about the specific stocks he’s buying and selling.

We cannot talk about our current investment operations. Such an “open mouth” policy could never improve our results and in some situations could seriously hurt us.  For this reason, should anyone, including partners, ask us whether we are interested in any security, we must plead the ‘5th Amendment’.” Warren Buffett, Partnership Letter 1964

"Despite our policy of candor, we will discuss our activities in marketable securities only to the extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are. Therefore, we normally will not talk about our investment ideas. This ban extends even to securities we have sold (because we may purchase them again) and to stocks we are incorrectly rumored to be buying. If we deny those reports but say “no comment” on other occasions, the no-comments become confirmation." Warren Buffett 1983

"Our never-comment-even-if-untrue policy in regard to investments may disappoint "piggy-backers" but will benefit owners: Your Berkshire shares would be worth less if we discussed what we are doing." Warren Buffett 1998

Buffett’s not alone in this regard.

“The less definition offered, the less positions revealed, the less statistics applied – all the better for the portfolio that aims for these supra-normal returns. Hence, the fund’s individual positions may not be revealed except at the discretion of the manager.”  Michael Burry

“We will publicly discuss our transactions in marketable securities only when we believe such disclosure will be to your advantage. Good ideas are scarce, and the output of our research efforts is your exclusive property.” Frank Martin

“I follow Buffett’s perspective. He has said that specific investment ideas are rare and valuable and they’re like intellectual property and subject to being lifted. Therefore he only discloses them to the extent required by law. That’s pretty much what we follow.” Mohnish Pabrai

“One reason we don’t disclose our holdings is that we don’t want competition.  If the stock goes lower, which is quite possible, we’ll want to buy more.” Walter Schloss

“While I was at Graham-Newman, a man called up and said he’d like to speak to Mr. Graham. Because he was out of town that day, I asked if there was anything I could do in his stead. He said, “I just wanted to thank him. Every 6 months Graham-Newman publishes their portfolio holdings. And I’ve made so much money on the stocks that he had in his portfolio, I just wanted to come by and thank him. That was one of the reasons I decided never to publish our holdings. We work hard to find our stocks. We don’t want to just give them away. It’s not fair to our partners.” Walter Schloss

“I don’t want to disclose things pertaining to what positions we’re going into and why.” Ray Dalio

"I really don't like to give out ideas." Bruce Berkowitz

We do not disclose information that would create a competitive disadvantage for the funds unless we are legally required to do so.” Bill Ackman

“We try not to talk very much about the companies in our portfolio and we certainly never talk about ones that are coming in and going out.” Chuck Akre

“If I figure out something really clever, I’m not going to go out and tell anyone, I’m not even going to tell my clients. I’m just going to do it in privacy and tell them later, “Hey, we made a bunch of money.” Maybe I’ll tell them what it was if the opportunity falls over.” David Abrams

“Given our larger AUM and the ease of disseminating our letters across the internet, we think it’s risky to detail our thesis about our scarce ideas. I’ll do my best to provide commentary without tipping our hand or revealing future intentions” Allan Mecham

“We have discussed the dysfunctional of disclosing specific investment ideas. The problems are mainly psychological and include the locking in of an idea, the desire to seem consistent, the wish to seem prudent in other people’s eyes and so forth. There is then the effect of copy-cat investing, brokers trading against us and, as Walter Schloss found out, dealing with nervous-Nellies and so on.” Nicholas Sleep

‘Book Talking’

The process of talking up your investments is often referred to as ‘book talking’. Some managers see it as a way to attract interest in a name once it’s purchased, a catalyst to closing the gap between the stock’s trading price and ‘fair value’.

Unsurprisingly Buffett takes an unconventional view on this particular activity. While he doesn’t talk individual stocks, theoretically, he’d be more inclined to talk them down than up.

"We get asked questions about investments we own, and people think we want to talk them up. We have no interest in encouraging other people to buy the investments we own. We or the company are likely to be buying stock in the future. Why would we want the stock to go up if we’re going to be a buyer next year, and the year after, and the year after that?

But the whole mentality of Wall Street is that if you buy something — even if you’re going to buy more of it later on, or if the company is going to buy its own stock in — the people seem to think that they’re better off if it goes up the next day, or the next week, or the next month, and that’s why they talk about “talking your book.

If we talked our book, from our standpoint, we would say pessimistic things about all four of the biggest holdings we have, because all four of them are repurchasing their shares, and, obviously, the cheaper they repurchase their shares, the better off we are. But people don’t seem to get that point.” Warren Buffett


Without the benefit of the many investor letters I’ve read over the years, I’d be less than half the investor I am today. Notwithstanding this benefit, there are risks that can arise from disclosing too much information. When you combine the market knowledge of a portfolio of illiquid or very large positions with redemption requests, things can quickly turn from manageable to disastrous. Just as telegraphing short positions can be asking for trouble.

It’s important to not let the public disclosure of positions blind you to evidence that you may be wrong. The courage to admit a mistake in the face of public disclosure is quite often difficult if not downright impossible for many investors.

Ultimately, like most things when investing, it really comes down to common sense. Remain open-minded and consider worse case scenarios.

Don’t let your disclosures get the better of you or your fund.

Join our Investing Community for daily insights on Twitter: @mastersinvest


Learning From David Abrams

What if I told you that there was a guy who has a degree in History, who, when he started his career in investing not only did not know the difference between a stock and a bond but also hadn’t a clue as to what they actually were, has worked in Risk Arbitrage with Seth Klarman and currently runs a fund that has over $9 billion under management. He’s generated consistent returns of at least 15% since the fund’s inception in 1999 and he’s also been labelled ‘The Wealth Machine’ by the Wall Street Journal. Do you know this investor?

His name is David Abrams.

It’s no surprise if you haven’t heard of David Abrams. He keeps a pretty low profile, so I was pleasantly surprised to see a recent interview with him on Columbia Business School’s ‘Value Investing with Legends Podcast series. I’ve included some of my favorite quotes below. You’ll notice many of them relate to topics that are common to the Investment Masters, but it was David’s commentary about the need for growth that particularly struck out at me: it’s no accident that Buffett has often stated his preference for businesses with growth:

"It’s pretty hard in a declining business to buy things cheap enough to compensate for the decline." Warren Buffett

Let’s start with that one…

The Need for Growth

“If we buy things with what we call a ‘hard catalyst’, an event that is going to close the gap between where we bought it and what it’s worth, we don’t need that much growth. We need to buy it cheap and get out. Where there is no catalyst, we absolutely need growth. The growth can come in all kinds of ways, it doesn't have to come through increased revenues, although a lot of times it does. It can come from running operations more efficiently, from acquisitions, or from buying back shares cheap. But if there is no catalyst, we absolutely need growth.”

Raising Money

“The best times to invest are the hardest times to raise money and the worst times to invest are when it’s easiest to raise money.”


“In all cases we do want to understand the fundamental economics because it’s easy to tell what has been, it’s easy to tell what is today, but as an investor we are always trying to deal with what’s going to be tomorrow, in two years or five years from today. To understand the dynamics of what’s going on has a lot to do with who has power in the relationship, what people’s alternatives are, what is the value to the customer or to the employees. So you try to understand that as opposed to just taking historical numbers and projecting them forward.

Pricing Power

We like to find businesses with pricing power. But to say that something has pricing power and to leave it there is really an incomplete line of thinking because nobody has unlimited pricing power.”


A lot of times the analysis [on companies] is as much just thinking it through. There are plenty of times when there is information and data you can get, but in the end you’re trying to form a judgement about something and I don’t think the judgements are going to be found on an excel spreadsheet. It is about thinking those things through as much as anything.”


“You have to live with qualitative analysis. There’s uncertainty, there’s competition and I think what’s obvious to everyone, particularly in the last ten years, is that capitalism is very competitive and there is a lot of change. And there is change going on every day, all around us.”


You always need to approach markets and business with a lot of humility, and as a generalist, even more so.”

People’s Thinking

“We are trying to determine what [other] people think, not by reading reports but really by understanding the economics of the business and by comparing it to the securities prices. And that will really tell you what people are really thinking.”

Consider Alternate Scenarios

“You’re trying to think about the multiple paths that could happen. There is not one path that can happen in the future. When you look back there is one path that happened but that doesn’t mean going forward there is only one path. In the future there’s multiple paths. You need to have the range about what that could be.”

Management Ownership

We have a bias to liking companies where the management owns a lot of stock and has created value. The idea is fairly simple, people who have created value have a way of figuring out what will do more of it in the future. If you have a management team whose primary economics are coming through salary and bonus you can be at odds versus being a shareholder.”


“The hard part about stocks is the future is unknowable. Is a five year track record the beginning or is the end. You won’t know that until you are in year ten.”

Stock List

We have a list of things that we are always updating, adding and subtracting to it businesses we’d like to buy or people we’d like to invest it with. A lot of our research takes many years, sometimes more than a decade before we first look at something to buying it.”


I try to keep a lot of things coming into the intellectual funnel. I try to have a pretty good screen so I can sort through it. I invest in a wide range of things. Most of my money is invested in the fund. I put small amounts of money into VC funds that got me more in the flow of what’s going on in Silicon Valley. I travel and I try to expose myself to people thinking really differently. Sometimes it’s people with more positive or negative views of the world. Sometimes getting out around the world gives you a different perspective. Even within the US, travelling to different places gives you different perspectives.”

Position Sizes

“We try to put more money into the things that we have more conviction about. We’ll tend to top out stock positions at cost around six or seven percent. We can hold them if they go up but we tend to top them out around that cost. We look at industry concentration. We loosely keep an eye on it. We want to be fairly concentrated. I don’t target industry diversification, I keep an eye on it to make sure we are not getting too concentrated in a particular industry.”


“I’m not a huge fan of [hedging risk in positions with other instruments], I think sometimes the strategy can make people enter them with the idea they’re reducing risk but they actually maybe increasing risk. I always say, if we’re not comfortable with the risk the best and easiest way [to manage risk] is not taking that risk.


“We don’t use leverage in the portfolio. That is a basic philosophical decision on my part. I don’t want to have to meet a margin call at the wrong time. We try to study financial disasters and when you study all the people who had huge financial issues and you said ‘what was the reason they had those huge issues?’ Leverage was one reason that would probably capture 90% of all the disasters. In that sense, it seems fairly easy and straightforward to stay away from the one thing that causes most of the distress. Buffett said ‘If you’re smart you don’t need it and if you’re dumb you don’t want to use it.’ I think that captures the idea too.”


Companies are responsible to all their constituents. If you don’t have a good product or good service you won’t have any customers. If you don’t treat you’re employees well, they are going to leave. If you don’t do all of that, you won’t make any money and you won’t attract any capital and you won’t have the investors. It’s not perfect, there are a lot of issues but it works pretty well. It’s better to let people, companies and individuals figure that out than mandating it like they do in Germany with works councils. There is not a lot of new business formations and innovation in Europe and there is a big reason for it. Our country has been a home for risk taking and innovation and if anything it’s picked up speed. But there are proposals out there that could dent that.”


“We do get closer to the companies and the people and I think it is certain the human relations and the human factor is not something a computer is ever going to dis-intermediate. I’m not overly concerned about quants. You don’t want to be Polyannish about it, or arrogant, nor in denial about these changes as they are really important. People have been looking for black boxes for investing since the day I got on Wall Street and well before. They will always look for it. The reason why its very unlikely to really happen is behind every pool of money there’s people. Whether endowments or foundations, the quants are interesting and shouldn't be ignored but they can only grow in popularity when they are working in the moment. If they haven’t produced good results in the short term people are going to throw them out.”


What I appreciate about David Abrams and the other Investment Masters is their willingness to teach and share their wisdom. With the plethora of podcasts, videos and investment newsletters that are available from the Investment Masters, it’s possible for all of us to learn new investment precepts from the best in the game. And once you have the new concepts, you can then apply enhanced investment skills to your own money management. I’ve always said I’d much rather learn from those with great long term track records and skin in the game and Abrams, whilst largely unknown, remains one of the best.

Source: ‘Value Investing With Legends Podcast’ with Tano Santos, Columbia Business School.

Join our Investing Community for daily insights on Twitter: @mastersinvest


How Buffett Manages Risk

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Investing involves risk.

No surprise there and virtually every investor will agree. When there’s the chance of losing your capital, and by that I mean permanent loss of capital, then it’s something to be concerned about. You’re exposing yourself to danger and that in essence is the definition of risk. Interestingly though, whilst we’re all on the same page that investing involves risk, if we asked different investors what they actually think risk is, we’d end up with some different answers.

So what is risk to a long term investor?

OK, if your answer is ‘Share Price Volatility’, then you’re incorrect. Risk in investment parlance is not volatility.

Share prices are naturally irrational; emotional participants, and more frequently today, computer algorithms, can drive share prices to nonsensical levels. Of course there is a degree of risk in this, however that risk can be mitigated by two simple factors - the first of which is having a long-term horizon on your investment portfolio, rather than trying to buy this morning and sell this afternoon; and the second is having a deep understanding of the businesses which you own. Too many investors know little about the businesses they invest in, and therefore live or die based on what the stock price does. If you know the company has intrinsic value, a good runway, deep moat, strong management and a healthy culture for example, then the daily rise and fall of the stock price should not be of concern to you. It is not where risk lies for an investor.

Warren Buffett understands this.

For over 60 years he has navigated market cycles, macro forces, technology changes, sharp salesmen and geopolitical currents, and in the process has left a track record of returns few could match. If you want to understand risk, study Buffett.


Buffett’s approach to risk management is simple. It’s also common sense. It’s not some esoteric risk management system built with complex formulas, in fact it’s more prevention than anything else.

Wisdom is prevention but very few people do much about it.” Charlie Munger

“The biggest thing is to have something in the way you’re programmed so that you don’t ever do anything where you can lose a lot. Our best ideas have not been better than other people’s best ideas, but we’ve never had a lot of things that pulled us way back. So we never went two steps forward and one step back. We probably went two steps forward and a fraction of a step back. Avoiding the catastrophes is a very important thing.” Warren Buffett

Before we delve into Buffett’s risk management toolkit, it’s worth taking a step back to understand how Buffett approaches investing. It’s certainly not conventional. But it’s important to understand so we can put his risk management framework into context.

Ever since Buffett picked up Ben Graham’s book, ‘The Intelligent Investor’, Buffett’s defining principle has been that the shares he owns are simply the fractional ownership of the underlying businesses. If he pays a reasonable price for those fractional pieces, and provided the businesses do well, over the long term, the share prices will also do well.

“You are not buying a stock, you are buying part ownership in a business. You will do well if the business does well, if you didn't pay a totally silly price. That is what it is all about." Warren Buffett

Buffett recognises that in the short term, share prices are often irrational. Given his long term investment horizon he doesn’t concern himself with short term price fluctuations. Buffett has an advantage here, he’s got the luxury of permanent capital, which allows him to take a long term view.

We do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset. I mean, if your risk is that if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, in our view that is a very risky transaction. Because we think 50 percent of the time you’re going to suffer some harm or injury. If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction.” Warren Buffett

"We look to business performance, not market performance. If we are correct in expectations regarding the business, the market will eventually follow along."  Warren Buffett

Most people don’t think about risk in this way and it’s certainly not the way it’s taught in most business schools. The typical finance textbook defines risk as ‘share price volatility’. In contrast, Buffett sees heightened volatility as opportunity. He can choose to buy shares at cheaper prices or simply ignore them. Buffett actually rejoices when share prices decline as most of the companies he owns are buying back their own stock, effectively increasing his entitlement to the company’s future earnings without him lifting a finger.

“In business schools, volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEO’s astray." Warren Buffett

Ultimately, Buffett views Risk as that which gets in the way of compounding; the permanent loss of capital. Or more specifically, the permanent loss of purchasing power over the holding period.

"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period." Warren Buffett

Know What You Own

Buffett doesn’t panic out of stocks he owns if their share prices decline because he understands what he owns, he knows what he’s doing. He doesn’t let share prices tell him whether he’s right or wrong.

"Risk comes from not knowing what you're doing." Warren Buffett

Business Risk

Given Buffett’s objective is to own companies whose earnings will be higher in the future, his primary concern is Business Risk; how will a companies earnings manifest themselves over time?

“Should we conclude that the risk in owning a piece of a company - its stock - is somehow divorced from the long-term risk inherent in its business operations?  We believe [this] conclusion makes [no] sense and that equating beta with investment risk also makes no sense.” Warren Buffett

When we look at businesses, we try to think of what can go wrong with them. We try to look [for] businesses that are good businesses now, and we think about what can go wrong with them. If we think there’s a lot that can go wrong with them, we just forget it. We are not in the business of assuming a lot of risk in businesses.Warren Buffett

“We think of business risk in terms of what can happen — say five, 10, 15 years from now — that will destroy, or modify, or reduce the economic strengths that we perceive currently exist in a business.” Warren Buffett

Like all investors, Buffett’s not infallible. And when he has stumbled in the past, it’s usually because he’s mis-assessed the fundamental economic characteristics of the business. Think Dexter Shoes, Blue Stamps, Department Stores and the original Hathaway Textile business.

“What costs us money is when we mis-assess the fundamental economic characteristics of the business.” Warren Buffett

“We’ve made mistakes on judging the future economics of the business[es].Warren Buffett

Filters, Base Rates and Pattern Recognition

Buffett deploys a concise filtering system when considering investments and he’s collected a huge repertoire of ‘base rates’ he applies to avoid risk. Furthermore Buffett has a well developed pattern recognition system drawing on his accumulated knowledge which he uses to identify potential risks and opportunities.


One of Buffett’s most powerful risk mitigation and prevention tools are his Filters.

“We do care about being right about the economic characteristics of the business, and that’s one thing we think we’ve got certain filters that tell us in certain cases that we know enough to assess.” Warren Buffett

“We have a bunch of filters we’ve developed in our minds over time. We don’t say they’re perfect filters. We don’t say that those filters don’t occasionally leave things out that should get through. But they’re very efficient.” Warren Buffett

Every investment needs an edge and it’s impossible to have an edge if you don’t understand an investment or other people have a better understanding than you. Buffett’s first filter is understanding what he owns and it relies on a strong appreciation for the boundaries of what he knows and what he doesn’t - his circle of competence.

“Different people understand different businesses. And the important thing is to know which ones you do understand and when you’re operating within what I call your “circle of competence.Warren Buffett

If a potential investment falls outside of that circle or he won’t be able to get it within that circle it is discarded immediately. Buffett doesn’t venture outside of the circle.

“The first filter we probably put it through is whether we think — and we know instantly — whether it’s a business we’re going to understand, and whether it’s a business that — if it passes through that, it’s whether a company can have a sustainable edge.” Warren Buffett

“We do have filters, and sometimes those filters are very irritating to people who check in with us about businesses, because we really can say in ten seconds or so “no” to 90 percent-plus of all the things that come in, simply because we have these filters. We have some filters in regard to people, too.” Warren Buffett

Buffett doesn’t compromise his filters, they’re black and white. He doesn’t raise his discount rate to overcome his risk concerns, the filters work as a strict go/no-go valve.

We look at riskiness, essentially, as being sort of a go/no-go valve in terms of looking at the future businesses. In other words, if we think we simply don’t know what’s going to happen in the future, that doesn’t mean it’s necessarily risky, it just means we don’t know. It means it’s risky for us. It might not be risky for someone else who understands the business.” Warren Buffett

"Don't worry about risk the way it is taught at Wharton. Risk is a go/no go signal for us - if it has risk, we just don't go ahead." Warren Buffett

Base rates

Base Rates are one of Buffett’s most useful filters to mitigate risk. An example of a base rate would be the history of successful pharmaceutical drug tests as a percentage of the total population of trials. In this case, it’s a very small number. Needless to say Buffett has weeded out a plethora of investment categories with low base rates such as this.

“People who have information about an individual case rarely feel the need to know the statistics of the class to which the case belongs.” Daniel Kahneman

Examples of common investment categories with ‘base rates’ too low for Buffett include: start-ups, turnarounds, new issues, declining businesses, highly leveraged entities, low ROE businesses, low quality management, unpredictable or quickly changing industries and/or business with headwinds as opposed to tailwinds.

“If it’s got a lousy past but bright future we’ll miss it.” Warren Buffett

"Start ups are not our game." Warren Buffett

“Charlie and I haven’t bought an IPO since 1955.” Warren Buffett

“If you really think a business is declining, most of the time you should avoid it. The real money is going to be made by being in growing businesses, and that’s where the focus should be.” Warren Buffett

“We have to stay away from businesses that have low returns on equity.” Warren Buffett

"We do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business." Warren Buffett

“We favor businesses and industries unlikely to experience major change.Warren Buffett

"I would say anybody that's investing in something they consider opaque should just walk away" Warren Buffett

“One of the lessons our management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds.Warren Buffett

"We don’t play big trends. We don’t think about demographic trends or anything of the sort.... Big trends, they just don’t mean that much. There’s too much money to be made from year to year to think about things that take decades to manifest themselves." Warren Buffett 

Pattern recognition

Buffett relies on a vast mental database of information which he employs to identify patterns which help him manage risk.

"Pattern recognition is one of [Buffett’s] primary skills and perhaps his greatest skill. So in terms of data points, unlike many people who learn by seeking information on an as-needed basis, Warren is always looking for fuel for pattern recognition before he needs it." Alice Schroeder

Having studied and been exposed to a vast array of businesses and business problems over decades, Buffett utilises his vast filing cabinet of knowledge to identify potential future business risks.

“There is nothing mystical about an accurate intuition .. it’s pattern recognition. With training or experience, people can encode patterns deep in their memories in vast numbers and intricate detail - such as the estimated fifty thousand to one hundred thousand chess positions that top players have in their repertoire. If something doesn’t fit a pattern, a competent expert senses it immediately.” Philip Tetlock

“Charlie and I have seen, and we’re not remotely perfect at this, but we’ve seen patterns. Pattern recognition gets very important in evaluating humans and businesses. And, the pattern recognition isn’t 100 percent, and none of the patterns exactly repeat themselves, but there’re certain things in business and securities markets that we’ve seen over and over, and that frequently come to a bad end, but frequently look extremely good in the short run.” Warren Buffett [on Valeant blow-up]

“If you focus, you do see repetition of certain business patterns and business behavior. And Wall Street tends to ignore those, incidentally. I mean, Wall Street really doesn’t seem to learn, for very long, business lessons.” Warren Buffett

Margin of Safety

In complex adaptive systems like markets and business environments, the future is inherently uncertain. Not all things will work out as expected. One way Buffett mitigates this uncertainty is by seeking a margin of safety in his investments. This means buying at a discount to a conservatively estimated intrinsic value.

"We insist on a margin of safety in our purchase price.  If we calculate the value of a common stock to be only slightly higher than it's price, we're not interested in buying.  We believe this margin of safety principle, emphasised by Ben Graham, to be the cornerstone of investment success"  Warren Buffett

No Intolerable Outcomes

Buffett always looks down before he looks up. And while an investment may have significant upside, Buffett won’t invest if the consequences of a bad outcome to his entire portfolio are intolerable, no matter how remote those consequences might be. Buffett is happy to compromise upside for the ability to sleep soundly at night.

If we can’t tolerate a possible consequence, remote though it may be, we steer clear of plantings its seeds.” Warren Buffett

“I put heavy weight on certainty .. if you do that, the whole idea of a risk factor doesn’t make any sense to me. You don’t do it where you take a significant risk.  But it’s not risky to buy securities at a fraction of what they are worth.” Warren Buffett

“I would rather be, you know, a hundred times too cautious than 1 percent too incautious, and that will continue as long as I’m around.” Warren Buffett

“We are perfectly willing to trade away a big payoff for a certain payoff. And that’s the way we’re put together.” Warren Buffett

Think About Worst Case Scenarios

To avoid intolerable outcomes, you need to get a handle on what those may be in the future. Buffett spends his time thinking about what those scenarios may look like. These tend not to be the things that fall out of a spreadsheet model.

“We think in terms of not exposing ourselves to any mistakes that could really hurt our ability to play tomorrow. And so we are always thinking about, you know, worst-case situations … we have to think about whether we’re doing anything really big that could have really terrible consequences.” Warren Buffett

“We don’t have any formula that evaluates risk, but we certainly make our own calculation of risk versus reward in every transaction we do.” Warren Buffett

“The best way to minimize risk is to thinkWarren Buffett


You can see that Buffett doesn’t follow the daily irrationality of share prices. And he certainly doesn’t view what they teach in most business schools as the correct definition of Risk. He has long talked about being a business owner rather than a stock owner, and the underlying principle of this is that he understands the businesses within which he owns stock. If he doesn’t understand them, then he simply doesn’t own them.

We will never buy anything we don’t think we understand. And our definition of understanding is thinking that we have a reasonable probability of being able to asses where the business will be in 10 years.” Warren Buffett

He further mitigates risk by ensuring he avoids fundamentally risky ventures. He doesn’t go into IPO’s, he’s not interested in turn-around businesses, and you won’t see him going anywhere near companies with dangerously high leverage or low returns on capital.

