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 they 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.

Follow us on Twitter: @mastersinvest


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.”


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“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

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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.

Screen Shot 2019-01-28 at 9.31.53 PM.png

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

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

“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

“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

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

“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

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

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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

 Keep learning on Twitter: @mastersinvest


The First Investment Primer

greek philosopher_1.jpg

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.

 Keep learning on Twitter: @mastersinvest


Factfulness -Learning from Hans Rosling

Facts are important. They are the fundamental truth that allows us to make decisions. They allow us to determine what is right and what is wrong. They help us decipher critical information so we can sift the lies and stories from the actual statistical details, and because of this, they’re very hard to refute. In fact, they’re important to almost everything we do, and never more so than in investing.

Having written the last blog post, ‘Investment Stories vs. Facts’ I happened upon a fabulous interview of Oaktree Capital’s, Howard Marks by Tim Ferris. In the interview, Tim Ferris asked Howard Marks if there were any books he’d recommend. Here’s what he had to say..

“The book I’m working on now is called Factfulness, and basically, it unmasks a lot of misperceptions that people have about the state of the world, and they hold these perceptions generally qualitatively, not based on data, and the author tries to substitute facts for these perceptions. He starts with a list of 13 questions describing the state of the world, and fascinatingly, he gives you the answer to one, and you have to think about the answer to the other 12. The average score on the 12 is two, and he points out that if you flip the coin, you’d get six right. So the average American gets two of the 12 questions right, so not only are they systematically wrong, but they’re wrong in the same direction, which is they always pick the more pessimistic answer when the more optimistic one is true, and so he responds to our bias and tries to overcome the ignorance and the bias by using facts and some great, very communicative graphics. So I would recommend Factfulness, and I love the idea of unmasking biases.”

Surprisingly enough, I already owned the book, and I distinctly remember Microsoft’s Bill Gates praising it. When Bill Gates said this book, “.. is one of the most important books I’ve ever read, an indispensable guide to thinking clearly about the world”, it got my attention.

As Howard Marks suggests, the book highlights the biases that most people carry. And not just Joe Averages either, but groups of Professionals, Nobel Prize laureates and medical researchers. It’s striking to think that people can hold firm to such strong, yet erroneous views.

The books author, the late Hans Rosling, details how the world is getting better, why we don’t notice it and he provides us with some tools for better thinking. There are striking similarities between the approaches to improve one’s thinking and seeing the world as it is, with those commonly espoused by the Investment Masters. The book could easily have been written with an investor in mind, for all great investors are seekers of truth. As Warren Buffett has observed:

“The most important thing in investments is not having a high IQ, thank God. I mean, the important thing is realism and discipline. And you don’t need to be extraordinarily bright to do well in investments, if you are realistic and disciplined.”

And this book will help you with realism

“This is a book about the world and how it really is. It is also a book about you, and why you (and almost everyone I have ever met) do not see the world as it really is.” Hans Rosling

It’s an easy read with lots of insightful examples. I’ve included some of my favourite quotes below:

“The human brain is the product of millions of years of evolution, we are hard-wired with instincts that helped our ancestors to survive in small groups of hunters and gatherers. Our brains often jump to swift conclusions without much thinking, which used to help us avoid immediate dangers. We are interested in gossip and dramatic stories, which used to be the only source of news and useful information.”

“We need to learn to control our drama intake. Uncontrolled, our appetite for the dramatic goes too far, prevents us from seeing the world as it is, and leads us terribly astray.”

“I want people, when they have been wrong about the world, to feel not embarrassment, but that childlike sense of wonder, and curiosity that I remember from the circus, and that I still get every time I discover I have been wrong; ‘Wow, how is that even possible?’.”

“If you want to convince someone they are suffering from a misconception, it’s very useful to be able to test their opinion against the data.”

Human beings have a strong dramatic instinct toward binary thinking, a basic urge to divide things into two distinct groups, with nothing but an empty gap in between. We love to dichotomize. Good versus bad. Heroes versus Villains. My country versus the rest.”

Averages mislead by hiding a spread in a single number.”