Ultimately, Buffett is trying to avoid Business Risk. He does use three simple tools to assist him with all of this. Base Rates, Filtering and Pattern Recognition. True, he’s had a lot longer at this than most of the rest of us, however that simple fact alone, probably coupled with his outstanding track record over those same years makes it very hard to refute his beliefs in all of this.

So who are you going to believe?

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Further Reading:
Investment Masters Class Tutorials:
Volatility, Risk, Permanent Loss of Capital, VAR

Merger Masters - The Art of Risk Arb

If you’ve worked in investing for a while, or even if you’re a private investor, I’m sure you will have come across the term Arbitrage. It comes from the French, and in investing its definition is ‘the buying and selling of securities, assets or commodities in different markets to take advantage of differing prices for the same asset.’ Quite simple really.

When we talk about Risk Arbitrage however, we’re referring to something slightly different. Risk Arbitrage, which is also known as Merger Arbitrage, is ‘an investment strategy that speculates on the successful completion of mergers and acquisitions.’ In reality this is not as simple, and as the name suggests it is arbitrage with the added element of RISK. Quite often a lot of it.

Make the Assumption There Can be No Assumptions

These profound Eight Words were written in thick black pen on a post-it note which I stuck to my computer monitor sometime in late 2007. At that time my job was advising Global Hedge Funds on risk arbitrage, and the words served as a daily reminder to me right through the Financial Crisis until I left that job to join another bank in 2010. I can’t tell you how much money those words saved my clients along the way, but I can say they helped us avoid recommending plenty of deals that broke. And broke ugly.

In late 2007, the world’s largest commodity company, BHP Billiton, announced it was going to take out its largest rival. China’s massive stimulus program had ignited a frenzied rally in commodity prices and the race was on for commodity companies to lock down more supply. BHP lobbied an audacious scrip-based bid for it’s iron ore arch rival RIO Tinto. The ink had only just dried on RIO’s own acquisition of Alcan, a large aluminium producer. At the time, many saw RIO’s bulking up as a defensive tactic to ward off potential bidders. There had been speculation that RIO was in the cross-hairs of numerous acquirers including the Chinese.

Once the dust had settled and BHP’s bid was live, the common assumptions that surfaced were: BHP would be willing to divest any assets required for competition authority approval; BHP’s initial bid was an opening gambit and given the significant synergies available, was sure to be raised; BHP was taking a long term view and wouldn’t be swayed by weaker commodity prices; a counter-bid from the Chinese or another miner was possible and finally; even should the deal break, BHP and RIO would trade back to the stock price ratio consistent with that prior to the bid.

BHP RIO Share Price Ratio [Source: Bloomberg]

BHP RIO Share Price Ratio [Source: Bloomberg]

Those assumptions ended up costing the hedge fund industry hundreds of millions of dollars. In actual fact, commodity prices weakened, BHP couldn’t extract the required synergies, debt markets closed and BHP abandoned it’s bid. On the day the deal broke, BHP’s shares rose 15% while RIO’s shares collapsed nearly 40%. The prior ratio did not hold. Expensive assumptions, indeed.

I think you would all agree that learning investment lessons from others is far preferable to doing so with your own money.

Recently I read a wonderful book on Merger Arbitrage entitled, ‘Merger Masters - Tales of Arbitrage’ by Kate Welling and Mario Gabelli. Kate and Mario have done an incredible job of bringing together many excellent tales of merger arbitrage via interviews with the world’s Risk Arbitrage Masters, and have identified the learning insights we can take from each.

The book is a must read if you’re considering adding merger-arb to your investment toolkit and it’s a useful adjunct for all investors. Like the Investment Tutorials that form the Investment Masters Class, you’ll notice some themes common to successful risk-arb practitioners. I have included a number of the pertinent points and quotes raised in the text below.

Free Calls

“Focus on finding a free call. If you were risking a really small sum of money but there was a chance for the bid to be increased, we liked to load up.” Martin Gruss

“What you’re trying to do in a deal is put yourself in a position to win the call option.” Drew Figdor

Market Downturns

“All boats- yachts and rowboats-go down together in a severe market decline. And if you’re highly leveraged, you’ll be carried out.” Martin Gruss

Arb stocks get pounded in extreme market situations. And that’s true whether it’s your basic cyclical crash, as ‘87 proved to be, or crashes that are actual harbingers of recessions and economic crisis, like more recent examples.” Michael Price

“Sometimes everything is correlated - but that’s not anything you’ll get away from.” Clint Carlson

“I hate a merger agreement with a market escape clause - I hate it.” Karen Fineman

“Almost every long position is correlated, if the downturn is bad enough.” John Bader

Meeting Mario Gabelli at BRK 2019

Meeting Mario Gabelli at BRK 2019


“You can’t always get it right. If you have leverage when you slip, it takes you down.” John Paulson

“If you’re running a very concentrated portfolio, you need to bring the leverage down… The wrong strategy is, ‘My arb spreads are tight so now I’m going to lever up. No, you lever up when arb spreads are wide and the opportunity is really good.” Clint Carlson

Why The Deal?

My first and most important thought process when a new deal emerges is why is there a deal? Why does this deal make sense? Michael Price

“The first question is not the obvious, what’s the spread? Or what’s the rate of return? It is why? What’s the motivation, Why are they doing this? Second question, What’s the valuation? Does it make any sense? Is it cheap? Is it expensive? I’d much rather invest in a deal - even if nobody comes in and tops the bid - if it’s on the low side of fair value because (a) there are that many more chances that something good will happen and (b) there’s that much less downside.” John Bader

“There’s one key element that’s going to make or break your investment and you’ve got to focus on getting that one big thing right. That’s why, to this day, my first question is, ‘Does this deal make sense? Should both parties be wanting to do this?’” Clint Carlson

“[We do] lots and lots of fundamental research work on the acquirer and the target, as well as on the industry involved trying to understand why they’re doing the deal, what they see, who the people are, and what the incentives are.” Jamie Zimmerman

I always try to figure out: What is the industrial logic for this deal? Why are they doing it? Is it accretive, dilutive? I do a lot of valuation work and try to understand the business - because if I didn’t understand them, I wouldn’t know what risks could stand in the way of completion of the deals.” Clint Carlson

“When assessing deals, the most important factor for us - is whether there is strategic merit to the combination. Is there a strategic reason why these people are getting together? Or is it just a financing deal or a tax deal or some other motivation, which is not as strong or not as good?” George Kellner

“A deal should be a big opportunity for the buyer or a big opportunity for the seller.” Michael Price

I’m always leery of tax-driven deals as opposed to deals driven by real business reasons.. Another red flag is a lot of debt financing. Another is sketchy earnings. You look through the products, you look through the people.” Michael Price

Avoid politicized deals, which seem to have a tendency not to work out well.” John Bader

“Avoid the spreads where the buyer has a get-out-jail-for-free card.” James Dinan

Deals Break

“There’s risk in even ‘sure things.’” Michael Shannon

“There’s no such thing as a ‘sure thing’ and deals can break for a whole host of reasons - which can’t be foreseen. What’s more, my experiences also taught me that the insiders very often don’t know how it will turn out. Deals get done by human beings, and human beings can be fickle. Attitudes can turn on a dime. So much so that maybe a degree in psychology would be good preparation for merger arbitrage.” Martin Gruss

“There’s no such thing as a safe deal. That’s why it’s called risk arbitrage.” Clint Carlson

“No matter how sure you are that something will happen, there’s always a bit of uncertainty.” James Dinan

“I learned about risk management in the tails by experiencing very real pain.. If there is one thing I have learned - and really learned it in this business - it is that the losers are what kill you in the merger arbitrage space.” James Dinan

Inevitably there will be broken deals. There will be fraud at a company, there may be a natural disaster - anything can happen… We deal with that by limiting our position sizes and properly diversifying.” Roy Behren

You always have to be thinking, ‘What could go wrong'?’ Finally you need a high degree of skepticism - bordering on cynicism. You can’t take anything at face value.” Clint Carlson

Broken Deals

“If the deal breaks, you’re not losing a rate of return, you’re going to lose money.” Drew Figdor

“We hold to a general philosophy that making valuation bets on companies is not our business. So, if a deal breaks, we work our way out of related positions, ideally, methodically and carefully.” Michael Shannon

“Hoping is a terrible strategy. I try to be very disciplined about it - as in, ‘I’m here for an event. It didn’t happen. We’re out’. That is a pretty firm rule for me, and it’s painful, but how many times do you see that your first sale was your best sale? My biggest losers always started out as a smaller losses.Karen Finerman

“There’s often real value to be found in playing the busted arb deals.” James Dinan

Knowing where intrinsic value is means you can take advantage of the technical selling pressure from arbs unwinding - it can create opportunity. But you have to have done the work first.” Clint Carlson

“You have to have a sense of what you think the risk/reward is for holding or covering.Jamie Zimmerman


Hubris and bravado have no place in arbitrage.” George Kellner

“There’s a set of mind that is an absolute requirement. If’ your’re not a person whose starting point is “What am I missing?” rather than “How frickin’ great am I?” you are missing something essential to survival. “What am I missing?” is like oxygen. If you’re asking, “How great am I?” you’re the Night of the Living Dead.” Paul Singer

If you think you’re smarter and right on deals, you’re going to go down the tubes too often. My approach is always trying to control risk by not assuming I’m right versus the market.” Drew Figdor

“Being taken to the edge and being forced to look down, it taught me something very important.. I learned that you’re not as smart as you think you are - and bad things can happen totally unexpectedly.” George Kellner

Capital Preservation

The real key is avoiding losers.” James Dinan

Capital preservation is the key to the risk-arb business.” Drew Figdor

I don’t want to lose money, ever, with no excuses. My goal with investors is a combination of under promising and over delivering whenever I can. And I try not to be benchmarked. We just try to make moderate returns - as high as possible - given that our goal is not to lose money.Paul Singer

We always spend a lot more time trying to figure out what the downside could be than we do on the upside - and continuously update the downside calculation over time to track how the values are changing.” Clint Carlson

“The way you get really rich in this country is you live a really long time and don’t lose money - keep it compounding.” Joe Gruss

“Any young MBA can do the math. But you need judgement, experience to know when to get involved. Even then, no one is right all the time, so part of risk arb - and all investing - is managing losses, and that goes first to position sizing.” Michael Price

“The downside of the business is that when you’re wrong, it’s very painful. So you can’t be too wrong, too frequently - which makes avoiding busted deals the name of the game. Figuring out what that risk is and the probability of that risk - which is not a science, it’s a little bit of an art - is the key.” George Kellner


“I actually think the technical skills are secondary. The important stuff is creativity and a little intelligence.” Paul Singer

“The whole business, at least on the senior level, is very much an art form and it pays to be able to draw upon history.” Peter Schoenfeld

Hard Work & Channel Checks

You’ve got to be 100% focused… The way you get or find things is by 100% focus and constant digging, finding information, and understanding the relevance of that information - because when you look back, there are always clues. You want to find those clues before the event happens.John Paulson

“We actually go visit companies. They’re like, ‘Why are you here? Why aren’t you just asking questions on the conference call? But risk arbitrage is like the insurance business. We’re taking on the risk the deal won’t close. If you’re writing a life insurance policy on someone, wouldn’t you want to take a look, make sure they’re healthy?” Michael Shannon

“We travel to directly meet with companies, competitors, regulators.Drew Figdor

“Start with the documents, read the merger agreement, go through the 10-K. There are no short cuts. But don’t get lulled into thinking, as some people do, that nothing else matters ‘if the merger agreement is airtight’… You can’t rely on an ‘airtight’ merger agreement.Clint Carlson


“It’s not a business for all seasons.” Paul Gould


“We were quite risk-averse and very conscious of avoiding concentrating our positions in industries or sectors or with a specific investment banker.” Paul Gould

“If you only sell ten life insurance policies and one guy dies, it wipes out all the premium. You can’t do it, you have to be more diversified. Michael Shannon

“Unusual things happen. That’s why you have to diversify Jeffrey Tarr

Market Neutral

“The important thing for us is to squeeze out any directional exposure. Our goal in managing the merger-arbitrage portfolio is to create a market-neutral vehicle to provide absolute return for our investors.” Roy Behren

“The great thing about these strategies is that you can be market-neutral or uncorrelated to the market.” Jamie Zimmerman

Common Sense

“The core of a good risk-arb strategy has always been and remains, even today, despite all the computers, just common sense about where the risks are and how they correlate and don’t correlate - things that machines can’t necessarily tell you. The analysis of deal dynamics and of people’s motivations.” Paul Gould


“As an investor, you need tenacity, resilience. Everybody makes mistakes - sometimes big - and you have to have resilience to come back, survive, make decisions amid ambiguity.” Paul Singer

“You have to remember these are essentially bets; you’re not always going to get them right. What’s more, when you’re wrong about a position, you can’t let it get in your brain so it defeats you. You have to pick yourself up and do the next deal.” Jamie Zimmerman

Low Risk and Last Mile Trades

Nor will we play what we call ‘Last Mile Trades,’ which involve taking positions in deals that are almost certain to happen - ones with four or five days to closing that you can maybe make a nickel in. To us, the asymmetric optics of buying a position to make a nickel when - God forbid - something could go wrong and you’d lose $8.” Roy Behren

We’ve always been highly selective. I’m not a fan of investing in vanilla, low risk-mergers. In that game, you get nine right and then you give it all back with the tenth. The merger business we tend to do is stuff that’s complicated; has hair on it.Paul Singer

“We get involved in deals that have different characteristics, where we can trade effort for risk or complexity for risk - and that’s why our pattern of returns is so different than others.” Paul Singer

“Embrace complexity. Complexity is your friend. For the simple reason it is where you can add value.” James Dinan

“We’re not a buy and hold merger-arb spread shop. Instead we focus on being a complex, trade the events, creative shop.Drew Figdor

Position Size

Position sizing in arbitrage really matters because that’s what determines your success. You’ve got to be right, but if you have tiny positions in the deals than happen and a big position in one that doesn’t, you’re done. You’re toast.Michael Price

“Before you put yourself into a position to get lucky if a bidding war or whatnot breaks out, you first have to decide, ‘How do I size this?’.. Its always tempting to look at the potential rewards but it’s much more disciplined to look at what could go wrong; what do I lose if it goes wrong; The last thing you want to do is kill yourself. You have to live to fight another day. If you size yourself appropriately and something goes wrong, you can go and make the money back somewhere else.” Jamie Zimmerman

“We basically limit our positions to 2 percent of the portfolio. So our basic metric in the worst case we can anticipate, we’re not going to lose more than 2 percent of our capital. Over the many years that worked pretty well for us. George Kellner

'“The game plan is not to be the Babe Ruth of the business. In other words, I want to have a 0.300 batting average wherever possible, but I don’t need to hit sixty-one home runs, or whatever Roger Maris hit, to break the Babe’s record. Consistently hitting singles and doubles is just fine.George Kellner


“You have to know the cast of characters.Michael Price

“Its crucial to assess who is pulling the strings and to understand what assumptions they are operating under and to assess whether they are realistic or not.” Peter Schoenfeld

“All the probabilities built into your best models - they don’t apply when it’s just one person, one decision.” James Dinan

I also care who the lawyers and bankers are. I care if it’s the A-team, because the A-team get deals to the finish line.” Karen Finerman

“We should always want to think about: Does the CEO have his board behind him?John Bader

“I've long considered management-led leveraged buyouts to potentially be the most egregious form of insider trading. If management participates in a buy-out group, you know they have hidden jewels.Mario Gabelli

Watch what the smart guys do. Today, that might be Jeff Immelt or Seth Klarman, Warren Buffett or Charlie Munger.” Michael Price


You can see that many of the principles of value investing are present in Risk Arbitrage as well. No one has a clean batting record; all of us will, and do, fail from time to time. Acknowledge your mistakes and pick yourself up and get on with it. Spread yourself rather than place all your eggs in one basket. Focus on the downside first.

Mario’s comment that if ‘management are involved in a buy out group, you know they have hidden jewels’ is a valuable insight. Look to the people involved for the real clues as to whether the merger has legs. All the research in the world won’t necessarily give you insight into people’s intentions, and the ‘why’ of the matter is crucial to success in this field. Why are they merging, indeed.

As the name suggests, Risk Arbitrage is fraught with peril. Never make the assumption there are no risks. And while things can go wrong, risk-arb can provide attractive returns if you use common sense, work hard and manage risk appropriately.

“There’s no way anyone could get bored with this business.” Paul Singer

Knowledge is the key, as it is with all investing. The information you glean from reading and meeting and talking and analysing makes all the difference in the world. I’ll let Mario have the last say:

“You don’t have to have good hand-to-eye co-ordination to be a good investor if you have the benefit of accumulated and compounded knowledge.” Mario Gabelli

Further Reading:
Merger Masters: Tales of Arbitrage - Kate Welling & Mario Gabelli. (Columbia Business School Publishing)
Investment Masters Class -
The Arbitrage Series - Part 1
Investment Masters Class -
The Arbitrage Series - Part 2

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Buffett on Recessions, IPO's, Capitalism & the Media Sector


Knowledge is cumulative.

That’s a known fact. As human beings we accumulate new knowledge every day; from reading and listening, experimenting and exploring and from observing others in what they do. And if you’re interested in learning, then the world has a limitless supply of information ready for you to absorb.

It’s one of the things I’ve always admired about the Investment Masters, and in particular, Warren Buffett. Even at 88, and with more than 70 years of investing experience behind him, you’d think he would have already learnt everything there it to know. But it’s not the case. He still has lessons to give, and I am always on the hunt for any new gems that fall from the fertile tree of his mind.

Warren was recently interviewed by Becky Quick on CNBC. During that interview, he spoke about his thoughts on recessions, investing (or not investing) in IPO’s and about the media landscape. All are topical conversations in the investment world currently and I found his thoughts on each subject compelling.

Here are the highlights from that interview:


“[Recessions] are part of a capitalistic system. We will have them and it won’t change anything Berkshire invests in. It may offer us more opportunities in marketable securities or businesses. If we see a good business and everybody in the world is bearish and [thinks the yield curve] inversion is going to 100 basis points, we are going to buy it and buy it enthusiastically.”

Interest Rates and Stock Prices

The lower interest rates are, basically, the better the option stocks are, because stocks are going to produce whatever they are over the next 20 or 30 or 40 years. But if you buy a 30 year bond, you’re going to get that rate. So when the 30 year is at 2.8-2.9% and the Federal Reserve’s intent is to have 2% a year inflation, and you pay tax on that 2.8-2.9% that you receive, your net is around 2%. Your’e essentially saying ‘I’m willing to go with a profitless investment for 30 years’. I don’t get excited about that. You can buy good businesses that may earn 14-15% on taxable equity and they’ve done it in aggregate for a long, long time. You have to think about these good businesses and how they’ll compound over time. You can start with [stock] yields that are higher than the bonds give you and the odds are that a diversified group [which are effectively] bonds with ascending coupons [will do better]. Because that’s all a stock really is, it’s a bond with a whole bunch of coupons that go out to infinity, you just have to [effectively] print the amount on the coupons yourself [because they are not fixed]. The one thing you know is the numbers on stocks as a whole are going to be way greater than 2.8%. The lower bond yields go, the more attractive stocks are as a long term investment.

The Auto Industry

The auto industry is not a static industry and if you keep doing everything the same way you did it in that business, if you aren’t thinking many years ahead, you’re making a very big mistake. Every footprint that an auto company might have had 10 or 30 or 50 years ago is going to be obsolete at some time. And the ones they are putting in now are going to be obsolete. It’s the nature of it.”


Capitalism is described as creative destruction. Change is part of a capitalist system. If you don’t believe it, you’re going to be doing some very dumb things.”

Free Trade

“I’m 100% for free trade. I think is has benefited this country enormously and will continue to benefit it. But the benefits of free trade are invisible. You don’t think about the fact your shoes or underwear or whatever cost ten percent less. You’re benefiting all the time in ways totally invisible. There’s nothing at Walmart that says you’ve just saved 8% because we bought this somewhere other than an American manufacturer. So you have this huge national benefit, unseen, but you ruin the economic lives of people who are 50 or 55 and are not going to be re-trained or re-located. A rich country can take care of those people if they follow policies that benefit all of us and take care of the relatively few who are dislocated. I think that’s the obligation of a rich country.

IPO’s and LYFT’s $25b Market Capitalisation

“I certainly wouldn’t buy [the] business for $25b. I always think in terms of buying the whole business. I look at what I’m getting as a part owner of a business and I don’t know why, with all the things you could buy for $25b in this world, that you would pick a business that really has to be earning $2.5-$3b pre-tax in five years [versus losses now] to even be on the same radar screen as things you can buy right now. I’ve never been a big buyer of IPO’s. Charlie and I haven’t bought an IPO since 1955.

I don’t think buying new offerings during hot periods in the market is anything the average person should think about at all.

“[Question from Becky Quick - But IPO’s always could be opportunities, e.g. Google and Amazon?] You can go around making dumb bets and win. It’s not something you want to take as a lifetime policy though. I worry much more about the things I do than I don’t do. I’ve missed all kinds of opportunities in my life. You just want to make sure you’re on the side of the house when you bet, rather than bet against the house.”

Media is Too Tough

“Entertainment is a big game with big players in it and they are playing for keeps. One problem they all have is that everybody has just two eyeballs and they’ve got x hours discretionary time, maybe they have 4 hours a day. Obviously there is disruption going on in delivering various things. People are always going to want to watch sports. They’ll want to watch the Olympics; the question is how much it’s worth. You’ve got some very, very big players who are going to fight for those eyeballs. The eyeballs aren’t going to double. The time isn’t going to double. It’s a relatively fixed market and then you get the size of certain players and disruption from Netflix which no-one predicted ten years ago. We’ll see how it plays out but that’s not an easy game to predict because you have very smart people with lots of resources trying to figure out how to grab another half hour of your time. I would not want to play in that game myself, that’s too tough for me.

“Ten years from now when we look at entertainment delivery, it will be what people want. It will be in the form they want, it will be whatever the creativity comes up with. It’s going to be a very hotly contested game and the one thing I can guarantee you, is the public will be the winner.

Companies and Mistakes

“I’d love to see Apple succeed [in media]. That’s a company that can afford a mistake or two. You don’t want to buy stock in a company that has to do everything right. In the mining business, they say any mine being dug should be able to stand a certain amount of bad luck because you get into different things as you get 5,000 feet down. There’s some businesses that are quite predictable. Berkshire’s made lots of mistakes over the years; my mistakes. We started with a textile mill and we had two businesses that failed. You’re gonna make mistakes and you don’t want to make them with too big a portion of your capital and you want to recognise them when you make them. You want to basically hang onto your winners. Apple should do some things that don’t work.”

Addressing Bad Acts

The only thing I worry about Berkshire Hathaway [is bad acts of one or a few people reflecting on the business]. I don’t worry about our financials or earnings. I recognise we have 390,000 people and somebody’s doing something wrong. Probably fifty or a hundred people are doing something wrong at any given time. The only thing I have to remember is an ounce of prevention isn’t worth a pound of cure; an ounce of prevention is worth a ton of cure. So anytime you have anything unpleasant you’ve got to attack it immediately. It’s so easy just to shove it off or hope somebody down the line solves it. You pay a huge price for that.


It’s clear that even after those 70 years, Buffett still thinks in simple terms.

He sees recessions as opportunities, doesn’t invest in hot IPO stocks or businesses he doesn’t understand, but he does want the businesses he invests in to make the odd mistake now and then. That’s how innovation comes about - from stumbling on occasion and learning from the error.

Investing is about connecting the dots. This also is a known fact. But if you want to succeed in investing, its important that you actually have dots to connect. In reality, the dots are information, disparate pieces of knowledge that we accumulate through learning from others, such as Buffett. And I for one am glad that the man still has ‘dots’ that the rest of us can learn from.

Source:Becky Quick interviews Warren Buffett at The Gatehouse” CNBC.

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Learning from Jim Simons

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To be an investment master, one must be an innovator, humble, open to learning and above all, have an outstanding track record of success.

And when it comes to investment track records, few, if any, come close to those of Jim Simons.

Unlike most of the investors we’ve covered in the The Investment Masters Class, Jim is an anomaly. He’s a Quant, in fact I’d go so far as to say that he’s the undisputed King of the Quants. His firm, Renaissance Technologies, is somewhat of an anomaly also; they don’t employ business or finance graduates, but do employ scientists, programmers, physicists, cryptographers, computational linguists and mathematicians. They then put these critical thinkers to good use by sifting large amounts of data in order to profit from the world’s financial markets. These atypical investors focus on developing algorithms to exploit inefficiencies in the market, to find profitable patterns to trade across the globe.

Jim’s story on how he came to investing is unconventional to say the least; he’s a math’s genius who worked as a code-cracker for the US government, and only dabbled in the stock market on the side. They don’t come more unconventional than that. He then left code-cracking to start an investment fund, at first adopting a fundamental investment approach. When this failed, Jim decided to use his maths skills to apply quantitative processes to exploit inefficiencies in the market, and when he did this, the results were remarkable.

“Dr. Simons received his doctorate at 23; advanced code breaking for the National Security Agency at 26; led a university math department at 30; won geometry’s top prize at 37; founded Renaissance Technologies, one of the world’s most successful hedge funds, at 44; and began setting up charitable foundations at 56.” William Broad, NYT

Over the years, I’ve always enjoyed reading about Jim’s firm, Renaissance Technologies. The firm’s methods are clouded in secrecy, and employees sign a lifetime non-disclosure agreement. I recently listened to an interview with Jim which was part of a three-lecture series on ‘Maths, Money and Making a Difference’, the second lecture of which was focused on Jim’s experience in the markets. While Jim was coy about the methods Renaissance uses, he did share a few investment gems. Needless to say, it seems the scientists have built a nice money making machine.

“There are times that go by where we don’t make money in a month. It’s very rare we don’t make money in a month. But once in a while that happens. But it’s always come back.” Jim Simons

I’ve included some highlights from the interview below:

Continuous Change

‘In a business like this you have to just keep making things better. Improving the system. Because other parts of the system will wear out after a while. People will catch onto it. Like any business you’ve got to try and make things better and better and better, because that’s what everyone else is trying to do. We try and hire the best scientists we can.’

“You have to keep running. People will discover some of the things you’ve discovered and they’ll get traded out so you just have to keep coming up with more and more things.”

Change Causes Inefficiencies

Efficiencies eventually do get traded out if they get discovered. But the market is not static, it’s dynamic; things change. Therefore I think there’s room for new inefficiencies to materialise. I think it’s never going to be that all inefficiencies are out with nothing new to discover. So far our returns have been more or less stable for a long time. We keep finding new things and throwing out things that are no longer working.’

Hire Smart People & Work Collaboratively

‘The model has been, first hire the smartest people you can. Work collaboratively. Let everyone know what everyone else is doing. We have one system and once a week there is a research meeting. If someone has something new it gets presented. It gets chewed up and looked at. The code is there, everyone can look at the code and see what they think, does this really work? It is a very collaborative enterprise and I think that’s the best way to accelerate science.’

‘Just hire great young people into the business, it’s the best thing you can do.’

Fees & Size Limitations

After years of very high returns, the management decided to close the firm to outside capital and return any external capital to outside partners. The firm’s Medallion fund continues to manage only the staff’s capital. The original fee card was likely one of, if not, the highest in the world.

‘First we raised fees to 5 and 36 and the investors complained but wanted more exposure. And then we raised them to 5 and 44 and it was still a good return at 5 and 44. We realised there was a limit to how much we could manage. The system could manage a certain amount but not huge, huge amounts, not hundreds of millions or trillions. So we decided first no new investing from outsiders and then we decided to buy in the outsiders in 2003. By 2005 we had bought in all the outsiders.’

Madoff Experience & Understanding

Interestingly, Jim explained how he had invested in Madoff’s ponzi scheme. He also explained how he got out of it because he did not understand it. After Madoff’s fund blew up, the SEC investigated Renaissance’s fund, given the firm’s secrecy and consistent, exceptional track record. As Jim noted, at this time they were only running internal capital in the fund. External capital was the missing input for a ponzi scheme.

‘We had had money invested with Madoff for a very long time: Not the firm, but relatives of mine, and our foundation had an investment with Madoff, and I knew him a little bit. He was really amazing. He kept coming up with these very very steady returns, come rain or shine. At a certain point I said ‘this guy has to know something that we don’t know’. I had all the trade confirmations going back years so I asked one of the guys to analyse these trades he was doing and tell me what you learn, what’s his secret. So this guy went to work and here was his conclusion: ‘when they put on a position and are buying something they generally get a very good price, maybe the low of the day if they are buying or the high of the day if they are selling. He said, ‘that accounts for maybe ten percent of their profit’. They claim they have T-bills sometimes so there was also interest, but eighty percent of the profits were a complete mystery.

They would put on a big position according to the tickets, with stock that would approximate the S&P index, and then buy a put or call to protect themselves from outside moves. From what we understood they had huge amount of money under management so you would think when they put on the puts or calls it would actually move the market. But we could see no evidence of that. I thought, let’s get out of this.

Even Medallion [Fund] had a little bit. We sold it and nothing happened. Several years went by and my relative called and said ‘do you still like Madoff?’ I said, ‘I can’t tell you to take your money out because he’s been going for a long time and he keeps on going. He must know something’. I said ‘I took my money out’. I couldn’t advise someone to take their money out. It never dawned on me it was a Ponzi scheme. I didn’t know what the heck he was doing, I just didn’t like the looks of it. That’s why we got out. Five years later the crap hit the fan and he was outed. It was the craziest thing in the world.’

Fundamental Investing

[Fundamental investing] is a perfectly legitimate way to invest. Look at Warren Buffett, I don’t think he has a computer on the premises, except maybe to count his money.’

“I think there is a world of difference between being a good fundamental investor and a good quant. A good fundamental investor wants to evaluate the management, have a sense of the human beings running it, a sense of where the market might be going. It’s a set of skills. And some people are very good at it. Quantitative stuff is a different set of skills.”

Source: Bloomberg

Source: Bloomberg

Luck Helps

“Luck plays quite a role in life; we’ve been lucky.”

Work Hard

“Work hard, hire good people.”


Largely because he does not practice Fundamental Investing, its pretty easy to say that Jim Simons is unlike most of the other masters we have reviewed. As Jim says, Buffett prefers to review a business’ management and culture, and get a feel for that business’ market before deciding to invest, whereas Quants use computer algorithms to first deduce inefficiencies and then make their investment decision. To be fair, though, despite their differences, both styles can point to considerable track records.

And while most investors prefer the fundamental approach to investing, Jim is not as alone as you might think in his arena. Like Ed Thorp, he identified that his skills and style are best used as a Quant, and pursued that approach vigorously. Interestingly, there are some similarities between Quants and the other Investment Masters, though; they all use ‘thinking’ to generate outstanding returns.

“I like to ponder. And pondering things, just sort of thinking about it and thinking about it, turns out to be a pretty good approach.” Jim Simons

Its clear that there are still plenty of ways to ‘skin a cat’. Fundamental or Quant, they both have their place in the market. Jim’s own successes speak the truth of that adage.


Maths, Money and Making a Difference” S. Donald Sussman Fellowship Award Fireside Chat Series. MIT Management Sloan.

Further reading:

The Secret World of Jim Simons” by Hal Lux
Jim Simons, the Numbers King” by DT Max. The New Yorker.
Inside a Moneymaking Machine Like No Other” by Katherine Burton. Bloomberg.
The Mathematician Who Cracked Wall Street” TED Talk.
“Seeker, Doer, Giver, Ponderer - A Billionaire Mathematician’s Life of Ferocious Curiosity” by William Broad. New York Times.

Follow us on Twitter: @mastersinvest


Learning from Aldi

Much of our time at Masters Invest has been spent on reviewing a couple of key things - Good Companies, and Investors and Business people who have stood out from the crowd; those few who have made a name for themselves through their innovative investment strategies or business practices, and the enviable track records they have created because of them.

And standing out in Retailing is as difficult as it is in the Airline Industry. Few have done it, and even less have consistently done it well, but one of those is a brand name that’s known globally.


I recently read a fascinating story on ALDI authored by Xan Rice in the British newspaper, The Guardian. The Aldi name, which is short for ‘ALbrecht DIscount’, was the brainchild of two German brothers - the late Karl and Theo Albrecht. From humble retailing beginnings in 1946, the brothers, through trial and error, developed one of the most successful retailers in the world. The company has an estimated worth approaching $50b.

What stood out to me in the article were the similarities between ALDI and the other great companies we have studied; a decentralised structure, above market wages for employees, a win-win mentality, continuous innovation, a long term horizon and a strategy based on simplicity. In fact it should be no surprise to you to learn that so many of the unconventional characteristics that define ALDI are also found at Berkshire Hathaway. These include things like simplicity, rigorous decentralisation, no annual budgets, no consultants, minimal head office, freeing up subsidiaries to focus wholly on the business [as opposed to appeasing shareholders] and a philosophy of treating others as you wish to be treated.

The article talks of the advantages of taking a long term view; a competitive advantage public companies often can’t compete against.

“Aldi, which is still family owned and unburdened by the short-term pressures for profits faced by its stock-market listed rivals, has changed the way we shop.”

“The best way to fight Aldi early on is to slash prices, but few bosses of public companies are happy to accept lower profits, and thus lower bonuses, by pursuing long-term strategies.

Most other companies don’t have a 30-year view – or even a five-year view.

Xan Rice’s article referenced a book called Bare Essentials - The Aldi Way to Success, written by Dieter Brandes. In the book Mr Brandes, a 14 year ALDI veteran and member of the company’s administration board, reveals how this highly secretive company has achieved such phenomenal success over the last 50+ years. Eager to learn more about ALDI, I ordered the book and read it over a weekend.

At the beginning of the book Mr. Brandes makes an important observation:

Quantitative data can form only a limited basis for comparing companies and is not very helpful. It should be much more important for competitors to think about the purpose and goals of their own businesses.”

Having finished the book, I realised it’s largely the qualitative factors that define ALDI’s success. The keys to ALDI’s prosperity won’t be found in a spreadsheet.

ALDI’s success is driven by its DNA, which is wholly unconventional in nature. Without the benefit of Mr. Brandes book, gaining an understanding of such a business demands the curiosity to keep asking ‘why?Channel checks and taking the time to think are prerequisites.

With my newfound knowledge of the business, I could see why ALDI’s supermarket competitors, with their much wider and more expensive branded product range, lower product turnover, relatively inefficient operations and inconsistent focus struggle to compete. Over the years, ALDI has crept up on them. ALDI is all in. And unless ALDI’s competitors are prepared to start afresh, which isn’t feasible, their future is likely to be challenged.

I’ve included some of my favorite quotes below. You’ll be familiar with most of the sub-titles from previous posts on other success stories we’ve analysed.

Keep it Simple

“Those imitators who tried to copy ALDI apparently ran into the problem described by the poet Marie Ebner-Eschenbach: ‘Most imitators are attracted by what cannot be imitated.’ The problem was that ALDI was much more than just a marketing concept. It was founded on simplicity.”

“The case for customer orientation appears to be self-evident and simple - customers’ needs are the obvious focus for company strategy. The problem is that few people are good at sticking to what is simple.

“ALDI was and remains a success because of its focus on simple issues.”

“The success of ALDI in inseparably linked to the simple design of systems and processes. The path of ‘fanatic simplicity’ is always the more intelligent one.”

“ALDI never had a mission statement and never needed one. The reason, in my opinion, is as clear and simple as the company’s goals themselves; the goals of lowest prices and best quality are simple, understandable and sensible.”

The simpler an organisation is the better it can perform. Simplicity requires less management capacity - at least in terms of quantity.”

ALDI won its enormous competitive lead with its principle of simplicity, with its rigorous approach, and its work on details. ALDI was able to make use of the time which competitors kitted themselves out with rigid organisational structures, looked down arrogantly on the newcomer, and maintained and expanded their complexity.”

“One can only repeat ‘back to the basics’, or ‘keep it simple’. An independent corporate culture with good organisational and business principles, focused on the core question ‘Why should the customer shop in my store?’ will deliver solutions and positive developments.”

Commitment to Principle

The original concept remained, in essence, the same over the decades - changes were confined to incremental adjustments made in response to a wide range of internal and external developments.”

Commitment to principle is the quality that provided the foundation for Aldi’s expertise.

Customer Focus


“The customer pays for and finances everything. He pays the salaries, he pays the suppliers’ bills, and he pays taxes. In addition, he also - it is to be hoped - contributes to profits so that owners and shareholders can get some ‘fun’ out of their efforts.”

Improve value to the customer instead of merely concentrating on increasing profits”

ALDI’s success is based largely on simple and committed customer orientation. I do not remember seeing anyone, in all my years at ALDI, put profits or operational efficiency above the interest of the customer.”

“ALDI adheres to the principle of offering good or even the best quality at the lowest possible price. Customers can trust the offer. They come to know shopping around for a better price would be pointless.”

“ALDI is something of a customer trustee. It never wants to mislead the customer: what you see is what you get.”

“As a principle, ALDI takes back anything that the customer does not like or that is not in perfect condition.”

“ALDI’s commitment to its goals - all of which are underpinned by a strict faith in customer orientation - is consistent down to the smallest details. That is why it is different from the opposition.

Close-to-customer procedures are much more important than the painful exercises which take place at headquarters in an effort to get control over the reams of data.”

ALDI’s success is not ultimately based on purchasing - as many competitors believe - but on the selling-out side, on its sales and customer orientation strategies.

ALDI puts together its product range based on its own considerations and, primarily taking into account its own customers’ needs. Suppliers’ terms and conditions do not play any role at all in the product range strategy, while at their supplier-orientated competitors they are often the only ‘strategy’ they have.”

Touch the Business

What does the customer want? How can we find out? For a start, the senior manager has to come down from his Ivory Tower and visit his own stores. Market research and Nielsen are not very helpful. Tests, surveys, listening, observing and sensitively stepping into customer’s shoes - being one’s own customer - are what help.”

Low Prices

“Customers are not supposed to believe ALDI is low-price. ALDI is low-price.

“The company’s inbuilt principle is to sell products at the lowest prices possible. It was never a goal to get the highest possible prices allowed by the competitive environment.”

Every price is a long-term price. The prices of our items only change in response to changes in the purchase prices.”

“Our only consideration in pricing a product is how cheaply we can sell it. Not how much people will pay for it.


The contribution ALDI’s corporate culture has made to its success should not be underestimated.

Corporate culture is the key to success. ‘What is essential is invisible to the eye’. This observation by Saint-Exupery is probably the best way of summing up ALDI’s secret. What is visible - store decorations, product ranges and prices - have been easily copied by competitors. It is the invisible that has determined ALDI’s success. To understand the company, you must understand the essential defining characteristics that lie beneath the surface.”

corporate culture feeds on examples and role models, on the special ‘characters’ of the company, especially the founders and owners. Theo and Karl Albrecht are just such ‘characters,’ standing for the corporate culture they endorse. ALDI is decisively shaped by its founders, and this is probably why attempts to copy the company have been doomed to failure.

Owner operated companies generally start small and take many years to mature. A culture which is largely determined by an owner cannot be easily copied.”


Screen Shot 2019-03-22 at 5.03.22 PM.png

“If anyone were to ask why ALDI’s competitors still have not decoded ALDI’s secrets: Everything which ALDI did contradicted the assumptions and convictions of German retail managers. ALDI does everything differently from all the others.

“Although ALDI always kept an eye on the competition, the competition were never a source of ‘benchmarks’ for ALDI’s own practice. ALDI has always set its own course.

No Budgets

“There is hardly a manager or corporate executive today who can imagine working without annual or departmental budgets. Yet budgets and forecasts are not necessary. ALDI has proven it.”

Tone at the Top

To reinforce a specific culture in a company, the role models and the examples set by owners and managers are very important.

Theo Albrecht is known by everyone as someone who turns off the light when he enters a room to save on electricity if - in his opinion - there is enough light without it.”

“There has never been any attempt to ignore or evade statutory regulations. How can you expect your employees to behave correctly if you set a poor example?

Consultants & Experts

ALDI never spent any money on market research. ALDI people thought about their customers needs and then pursued a suck-it-and-see-policy. They acted on their feel for what customers might like, and never paid for expensive research.”

“Given that, like Einstein, the Albrechts preferred to ‘grope their way forward’, it is no surprise that ALDI operates completely without consultants - there are no management consultants, no market researchers, no advertising consultants.”

Innovation & Experimenting

Trial and error is the ALDI way.

“The ALDI strategy was the result of a dynamic process, driven by intuition and decisions whose consequences were not always foreseeable.”

ALDI has developed a system that allows three pallets to be transported simultaneously by forklift trucks, In a co-operative effort with suppliers, ideal box sizes were established, eliminating the frequent need to cut boxes.”

ALDI required its suppliers to apply the bar-code to the packages at three or four different places, enabling scanners to register the items faster.”

Each effort, each solution is a manifestation of the guiding principle and an endorsement of the corporate values of the company, waste avoidance and extreme cost consciousness

ALDI people are doers. Everything is tried out as fast as possible; they don’t get tied down in endless, in-depth analysis. There could hardly be a better driver of the innovation so frequently lacking in business than opening up the opportunity to invent and try absolutely everything that could serve the company’s objectives".

New products are piloted in ‘three stores’. This avoids burdening the whole organisation with a possible flop.

A by-word at ALDI is the ‘three store test’. These tests are used to try out the potential success of new items or changed package contents and the like. This kind of test tells you fairly accurately nearly everything you need to know, and at the lowest possible effort.”

“Companies need to ask the kind of simple questions children do. Asking ‘Why?’ clears things up. The more frequently ‘why’ is asked, the question about the sense and purpose of things, measures and ideas, the clearer and simpler the answers become.”

“ALDI has benefited above all from the fact that no generally valid rules were established as is the practice at many other companies.”

“Shelves, aisle widths, and if possible - even the length and width of the store itself are determined solely in terms of logistics (box size, pallet size, the maneuvering need for forklifts and similar matters.)”

Accept Mistakes & Learn From Them

If something flops, the result - the insight which is gained in the process - is the centre of attention rather than the question: ‘Who is to blame?’ There are very few decisions that are right or wrong. Using the ‘trial and error’ method ALDI succeeded in avoiding major catastrophes and mistakes.

Quality & Product Range

Screen Shot 2019-03-22 at 5.47.29 PM.png

Reliable, uniformly perfect quality was and remains decisive for ALDI’s success - more important than any distribution system. A distribution system can be watched, analyzed and copied. Such a fanatic and no-compromise quality policy, however requires a specific corporate culture.”

“Even starting from 2000 [products versus ALDI’s c650], and certainly when the range goes up to 20,000 items, managers at other retailers must resort to generalised methods of quality assurance and product range management.”

“One of the most admirable achievements for ALDI’s business policy, of a strong culture, that it has not succumbed to the temptation of widening its product range.

Decentralisation & Maintaining Smallness

Decentralisation - a core principle of the ALDI corporate management.”

“The ALDI organisation is a model of decentralisation. Only central cash management, purchasing and ‘a little bit’ of data processing are brought together in centralised functions. ALDI has learnt by experience that it is not centralising functions that cut costs, but breaking them up!

“Each ALDI company operates approximately 40 to 80 stores. When they become large enough to require two sales managers, a kind of cell division generally takes place.”

Decentralisation enables methods, experiences and results to be compared and creates the freedom to make decisions for or against based on these comparisons.”

“As soon as a certain number of stores has been reached (60-80 stores) .. a split-off in the form of a new company is created. The new entity is complete in itself, including separate bookkeeping, a separate balance sheet and all the functions found in the former company. The increasing competition between ways of handling daily details has frequently led to costs being reduced in absolute terms across all ALDI’s decentralised units.”

Small units are more flexible and more adaptable. Several small errors are easier to weather than one ‘large error’ which can be made by one powerful leader.”

“Experience generally shows that mistakes and problem areas involved are more easily isolated in a decentralised system.”

Decentralised companies give more authority to their local employees who are in direct contact with customers.

The secret of success is that decentralisation turns many employees into entrepreneurs inside the enterprise, ‘intra-preneurs’. I consider this principle of leaders and organisation to be the dazzling recipe for success at the ALDI organisation.”

Head Office

“If you compare the cost of managerial staff and offices at competing companies that earn a fraction of the profits, the cultural differences appear even more stark. I think this one factor - if not the biggest factor - behind the differences in the annual statements.”

Key Variables

“At ALDI the number of statistics is so few they can nearly be counted on one hand. They are simple, manageable and comprehensible, and not a bit scientific. Only the vital data are prepared for the internal auditing and information systems.”

“[ALDI’s focus is] ‘not too many numbers and analysis’, rather, think about the concrete inter-relationships and about how one can achieve higher sales to customers.

At ALDI they only work with very few figures, but with key figures, focusing on the most important business processes. And these are not budget figures, but true and actual figures which can be easily established and understood, and which result in transparent conclusions.”


Retailers should treat their suppliers as they wished to be treated themselves.”

“A company’s core cultural value - fairness towards others, especially suppliers.

ALDI was just as correct in its relationship with suppliers - many of which have continued for decades - as it was in its treatment of customers.”

“Every company can only survive in the long term if its profit margins are big enough - so it simply does not make sense to drive a partner into insolvency or - one step short of that - to kill his appetite for business.”

“The ALDI companies are seen by everyone as partners who know that they need good capable suppliers that have to be allowed to survive, i.e. to earn money.”

Employment Policy

“To ALDI, the right character is generally more important than, say, a degree from Harvard: none of our executives are from McKinsey; no one boasts any other kind of exclusive background”

Correct Incentives

Correct practices also include the rejection of bribery. A bottle of champagne at Christmas may seem like an innocent enough gift but the giver has an ulterior motive. There is no such thing as a free gift.”

Quiet Success

Competitors were blind to the development of ALDI. To this day, even trade journals barely know who the members of the company’s management are.”

The principle for dealing with the public, especially the trade journals, was: what we do, we do for our customers. For this purpose we do not need journals that are read by curious competitors.”

Listen To Ideas

The collective knowledge of employees is greater in every company than is generally assumed. To unearth the treasure trove of information, facts, ideas, experiences and insights one needs an organisational framework, a corporate culture, in which employee input is encouraged. A genuine culture of success is one where employees make suggestions on their own initiative and even implement them on their own.”

Value Employees

“ALDI achieves its best values for prices by cost-cutting in all areas - with the exception of wages and salaries which generally are among the highest but, due to the high productivity of staff, nevertheless generate the lowest personnel costs.”

Lowest Costs

“With a powerful ability to come up with simple solutions that repeatedly lead to extremely low costs, ALDI is many years ahead of the competition. It has developed what Cuno Pumpin has called ‘strategic success factors’. This ability cannot be developed easily and is impossible to copy.”

“An utterly uncompromising stand has given ALDI a cost advantage on store rents. Its motto is: a low rent - even in the best locations - or no rent. It would rather do without a unit than pay a high price for it.”

“The targets set by ALDI are extraordinarily simple. The only concern is lowest costs, or rather maximum performance and productivity in all areas, lowest possible sales prices and best quality. This is understood by every cashier, and by every packer in the warehouse. These are goals that can be applied and implemented in all departments by any employee on an ongoing basis. Differentiating between short, medium and long-term goals is unnecessary, nor is there any need for hierarchy of objectives from the top executives to the lowest ranking employees in the stores.

“ALDI was never stiff-necked or short-sighted in the sense that it gave an ‘order’ to reduce cost category X by a certain percentage. Cost reduction was never forced. The basic concepts of value analysis played more of a role.”

By not having an enormous selection we are in a position to order enormous quantities of each individual item at the best possible price.

None of our employees needs to unpack individual packages or put up decorations for the merchandise.”


Aldi has succeeded where so few retailers have in the past. And there have been many well known brands that have come and gone, or those who have remained but who don’t create the same incredible business results to be found in the German giant.

Even Buffet bought into Tesco and then later sold it when he realised it had been a mistake.

“I bought Tesco in the UK and I got my head handed to me.” Warren Buffett

Buffett had mis-assessed the fundamental economic characteristics of the business. Charlie Munger was asked about this at the 2014 Daily Journal Meeting…

Tesco owned the world for a long time. It looked inevitable. They had a formula that really worked.  Then one day it stopped working so well… Tesco got in trouble when Aldi came in one side and other people came in on the other.  It got tougher.  How many big companies stay totally on top forever?  Basically, the normal result is what happened to Tesco.  Listen, Aldi is a tough competitor.  Ruthlessly low cost, limited assortment, all private label.  It's terribly efficient.” Charlie Munger

Simplicity is an art form. It’s hard to create, but even harder to emulate. Aldi has done this well.

Follow us on Twitter: @mastersinvest


Further Reading:

Bare Essentials: The ALDI Way of Retailing’ by Dieter Brandes.

The Aldi effect: how one discount supermarket transformed the way Britain shops - The Guardian -by Xan Rice.

The Aldi effect: how one discount supermarket transformed the way Britain shops – The Guardian [Podcast].

Daily Journal Meeting Notes 2019

What makes a Master Investor? We have covered many of them over the last couple of years, and you would have to agree that every single Master we have reviewed has their own special qualities. Whether its Buffett, Dalio, Rochon, or Akre, et al; all are impressive in their own right and I have learnt from every single one.

Now whilst I have learnt from them all, one of the questions I have often asked myself is: “Which of them would I like my kids to learn from?” Which of these inspiring investors’ footsteps would I wish my children to follow in? And whilst the answer could be indeed them all, there is one that I have always felt would be able to teach my kids more than any other.

Charlie Munger.