“We almost always get a more accurate picture by digging a little deeper and looking not just at averages but at the spread; not just the group all bundled together, but the individuals.”

“The stories of opposites are engaging and provocative and tempting - and very effective for triggering our gap instinct - but they rarely help understanding.”

What do you need to hunt, capture, and replace misconceptions? Data. You have to show the data and describe the reality behind it.”

“I never trust data 100 percent, and you never should either. There is always some uncertainty.

“It is easy to be aware of all the bad things happening in the world. It’s harder to know about the good things; billions of improvements that are never reported.

“We are subjected to never-ending cascades of negative news from across the world: wars, famines, natural disasters, political mistakes, corruptions, budget cuts, diseases, mass layoffs, acts of terror. Journalists who reported flights that didn’t crash or crops that didn’t fail would quickly lose their jobs. Stories about gradual improvements rarely make the front page even when they occur on a dramatic scale and impact millions of people.”

“The news constantly alerts us to bad news in the present. The doom-laden feeling this creates is then intensified by our inability to remember the past; our historical knowledge is rosy and pink and we fail to remember that, one year ago, or tens years ago, or 50 years ago, there was the same same number of terrible events, probably more.”

When you hear about something terrible, calm yourself by asking, If there had been an equally positive large positive movement, would I have heard about that? Even if there had been hundreds of larger improvements, would have I of heard? Would I ever hear about children who don’t drown? Can I see a decrease in child drownings, or in deaths from tuberculosis, out of my window, or on the news, or in a charity’s publicity material? Keep in mind the positive changes may be more common, but they don’t find you. You need to find them, and if you look at statistics, they’re everywhere.”

“When looking at a stone flying toward you, you can often predict whether it is going to hit you. You need no numbers, no graphs, no spreadsheets. Your eyes and brain extend the trajectory and you move out of the stone’s way. It’s easy to imagine how this automatic visual forecasting skill helped our ancestors survive. And it still helps us survive: when driving a car we constantly predict where other cars will be within the next few seconds. But our straight line intuition is not always a reliable guide to modern life.

“To understand a phenomenon, we need to make sure we understand the shape of its curve. By assuming we know how a curve continues beyond what we see, we will draw the wrong conclusions and come up with the wrong solutions.

When we are afraid we do not see clearly

None of us have enough mental capacity to consume all the information out there. The question is, what part are we processing and how did it get selected? And what part are we ignoring? The kind of information we seem most likely to process is stories; information that sounds dramatic.

“The media can’t waste time on stories that won’t pass our attention filters.

If we are not extremely careful, we come to believe that the unusual is usual; that this is what the world looks like.”

“Of all our dramatic instincts, it seems to be the fear instinct that most strongly influences what information gets selected by news producers and presented to us consumers.”

“If we look at the facts behind the headlines, we can see how the fear instinct systematically distorts what we see of the world.”

“The fear instinct is a terrible guide for understanding the world. It makes us give our attention to the unlikely dangers that we are most afraid of, and neglect what is actually most risky.”

To control the fear instinct, calculate the risks.”

“It is pretty much a journalists’ professional duty to make any given event, fact or number sound more important than it is.”

“The most important thing you can do to avoid misjudging something’s importance is to avoid lonely numbers. Never, ever leave a number all by itself. Never believe that one number on its own can be meaningful. If you are offered one number, always ask for at least one more. Something to compare it with. Be especially careful about big numbers.”

Beware of exceptional examples used to make a point about a whole group .. ask whether an opposite example would make you draw the opposite conclusion. If you are happy to conclude that all chemicals are unsafe of the basis of one unsafe chemical, would you be prepared to conclude that all chemicals are safe on the basis of one safe chemical?”

Beware of vivid examples. Vivid images are easier to recall but they might be the exception rather than the rule.”

“We must try hard not to generalise across incomparable groups. We must try hard to discover the hidden sweeping generalisations in our logic. They are very difficult to discover. But when presented with new evidence, we must always be ready to question our previous assumptions and re-evaluate and admit if we were wrong.”