At this year’s Daily Journal AGM, Charlie Munger once again shares his wisdom and some of the secrets to Berkshire’s success with the audience. The man is a veritable master when it comes to understanding both business and investing, and he’s a genius in articulating the psychological aspects that makes an investor successful. He’s also built a framework for living a successful and content life. And its this stuff I want my kids to heed. What he talks about, more than anything, I believe is absolutely fundamental to anyone’s success not only in the investment world, but in life in general.

I’ve included some of my favourite quotes below.

Try to Do Less

“At a place like Berkshire Hathaway, or even the Daily Journal, we’ve done better than average and now there’s a question why has that happened? The answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. We always realised that if we worked very hard, we could find a few things where we were right and the few things were enough and that that was a reasonable expectation. That is a very different way to approach the process [of mutual funds]. And if you would have asked Warren Buffett the same thing that this investment counselling did, give me your best idea this year. And you just followed Warren’s best idea you would find it worked beautifully. But he wouldn’t try to know a whole heap, he would give you one or two stocks, he had more limited ambitions.”

Traits That Help

“I think personal discipline, personal morality, good colleagues, good ideas - all the simple stuff. I’d say if you want to carry one message from Charlie Munger it’s this: if it’s trite it’s right. All those old virtues work.”

Know Something Better

“The whole trick of the game is to have a few times when you know that something is better than average and invest only where you have that extra knowledge. And then if you get a few opportunities that’s enough. What the hell do you care that you own three securities and J.P. Morgan Chase owns 100. What’s wrong with owning a few securities. Warren always says in a growing town if you owned stock in three of the best enterprises in the town that’s diversified enough. The answer is of course it is.”

Diversification vs. Excellence

“The whole idea of [wide] diversification when you’re looking for excellence is totally ridiculous. It doesn’t work. It gives you an impossible task. What fun is it to do an impossible task over and over again?”

Fees Are a Big Toll

“People don’t realise, because they’re so mathematically illiterate, is that if you make five per cent and pay two of it to your advisers, you’re not losing 40 percent of your future. You’re losing 90 percent because over a long period of time that little difference becomes a 90 percent disadvantage to you. So it’s hugely important for somebody who is a long term holder not to be paying a big annual toll out of performance.”

Get Rich Quick Books

“If you take the modern world where people are trying to teach you how to come in and trade actively and stocks - well I regard that as roughly equivalent to trying to induce young people to start off on heroin. It is really stupid. And when you’re already rich do you make your money by encouraging people to get rich by trading? Then there are people on the TV and they say I have this book that will teach you how to make 300 percent a year and all you have to do is pay for shipping and I will mail it to you. How likely is it a person who suddenly found a way to make 300 percent a year will be trying to sell books on the internet to you? It’s ridiculous.”

You Don’t Need Many Great Decisions

“If you actually figured out how many decisions were made in the history of the Daily Journal Corporation or the history of Berkshire Hathaway it wasn’t very many per year. They were meaningful. It’s a game of being there all the time and recognising the rare opportunity when it comes and recognising that a normal human life does not have very many. Now there is a very confident bunch of people who sell securities who act as though they’ve got an endless supply of wonderful opportunities. Those people are the equivalent of the racetrack tout. They’re not even respectable. It’s not a good way to live your life to pretend to know a lot of stuff you don’t know, and pretend to furnish opportunities you’re not furnishing. My advice to you is avoid those people, but not if you’re running a stock brokerage firm. You need them. But it’s not the right way to make money.”

Find Costco’s, Not Stocks to Sell

“I’m no good at exits. I don’t like even looking for exits. I’m looking for holds. Think of the pleasure I’ve got from watching Costco march ahead. Such an utter meritocracy and it does so well, why would I trade that experience for a series of transactions? I’d be less rich not more after taxes. The second place is a much less satisfactory life than rooting for people I like and admire. So I say find Costco’s, not good exits.

Under Spend Your Income

“This business is of controlling the costs and living simply. That was the secret. Warren and I had tiny little bits of money. We always underspent our incomes and we invested it. You live long enough, you end up rich; it’s not very complicated.”

Scramble Out of Mistakes & Change Your Ways

“There is a part of life which is, how do you scramble out of your mistakes without them costing too much? We’ve done some of that. If you look at Berkshire Hathaway, think of its founding businesses: a doomed department store, a doomed New England textile company and a doomed trading stamp company. Out of that came Berkshire Hathaway. We handled those losing hands pretty well and we bought into them very cheaply. But of course the success came from changing our ways and getting into better businesses.”

Avoid Difficult Things

“It isn’t that we were so good at doing things that were difficult. We were good at avoiding things that were difficult, and finding things that were easy.”

Only Do Things If They Are Better

“If we’ve got one thing we can do more of, we’re not interested in anything that’s not better than that. That simplifies life a great deal. It’s amazing how intelligent it is to spend some time just sitting. A lot of people are just way to active.”

Don’t Expect too Much from Human Nature

“I like those old Stoics. Part of the secret of a long life that’s worked as well as mine is not to expect too much of human nature. There’s almost bound to be a lot of defects and problems and to have your life full of seething resentments and hatreds; it’s counterproductive. You’re punishing yourself and not fixing the world. Can you think of anything much more stupid?”

Recognise Good Ideas Can be Overdone

“A problem thoroughly understood is half solved the minute you point out there’s a big tension between good ideas yet over done so much they’re dangerous, and good ideas that still have a lot of runway ahead. Once you have that construct in your head start classifying opportunities into one category or the other. You’ve got the problem half solved. You’ve already figured it out. You’ve got to be aware of both potentialities and the tensions.”

Less Bureaucracy is Better

“One of the reasons that Berkshire has been so successful is there is practically nobody at headquarters. We have almost no corporate bureaucracy. Having no bureaucracy is a huge advantage. The people who are running it are sensible people.”

Bureaucracy and successful bureaucracy breeds failure and stupidity. How could it be otherwise? That’s the big tension of modern life and some of these places that go into a stupid bureaucracy and fire a third of the people in place works better.”

Reduce Your Return Expectations

“My advice for a seeker of compound interest that works ideally is to reduce your expectations, because I think it’s going to be tougher for a while and it helps to have realistic expectations - it makes you less crazy.” 

Opportunities in China

Some very smart people are wading in [to China] and in due course I think more will wade in. The great companies in China are cheaper than the great companies in the United States.”

Have a Too-Hard Pile

Part of our secret is that we don’t attempt to know a lot of things. I have a pile on my desk that solves most of my problems - it’s called the ‘too-hard pile’ and I just keep shifting things to the too hard pile. Every once in a while an easy decision comes along and I make it. That’s my system.”

Look at Qualitative Aspects

“We pay attention to the qualitative metrics and we also pay attention to other factors. Generally we like to pay attention to whatever is important in a particular situation and that varies from situation to situation. We’re just trying to have that uncommon sense. And part of our common sense is to refer a lot of the stuff in the too-hard pile.”

Companies Tend To Buy Back Stock at the Wrong Time

When it was a very good idea for companies to buy back their stock they didn’t do very much. And when the stocks got so high - that is frequently a bad idea they’re doing a lot. Welcome into adult life. This is the way it is. It is questionable at the present levels whether it’s smart.”

The Trouble with Economics

“A great philosopher said: 'A man never steps into the same river twice, the man is different, and so is the river when he goes in the second time.' That's the trouble with economics. It's not like physics. The same damn recipe done a different time gets a different result.”


“Humour is my way of coping.”

Why Buffett is Richer Than Munger

“He [Warren] got an earlier start. He probably was a little smarter, he worked harder. There are not a lot of reasons. Why was Albert Einstein poorer than I was?

Investment Products

I tend to be suspicious of all investment products created by professionals, and I tend to go where nothing is being hawked aggressively or merchandised oppressively or sold aggressively.”

Bank Worry

All intelligent investors worry about banks because banks present temptations to their managers who do dumb things. There are so many things you can easily do in a bank that looks like a way of reporting more earnings soon where it’s a mistake to do it, long term considerations being properly considered. As Warren puts it, the trouble with banking is there are more banks than there are good bankers.”

How to Sleep Better

“Now I actually deliberately blank out my mind and go to sleep rather easily and I recommend it to all of you. It really works. I don’t know why I didn’t get to it before 93.”


I do think that index investing, if everybody does it, won’t work, but for another considerable period index investing is going to work better than active stock picking where you try and know a lot.”


Munger is a genius. Even at 95, the man is still so intellectually active and has so much to teach. You can see he’s made his life as simple as possible, which has to be an invaluable lesson to us all. You don’t get to his age without gaining some knowledge along the way, and given his track record of success, I for one, and my kids, too, I hope, will gladly listen to what he’s got to offer.

Follow us on Twitter: @mastersinvest


Further Reading:
2019 Daily Journal Annual Meeting [
2019 Daily Journal Annual Meeting [
Full Transcript] - ValueWalk
Poor Charlie’s Almanack - Peter Kaufman
CNBC Becky Quick
Munger Interview at Daily Journal Meeting 2019

Thinking About P/E Ratios

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When it comes to work, everyone likes a short-cut to success; in investing it’s no different. And the one short-cut investors use a lot of the time is the ‘Price to Earnings’ or ‘P/E’ ratio. Using this, you make an estimate of what the company’s earnings per share will be in the forthcoming year, and then divide that into the current share price. Hey presto, you’ve got a ratio you can compare against other companies and a tool for picking stocks. Great, huh?

It’s a nice way to think but in reality its not that simple.

Needless to say relying on the P/E ratio can be problematic. There are a few issues with it - here’s are some of the more obvious ones …

While the ‘Price’ component in the P/E ratio is pretty foolproof (assuming you can get volume there), relying on the ‘Earnings’ can cause some problems. Sometimes the earnings of a company don’t reflect the cash available to management and shareholders; lots of capex could be required or revenue is accrued rather than received in cash, etc.

Alternatively, a company’s earnings could be depressed by short term investments which will yield high returns in coming years, thus understating the current earnings power of the business.

“As a measure of undervaluation for me, P/E may not be terribly useful, as I may hope the company spends aggressively to exploit their nascent franchise advantages in markets and the spending may reduce current income. [For example] Berkshire has done a tremendous amount of investment that destroys current income so you can't really use P/EThomas Russo

Complicating matters further, the P/E ratio doesn’t take into account the capital structure; is a lot of debt required to produce the earnings? These are all considerations that need to be made.

But it’s also the level of the P/E ratio that can send the wrong signal.

When most people think of ‘value investing’, there’s a natural tendency for them to think of stocks on low P/E ratios. I certainly started out my investment advisory career in that camp. I was always looking out for ‘cheap’ stocks; low multiple companies that could benefit from multiple expansion and an improved earnings outlook. I deemed high P/E stocks as the antithesis of value investing - far too dangerous.

Over time, my appreciation for what makes a value investment has dramatically changed. While investing in high P/E stocks can be dangerous, I now place far less emphasis on low P/E ratios, and more on the quality of the business and it’s ability to continue to grow. I’ve learnt from Buffett and Munger and many of the other Investment Masters about the true power of compounding and its ability to diminish the importance of the P/E ratio over time. I’ve also witnessed the capital destruction that sometimes results from chasing low P/E stocks.

This essay draws on some of those insights…

There Is No Single Metric

First things first, there is no single formula that leads to investment success.

"I don’t think price-earnings ratios, determine things. I don’t think price-book ratios, price-sales ratios — I don’t think any — there’s no single metric I can give you, or that anybody else can give you, in my view, that will tell you this is a great time to buy stocks or not to buy stocks or anything of the sort. It just isn’t that easy." Warren Buffett

“I wouldn’t look for a single metric like relative P/Es to determine what, or how to invest money.” Warren Buffett

‘Value Investing’ Is Not Buying Low P/E Stocks

Many investors confuse the term ‘Value Investing’ with buying stocks on low multiples. It’s not. Value Investing is buying a company for less than it’s intrinsic value. In layman’s terms it means you’re going to get back more than you outlaid. You’ll get an attractive return on your money and if your assumptions are out, you’ve still got a decent chance of doing okay because you allowed yourself a margin of safety.

“Whether appropriate or not, the term "value investing" is widely used.  Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield.  Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth, and is therefore truly operating on the principle of obtaining value in his investments.  Correspondingly, opposite characteristics - a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield - are in no way inconsistent with a "value" purchase."  Warren Buffett

“The ‘value/growth dichotomy’ is false - at least, to a true value investor, whose aim is not to buy stocks which are ‘cheap’ on accounting measures (P/E, price to book, etc.) and to avoid those which are expensive on the same basis, but rather to look for investments trading at low prices relative to the investor’s estimate of their intrinsic value.”  Marathon Asset Management

High P/E Stocks Can Be Value Stocks

Of course, everyone would like to buy high quality companies on low P/E ratios. Unfortunately that’s often not possible. History suggests that high quality companies that compound capital at high rates of return could have been purchased at very high multiples and still delivered attractive returns. Stocks that look ‘optically expensive’ on traditional ‘value metrics’ can still be great investments, provided they deliver earnings growth, even in the event of future P/E compression.

A recent Investment Insight note by Lindsell Train’s Nick Train, looked at the history of McDonald’s:

“.. by the start of 1990 McDonald’s was now trading at over $8 – an 8-bagger since 1980. Historic earnings were $0.48, for a P/E of 18x. I imagine in early 1990 there was prolonged discussion in institutional investment meetings about what the right P/E should be for McDonald’s and whether 18x wasn’t a bit rich – especially for a stock that had already done so well. Of course – with hindsight – we can now be sure that any debate about the valuation of McDonald’s in 1990 was more or less irrelevant. It could have been valued on over 50x and even at that rating it would still have performed in line with the S&P 500 through to today. (The S&P rose 7.5x between 1990 and 2018 and McDonald’s 22x – nearly 3x as much. Therefore McDonald’s could have been nearly 3x more expensive in 1990 and still performed in line.) And any quibbling about the valuation that actually encouraged a sale of the stock was downright ruinous.

Yet we all know that the credibility of the investment professional who argues that such and such stock is overvalued on 18x is often higher than that of the investor who counters along the following lines. “I don’t know what the right rating or price is for McDonald’s today, I just think the business has a lot of growth ahead of it and that we should hang on and just ignore the valuation, except in extremis.”

Terry Smith, in Fundsmith Equity Fund’s 2013 letter, looked back on the performance of Colgate and Coke;

“We examined the relative performance of Colgate-Palmolive and Coca-Cola over a 30 year time period from 1979-2009. Why 30 years? Because we thought it was long enough to simulate an investment lifetime in which individuals save for their retirement after which they seek to live on the income from their investment. Why 1979-2009? We wanted a recent period and in 1979 it so happens that Coca-Cola was on exactly the same Price Earnings Ratio (“PE”) as the market – 10x and Colgate was a little cheaper on 7x. The question we posed is what PE could you have paid for those shares in 1979 and still performed in line with the market, which we took as the S&P 500 Index, over the next 30 years?

We found the answer rather surprising - it was 36x in the case of Coke and 34x in the case of Colgate when the market was on 10x. Another way of looking at it is that you could therefore have paid a PE of 3.6x the market PE for Coke and 4.9x the market PE for Colgate in 1979 and still matched the market performance over the next 30 years. The reason is the differential rate of compound growth in the share prices (to a large extent driven by growth in the earnings) of those companies over the 30 years. They compounded at about 5% p.a. faster than the market. You may be surprised that this differential can have such a profound effect upon the outcome. It’s the magic of compounding.

.. Coke & Colgate’s total returns grew at about 5% p.a. faster than the market over the period 1979-2009, this 5% differential multiplied their share prices four times more than the market over that period. Of course, the next 30 years may be different to the 1979-2009 period.

It is also fair to point out that quality stocks may indeed not be too expensive relative to the rest of the market but that both will prove to be expensive, particularly when interest rates rise. But even so, I suggest you consider how you might have reacted if someone had suggested that you invest in Coke or Colgate at say twice the market PE in 1979. In rejecting that idea you would have missed the chance to make nearly twice as much money as an investment in the market indices over that period which included some periods of very high interest rates. Of course, capturing this opportunity would have required you to have the fortitude to sit on your hands during those periods of high interest rates and poor performance. As at 31st December 2013 they were trading at PE’s slightly above the market – our portfolio was on a PE of 20.6x versus 17.4x for the S&P 500, which doesn’t sound quite so expensive when you look at their historical performance and quality.”

And finally Polen Capital’s September 2018 Insights titled ‘Wonderful Companies at Fair Prices’ looked at the relationship between strong growth and P/E ratings and the implications of future P/E de-ratings …

“We spend far more of our time understanding the earnings potential of a business rather than trying to determine its fair value. Strong earnings growth is not only indicative to us of a potentially great business, but of a business that may be able to protect investor capital through a range of financial and economic circumstances. The charts in Figure 1 illustrate this point.

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The chart on the left shows the effect of four different scenarios of earnings growth, P/E multiple compression and the resulting annual rate of return on a $100 investment in the same company. The first scenario (top line) is the most straightforward: assuming a company’s EPS grows 15% per year for five years (with no dividend payments) and its valuation doesn’t change, the investor’s annual rate of return over the five-year period will be 15%. In the second and third scenarios, the company’s EPS growth remains at 15% per year but the P/E of the company’s stock decreases by 10% and 20%, respectively, over the five-year period. In these two scenarios, though the valuation works against you, the investor still realizes annualized returns of 12.6% and 10%, respectively because the EPS growth remained strong. In the last scenario (bottom line), the company’s EPS growth is once again 15% but the valuation compression is more significant with a P/E ratio reduction of a full 50% over the five-year period, yielding a 0% annualized return for the investor. While not ideal, it is still worth pointing out the obvious: the investor didn’t lose money. Thus, even in the scenario where one arguably invested in an overvalued business, the underlying EPS growth provided a buffer and helped to prevent capital loss.

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The chart on the right in Figure 1 presents the effects on the resulting annual rate of return for a $100 investment in the same company in a scenario where both the EPS growth of the business decelerates and the P/E ratio compresses. In this dynamic, over a five-year period the earnings growth could slow from 15% to 10% and the P/E multiple could contract by nearly 40% - yet the worst outcome would be flat returns. Put another way, EPS growth and valuation projections would need to be overestimated by more than 33% for an investor to lose money over the five-year time horizon.

This is how we approach valuation. It’s not overly complex nor is it meant to be. If, after thorough analysis, we have high confidence in a company’s ability to deliver attractive investment returns over a sustained period, then it becomes a business worth considering for our portfolios. projection Importantly, this return may very well assume that the stock’s P/E multiple compresses over our time horizon.

The Polen article provided the examples of Visa and Alphabet where despite P/E contractions, the stocks delivered outstanding long run returns. In the case of Alphabet, the stock delivered 25% annualised returns, significantly outperforming the market, despite a near 60% PE compression.

“Perhaps the most notable thing about the Alphabet example is that the 25% annualized return was achieved despite the stock’s valuation compressing significantly. Alphabet’s forward P/E ratio was over 70x at one point in 2004 but then steadily declined to as low as 12.5x by 2012 (an 80% decline in valuation) before steadily recovering. Even with that recovery, Alphabet’s P/E declined by nearly 60% over the entire period and yet that significant P/E multiple compression did not prevent the investor from achieving outstanding long-term returns.”

The reason Alphabet could sustain such a significant PE compression was because earnings growth dwarfed the impact of the PE de-rating on the stock price. Finding companies with high earnings growth provides protection against a PE de-rating.

“If you have an asset that’s growing earnings at 20%, your money is doubling roughly every 3 ¼ years.  If you could have a five year time horizon and let’s say your money goes up 3 fold and you buy at a reasonable price, there is literally no way you lose money. If its cashflows grow 3 fold and you bought it at a reasonable price there is no scenario where you lose money. If the multiple gets cut in half or by 75% you still win assuming you bought it reasonably. I am not assuming you bought it at 500X or something like that. Having underlying growth of the cashflows solves so many problems so I always look for things that actually are generating some form of growth. I don’t know what the multiple will be in 2 years, but I know I underwrote it well.”  Jason Karp

A recent excellent post by Morgan Housel summarised why over time a company’s earnings growth has a larger impact on a stocks value than the multiple. It’s about compounded earnings.

Valuation changes have a majority impact on your overall returns early on because company earnings are likely the same or marginally higher than when you made the investment. But as earnings compound over time, changes in any given year’s valuation multiples have less impact on the returns earned since you began investing.Morgan Housel

Source: Collaborative Blog, Morgan Housel

Source: Collaborative Blog, Morgan Housel

Over time the impact of purchase multiples fade while earnings growth and ROE determine long term returns.

“While valuation multiples matter a lot in the short-term – they drive stock performance tremendously in years one through three – in years three and beyond, the impact of a change in multiples, unless extreme, fades when it comes to long-term capital compounding.Yen Liow

Buffett and Munger have long recognised the benefit of buying wonderful companies at fair prices, as opposed to fair companies at wonderful prices.

“Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price.” Warren Buffett

Over the years, they’ve shown a reluctance to part with high quality companies despite high multiples. They’ve even recognised the benefits of such companies buying back their own shares at high multiples, implying they believe intrinsic values are higher than those prices.

“The last bit of Coke Warren bought in 1990 was bought at 25X trailing earnings. So it wasn’t  cheap by traditional metrics, but on many fronts they considered it a no-brainer.” Mohnish Pabrai

"In GEICO, we paid 20 times earnings and a fairly sized multiple of book value." Warren Buffett

"If you’re right about the companies, you can hold them at pretty high values." Charlie Munger

"We really have a great reluctance to sell businesses where we like both the business and the people. So I don’t think I’d count on seeing many sales. But if you ever attend a meeting here, and there are [holdings at] 60 or 70 times earnings, keep an eye on me.... You can really hold them at extraordinary levels if you’ve got [wonderful businesses]." Warren Buffett 

"Looking back, when we’ve bought wonderful businesses that turned out to continue to be wonderful, we could’ve paid significantly more money, and they still would have been great business decisions. But you never know 100 percent for sure." Warren Buffett

“When we own stock in a wonderful business, we like the idea of repurchases, even at prices that may give you nose bleeds. It generally turns out to be a pretty good policy.” Warren Buffett

“The really great companies that buy [back stock] at high price-earnings, that can be wise.” Charlie Munger

Buffett makes the point above “you never know 100 percent for sure”. And therein lies the difficulty. The problem is, the future is never knowable. The key is to get comfortable such businesses have longevity and will continue to compound into the future. Ordinarily such businesses display a track record of performance, high and sustainable returns on equity, and excellent management. As few businesses can sustain high earnings growth over a period of ten to fifteen years most don’t deserve premium multiples. And when companies on high PE multiples stumble due to high earnings growth expectations that didn’t transpire, the results can be brutal; a double de-rating as earnings and the P/E ratio get marked lower. Paying high multiples for speculative stocks with limited track records is gambling not investing. It’s very, very dangerous.

“Most investors usually confer the highest price-earnings ratios on exotic-sounding businesses that hold out the promise of feverish change. That prospect lets investors fantasize about future profitability rather than face today's business realities.  For such investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be. Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.” Warren Buffett

Focussing On Low P/E’s Can Lead You Into Value Traps

Screening for low P/E stocks, unsurprisingly, can lead you into low quality businesses. It’s one of the reasons that many of the Investment Masters focus on business quality first and valuation second.

“Many of our value competitors start the process of identifying likely investments by starting with price.  Looking at a screen.  We don’t believe in those screens.  Cheap looking stocks will end up on screens. They will be either the lousiest competitors in an industry or operating in industries which are overly competitive.  What makes us want to investigate a stock idea? - it’s not that it looks cheap - but if there seems to be something unique or superior about it. It may not optically look cheap.” Charles De Vaulx

"I’ve found that when valuation is the overriding driver of interest, I’m prone to get involved in challenging businesses or complicated ideas and liable to confuse a statistically cheap price with a margin of safety."  Allan Mecham

"When you find a “cheap” stock, you can easily convince yourself that the long-term prospects of the company are great. That is why I try not to look at valuation at the beginning of the process.  Cheap is not cheap when you hope for an increase of the P/E ratio in the short-run even though the long-term economics may be poor." Francois Rochon

“We try to avoid value traps by not making valuation the first, second, or third thing we look at. We never base our thesis on valuation alone. .. When you are analyzing your portfolio and opportunity costs, if the only thing your thesis rests on is "it's cheap," then it is time to move on.” Dan Davidowitz

Too many investors focus on price first and business quality later, if at all. While every asset has a price, there are many we wouldn’t touch at any price, or with a ten-foot pole. Price is not value.” Chris Bloomstran

"I used to spend a lot of time screening the market according to typical value criteria such as price to book or P/E, but I now do this a lot less often.  I find that these types of screen naturally direct you to cheap stocks, whereas what I am looking for are value stocksThe two things are not the same. I much prefer to make the first cut according to whether a company has a wide moat as the time is unlikely to be wasted."  Robert Vinall

“We want to avoid value traps like the plague. That’s when you get down to the execution of value investing. Value investing works really well when it is well executed.  But you can’t be superficial.  You can’t just say it’s got a low PE, or a high dividend yield. Those are dangerous things.”  CT Fitzpatrick

"Starting out I was a Graham and Dodd investor, focused on low price/ earnings ratios, good balance sheets and high dividend yields. The problem with that is you can get caught in too many value traps. I concluded I was better off focusing primarily on two key variables in weighing investment attractiveness: company valuation and business quality." David Herro


It should be clear that simply picking a stock based on the P/E level is a not sound investment strategy. Whilst some of the early indicators may suggest that a stock is a steal because of favourable ratios, it has been proven time and time again that it will more than likely end up being a value trap.

I’ll leave you with some final thoughts on this topic from some very wise people…

“In the evaluation of any business, we believe investors are best served by taking the time to fully understand the enterprise before giving appropriate consideration to its valuation.” Dan Davidowitz

“If you plan to hold a share for the long term, the rate of return on capital it generates and can reinvest at is far more important than the rating you buy or sell at.” Terry Smith

“We think, that the parameters that circumscribe “cheap” and “dear” in investors' minds are much too narrow. Investors are “anchored” to the top and bottom ends of a valuation range in a way that is not economically rational and is, therefore, inefficient. It can be hugely rewarding to buy a value-creating, strategically-advantaged company on 20.0x earnings and hugely damaging to your wealth to buy a supposedly “cheap” stock, in a value-destroying company on 10.0x.” Nick Train

“The funny thing with the investing business is that sometimes you can buy something at 20 times earnings and it can be cheap depending on the moat and the runway.”  Mohnish Pabrai

“On my time horizon, the calibre of a company is much more important than its value. You can be wrong about value in the short term, but still have a great investment over time. My worst errors have come from overestimating a company's business model, not overestimating the worth of a fine company.” Nick Train

Market Timing

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There are many impossibilities in life.

And I’m sure you’ve heard of some of them - to live forever, to travel at the speed of light, or even to travel back in time. But one of the lesser known impossibilities is the belief that someone is able to consistently Time the Markets. And anyone telling you they know exactly when something is going to happen in those same markets is quite simply not telling you the truth.

If only it were possible.

Imagine being able to predict what the market was going to do at some point in time. To know exactly when it was going up, or down, or when it was time to get in or out. You’d be very wealthy and also very famous. But its not reality, despite many people acting like or believing that they can.

Market commentators and forecasters are always sprouting off on what the market is about to do. ‘Sell now, before it’s too late’. ‘Buy the dip.’. ‘A Market Crash is Imminent’. ‘Rotate into Cyclicals’. The unfortunate thing is that very few people have shown an ability to successfully navigate the ups and downs of the stock market, including the world’s best investors.

“There are only two types of people: those who can’t market time, and those who don’t know they can’t market time.” Terry Smith

Timing the Market is a very tricky thing to do. Despite knowing this, the most basic rules of investing almost suggest that we should be able to. Buy Low, Sell High - that is the simplest recipe for success in the stock market. When the market appears braced for a fall, move to the sidelines. After the decline, buy back those stocks cheaper.

If only it was that simple.

The good news is that the Investment Masters long term track records of success, stand in spite of this. You don’t have to be able to time the market, and in fact, Timing the market isn’t a pre-requisite to success at all.

Here’s what some of the world’s greatest investors had to say about market timing:

I can’t time stocks.. I don’t know anybody else who can either.”  Warren Buffett

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“I don’t think we would want a manager who thought he could just go to cash based on macroeconomic notions and then hop back in when it was no longer advantageous to be in cash. Since we can’t do that ourselves.” Charlie Munger

“We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will.” Seth Klarman

"Do not try to time the market." Chris Davis

“Active market timers usually fail.” David Swenson

"We don't try to time the market." Glenn Greenberg

"Our observation over 38 years is that no one can consistently predict either the stock market or the US economy." Bill Smead

“The odds of my adding value consistently by trying to time the market are very slim.” Lee Ainslie

“We think attempting to time markets (knowingly or unknowingly) is a fool’s errand.” Allan Mecham

“In more than 35 years in the investment business, I have yet to find a short-term timing strategy that works.” Christopher Browne

“The character of the markets is continually changing, and there is no single timing system that will consistently, indefinitely work.” Barton Biggs

"After nearly 50 years in this business, I do not know of anybody who has [timed the market] successfully. I don't even know of anybody who knows anybody who has done it." Jack Bogle

"I don't believe all this nonsense about market timing. Just buy very good value and when the market is ready that value will be recognised." Henry Singleton

Market timers consistently try to guess when to sell equities. To us, that’s a losing battle given the market had a positive return about three-quarters of the time.” Bill Nygren

Market timing, rather than long-term investing, is ‘your first instinct’ as a money manager. But as I got older, I decided it's a fool's game." Roger Engemann

“We never try to ‘time’ the market.” Dan Davidowitz

“The greatest investors in history like John Templeton, Peter Lynch, Philip Fisher, Philip Carrett and Warren Buffett believe that it’s futile to attempt to predict the market in the short term. We share in their market agnosticism.” Francois Rochon

"For the record, and in case there is any misunderstanding, we do not have the faintest idea what share prices will do in the short term - nor do we think it is important for the long-term investor." Nicholas Sleep

“Our data in our firm says most of the people in our firm are not very good market timers. They’re very good stock pickers but they’re not great market timersSteve Cohen

“When we look at the US trading records for the long-term, we cannot find successful long-term investments that are based on short-term-oriented theories and strategies. The great long-term investments have all been made by value investors.” Li Lu

“While we may, from time to time, have views on where the stock market is headed, we generally do not make bets on its direction.David Abrams

“Has anyone ever consistently gauged turning points, timed markets? Sure, people can get it right once, twice. But then they’re dead the third time or the fourth time. I mean dead. I mean, buried.” Paul Singer

“Our directors will tell you that they’ve never been to a directors meeting where the subject of the direction of the stock market is — we are not in that business. We don’t know how to be in that business. Obviously, if we could guess successfully a high percentage of the time where the stock market was going to go, we would do nothing but play the S&P futures market. There wouldn’t be any reason to look at businesses and stocks. So it’s just not our game.” Warren Buffett

Markets are Complex Adaptive Systems

The reason it’s so hard to time the market is that markets are complex, adaptive systems. Some information is always unattainable and human reactions can be irrational and unpredictable. This often results in unexpected and non-linear outcomes.

"Do not attempt to time the stock market. The near term direction of the stock market is determined by so many forces that it is difficult for anybody to identify all the relevant ones, let alone understand them and weigh them and then determine the extent that they are already discounted into the market. Furthermore, the forces are dynamic, leaving market timers at the mercy of future forces that are difficult (and many times impossible) to predict. For all these reasons, most market timers do not seem to enjoy acceptable batting averages." Ed Wachenheim

“It is worth reminding oneself from time to time that almost any description and every prediction about the U.S. stock market involves a gross oversimplification of an extraordinarily complex system, a system that adaptively incorporates the collective expectations of all its participants into the price of its securities.” Bill Miller

“The important turning points in markets are never identified with precision in advance by ‘experts’ and policymakers. This lack of foresight is not surprising, because markets and the course of the economy are not model-able scientific phenomena but rather are examples of mass human behavior, which are never predictable with anything like precision.” Paul Singer

“Markets are a so-called second-order system - to usefully employ your predictions you would not only have to make mostly correct predictions but you would also need to gauge what the markets expected to occur in order to predict how they would react. Good luck with that.” Terry Smith

Research suggests Market Timers Fail

Research shows the odds are against you if you try and time the market.

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“Nobel Prize winner William Sharpe found that a market timer must be right a staggering 82 percent of the time to match a buy and hold return. That’s a lot of work to achieve what could be achieved by taking a nap.” Christopher Browne

“The persistent belief that superior returns can be generated through dancing in and out of stocks as the tune of the music changes, defies logic or empirical analysis but at least provides useful material for students of behavioural finance.”  Marathon Asset Management

“The vast majority of us are terrible at so-called “market timing”, in which investors try to sell at or close to market peaks and buy at market lows. All the statistics about investor flows show that believing you can accomplish this feat is the triumph of hope over experience. The wisest investors who are most likely to get the best performance are those who have at least realised that they can’t do this successfully and so don’t try.” Terry Smith

Markets Timers Must Get Multiple Decisions Right

When attempting to time the market you need to get multiple decision right; the buying and the selling.

“In my experience, most people who are lucky enough to sell something before it goes down get so busy patting themselves on the back they forget to buy it back.Howard Marks

“Are you really smart enough to not only a) predict a market fall but also; b) figure out how this translates into individual stock movements; c) get your timing sufficiently correct that you do not either forgo gains which far outweigh any losses you protect against or suffer some of the downturn; d) have sufficient mental agility and nerve to start buying when your prediction of a market fall has become reality; and e) get the timing roughly right on that side of the trade so that you don’t end up catching the proverbial falling knife or missing some or all of the recovery? If so, I doubt you will be reading this letter on your private island. But above all, I doubt you exist.” Terry Smith

Most Investors are driven by Emotion

Furthermore, human nature usually works against your chances of success. Most investors tend to be wired so they panic after markets decline and sell at or near the lows. Ordinarily they wait for the markets to stabilise before re-entering and miss the bottom.

Being human, we are our own worst enemy. Everything that goes on in the world and the market conspires to make people buy when things are going well and prices are high and sell when things are going badly and prices are low.” Howard Marks

Human nature - innate, deep rooted, permanent. People don't consciously choose to invest with emotion - they simply can't help it." Seth Klarman

Costs are a Drag on Performance

A market timing strategy also incurs additional costs in the form of trading commissions, spreads and taxes.

"If you buy, sell, buy, sell you’re gonna pay a lot of commissions and dealer spreads and lose your money." Shad Rowe

Markets have an Upward Bias

When you move to the sidelines there’s also an opportunity cost. Over time the markets have had a natural tendency to rise.

“Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. (The Dow Jones Industrials advanced from 66 to 11,497 in the 20th Century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions. And don’t forget that shareholders received substantial dividends throughout the century as well.) Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.Warren Buffett

“I think it’s dangerous to draw lines in the sand after which you’ll just sit it out. Once you do, the temptation is to spend all your time trying to defend why now is not the time to be invested. I wrote a piece last year on the 25th anniversary of Oakmark Fund. At the time the fund had returned something like 20x investors’ initial capital, while the S&P was up 10x. But when you look at the list of things investors had to deal with over that time – wars, hurricanes, global financial crisis, oil-price collapse, just to name a few – it’s amazing the market returned 10-fold.” Bill Nyrgen

“You want to spread the risk as far as the specific companies you’re in by owning a diversified group, and you diversify over time by buying this month, next month, the year after, the year after, the year after. But you are making a terrible mistake if you stay out of a game that you think is going to be very good over time because you think you can pick a better time to enter it.” Warren Buffett

The odds are high you’ll miss the best returns.

"We believe that the nature of financial markets do not favor timing investment strategies. In fact, historically, 90% of stock returns happened during 1.5% of trading days. Statistics are against those that think they can outsmart the market over a long period of time." Francois Rochon

The Best Long Term Performing Stocks Decline

“I don’t know how to time the market effectively, nor am I aware of any person or computer that has consistently done so. Inevitably, market timing leads to under-investment. Portions of the downside are often avoided, but so are the recoveries. Given the positive expected values of our investments over the long term, trying to predict the daily movements of the market is not likely to improve returns… Even the highest quality companies like Berkshire Hathaway and Nike have each had multiple 50%+ drawdowns during their decades of heroic returns. Only those able to endure the pain of such declines actually participated in the 100x+ returns that ultimately were realized by the holders.” Scott Miller

Timing May Interfere with the Investment Process

"You may have trouble believing this, but Charlie and I never have an opinion about the market because it wouldn’t be any good and it might interfere with the opinions we have that are good." Warren Buffett

So what can you do?

Rather than focus on what the market will do, focus on the things you can control; like your investment process.

“In my nearly fifty years of experience on Wall Street I’ve found that I know less about what the stock market is going to do but I know more about what investors ought to do; and that’s a pretty vital change in attitude.” Benjamin Graham

Position Properly / Follow a Game Plan

Portfolios need to be built so they can handle worst-case scenarios, which are often magnitudes greater than you expect. The ‘cardinal sin’ of investing is being stopped out at the bottom. This means having appropriate diversification, position sizes, liquidity, aligned clients and avoiding leverage.

“I never really have a strong outlook for what is going to happen in the coming year. I have never felt that you can really predict with any useful degree of precision what’s going to happen from one year to the next in terms of generalized market moves. So rather than waste any mental energy doing so, we just make sure that we are positioned properly so that no matter what happens, our clients are in good shape.” Chris Mittleman

“It’s always hard to know why the market does what it does. That’s part of the ever-interesting challenge we face in traversing the twists and turns of fluctuating prices and evolving fundamentals. On any given day, the sheer number of players, behaviours, economic factors, and business developments defy anyone’s ability to fully grasp what is going on and why. That’s why we develop and follow a game plan that does not purport to tell us what to do moment by moment, but rather is intended to help us successfully navigate the most challenging tumult. This is the essence of value investing.” Seth Klarman

To survive markets that can be irrational for long periods of time requires not betting the farm, spreading risks, and seeking asymmetric opportunities where the upside is substantially higher than the downside.” Scott Miller

Don’t Try and Predict the Next Crash

The Investment Masters realise the folly in trying to predict the next stock market crash.

"Market forecasters will fill your ear but will never fill your wallet." Warren Buffett

“Trying to predict the timing of the next major market dislocation has always been a “fool’s errand.”  Paul Singer

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves.” Peter Lynch

No one can predict market downturns with any useful level of reliability.” Terry Smith

“We believe that declines are unpredictable and those who attempt to predict the market are choosing a strategy which will serve them a loser’s hand over the long term.Francois Rochon

Maintain a Long Term Perspective

As Buffett noted in the quote above, US equity markets have delivered attractive returns over the long term. That’s just as likely to be the case for the next century as well. That means if you have a long term investment horizon, you’ve got a natural tailwind behind you.

“It’s time in the market, not market timing that counts.” Christopher Browne

“History shows that time, not timing, is the key to investment success. Therefore the best time to buy stocks is when you have money.” Sir John Templeton

“We do not attempt to manage the percentage invested in equities in our portfolio to reflect any view of market levels, timing or developments. Getting market timing right is a skill we do not claim to possess. Studies clearly show that most successful fund managers avoid market timing decisions.” Terry Smith

“Let me underscore my belief that the short-term price movements are so inherently tricky to predict that I do not believe it is possible to play the in and out game and still make the enormous profits that have accrued again and again to the truly long-term holder of the right stocks” Phil Fisher

In his recent 2018 annual letter, the Fundsmith Equity Fund’s Terry Smith looked back at the 1987 stock market crash, the largest percentage one-day stock market drop in history, and it’s impact on the long run returns of the US stock market. As is evident in the chart below and as Smith noted, ‘In the long term, it did not matter’.

Smith continued:

“However, this does not stop advisers and commentators predicting crashes and bear markets and suggesting you take preventative action, which ranges from reducing your equity holdings, buying or ‘rotating’ into lowly rated so-called ‘value’ stocks, through to selling everything and holding cash to safeguard the value of your assets or buying Bitcoin (down 80% in 2018).”

Source: Fundsmith 2018 Annual Report

Source: Fundsmith 2018 Annual Report

Cash Should Reflect Opportunity-Set

The Investment Masters hold significant cash when they are unable to find attractive investments, not due to a market call.

“When bargains are lacking, we are comfortable holding cash.Seth Klarman

"Because we are focused on absolute returns, we will hold cash in the absence of values and a margin of safety. We view cash as an opportunity fund." Arnold Van Den Berg

“It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.” Charlie Munger

"Our cash position is not a “market call,” it simply reflects an absence of ideas that we find attractive. We’ve never made hay by hoarding cash in anticipation of market corrections; a quick trip down memory lane serves as a reminder that we entered both bear markets (2002 & 2008) fully invested. We prefer partial ownership in businesses over snappy trades that require gazelle-like instincts to dart away from any hint of danger. We think attempting to time markets (knowingly or unknowingly) is a fool’s errand and agree with Peter Lynch: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Allan Mecham

"If we have cash, it’s because we haven’t found anything intelligent to do with it that day, in the way of buying into the kind of businesses we like. And when we can’t find anything for a while, the cash piles up. But that’s not through choice, that’s because we’re failing at what we essentially are trying to do, which is to find things to buy." Warren Buffett

“We tell our clients .. ‘we are fully invested all the time, we’re not market timers, we don’t know anything about the market’. If we can’t find anything we will buy a company that’s being taken over.” Mario Gabelli

Own Quality Companies

Owning quality companies is the best defence to endure economic downturns. They often come out the other side stronger.

"Generally speaking, trying to dance in and out of the companies you really love, on a long-term basis, has not been a good idea for most investors. And we’re quite content to sit with our best holdings. People have tried to do that with Berkshire over the years. And I’ve had some friends that thought it was getting a little ahead of itself from time to time. And they thought they’d sell and buy it back cheaper and everything. It’s pretty tough to do. You have to make two decisions right. You know, you have to buy — you have to sell it right first, and then you have to buy it right later on. And usually you have to pay some tax in-between. If you get into a wonderful business, best thing to do is usually is to stick with it." Warren Buffett

"A few words on the timing of purchases. Woody Allen said that 80% of success is showing up. That's one of the main reasons we always want to be invested in the stock market, because we believe that owning great companies, not trying to predict the stock market, is the key thing to be able to beat the index over the long run." Francois Rochon

Price, don’t Time

Focus on paying the right price for quality companies. If you can buy a good business at an attractive price, do so.

"It’s uncertain every single day. Take uncertainty as being involved in investment. But uncertainty can be your friend. When people are uncertain, we pay less for things. We try to price, we don’t try to time at all.Warren Buffett

We don’t have an opinion about where the stock market’s going to go tomorrow or next week or next month. So to sit around and not do something that’s sensible because you think there will be something even more attractive, that’s just not our approach to it. Anytime we get a chance to do something that makes sense, we do it... So picking bottoms is basically not our game. Pricing is our game. And that’s not so difficult. Picking bottoms, I think, is probably impossible. when you start getting a lot for your money, you buy it.." Warren Buffett

Be Guided by the Business, not Market Forecasts

“If we’re right about a business, if we think a business is attractive, it would be very foolish for us to not take action on that,because we thought something about what the market was going to do, or anything of that sort.” Warren Buffett

Expect Uncertainty, Volatility and Down Markets

Maintaining a disposition toward future uncertainty, volatility and down markets will better prepare you for when they inevitably come.

“The idea that you try to time purchases based on what you think businesses are going to do in the next year or two, I think that’s the greatest mistake investors make because it’s always uncertain. People say ‘well it’s a time of uncertainty’. It was uncertain on September 10, 2001, people just didn’t know it was uncertain. It’s uncertain every single day. Take uncertainty as being involved in investment. But uncertainty can be your friend. When people are uncertain, we pay less for things. We try to price, we don’t try to time at all. ” Warren Buffett

“If I buy a farm near here and it turns out to be a terrible year, and pests come in, and there’s no rain and all that sort of thing, am I going to sell if for half the price that it was selling for a year earlier? When I know over the next 100 years, there are going to be 90 years that are pretty good and a few bad ones? It doesn’t make sense to try and time things that way.” Warren Buffett

Control Your Emotions

“We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will. The key is to find a way to care about one’s investment results over time, but to not feel burdened by the daily fluctuations of Mr. Market. The only way to invest, after what you purchased has fallen in price, is to be that successful relief pitcher. Put yesterday’s outcome out of your mind, get back on the mound, and make the best decision you can today with all the information at hand.” Seth Klarman

Be Optimistic

“I feel that people should learn to be optimistic because life goes on, and sometimes favorable surprises come out of the blue, whether due to new policies or scientific breakthroughs.” Irving Kahn

“Bulls make more than bears, so if anything be an optimist about life and about things in general is a great attribute as an investor. You just can’t be starry eyed and naive.” Stanley Druckenmiller

“We have chosen optimism and the belief that our civilization is fundamentally progressing. While prudence frames our approach towards stock selection, we have so far been rewarded for maintaining a constructive attitude.” Francois Rochon

“I had to teach myself to be bullish. But I promise you, as soon as I started looking on the bright side, not only did my investment performance begin to improve, but I felt and looked younger, too. Let’s face it – bearishness is the natural province of crabby old people.  All the great investors – Buffett, Fisher, Munger, Templeton – stayed structural bulls and (have) reached grand old ages. Not only were they intellectually correct to be bullish – as history and their track records amply confirm – but they were emotionally smart, too.” Nick Train


"It’s very hard to move around successfully and beat, really, what can be done with a very relaxed philosophy." Warren Buffett

“Those investors who put the market on a time table not only become frustrated but end up making foolish moves. Instead, get on the train, sit back and enjoy the scenery.Roger Engemann


So if you know someone who not only states they can predict the near term future, or this or that downturn or recession, but also the precise timing of those events, ask them what other things they’ve been able to predict. I guarantee there wont be much else. If it’s true, and I highly doubt that it is, it will have been no more than luck. Even a broken clock is right twice a day.

When the world’s greatest investors acknowledge they can’t time the market, what makes other people think they can? Seriously speaking, given the attractive long term returns generated by the world’s best investors without market timing, there is no logical reason that anyone should try to time the markets.

But if you do meet someone who wants to persist in this fool’s errand, borrow the very wise words of Terry Smith and say: “Good luck with that.”

Follow us on Twitter: @mastersinvest


Further Reading:
The Futility of Market Timing” - Drew Dickson, Albert Bridge Capital
Even God Couldn’t Beat Dollar-Cost Averaging- Nick Maggiulli
The Stock Market Timing Game

Thinking About Return on Capital

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Return on capital. Its a simple thing. It’s defined as the amount of money the business earns on the capital that has been invested in the business. And its also one of the attributes the world’s most successful investors are after when they’re looking for quality companies.

There are other attributes that make up a great company, too. And every investor places a different level of importance on the characteristics they feel are important; strong management, consolidated industry, high barriers to entry, attractive product, good culture, solid balance sheet, low obsolescence risk, etc. But among all these traits, one of the most common characteristics they seek is a high return on capital.

“What we really want to do is buy a business that’s a great business, which means that business is going to earn a high return on capital employed for a very long period of time, and where we think the management will treat us right.” Warren Buffett

The higher the return on capital, generally speaking, the better the business. It’s even better when such businesses can re-invest more capital at attractive rates of return. Not many businesses can do this.

“If you earn high enough returns on equity and you can keep employing more of that equity at the same rate — that’s also difficult to do — you know, the world compounds very fast.” Warren Buffett

“If you’re going to own a company for a long time, the earnings it generates today will be a small component of the eventual return.  Much more important will be how those earnings can be reinvested over time to build value.  When companies with positive compounding characteristics become available at really attractive prices, we’ll hope to take advantage.” Chris Davis

“It is not enough for companies to earn a high un-levered rate of return. Our definition of growth is that they must also be able to reinvest at least a portion of their excess cash flow back into the business to grow while generating a high return on the cash thus reinvested. Over time, this should compound shareholders’ wealth by generating more than a pound of stock market value for each pound reinvested.” Terry Smith

Such business are often referred to as ‘compounding machines.

“The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine.” Warren Buffett

"A compounder is a competitively advantaged business that earns superior returns on invested capital. As cash earnings are reinvested back into the business, the value of the business grows year after year compounding our investment.” Christopher Begg

While stock prices often swing around erratically in the short term, over the long term, a company’s share price will reflect the business’ earnings. Over the long term, all you can get out of a business are the returns it produces.

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“Bear in mind--this is a critical fact often ignored - that investors as a whole cannot get anything out of their businesses except what the businesses earn. Sure, you and I can sell each other stocks at higher and higher prices.” Warren Buffett

“Occasionally, people lose track of the fact that in the long run, shares can’t do much better than the companies that issue them.”  Howard Marks

“The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.” Warren Buffett

And it’s the business’ return on capital and the re-investment rate that drive future earnings, making it the key driver of a stock’s long term performance.

“A stock return will eventually echo the increase in the per share intrinsic value of the underlying company (usually linked to the return on equity).” Francois Rochon

“Over the long run, it is a company’s return on capital, not changes in quarterly earnings, which primarily determines the direction of its share price. The return on capital of any company is largely subject to the state of competition within its industry.” Marathon Asset Management

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.” Charlie Munger

“The higher return a business can earn on its capital, the more cash it can produce, the more value is created. Over time, it is hard for investors to earn returns that are much higher than the underlying business’ return on invested capital.Warren Buffett

It’s the reason Buffett and Munger steer well clear of businesses with low returns on capital.

“We like to think when we buy a stock we’re going to own it for a very long time, and therefore we have to stay away from businesses that have low returns on equity.” Warren Buffett

"If you have a business that’s earning 5 or 6 percent on equity and you hold it for a long time, you are not going to do well in investing. Even if you buy it cheap to start with." Warren Buffett

It’s also the reason Buffett and Munger et al think it’s worth paying more for businesses with high returns on capital. The high returns on capital combined with a high re-investment rate compound to drive extraordinary earnings and share price gains over time.

"Looking back, when we’ve bought wonderful businesses that turned out to continue to be wonderful, we could’ve paid significantly more money, and they still would have been great business decisions. But you never know 100 percent for sure. And so it isn’t as precise as you might think. Generally speaking, if you get a chance to buy a wonderful business — and by that, I would mean one that has economic characteristics that lead you to believe, with a high degree of certainty, that they will be earning unusual returns on capital over timeunusually high — and, better yet, if they get the chance to employ more capital at — again, at high rates of return — that’s the best of all businesses. And you probably should stretch a little." Warren Buffett

“Faced with the choice between investing in two companies with the same earnings growth, we are prepared to pay materially more (in P/E terms) for the business with high returns on equity and superior cash flow generation.” Marathon Asset Management

“If you invest for the long term in companies which can deliver high returns on capital, and which invest at least a significant portion of the cash flows they generate to earn similarly high returns, over time that has far more impact on the performance of the shares than the price you pay for them. Yet I have been asked far more frequently whether a share, a strategy or a fund is cheap or expensive than I am asked about what returns the companies involved deliver and whether they are good companies which create value or not.” Terry Smith

As high returns on capital attract competition, it’s important to get comfortable that the returns are sustainable.

“For most companies, high ROE’s and dividend growth rates will quickly be competed away.James Bullock

“The problem with high ROE’s in capital intensive businesses is that it is hard to sustain the ROE’s. Here, high returns attract competition both from new entrants that come with new capital and existing competitors that try to see what the better performing competitor is doing to copy it. The new capital and the copycats often succeed in driving down the superior ROE’s. Really bad things happen to earnings when a 25% ROE turns into a 10% ROE.” David Einhorn

“Note that we are not just looking for a high rate of return. We are seeking a sustainably high rate of return.Terry Smith

A long history of high returns on capital is a sensible starting place to look for potential investments.

“We think a long history of high returns is on average a strong indication of an exceptional, durable business model - a factor to which we don’t think other investors give a high enough weighting.” James Bullock

Ordinarily such businesses are protected by a ‘moat.

“The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with ‘Roman Candles’, companies whose moats proved illusory and were soon crossed.” Warren Buffett

“A truly great business must have an enduring 'moat' that protects excellent returns on invested capital.Warren Buffett

“Few businesses possess an ‘economic moat’ formed by enduring competitive advantages. Our experience reinforces the fact that it is these moats which enable the businesses to earn higher returns on capital than average" Chuck Akre

“There is a reasonably sound piece of economic theory called mean reversion which suggests that companies which generate high returns should attract competition, which will eventually reduce their returns to the average, or worse. The very small group of companies that manage to avoid this economic law of gravity have some kind of defence which enables them to fend off the competition. This is the oft quoted concept of the “moat” popularised by Mr Buffett.” Terry Smith

"Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits." Joel Greenblatt

Identifying businesses with high sustainable returns on capital and sticking with them is a sure fire way to investment success. It’s a reason, once identified, why many of the Investment Masters are reluctant to sell great companies. Regardless of what their share prices do in the short term, the intrinsic value of the business grows. Time is on your side.

“Time is the enemy of the poor business, and it’s the friend of the great business. I mean if you have a business that’s earning 20 or 25 percent on equity, and it does that for a long time, time is your friend.” Warren Buffett

“A good company is one that regularly makes a high return in cash terms on capital employed, and can reinvest at least part of that cash flow in order to grow its business and compound the value of your investment. Bad companies do not do this. They make inadequate returns on the capital they employ. You may think you should invest in these poor companies as they are going to improve because the management will change, or they will be taken over, or their results will pick up with the economic or business cycle. But each day you wait for such events, these companies destroy a little bit more value. Good companies do the opposite. With a good company, time is on your side.Terry Smith

Little wonder many of the Investment Masters focus on buying such businesses.

“Our  ideal investment  couples  high  returns  on  capital  with  shareholder-oriented  management, where  there  is  significant  opportunity  to  re-invest  excess  cash  flow.  We  buy these  companies  when  they  appear  to  us  to  be  undervalued.” Chuck Akre

“Very simply, we are trying to find businesses that exhibit three characteristics: predictable long-term growth, high returns on invested capital and well established, sustainable barriers to competition.” Brian Vollmer

“We also require companies to have extremely high returns on capital, which we define as 20% or more sustainably.” Daniel Davidowitz

“It’s not P/E’s that matter, or profit margins on sales, but how much a business earns on the capital invested in it.” Christopher Bloomstran

Return on capital is probably the single biggest measure that I feel one has to look at. Valuations comes a distant second or third.” Rajiv Jain

“Return on capital at Nomad’s firms is over twice that of competing businesses.” Nicholas Sleep

“The metric we follow most closely is return on equity, which absent distributions and changes in multiples, is the return we as shareholders can expect to earn.” Brian Bares

"I think [estimating] return on incrementally invested capital is one of my most important jobs, i.e assessing how well the management teams and boards are keeping our portion of profits we are not receiving as dividends." Chris Bloomstran

As good as return on capital is as a measure of a superior business, it must be considered in the context of sustainability. Return on capital is a historic measure and so you must form a view as to whether the business is likely to be able to continue to earn those same attractive returns. This requires thinking qualitatively about the business and it’s competitive position; how is it performing today and how likely is it that it will continue to perform in the future? They’re both necessary questions.

Remember, the first rule of investing is ‘preserve capital’ which means ‘Return of Capital’. Buying businesses with highReturns on Capital’ at fair prices are what have made the Investment Masters successful. How do your businesses look by comparison?

Further Reading:
Investment Master Class Tutorial: Capital Allocation
Berkshire Hathaway 1987 Letter

Follow us on Twitter: @mastersinvest


Learning from Herb Kelleher

If you’re a fan of Warren Buffett you’re probably aware that for the last forty years or so, he’s admonished the merits of investing in airlines. It’s little wonder, as the industry is notoriously cyclical, is capital, fuel and labour intensive, has powerful unions and a history of attracting fresh capital. Given that history, its no surprise that most US airlines have been been bankrupted numerous times over, and have left a trail of capital destruction in their wake for investors.

In a 2002 interview with the London newspaper The Telegraph, Buffett stated:

“If a capitalist had been present at Kitty Hawk back in the early 1900’s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You've got huge fixed costs, you've got strong labor unions and you've got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: 'My name is Warren and I'm an aeroholic.' And then they talk me down.”

On the basis of the above, you’d probably be surprised to learn that an airline stock was actually the best performing stock in the S&P500 in the thirty years since it went public. That airline stock turned $10,000 at it’s IPO into $10.2m thirty years later. That same airline stock became more valuable than all it’s rival competitors combined. That airline stock never had a money-losing year. And that airline stock never laid-off an employee.

Source: Bloomberg

Source: Bloomberg

These incredible statistics lay at the feet of business maverick, pioneer and innovator, Herb Kelleher, the co-founder, later CEO, and chairman emeritus of Southwest Airlines. Mr Kelleher passed away in early 2019, leaving a legacy of business insights we can all learn from. Over the years I’ve read a lot about Southwest Airlines and Herb Kelleher and thought it time to dig a little deeper into what made him such a success. As Charlie Munger likes to say, when you find something that’s an anomaly, ask why? why? why?

“The idea of picking some extreme example and asking my favorite question, which is 'what in hell is going on here?'; that is the way to wisdom in this world.Charlie Munger

Like Cornelius Vanderbilt had seen the opportunity to bring steamships to the masses on New York’s harbour one hundred years before him, Kelleher recognised the opportunity to ‘democratise the skies’ and make air travel a quicker, convenient and affordable alternative to travel than via cars, buses and trains for the masses.

Kelleher kept the company’s strategy simple and his unconventional approach helped keep costs low so he could offer 50%-60% discounts on competitor’s fares.

“To support the strategy, the company determined to fly only one type of airplane, the Boeing 737, and to substitute linear flying for the hub-and-spoke model that has prevailed in the industry. But at the center of Southwest’s success are its culture and employees.” Chuck Lucier

The key to Kelleher’s success was leveraging the human trait of ‘reciprocation’ to the maximum extent possible. He built a cultural flywheel that his competitors couldn’t match. He shared the spoils with his employees and in the process built America’s most successful airline.

The more I dug into the roots of Southwest Airlines success, the more I found those same characteristics that have defined the other extreme business successes we’ve covered; Walmart, Nucor, In-N-Out Burger, Home Depot, Panera Bread, McDonalds, Starbucks etc.

I’ve drawn on many historic interviews with Herb Kelleher to piece together the ingredients of Southwest’s success. You’ll notice 90% of the sub-headings below are common to the previous posts on the CEO Masters. Just as there are common threads that link the Investment Masters, there are also many commonalities that permeate the ranks of the world’s greatest companies and their CEO’s. And that should be no surprise, either. If you’ll recall, Warren has always said, “to be a great businessman, you need to understand investing, and to be a great investor you need to understand business.”

It’s About People

"The business of business is people."

“I think the values of Southwest are humanism, number one. I think simplicity, number two. Humor, number three. Service, altruism, number four. I think that pretty well sums it up.”

“We have a People Department. That's what it deals with, so don't call it Human Resources - that sounds like something from a Stalin five-year plan. You know, how much coal you can mine.”

Value People / Leverage Reciprocation

"If you don't treat your own people well, they won't treat other people well."

I always felt that our people came first. Some of the business schools regarded that as a conundrum. They would say: Which comes first, your people, your customers, or your shareholders? And I would say, it's not a conundrum. Your people come first, and if you treat them right, they'll treat the customers right, and the customers will come back, and that'll make the shareholders happy.

We focused on our employees as people. We want them to know that they’re important to us not just because they’re at work uh, like they were cogs in a machine. So we pay a lot of attention to their personal lives. The grieves, the joys that their experience. We recognize those if they’re seriously ill. We communicate with them, we send them care packages. We want them to know that we value them as individuals, not as part of a workplace.”

“At Southwest Airlines, you can't have a baby without being recognized - getting communication from the general office. You can't have a death in your family without hearing from us. If you're out with a serious illness, we're in touch with you once every two weeks to see how you're doing. We have people who have been retired for 10 years, and we keep in touch with them. We want them to know that we value them as individuals, not just as workers. So that's part of the esprit de corps.”

“We used to have a corporate day. Companies would come in from around the world and they were interested in how we hired, trained, that sort of thing. Then we’d say, “Treat your people well and they’ll treat you well,” and then they’d go home disappointed. It was too simple.”

“We did have a different take [to competitors] as a matter of fact and that was the employees came first. Employees first, customers second, shareholders third. If the employees serve the customer well, the customer comes back, and that makes the shareholders happy. It’s simple, it’s not a conflict, it’s a chain. If you treated the employees well, if you cared for them, if you value them as people, if you gave them psychic satisfaction in their jobs uh, that they would really do a great job for the customers and the customers would come back, which would be good for the shareholders. Most companies didn’t operate that way. So we turned the pyramid upside down, in effect, and said the employees come first and they always have. Not just in our minds but in our hearts as well.”

“We’re perfectly happy with having, generally speaking, the highest pay for employees in the domestic industry. They reward us with tremendous productivity, which lessens the effect. And the other airlines disadvantaged their people. I’m not saying they didn’t have to, in the sense of “either we do this or we fail,” so it’s not a criticism. I’m just talking about the economic effects of it.”

“We teach each of our managers to sit down at least once a week with all of the people who work for them, so if they have any suggestions, they can make them in person.”

Promote Ownership

“We put in the first profit-sharing plan in the airline industry. Our people were very cognizant that they were owners. And there are two stories that I just love. Western Airlines asked to borrow a stapler in Los Angeles, and our customer-service agent went over with the stapler to their counter, and the Western ticket agent said: Why are you [waiting]? He said: Because I want the stapler back. That affects our profit sharing. Another classic was down in San Antonio, when one of our customers was railing at one of our customer-service agents and said: Don't you know I'm a shareholder of Southwest Airlines? And the customer-service agent looked at her and said: Lady, we all are.

Empower People

If you create an environment where the people truly participate, you don’t need control. They know what needs to be done and they do it. And the more that people will devote themselves to your cause on a voluntary basis, a willing basis, the fewer hierarchies and control mechanisms you need.” 

“Provide guidelines only, not rules. Give your employees the flexibility to make decisions on the spot.”

Culture is Key

“We don’t just have a central culture committee; we have one at each facility across the country. I think we’ve been pretty successful in going from 198 people to 35,000 and keeping the esprit de corps alive. At many other companies, they give up as they get bigger. They say, “We’re so big now that we can’t keep this joie de vivre, this effervescence, in our company.” We’ve always said, “It’s the most important thing we have, and we’re going to do everything that’s needed to maintain it.”

“We were a little concerned as we got bigger that maybe some of our early culture might be lost, so we set up a culture committee, whose only purpose is to keep the Southwest Airlines culture alive. Before people knew how to make fire, there was a fire watcher. Cave dwellers may have found a tree hit by lightning and brought fire back to the cave. Somebody had to make sure it kept going because if it went out, there was no telling when another tree would be hit by lightning. And so, the fire watcher was the most important person in the tribe. I said to our culture committee, “You are our fire watchers, who make sure the fire does not go out. I think you’re our most important committee at Southwest.

“We decided that we had to institute another limitation on expansion, one which is cultural in nature. We simply cannot increase our staff by 10% per year and expect to maintain the same kind of environment and culture we have, and that is important to us.”

Culture is a Competitive Advantage

“I think the difficulty for them [competitors] is the cultural aspect of it. That cannot be duplicated. One of the things that demonstrates the power of people is when the United Shuttle took out after us in Oakland. They had all the advantages. I mean, they had first-class seats for those who don’t want to fly anything but first class. They had a global frequent flyer program, which we did not have. They probably spent $25 million or $30 million on their advertising campaign. I probably have something like a thousand letters at my office that tell you why they finally receded from Oakland. Those letters say, “Herb, I tried them, but I just like your people more, so I’m back.” Don’t ever doubt, in the customer service business, the importance of people and their attitudes.

“One thing I tell our people is that the intangibles are much more important than the tangibles because anybody can buy the tangibles, but nobody can replicate the intangibles very easily. And I'm talking about the joie de vivre -- the spirit of our people.”

“The intangibles are far more important than the tangibles in the competitive world because, obviously, you can replicate the tangibles. You can get the same airplane. You can get the same ticket counters. You can get the same computers. But the hardest thing for a competitor to match is your culture and the spirit of your people and their focus on customer service because that isn’t something you can do overnight and it isn’t something that you can do without a great deal of attention every day in a thousand different ways. This is why I can say our employees are our competitive protection.”

“We basically said to our people, there are three things that we’re interested in. The lowest costs in the industry — that can’t hurt you, having the lowest costs. The best customer service — that’s a very important element of value. We said beyond that we’re interested in intangibles — a spiritual infusion — because they are the hardest things for your competitors to replicate. The tangible things your competitors can go out and buy. But they can’t buy your spirit. So it’s the most powerful thing of all.”

No Master Plan

We’ve never done the long-range planning that is customary in many businesses. When planning became big in the airline community, one of the analysts came up to me and said, “Herb, I understand you don’t have a plan.” I said that we have the most unusual plan in the industry: Doing things. That’s our plan. What we do by way of strategic planning is we define ourselves and then we redefine ourselves.”

Innovate / Change

"We tell our people all the time, 'You have to be ready for change.' In fact, sometimes only in change is there security"

I don’t want our people to be afraid of change. I want them to welcome change—substantive change for good reasons. Change is something that has always transpired at Southwest. You don’t change your principles or your philosophy, but tactically you adjust to outside competition and forces.”

I really attribute [our success] to historicity, a sense of futurity, and innovative thinking.”

“I think some of the critical elements are to remain outward looking, to preserve alacrity, and to stay loose.

Encourage Ideas for Innovation

Foster a fluid exchange of ideas, whereby everyone feels free to get the information they need without having to dig through multiple layers. Ideas should be able to easily circulate up, down, and around. I think that is extremely important. In this scenario, paperwork is the enemy. Yes, you need it, but you constantly have to fight to keep the volume down and simplify the information so that people can understand it readily. I also believe you need to exalt the people who come up with new ideas; they must be thanked and toasted and lionized for the ideas they’ve provided, and which have been productive and constructive.”

“We have a rule at Southwest Airlines: An employee can send an idea to anyone at any time. They can convey it orally, put it in writing; it does not matter who it is. Responses are sent within 1 week. We want to show respect for the fact that they cared enough to submit that idea. In addition, a simple ‘‘no’’ is unacceptable; that is just an exercise of power and can be invoked very irrationally. If we say ‘‘no’’ to your idea, you are likely to receive a page and a half explaining exactly why we don’t think it will work at that point in time. This process keeps ideas coming from people, because they do not feel as if they have been spurned as a consequence of being ignored or just being told ‘‘no.’’ If you consistently turn down ideas, you won’t get any more. A venture capitalist can entertain twenty ideas for every one that eventuates into something worthwhile, so within the company we try to do the same thing: keep the ideas coming. Otherwise, you end up curtailing innovation.

You have to welcome new ideas and creativity, and you have to entertain a thousand ideas for every good one that you get. But if you start turning them down just to turn them down, because you can’t be bothered and don’t have time, you never get a great one.”

“I think you have to listen to [people’s] ideas and you don’t credential them because you can get a great idea from anyone, anywhere, no matter what they do or how much education they’ve had or what their background is. Because people’s minds usually are working furiously. So it’s important to listen to everyone that has an idea. And even if the idea is not perfect, it may be the kernel of a great development in it. So I’d say, when it comes to ideas, keep your ears open.”

Hire Right

“We spend a lot of time trying to hire employees who have a customer service focus and are altruistic.

“At Southwest Airlines, we value education and experience, but we would rather have some-body with less education and experience but with a great attitude. If it comes down to a choice between the two, we’ll take the attitude over the education and experience and provide those ourselves.”

We devote an enormous amount of time to making sure we get people who are other-oriented, who have a servant’s heart, who enjoy working as part of the team.”

“Bad attitudes metastasize throughout your organisation, no matter where they are located.”

Keep it Simple

“We have been successful because we’ve had a simple strategy. Our people have bought into it. Our people fully understand it. We have had to have extreme discipline in not departing from the strategy.”

“What we try to do is establish a clear and simple set of values that we understand. That simplifies things; that expedites things. It enables the extreme discipline I mentioned in describing our strategy. When an issue comes up, we don’t say we’re going to study it for two and a half years. We just say, “Southwest Airlines doesn’t do that. Maybe somebody else does, but we don’t.” It greatly facilitates the operation of the company.

Corporate Debt

"Our job is to never lose focus on keeping our costs low and to never suffer an excess of hubris so we take on too much debt."

“We decided that no matter how attractive expansion looked, we were going to maintain the strongest balance sheet, the most liquidity, and the only investment grade rating in the airline industry. That measure was taken to hedge our bets against the inevitable bad times.”

“We're the strongest airline in the industry financially. So if somebody wants to charge the same fares as we do with higher costs and lose money, that's fine. If they want to fight a war, we're ready to go 2 years or 5 years or 10 years -- whatever it takes -- in order to be successful.”


“I constantly have warned our people over the years that, as we became bigger and more successful, our primary potential enemy was ourselves, not our competitors. Getting cocky, getting complacent, thinking that the world was our oyster, disregarding our competitors, both new and old. I think humility is very important in keeping your eye on the carrot, keeping focused outwardly instead of inwardly, and knowing when you have to change. An investor in the airline industry some years ago that I was talking to said, “Southwest Airlines is the most humble and disciplined airline that I deal with.” I said, “The two go together.”

"When you think you've got it all figured out, then you're probably already heading downhill."

Success Factors

“[You] have to focus intently upon what’s important and what’s unimportant, not be trapped in bureaucracy and hierarchy. Be results- and mission-oriented. “

Fight Bureaucracy

Fight hierarchy and bureaucracy as hard as you possibly can. Don’t ever let it become the master; always remember it’s the servant.”

Don’t Always Maximise Short-term Profit

“Since I’ve been in the industry, I think there have probably been over a million layoffs around the world. Southwest has never had an involuntarily layoff in its thirty-five year history. Many times we have sacrificed profitability during the bad times in order to provide our people with job security because that’s another aspect of how we value them. I think it provides a reciprocal trust in what our focus is. So, we’ve never had an involuntary furlough in the whole history of Southwest Airlines.”

We’ve never had a furlough. We could have made more money if we’d furloughed people during numerous events over the last 40 years, but we never have. We didn’t think it was the right thing to do. And you know, one of the disciplines is not furloughing. I didn’t realize this at first, by the way, so it came as somewhat of an insight to me. You know, suddenly a little synapse clicked, and I said, “You know, not furloughing is really a great discipline with respect to hiring.”

Head Office

“I’ve always said that the general office is at the bottom of the pyramid, not the top. Our job at the general office is to supply the resources that our front-line fighters need in order to be successful. They’re not there to glorify us or make us look good, which would be impossible, anyhow. So, the focus is on the people in the field actually doing the job.”

One of our vice presidents came to me and said, “Herb, it’s easier for a mechanic or a flight attendant or a provisioner to get in to to see you than it is for me.” I said, “Bill, I want you to understand why that is. They’re more important than you are.”

“We really do believe, as Sam Walton said, that the best leaders have to be the best servants and we try to make our company that way.”

Spend Time in The Field

“We think that our management ought to spend time with customers in the field, sampling what our employees and customers experience every day. So we have a requirement that each of our officers each quarter goes out into the field to act as a reservations agent, to load baggage, to dispatch airplanes, or whatever is required, and report back to me on what they did, what they found out, and what they did to improve the job.”

Tone at The Top

“I also think leadership by example is very important. Southwest has never had any disputes over our executives’ being paid too much. Because, quite frankly, we’ve always made sure they were underpaid. We’re not afraid to show our people that we’re not in it for ourselves. Let me give you an example: We negotiated a contract with our pilots in which they took a five-year pay freeze in return for getting stock options. Well, it wasn’t part of the deal, but I immediately took a five-year pay freeze.

I have turned down many, many millions of dollars in salary and options because it didn’t set a good example. Our officers have never received a salary increase that is larger on average than our non-contract employees have gotten. In other words, if they get a 3.5 percent increase, our officers get a 3.5 percent increase. We’ve always done that.”

Maintain Smallness

"Think small and act small, and we'll get bigger. Think big and act big, and we'll get smaller."

Think Differently / Grow the Market

“We don’t apply labels to things because they prevent you from thinking expansively.”

“The cost advantage is very important because we started out with a philosophy that we were going to charge low fares, come hell or high water. We were going to enable more people to fly. It didn’t matter whether we had competition or not. In other words, we just said we’re a different type of cat. When we get a load factor that gets into the 70 or 75 percent range over an appreciable period of time, we don’t increase fares. We add flights and put additional seats in. So if you come from that basic position, that this is what you are, then of course you have to have low costs.

Now, how do you get low costs? Through a lot of things, including the inspiration that you give your people, their productivity, the fact that they feel that they’re doing something that is really significant and that they enjoy. If you take all of Southwest’s compensation together — wage rates, profit sharing, the full 401(k) match, the stock options that our people have — Southwest employees are the most highly compensated people in the airline industry. One of our pilots just retired with $8 million in his profit-sharing account. Now, you have to do well to produce that.”

“If you go into a new city pair market and let’s say there are about 125 thousand people a year flying between the two cities when you enter it, and at the end of one year with Southwest Airlines’ great customer service, low fares, and high frequency which equals convenience there are a million people flying, what does that tell you? What that tells you is that you have just liberated a tremendous number of people who for business and personal reasons are now able to fly much more than they ever were before. And that’s very important to them. And that’s why we’re a symbol of freedom.”

“There’s no opposition between the two: offering low fares provides the largest return to our shareholders. Fortunately, we were sufficiently innovative–—or intoxicated!–—to realize that before we started Southwest Airlines. We charged the lowest fares in the airline industry; just look at the Department of Transportation (DOT) fare report. In its 30th anniversary issue, Money magazine featured an article that said our business model belongs in the Ripley’s Believe it or Not category, because the company which has produced the highest return to shareholders over the last 30 years is an airline: Southwest Airlines.  Charge low fares, get more people to fly, get them to fly more often, and you will produce the best return to shareholders. Low fares and high shareholder returns are not in conflict with one another in any way, shape, or form. You just have to keep your costs low.”

Focus on Your Core Competency

“Another thing we decided as a matter of policy years ago was that we wouldn’t do anything that wasn’t connected with the airline business. I guess what we were saying in kind of a humble way was, “We don’t know everything about everything. We know about one thing.” I have seen other airlines make mistakes, buying radio stations, hotel chains, rental car businesses, and so forth and so on. And I thought, We don’t want to get into thinking that we’re almighty because we’ve done pretty well. And that’s still the policy today.”

Mission Statement

“I want to tell you with respect to a mission statement is that a lot of people hire outside people to prepare their mission statements. My suggestion is that if you need someone outside your company to prepare a mission statement for you, then you really don’t know what your mission is and you probably don’t have one.”

“People always are writing and calling and saying we want to help you revise your mission statement, you know, they say, “Things have changed greatly in the American economy.” And I’ve said, ours is eternal. It has nothing to do with the American economy. It simply has to do with the way you treat people — the respect that you give them and the opportunity that you give them whether they are employees or customers. So it’s basically focused on people and how they should relate to one another and that’s eternal. So we don’t need to revise it to take into account new developments in corporate America.”


“We’re the most unionised airline in the industry, and we’ve never treated the labor unions as adversaries, we’ve always treated them as partners. Because if the canoe goes down we are going to go down with it. I don’t mean that in a perfunctory, superficial way'; we hold company events and we invite all the labor union leaders to come to them as they are part of the company, too. If they have an issue we take care of it as quickly as we can. Being very cognisant of their needs, and they reciprocate. They respond to that very very well.”

"Our relationship with Southwest is about more than just delivering great airplanes. It's about understanding their business, trusting each other and working together to achieve solutions. We know that while they have a lot of fun and play hard, they also run a business model that the entire industry emulates and admires. We are delighted and honored to have such a wonderful partner." Carolyn Corvi, Vice President/General Manager, Boeing 737/757


Ripley’s Believe It Or Not, indeed.

Who would have thought that was possible, given what we know about airlines and their destruction of capital over the years? One thing that is apparent to me, however, is that it doesn’t seem to matter what industry we look at, there are successful business stories to be found, regardless of what the greater competitive landscape looks like. And Southwest is just another example of a business that has succeeded in an industry where success doesn’t come about too often.

And how did they do it? In the same way that all the other success stories we have reviewed did. Walmart, Panera, McDonalds, Nucor, etc - they all used things like culture, people, innovation, humility and reward in the right way.

One other thing strikes me in all this - many of the business and investment masters we have reviewed have all talked openly about the secrets of their success. They have been remarkably transparent and at times brutally honest about it. And when it comes down to it, what they say isn’t really rocket science; the principals are actually quite simple. So if that’s the case, and it is, why have so many of their competitors (in all the industries) failed when they have tried to emulate that success?

I believe it’s because they don’t have the same outlook on things. And never will.

They don’t put people first or act with humility. They don’t lead by the right example. They don’t build winning cultures. They’re all foreign concepts to them, and even though they understand that those measures lead to success, they are unable to apply them because of their own personality biases. They discount them and treat them with scorn: “If I gave my people profit sharing, it would mean less for me!” Or, “If I allowed my people all the power, they’d never do anything and I would end up being my own janitor.”

Herb even mentions that business schools have looked scornfully on his premise of ‘people first, customers second and shareholders third.’ “That would make the shareholders unhappy!” would be their obvious reply. The funny thing is, the company’s job is not to make the shareholders happy, its to make them money. And Herb’s belief that if you treat your people right, they will treat the customers right, which will mean that the shareholders do make money. His track record over the last thirty years proves that theory correct, I would think.

Further Reading/Sources

How I Built This’ - Herb Kelleher Interview with Guy Raz. NPR.
The Legacy of Herb Kelleher’ - Bill Taylor - Harvard Business Review 2019
Herb Kelleher: The Thought Leader Interview’ - Chuck Lucier. Strategy+Business 2004
Herb Kelleher on the Record’ - Business Week’ - 2003
Corporate innovation at Southwest Airlines: An interview with Herb Kelleher’ Kelley School of Business. 2009.
Customer Service - It Starts at Home’ - Herb Kelleher. JLCRM. 1998
The High Priest of Ha Ha. Obituary: Herb Kelleher’ The Economist 2019.

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Learning from Robert Cialdini - Part III


Would you consider $300,000 a fair price for a book?

Charlie Munger did, and he even considered it ‘light’ payment, considering the billions he made from the learnings he took from within. That’s how powerful Robert Cialdini’s book, Influence, is. If you’ve got one of the greatest investors of all time happy to spend that much money on his insights, we all should be reading it. And no doubt you’ll be happy to know we don’t have to spend anywhere near that, though, to obtain our own copy.

You may recall that I have already posted on this subject before. And if you noticed that, you’d be right. You may even ask why I waited so long to post this final part. And here’s the answer - we just had the ten year anniversary of Bernie Madoff’s fund’s collapse, and if there was ever a scenario that displayed most if not all of the Influence factors that are explained in Cialdini’s book, then this was it.

Upon that recent anniversary, I found myself engrossed in the SEC report into the greatest ponzi scheme of all time. It’s an incredible story of regulatory incompetence, and that’s incompetence on a level you’d be hard-pressed to beat. As I progressed through the report, I found a smorgasbord of ‘Influencing and Persuasion’ techniques that form the basis of Cialdini’s work, which were apparent as the ponzi scheme developed. The techniques conspired to trip up investors and regulators; Social proof, Scarcity, Authority and Consistency Bias were there in black and white. Had the regulators and investors been mindful of the psychological tripwires, those investors may have been spared capital losses and the fraud would have been detected years, maybe even decades, before.

Once you’ve read Robert Cialdini’s book Influence you’ll start to notice the six powerful psychological techniques he unveils in the book everywhere. They each provide a useful principle, like a mental model, that can help explain an individual’s behaviour.

In the previous two posts, we covered off on four of the powerful influences including Consistency and Commitment, Reciprocation, Social Proof and Authority. In this post, we’ll cover off on Liking and Scarcity, two persuasion techniques you’ll see regularly in investment markets.


Let’s start with Scarcity. It should come as no surprise that people want more of those things they can have less of. Humans are challenged emotionally when freedoms are threatened. Retailers use this technique to great effect. Studies show that when supermarkets place limits on the number of items allowed to be purchased on sale, an increasing number of people buy the maximum number allowed. When Adidas releases it’s latest range of shoes, it elevates sales by collaborating with popular designers [social proof] and releasing limited numbers.

“You do much better in this world if you’re selling something, to say “only one to a customer,” and “you have to get in early,” or “you have to know somebody in order to get shares.” And many new issues are sold that way, and it’s very effective. I mean, you know, it’s like those old stories in Russia where there’d be lines, and people would get in them without knowing what they were going to buy when they got to the front of the line. And that’s a very effective selling tool. And it’s one that Wall Street is not unfamiliar with.” Warren Buffett

This tactic is often adopted by promoters in the financial markets. At the 1996 Berkshire meeting, Buffett expanded on the use of the scarcity principle in financial markets.

Most new offerings are done in a manner where the idea is to have far more demand than supply, and therefore cause people to, maybe, order stock they didn’t even want, and just on the idea that this restricted supply will cause a big jump the first day, whether, you know — you’ve seen Yahoo or a number of other offerings.” Warren Buffett

Bernie Madoff leveraged the power of ‘Scarcity’ by harnessing it’s ‘exclusivity’ and ‘privileged access’ when marketing to potential investors. In the SEC report I mentioned above, the investigation noted one of the Madoff feeder funds, Avellino & Bienes, was not available to everyone… “this was a ‘special’ and exclusive club, with some special investors getting higher returns than others.”

Scarcity is one reason auction prices can sometimes reach unwarranted levels. I’m sure you’ve heard of the winner’s curse, when the auction buyer overpays in the heat of the moment. It’s one of the reasons Berkshire doesn’t participate in auctions of businesses. They like to deal on an exclusive basis. As all businesses are unique, a scarcity element is present. Munger calls this trait the ‘super-deprival-reaction syndrome’ and he’s recognised open-outcry auctions combine some of the worst psychological pitfalls.

“The open-outcry auction is just made to turn the brain into mush: you've got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away... I mean it just absolutely is designed to manipulate people into idiotic behavior.” Charlie Munger

When demand exceeds supply and everyone is chasing the same investment, it’s more likely investors are overpaying. Howard Marks makes a pertinent observation:

“Watch which asset classes they’re holding conferences for and how many people are attending.  Sold-out conferences are a danger sign.”  Howard Marks

In addition to people wanting more of what they don’t have, people feel losses more than they feel gains. This is known as ‘loss aversion’ and it’s one reason most investors fail to cut losing trades. It’s also a reason investors can be wrong-footed when faced with portfolio losses.

Like the other ‘Influence’ principles, the mental short-cuts are innate actions; we make them without thinking. Dan Ariely and Daniel Kahneman provide an evolutionary explanation as to why we experience loss aversion:

“If you think about nature, if you get something good (like you get to eat more food and so on) that’s a good thing, but if you do something bad, you can die. So nature has kind of tuned us to look at the negative side because if you get a bit more food, a bit more money or whatever, there’s a positive expected value but it’s limited. Whereas on the negative side, you can lose a lot. So because of that we just attune more to losses.Dan Ariely

Loss aversion - When directly compared or weighted against each other, losses look larger than gains.  This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history.  Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce”  Daniel Kahneman

The Investment Masters, are well aware of loss aversion.

“People are really crazy about minor decrements down. Huge insanities can come from just subconsciously over-weighing the importance of what you’re losing or almost getting and not getting.Charlie Munger

 “One of prospect theory’s most important contributions to finance is loss aversion, the idea that for most people, losses loom larger than corresponding gains.  The empirical evidence suggests we feel losses about two to two-and-a-half times more than we feel gains. Loss aversion is a clear-cut deviation from expected utility theory.” Michael Mauboussin

 “There is the argument that for virtually any investor, the marginal utility of an extra gain is smaller than the marginal utility of an equal percentage loss.”  Ed Thorp

One method for not letting loss aversion trip you up is to take a longer term view. Remember the stock you own is a business, and the share price will reflect earnings over the long term. Prices don’t always equate with value, so monitor the business performance and understand the stock price contains less useful information. Given short term stock movements are largely random, checking your portfolio less frequently can also help.

"If I knew how to be up every single day, I would do it because up is better than down. The shorter the time frame on marketable securities, the closer you approach 50/50 as to whether it’s going to be up or down." David Abrams

“Well-worn studies confirm the financial utility of long-term viewpoints; however, behavioral psychologists augment the case by showing investors dislike losses two to three times more than they like gains. If short-term gains/losses carry 50/50 odds, then the disdain for losses implies that infrequent monitoring and long-term horizons aide both mental health and financial wealth. In short, Winston Churchill's quip on revenge may aptly apply to myopic investment habits: "Nothing costs more and yields less."  Allan Mecham

“If you don’t check your portfolio every day, you will be spared the angst of watching daily price gyrations; the longer you hold off, the less you will be confronted with volatility and therefore the more attractive your choices seem.  Put differently, the two factors that contribute to an investor’s unwillingness to bear the risks of holding stocks are loss aversion and a frequent evaluation period. Using the medical word for short-sightedness, Thaler and Bernartzi coined the term myopic loss aversion to reflect a combination of loss aversion and the frequency with which an investment is measured… In my opinion, the single greatest obstacle that prevents investors from doing well in the stock market is myopic loss aversion.”  Robert Hagstrom


The final technique Cialdini recognised was the human trait of liking. People prefer to say yes to those that they like.

“Everybody likes people who like them.” Charlie Munger

Cialdini notes three important factors when it comes to why people will be inclined to ‘like’ others; we like people who are similar to us, we like people who pay us compliments, and we like people who cooperate with us towards mutual goals.

“One very practical consequence of liking/loving tendency is that it acts as a conditioning device that makes the liker or lover tend (1) to ignore faults of, and comply with wishes of, the object of his affection, (2) to favor people, products and actions merely associated with the object of his affection, and (3) to distort other facts to facilitate love.” Charlie Munger

A classic example in investment markets is an analyst who gets close to the company. Analysts can become less objective and focus only on the positives at the expense of potential negatives. Marathon Asset Management are wary of such analysts:

"There is always a danger that an analyst is 'captured' by management. This risk rises for specialist analysts who spend most of their time covering a small handful of companies, whereas a generalist might cover a few hundred. Capture poses the threat that an analyst lands up becoming the mouthpiece of management" Marathon Asset Management

They use the analogy of the ‘Stockholm syndrome’..

“There is also the issue of 'Stockholm syndrome'.. Research analysts are also vulnerable to this and particularly when they get too close to the companies they follow. If an analyst only covers ten or so companies and works for a big influential house, then it is likely the analyst will have a close relationship with the management of the companies. It is often the case that a friendship and a closeness develops whilst analysts also receive significant hospitality from these companies and as a consequence objectivity may be compromised." Marathon Asset Management

And investors can get caught too. It’s one reason some investors prefer not to meet management. Instead they prefer to work through old company reports to see if what management said they would do, they did.

"I typically don't meet management. I don't talk to management. I was in private equity for 15 years. And generally, if you become a CEO of a company you’re a really good salesman, one way or the other, and you're gonna probably spin people. I made a couple of big mistakes when I got involved in situations where I liked people too much. And, I generally like people. So, the way to avoid that is put the filter on that rely on reading transcripts, 10ks, 10qs." Ted Weschler

"Given the availability of so much information on the internet, I'm not so interested in meeting management today.  You can get seduced too easily.  I'm more interested in finding out how a person has behaved in the past.  If I can listen to a few of the CEO's speeches and read the transcripts or earnings calls, that is more important than talking to him.  A smart, dishonest person can fool you, especially when he's talking about his own business." Bruce Berkowitz

“The conclusions I’ve come to about managers have really come about the same way you can make yours. I mean they come about by reading reports rather than any intimate personal knowledge or — and knowing them personally at all. So it — you know, read the proxy statements, see what they think of — see how they treat themselves versus how they treat the shareholders, look at what they have accomplished, considering what the hand was that they were dealt when they took over compared to what is going on in the industry." Warren Buffett

Or it may be that an analyst or expert has had similar views to your own in the past or a track record of success. This can lead one to be less objective and less reliant on the facts than required.

"Avoid the Pied Piper. Just because someone has been right seven times in a row is no guarantee that number eight will work. When he is finally wrong, the size of the herd will be at its maximum - just as it plunges over the cliff and into the sea. As investors walk in lockstep with the guru over the cliff, a new guru who pointed the way correctly (though only a few listened) is thrust to the forefront. When he too falls, investors will again frantically search for a new guru so as to perpetuate the guru loser's game." Bennett Goodspeed

When a CEO wants to be liked by the market, their desire, can lead to poor decision making.

"Having a person running a company to please Wall Street can be really problematic." Jim Chanos

“I admire Amazon founder Jeff Bezos. He has revolutionized the retail industry and has two great qualities: He is patient and persistent, and he doesn’t care to please Wall St.’s quarterly expectations. This last quality is often overlooked but it is seldom found and represents, in my opinion, a true competitive advantage.” Francois Rochon

At times, subordinates can be pressured into making dumb decisions, to keep pleasing the CEO, who themselves want to please Wall Street.

“We have seen really decent people misbehave because they felt that there was a loyalty to their CEO to present certain numbers — to deliver certain numbers — because the CEO went out and made a lot of forecasts about what the company would earn.” Warren Buffett

Corporate Board members are particularly vulnerable to sub-optimal decision making where directors try to be liked. Liking correlates with ongoing director fees.

"I would say that the typical organization is structured so that the CEO's opinions, biases and previous beliefs are reinforced in every possible way.  Staff won't give you any contrary recommendations - they'll just come back with whatever the CEO wants.  And the Board of Directors won't act as a check, so the CEO pretty much gets what he wants." Warren Buffett

"CEO's get very diluted information.  They're told what people believe they want to hear. We tell them the facts.  We call a spade a spade." Richard Perry


It doesn’t take a massive leap of the imagination to see how understanding the persuasion techniques that Cialdini uncovered can help you in the markets. When you read the above, could you relate the themes to any personal experiences, or even experiences of those people who are close to you? I certainly could. It’s not hard.

Many people have discovered their uses; you don’t have to travel too far from home before you encounter one or more of the six factors. You can see, also, how the Investment Masters themselves have identified with the traits and taken active steps to avoid getting ensnared within the psychological trip wires. Charlie even paid large for the read, and if that man saw the sense of the ideas, then we all should. And that’s good enough for me.

Further Reading:
Investment Masters Class -
‘Munger Series: Learning from Robert Cialdini’, Part I and Part 2
Bloomberg Masters in Business: ‘
Robert Cialdini, author of Influence’, 2018

Follow us on Twitter: @mastersinvest




Learning from Ken Langone

I’m sure you’ve realised by now that I love learning. And stories about successful investors and business people are right at the top of my list when I choose what it is I want to learn. I believe I understand my own strengths and limitations, however because of that, I’ve found that enhancing my knowledge of how other people have come to be at the top of their game is truly invaluable when it comes to my own investment processes and thinking.

And Ken Langone and his book ‘I Love Capitalism’ is a man I have learnt a lot from.

‘I Love Capitalism’ is the rags to riches story of billionaire US investor, businessman and philanthropist, Ken Langone. And what a story it is. I came across the legendary Ken Langone in the book about Home Depot, ‘Built From Scratch. The son of a plumber, a knock-about-student who almost got expelled from college. Rough as diamond, and a brilliant story teller who is poles apart from your typical Wall Street banker, Langone takes you on an exciting journey through Wall Street, weaving lessons of investing, business, people and philanthropy. Langone’s story is also available in a self-narrated audible book, which I highly recommend.

Langone started out as a misfit on Wall Street, landing his first job at a second tier investment bank selling securities. Dabbling in capital raisings, Langone hit the big time when he won the mandate to float Ross Perot’s EDS. With a knack for numbers and sniffing out opportunity, Langone invested in lots of different businesses, including a US home-improvement retailing chain called ‘Handy Dan’. When Handy Dan’s CEO and CFO were improperly fired, Langone encouraged them to start a new competitor with funding he raised alongside his own; this was the beginning of Home Depot. Langone’s later successes spanned health care, laser patents and an early investment in Stan Druckenmiller’s hedge fund.

With a raspy New York accent, and plenty of expletives, the story is enjoyable from start to end. It concludes with a very funny story of Langone’s brush with Ponzi Scheme extraordinaire, Bernie Madoff, where after the meeting Langone asks, “What the f*ck is wrong with that guy?

I’ve included some of my favorite extracts below..

Capitalism Works

Capitalism works. Let me say it again: It works! And- I’m living proof - it can work for anybody and everybody. Blacks and whites and browns and everybody in between. Absolutely anybody is entitled to dream big, and absolutely everybody should dream big. I did. Show me where the silver spoon was in my mouth. I’ve got to argue profoundly and passionately; I’m the American Dream.


“The truth is that I loved what I was doing from the day I went to work, which is one of the great joys in life, I’ve found.”

“I learned early how essential it was to love the work I was doing. Sometimes I look back and wonder, how did all this happen? Then the answer comes. Shit, I know how it happened; I was at a place where I was having the time of my life! I still remember what Hudson Whitenight said to me sixty years ago: ‘If you really love your work as much as I think you’re going to, you’re going to be a big success.’ So I’m saying to a kid, I learned this ex-post facto; ‘you should learn it in front!’”

“I still love my work today; all of it. At eighty-two, I’m still excited to get out of bed in the morning, still charged up about what the next deal might bring. I can honestly say that if it came down to it, I would pay to go to work every day. How many people can say that?”

Education and Smarts

“I was never academically curious. I didn’t apply myself at all. I did the absolute minimum. I was too busy having fun and working at all my various jobs: the butcher shop, Bohack, caddying at the country club, selling Christmas wreaths.”

Learning & Curiosity

“All I knew was that I wanted to make money. And where did you make money? Wall Street… All I knew about Wall Street was that was where you bought and sold stocks and bonds. In other words, I knew nothing. But I read Fortune religiously every month, in the library at Bucknell. I was intrigued by mergers; I was intrigued by companies growing and how they financed their growth. I don’t know why I was so fascinated by Wall Street. I wasn’t from an Ivy League school. I really had no family connections.”


“I don’t know beans about options: puts and calls and strips and straddles and all this other crap. All I do is pick stocks, and I never buy anything I don’t understand.”


The one thing I can’t say and never will say is that I’m self-made. I’m not. To say that would be an injustice to all those people who bought me to the party. I’m grateful to every one of them.”

Arrogance is the enemy. For many years, Bernie Marcus and I never, ever went into a Home Depot store - never once - unless we were pushing carts in from the parking lot. I used to pray I would see a piece of trash on the floor so I could pick it up. Why? Those are entry-level tasks for the kid who works in that store. When he sees the top guying doing them, he can say to himself, ‘If it’s not too small for them, it’s not too small for me.’ The minute you take away all the artificial barriers between you and your people, you’re on your way to phenomenal success. But it takes a bit of humility.”


“[Investing in health care and now home-improvement.. ] Contradictory? Sure! Life is full of left turns, and I’ve taken quite a few of them, following my nose, which has very often pointed me in the right direction. The truth is I can’t help myself; I am a deal junkie. If the phone rings, I’m like the proverbial fire-house dog - off to the races. Who knows who might be calling. More often than not, it’s someone who has a very interesting business proposition. Doesn’t matter what kind of business it is.


“The first big lesson Bindy taught me was one he taught by example. I’d begun encountering some of the big, big guys on Wall Street, legendary guys, men I’d read about in Fortune. These men were gods to me, and I saw right away that Bindy simply wasn’t in awe of them. In short order, he taught me to understand that a man’s public persona usually has very little to do with his private persona. Without that lesson, I would have felt subservient toward these muckety-mucks, but with that lesson under my belt I felt completely equal to anyone I dealt with. And without Bindy in my life, I don’t think I would be as certain of myself as I am and as outspoken as I am.”

Resilience and Creativity

“The Home Depot didn’t exactly get off to a flying start .. If there’s anything I would take a bow for throughout this whole process [Home Depot’s IPO], it would be this: never give up, and thinking creatively, instead of just re-actively, when the chips are down. It’s a style I recommend highly.

“Yes, I’ve been lucky, incredibly lucky, and you can’t learn good luck. My old man used to say to me, ‘You could fall in a bucket of shit and come up with a gold watch and chain’. But we all fall in that bucket from time to time. What distinguishes the winners from the losers is the ability to turn adversity around: resilience and creativity.

Focus on People

People are always your best investment.”

“As I began my tenure [as Chairman of NYU Hospital] my first role was just to lift morale. It was a big lift. I decided to do some of the same things we did at Home Depot; hold town meetings, walk the halls, talk to the staff. Put my arm around people’s shoulders, tell them how much we appreciated them and what we were going to do for them - and deliver. In other words, don’t promise pie in the sky unless you’ve got the recipe to make it… There was a natural suspicion of me at first, as an outsider and non-medical person. A rich guy who maybe wanted to throw his weight around. And I’m proud to say I defused it - by never pretending to be anything I wasn’t, by being genuinely interested in everyone I met, but mainly by being present.”

Everybody talks about the bottom line, but as I’ve seen time and time again, you ignore the human element of business at your peril.

Source: WSJ.

Source: WSJ.


Home Depot’s great strength was (and still is) it’s culture, and culture isn’t about statistics. In our culture, you don’t measure the intangible value of a sales associate saying to a customer, ‘Can I help you?’, or, ‘You don’t really need that. Come over here and look at this. It doesn’t cost as much, but you’ll be fine with it.’

Store Visits

“Back when the company had first started, I’d recommended a policy requiring every director to visit three Home Depot stores every ninety days, casually dressed and as inconspicuous as possible, and report on his or her findings. What the directors were now finding on their store visits was that something was amiss [post Bob Nardelli’s appointment as CEO].”

Destroying Culture

“When I went to Bob [Nardelli] and told him that I’d been in the [Home Depot] stores and morale was not good, he said, ‘They’re a bunch of crybabies’. ‘Bob, they may be a bunch of crybabies to you, but they’re the most precious thing we have’, I said. ‘They’re the only thing that separates us from everybody else. They’re our secret sauce, our secret weapon. They’re what makes us what we are as a company.

“My first impression of Bob Nardelli - ‘he’s a real people guy; we’ve got a great operator here’ - had been exactly 50 percent right. The guy really was a great operator. But I came to realize - too damn slowly - that the whole people equation of Home Depot, the essence of our culture, had completely eluded him. To me, the whole issue with Bob was the damage to the culture. There’s nothing like these people in our stores. They’re special. Now, how do you get these special people? Well, you start by treating them special. You let them know they matter. You let them know you appreciate their opinion. You let them know that if they think there’s a better way of doing things than the way they’re doing them, they have an obligation to tell us, and we have an obligation to listen. You also let them know that anybody can build a big store space and put all kinds of inventory in it; the glue that holds Home Depot together are these values. We don’t just say them. We believe them, and we practice them consistently.

“Bob was a great leader until he wasn’t. Was I too slow to see the writing on the wall? Definitely. Bob was racking up great numbers but ignoring the human equation, and in business good numbers can be like sunlight: blindingly bright.”

Value Employees

“Bob [Nardelli] had developed the mind-set that these people, who started at well over minimum wage and got a raise every year if their performance reviews were good, were a cost. And they were a cost! They were a significant part of the company’s overall costs. And therefore Bob spent a lot of time trying to figure out how he could take that cost down. In my mind, it was like the reverse of the straw and the camel’s back. Nardelli kept taking one straw off, and it reached a point where something very valuable was being lost.”

We’ve never paid anybody minimum wage at Home Depot. We had a simple belief: minimum wage, minimum talent. We always wanted to have good kids who wanted careers and not feel they had to compromise their pay. We paid them two or three bucks an hour more than minimum. We reviewed them every six months. And from the beginning we were growing like a weed, so we created enormous upside mobility.”


“Complacency is the enemy. If we don’t stay focused on our mission every single day, every minute we’re awake, Home Depot will go to sleep.


“You want my whole philosophy in a nutshell? I want everybody to do well. The world is a lot more fun if we’re all rich instead of just some of us.”

Capitalism is brutal, but it’s rarely a zero-sum game. Both sides of a transaction should get something out of the deal.

One of the most important lessons of my life is this: leave more on the table for the other guy than he thinks he should get. And one of the most important rules in capitalism is incentive.


“I have no problem admitting my mistakes: I’m loaded with them. But I never bought a pencil without an eraser on it, and God invented erasers on pencils for people like me.”


“Warren Buffett says that wealthy people should give away at least half their wealth to philanthropic causes. I signed Warren’s Giving Pledge years ago, but in my case it was academic: I’d already given away more than half my net worth.

But as much as we give, it keeps coming back; we’ve made all the money we’ve given away and more.”

“We will make sure we’ve given most of our money away by the time we die, with the exception of what we leave to our kids. We want to pass along enough for them to live reasonably well, but not so much that they can do anything foolish with it. We want them to have a roof over their heads, but we also want them to have the meaning in their lives that comes from having to make their own way.


“As I said, I’ve been rich and I’ve been poor, and rich is better. Yet, too many people measure success the wrong way. Money should be at the bottom of the list, not the top.”


‘A lot [of how I learnt about business] was sheer stubborn curiosity. Whenever I served on a corporate board, I was notorious for asking more questions than any other director on the board. I didn’t give a shit if my question showed how stupid I was. A lot of people are scared to ask questions because they don’t want people to know how dumb they are. I’ve never had that problem.”

Career Advice

“Wall Street got a very bad reputation after the financial crisis, yet 40 percent of college graduates today are going into finance. I tell kids that’s a big mistake. I tell them they should learn the nuts and bolts of a business before going out and trading that business’s stock. I didn’t realize how stupid I was back when I was a salesman at Pressprich! I would look in the most superficial way at the companies whose stocks and bonds I was selling; I never truly understood how those business worked. It wasn’t until I got wealthy enough to buy pieces of companies that I developed a much deeper understanding of them.

“If there’s one lesson I could pass along to kids today, it’s this; the opportunities in America today are the very best they’ve ever been. You might have to look harder for them than in my day, but they’re there. Boy, do I wish I were twenty-one again and just starting out.”


Rough language aside, there is a wealth of learning to be taken from Langone. And beyond many of the aspects that denote success that have appeared so many times in other businesses I have reviewed - humility, curiousity, treat your people right and have the right culture - one of the other things that I love is how Langone is not afraid to ask questions, even if they appear dumb to other people. Buffett has said that if you’re reliant on the income that being a Director brings, then you shouldn’t be a Director; you’re unlikely to offer contrary opinions or advice as it may affect that income. Langone’s brusque approach to questioning things he doesn’t understand is crucial if not vital in my opinion - how can we learn if we don’t ask a question now and then? If you’re staying quiet in any effort to not appear dumb, then I believe you have failed miserably.

Further Reading:
I Love Capitalism - An American Story’, Ken Langone, May 2018.
I Love Capitalism - An American Story’, Ken Langone [Audible - HIGHLY RECOMMENDED].
Culture, Enculturation and the Cult of Home Depot’, The Investment Masters Class.
Learning from Arthur Blank’, The Investment Masters Class.
Talks at Goldman - Ken Langone’, June 26, 2018.

 Keep learning on Twitter: @mastersinvest


The Snyder Family made IN-N-OUT BURGER

Who doesn’t love a burger? As I mentioned in my McDonald’s post, most, if not all of us have had some interaction with the biggies in the fast food world, and the company with the golden arches is usually acknowledged as the leader in that space. But what if I told you that one chain of Burger restaurants actually outsells the average McDonald’s store by nearly twice over? And they’ve been around as long as McDonalds? And that Warren Buffett would LOVE to own some of it? Would you believe me? I hope you do, because its all true.

In-N-Out Burger is the story of three generations of the Snyder family, who took a small hamburger shop in California way back in 1948, and turned it into a 335-store East Coast American Cult.

In-N-Out arose out of the massive tide of change that was sweeping the US following the Second World War. Automobiles were far more common, the US highway system was growing extensively and women were entering the workforce, paving the way for societal change that would see the demise of the traditional sit-down family meal.

The brainchild behind the chain was Harry Snyder. A man with vision, he saw this tide of change sweeping America and identified the opportunity within. Simply put, he chose to use the highest quality food ingredients available, and invented quick ordering technology, and because of it In-N-Out became a mecca for the rapidly expanding Californian surburbia.

For the next 70 years, the Snyders steadfastly refused to follow industry trends, instead sticking with a simple strategy - Quality Food, Cleanliness and Service. With a recipe that worked, the business has passed down the family tree [via some tragic events] and to this day remains virtually unchanged.

A fascinating article on In-N-Out in Forbes by Chloe Sorvino recently caught my attention. The article draws on an interview with the sole third generation of the Snyder family, the current owner of the business, Lynsi Snyder. Sorvino notes:

“An In-N-Out store outsells a typical McDonald’s nearly twice over, bringing in an estimated $4.5 million in gross annual sales versus McDonald’s $2.6 million. In-N-Out’s profit margin is an estimated 20%. That’s higher than In-N-Out’s East Coast rival Shake Shack (16%) and other restaurant chains that typically own their locations, like Chipotle (10.5%).”

What’s amazing about In-N-Out’s margins is that they’re not a function of higher prices or lower wages. In fact, quite the opposite; In-N-Out’s prices are cheaper than it’s competitors.

“Over the past 30 years, the price of the Double-Double hasn’t even kept up with inflation. In 1989 the sandwich cost $2.15, or about $4.40 in current dollars. It costs $3.85 today. A combo meal (Double-Double, fries, drink) goes for $7.30, compared with $10.94 for Shake Shack’s standard double-burger patty and fries.”

It’s also renowned as the highest payer in the industry. Again, Sorvino notes:

Restaurant workers, or ‘associates’ in In-N-Out speak, make $13 an hour, versus the $9 to $10 or so that’s typical at most national competitors, including McDonald’s and Burger King. Part- and full-time restaurant workers can enroll in dental, vision and life insurance plans through the company, and full-timers can get health insurance and paid vacation, accruing time off after two weeks of employment.”

In part, In-N-Out’s margins benefit from simpler menus and distribution synergies.

So how does In-N-Out maintain its margins? To start, the limited menu means reduced costs for raw ingredients. The company also saves money by buying wholesale and grinding the beef in-house. By doing its own sourcing and distribution, it likely saves 3% to 5% in food costs a year. It cuts out an estimated 6% to 10% of total costs by owning most of its properties—many bought years ago—and not paying rent. In-N-Out picks its locations carefully, clustering them near one another and close to highways to lower delivery costs while also avoiding pricey urban cores. It has just one location within the city limits of Los Angeles and one in San Francisco, while many Shake Shacks are smack in the center of town.”

But In-N-Out also benefits from the power of reciprocation - treating customers, staff and suppliers well - which when combined with a quality, value priced product, an adherence to what they know, some scarcity value and pure simplicity drives what Charlie Munger refers to as a Lollapalooza: a combination of factors which combine together to deliver outsized results.

Having enjoyed the Forbes article I picked up the New York Times bestseller: ‘In-N-Out Burger - A Behind The Counter Look At The Fast Food Chain That Breaks All The Rules’ by Stacy Perman.

The book chronicles the development of In-N-Out from Harry and Esther Snyder’s original Hamburger Shop until Lynsi’s ownership after her own father’s passing. Harry’s second son Rich took over the business when Harry succumbed to cancer. A tragic plane crash which killed Rich left the business in the hand’s of Rich’s only sibling, his older brother Guy. And when Guy died the business passed to the only third generation descendant, Guy’s daughter Lynsi. Throughout this, Harry’s wife Esther, maintained a deep involvement with the business, always managing the books and taking the reigns at times after the tragic events.

What struck me about the book were the parallels with other great businesses we’ve covered in the CEO Masters series - Walmart, Home Depot, McDonald’s, Panera Breads, etc.

I’ve included some of my favorite snippets from the book below…

Leverage Change

“Harry wanted to serve quality food at reasonable prices, and as quick as possible. ‘We really have to have a place where people can get their sandwiches and go’ he said. Harry and Esther would open a new kind of hamburger stand - the drive through - catering to an increasingly mobile society.

“Harry Snyder’s instinct was a good one. Southern California was the most heavily motorized place on earth.”

“The asphalt tributaries developing all over the San Gabriel Valley were a boon for the fledging In-N-Out.”

“This casual new way of dining dovetailed into the rise of car culture and the establishment of the extensive interstate highway system that was starting to crisscross the nation. With better roads people could travel farther. Along the way people would need places to rest, sleep, and above all eat.”

“Harry had anticipated the significant role the car would continue to play in California. American life was becoming increasingly mobile. The exodus from the cities in favour of the suburbs meant that people had longer commutes. More women were working and less and less time was devoted to food preparation in the home. One of the first casualties of the new on-the-go lifestyle was the sit-down meal.”


"[Harry’s friend Carl Karcher told him, ‘I have always said that competition just makes you stronger. You shouldn’t be afraid of the competition. They make you stay top of your game.. it’s very important to have respect for your competitors. I may have had a different philosophy than some of the others. But I believe that your competitors are really your friends. They keep you on your toes.”

Keep it Simple

““Harry Snyder made a promise to himself that he had no intention of breaking: ‘Keep it real simple’, he always said. ‘Do one thing and do it the best you can’.”

“Their philosophy was simple; the product - if it’s a good one - should sell itself, and everything else is smoke and mirrors.”

Harry created the formula that emerged as the standard for running In-N-Out. It informed the company’s identity and was rigidly adhered to over the coming decades. It was not based on fancy management methodology - rather, it grew out of Harry’s own instincts and exacting personality. The system was based on three simple words, ‘Quality, Cleanliness, and Service’.”

“A frugal and practical man in most respects, Harry was profligate when it came to purchasing the freshest, highest grade meat, potatoes, and produce; he refused to sacrifice quality for the sake of profits.

Customer Focus

“From the start, In-N-Out ran a customer-driven shop.

“Harry put a huge emphasis on customer satisfaction. In-N-Out workers were instructed to always smile, look their customers in the eye, and maintain a level of courtesy with every guest. Long before Starbucks, the Snyders called their customers ‘guests’.”

“One of the basic tenets taught at the [In-N-Out] University was called rule number one: ‘The customer is always right'.’.. Rule number two was, ‘If by chance the customer makes a mistake, refer to rule number one’.”

Quality Control

“In order to maintain the chain’s strict quality standards even as it grew, Rich implemented a small army of ‘secret shoppers’. These undercover customers went from store to store on a monthly basis, making sure that associates were properly dressed and clean, orders were correct, food was presented properly, and even that the right amount of change was given.”

[Rich rejected IPO’ing the business], “I think it would be too difficult to maintain quality control’, he explained. ‘I like the fact I can visit all of our locations and they all know me. It’s kind of like what they say about farming - the best fertilizer there is in the field is the farmer’s footprints’.”


Inside the company, franchising was a dirty word. In building In-N-Out Burger, Harry followed no compass but his own. There was no hierarchical management structure, no bureaucracy, and there were no shareholders to answer to.”

“Since In-N-Out never followed the strategies or trends of its competitors, it was barely affected by the cyclical turn of events that first catapulted fast food to success and then savaged the industry.”

“Notably, only store managers manned the grill, unlike most fast-food chains, the company considered a grill position a highly skilled job. After all, it was the altar upon which the whole enterprise rested. It was a very intricate operation, since every single burger was made to order - a beef patty did not go down until an order ticket went up.”

Success Factors

“When asked to account for the chain’s success, Esther Snyder once said that it has been ‘accomplished only with the dedicated enthusiasm and wholehearted co-operation of the In-N-Out Burger employees and our pleased customers’.”

“The Snyders built In-N-Out by continuously producing quality hamburgers and fries, reinvesting in their employees, and keeping the chain’s growing legion of customers happy: nothing more, nothing less. In-N-Out’s enduring success stemmed from Harry’s capacity to understand what he did best and focus exclusively on it.”


“Harry didn’t feel that it was beneath him to scrub the floor or pick up the trash.”


Harry treated his suppliers well and never tried to exploit his relationships. Deals were struck on a handshake and lasted decades, often ending only if the supplier went out of business - or failed to meet Harry’s exacting standards.” 

“Like his father before him, Rich Snyder continued to stick by the company’s promises to pay full price for the highest quality ingredients. When prices plunged or spiked, or there were shortages due to weather or other events, In-N-Out always absorbed the cost. As long as the quality remained exceptional, he did not look for cheaper suppliers. It was part of the Snyder's’ business practice to take care of their purveyors as they did their customers and associates.

Harry and Esther believed in serving the communities in which In-N-Out operated. The Snyders made any number of charitable donations, and their efforts of promotion were often connected to grassroots community and philanthropic endeavours.. the result was that In-N-Out generated a kind of homespun feeling; there was a consistency and authenticity about the chain.”

“[In-N-Out] became good corporate citizens in each community where a new store opened.”

Value Employees

Harry Snyder had picked up the rhythm of human interaction, and his business philosophy was based on it. If you treated people fairly and rewarded them accordingly, he held, they would do likewise.

When In-N-Out first started, California’s minimum wage was sixty-five cents an hour, but Harry paid a dollar an hour, plus one free hamburger per shift. He believed in paying for quality, and that included wages. As Esther later explained, ‘They take your orders and make your food. They’re so important, so you want to have happy, shiny faces working there’.”

“Years before business schools discussed managerial terms like customer relations management, worker empowerment, or profit sharing, Harry Snyder put these and other concepts into practice. He gave associates a measure of ownership in the enterprise and he remunerated handsomely for their ability to meet targets and surpass them.”

“In many ways, In-N-Out Burger was an employee-driven company. The Snyders displayed an uncommon respect for their workers.. they never looked at their workers as just employees but saw them as part of their own growing, extended family. The Snyders made sure to know each individual by name. In fact, they banished the words ‘employees’ and ‘workers’ altogether and instead referred to them strictly as ‘associates’. The result was that from the outset, In-N-Out had the feel not of a workplace but of a joint enterprise in which everyone shared.

“The associates were considered the chain’s front lines. For starters, all were required to keep up a clean-cut appearance. All hires were expected to maintain a friendly attitude toward customers (or rather ‘guests’), smiling and looking them straight in the eye.”

“It is likely that the most important decision that Harry and Esther Snyder made was the loyalty they built between In-N-Out and its associates.”

'“[A] consultant told Rich Snyder that if he slashed salaries, In-N-Out could save a ‘ton of money’; the very idea infuriated Rich. This contradicted the very foundation of In-N-Out’s philosophy and its success. When Rich sourly recounted the story, he said the suggestion was exactly the kind of advice one would get ‘from a guy who wears a suit and who thinks you don’t pay a guy who cooks hamburgers that much money’.”

“Rich Snyder shared in the belief that running a successful fast-food-business was not about cutting corners or purchasing the right equipment. What it boiled down to was people management.”

“From the start, In-N-Out paid its employees more than the going rate and was an early practitioner of profit sharing. Under Rich, In-N-Out went further, establishing an expansive set of benefits under which part-time workers received free meals, paid vacations, 401(k) plans and flexible schedules. Full-time associates also received medical, dental, vision, life and travel insurance.”

“‘If you lose your workers, you lose customers’, Rich said. ‘I don’t know how others do it, but we just try to keep everybody happy that works for us’.”

Promote Ownership

“Esther once proudly stated, ‘We’re blessed with good employees, who run the restaurants as if they were their own stores’.”

“It was Rich’s belief that his job was the bottom point of an inverted triangle. He was there to support everyone else in the company. When talking to store managers, he was always careful to refer to the shops as ‘your stores’ and never asked them ‘What store do you manage?’. He wanted them to have pride of ownership. Regardless of anyone’s position or length of time with the company, Rich treated everyone equally and as if they were special… As a result, In-N-Out could boast one of the lowest turnover rates in a high-churn industry.

Maintain Smallness

“Rich imbued the family firm with his effusive personality and nimbly transformed the restaurants into a big business without damaging the integrity of the small burger chain that his parents had built.”


‘[In-N-Out had a] corporate culture operating in stark contrast to the competitor’s systems of burger flippers and vat fryers, floor moppers and cashiers who put on their paper hats and grease-stained aprons in what society calls McJobs and economists refer to as the requisite churn of capitalism. It was a place where people genuinely enjoyed getting up in the morning and going to work. Rich explained it this way: “We try to maintain the highest quality level possible, and to do that you need good training and good people. That’s why we pay the highest wages in the industry’. He added, ‘It means we tend to keep employees longer than at other places, and the reduced turnover helps us maintain consistency in our products’. Notably the philosophy did not trade on or lead to either higher prices or lower-quality food’.

Corporate Debt

“… the suburban network of In-N-Outs that followed alongside the new highways also happened to dovetail nicely with Harry Snyder’s third criterion for placing his stores; he abhorred debt.”

“Harry insisted on using cash, not credit, to open each new restaurant. Harry followed the old rules. He built one store, saved money, he built a second store and saved more money. He didn’t open another until he could afford to and had trained managers to run it - that was the Harry Snyder way. He didn’t take out a loan. He didn’t take on debt. He was beholden to no-one.”


Its fascinating to hear how this family-owned and run chain has maintained its ideals across three generations. Lynsi Snyder, the current owner, has held to her father’s and grandfather’s models faithfully, ensuring the success story continues more than 70 years later.

In a recent interview with Drew Kluger, Lynsi remarked on why she did not adopt the modern technology of on-line ordering: “We we would probably have a faster operation, and you know, which equals more people going through. I mean you've got the potential to make more money. But I would not consider it because we're going to lose one of the things we do best, and that's our customer service and the interaction we have and the relationship. I mean, I really see a relationship between the customer and In-N-Out because we have such a history, and you know our history involves treating the customer like they're number one. They're our most important asset, and how are we going to do that if it's just gone to, you know, basically like a text? That relationship is going to change a lot; and I don't want to give that up.”

I love how she sees the value of the customer relationship as sacrosanct. If you’ve been reading the MastersInvest blog posts in recent times, you’ll no doubt recognise this trait as a common reason for success for many of the businesses we’ve reviewed. And its not just in customers that we see the parallels. All of those same companies, Walmart, Panera Bread and Home Depot treat customers with respect, empower and reward their staff, have effective cultures and keep business practices simple - you don’t have to have the the lowest paid workers nor squeeze your suppliers to be the most successful brand in town.

“We have a special culture at this company. I really believe that it’s my job, and the job of the whole management team, to make sure we nurture that culture and keep In-N-Out the unique place to work it has been for all our Associates — from the 30-year veterans to the ones putting on their aprons for the first time. The simple answer to keeping Associates with us is to treat them the right way.” Lynsi Snyder

And all this hasn’t gone unnoticed. I mentioned earlier that Warren Buffett would love to own some of this business and I meant it - according to the UCLA business school website, Buffett told a group of visiting students back in 2005 that he hungered to own the chain.

He actually wrote to In-N-Out with that idea in mind but never received a reply. Keep in mind that Buffett rarely if ever does this - he would much prefer that valuable companies pay court to him.

With three generations and over 70 years of success, I have to assume that they did not want to dilute the ownership of their brand with outside ownership. They seem to have succeeded despite the revolutions that have swept their way through the fast food market and done it on their own.

Given all this success, I wonder whether the Snyders would swap In-N-Out for a holding in the S&P500? I think the answer is simple: NO WAY! And would they sell because of some concern over a Trump tweet or a trade war? NO WAY!

This is another example of a quality business that just keeps getting more valuable - no wonder Buffett is hungry for a piece, and not just because he’s a burger aficionado.

Sources/Further Reading -
In-N-Out Burger - A Behind The Counter Look At The Fast Food Chain That Breaks All The Rules’ Stacy Perman, 2010.
Recipe For Success: Why Employees Made In-N-Out a Best Place to Work’ Emily Moore, GlassDoor, 2017.
Tell Me What to Say - Drew Kugler: Lynsi Snyder

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The First Investment Primer

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People like to make investing complicated. And the more complicated they can make it sound, the smarter some people think they are. If you stop and think about it, the investment strategies that are marketed today could make anyone’s head spin; Value, Deep Value, Relative Value, Growth, Core Growth, Aggressive Growth, Growth at a Reasonable Price, Alpha Overlays, Quantitative, Momentum etc - they’re all complicated terms that when used can make the dumbest investor sound very smart indeed.

But let’s get back to basics. What is investing really all about? Mostly, it’s about simple common-sense; you outlay money today with the expectation you’re going to get more returned in the future.

So the value of an investment then is the value of the future cash-flows you will receive in the future.

As a dollar in your hand today is worth more than a dollar in the future [because you could invest that dollar today and earn interest on it versus, say a dollar received in a year’s time] you need to discount those future cash-flows back into today’s dollars. The total amount of those discounted dollars is effectively a company’s ‘Intrinsic value’. And Warren Buffett says that this is what businesses and investing is all about.

“The intrinsic value of any business, if you could foresee the future perfectly, is the present value of all cash that will be ever distributed for that business between now and judgment day. And we’re not perfect at estimating that, obviously. But that’s what an investment or a business is all about. You put money in and you take money out.

While most people think of Buffett as a ‘value investor’, the concept of value is often misinterpreted. Buffett uses the term ‘value’ in reference to a company’s ‘intrinsic value’. In short, Buffett wants back more than he puts in.

“I just cringe when I hear people talk about, “Now it’s time to move from growth stocks to value stocks,” or something like that, because it just doesn’t make any sense.Warren Buffett

"Anybody that tells you, “You ought to have your money in growth stocks or value stocks,” really does not understand investing." Warren Buffett

Among his many skills as an investor, one is keeping things simple. At the Berkshire meeting in 2000, Buffett noted the laws of investing were set out a long long time ago...

“It’s very simple. The first investment primer, when would you guess it was written? The first investment primer that I know of, and it was pretty good advice, was delivered in about 600 B.C. by Aesop. And Aesop, you’ll remember, said, “A bird in the hand is worth two in the bush.”

Buffett noted Aesop was smart, but there were a few more questions that need to be answered to identify an attractive investment ..

“Now, Aesop was onto something, but he didn’t finish it, because there’s a couple of other questions that go along with that.”

And the other things you need to know are; when do you get the other birds? How certain are you that you will get them? And: What are interest rates?

“[Aesop] He forgot to say exactly when you were going to get the two in the bush — and he forgot to say what interest rates were that you had to measure this against.

But if he’d given those two factors, he would have defined investment for the next 2,600 years. Because a bird in the hand is — you know, you will trade a bird in the hand, which is investing. You lay out cash today.

And then the question is, as an investment decision, you have to evaluate how many birds are in the bush. You may think there are two birds in the bush, or three birds in the bush, and you have to decide when they’re going to come out, and when you’re going to acquire them.”

A nice summary of Investing. Buffett appropriated the analogy of buying the bushes for modern day investment.

A bird in the hand is worth two in the bush. Now our question is, when do we get the two? How long do we wait? How sure are we that there are two in the bush? Could there be more, you know? What’s the right discount rate?

And we measure one against the other that way. I mean, we are looking at a whole bunch of businesses, how many birds are they going to give us, when are they going to give them to us, and we try to decide which ones — basically, which bushes — we want to buy out in the future.

It’s all about evaluating future — the future ability — to distribute cash, or to reinvest cash at high rates if it isn’t distributed.”

What that means is you need to work out what cashflows you as an investor will receive from the company you own. When do they arrive, and how certain are you you’ll get them? What can the company do to grow those cash flows? But use conservative forecasts; if you’re uncertain, it may be best to avoid the investment. Then use an appropriate discount rate to discount those cash flows back to a present value.

The key criteria then is, can I buy the stock at an attractive discount to my estimate of intrinsic value? And finally, how does this investment compare to all the other investment choices I have? The latter of course includes, doing nothing.

“When you say a bird in the hand is worth two in the bush, you’re comparing it — you’ve got to compare that to every other bush that’s available.” Warren Buffett

Aesop didn’t use terms like Deep Value or Alpha Overlays. He simply stated that what you hold in your hand today should be be worth more in the future. He kept it simple, and without over-complicating his theory. And Buffett says much the same thing; he even used Aesop’s theory, rather than develop a new one of his own. Which sounds pretty smart to me. It’s a time tested equation that was as relevant 500 years ago as it’s likely to be be 500 years in the future.

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