“Be prepared to update your knowledge. In the social sciences even the most basic knowledge goes off very quickly.. In 1996, a minority of 27 percent supported same-sex marriage. Today that number is 72 percent and rising.”

“A small change every year can translate to huge numbers over decades.”

Some knowledge goes out of date quickly. Technology, countries, societies, cultures, and regions are constantly changing.”

“Forming your worldview by relying on the media would be like forming your view about me by looking only at a picture of my foot.”

Being always in favour of or against any particular idea makes you blind to information that doesn’t fit your perspective. This is usually a bad approach if you like to understand reality… Instead constantly test your favourite ideas for weaknesses. Be humble about the extent of your expertise. Be curious about new information that doesn’t fit, and information from other fields. And rather than talking only to people who agree with you, or collecting examples that fit your ideas, see people who contradict you, disagree with you, and put forward different ideas as a great resource for understanding the world."

“When I know, for example, that all the population experts agree that population will stop growing somewhere between 10 billion and 12 billion, then I trust the data. When I know that economists disagree about what causes economic growth, that is extremely useful too, because it tells me I must be careful; probably there is not enough useful data yet, or perhaps there is no simple explanation.”

“Its better to look at the world in lots of different ways.

“Though we absolutely need numbers to understand the world, we should be highly skeptical about conclusions derived purely from number crunching.

Resist blaming any one individual or group of individuals for anything. Because the problem is that when we identify the bad guy, we are done thinking. And it’s almost always more complicated than that.”

When we are afraid and under time pressure and thinking of worst-case scenarios, we tend to make really stupid decisions. Our ability to think analytically can be overwhelmed by an urge to make quick decisions and take immediate action.”

The future is always uncertain to some degree. And whenever we talk about the future we should be open and clear about the level of uncertainty involved.”

“While it is truly pointless worrying about something unknown that we can do nothing about, we must also stay curious and alert to new risks, so we can respond to them.”

Beware of fortune tellers. Any prediction about the future is uncertain. Be wary of predictions that fail to acknowledge that. Insist on a full range of scenarios, never just the best or worst case. Ask how often such predictions have been right before.

“Most important of all, we should be teaching our children humility and curiosity.”

Being humble, here, means being aware of how difficult your instincts can make it to get the facts right. It means being realistic about the extent of your knowledge. It means being happy to say “I don’t know.”. It also means, when you do have an opinion, being prepared to change it when you discover new facts.”

Being curious means being open to new information and actively seeking it out. It means embracing facts that don’t fit your worldview and trying to understand their implications. It means letting your mistakes trigger curiosity instead of embarrassment.”

What you learn about the world at school will become outdated within 10 or 20 years of graduating. So we must find ways to update adults knowledge too.”


Everything we do in daily life revolves around our learning. And Rosling believes that what we have learnt in the past clearly has a ‘use-by-date’ attached. Basically that means all our known information can become obsolete. That also means we cannot rest on our laurels and must accept that as humans we can never stop learning. The trap with this is that nowadays we have to sift through all the data out there for the kernels of truth or facts, rather than accept all the information at face value.

There is a wealth of critical truth in all of the above which only reinforces my thinking about facts vs stories. Beware a sample size of one. The media’s professional purpose is to be make something more sensational than it really is. We only hear about the negatives, never the positives. Question the assertions of others; never accept what they say as fact until you have proven it so. And as humans we have a very unhealthy appetite for drama and stories.

I really like Rosling’s opinion on how we are wired the same way we have always been wired - to socially interact and hunt just as our prehistoric ancestors did. And we are still hunting; as humans, or investors, we are constantly seeking new information that will allow us to survive. Whether its factual or not is another matter altogether.

Factfulness - Ten Reasons We're Wrong About the World--and Why Things Are Better Than You Think’. Hans Rosling and Anna Rosling Rönnlund - Sceptre.

 Keep learning on Twitter: @mastersinvest


Jeff Bezos interviewed by David Rubenstein

Just five weeks after Apple became the first trillion dollar company, Jeff Bezos’ Amazon became the second company to reach that milestone. And off the back of that, Bezos has become the world’s richest person.

And how did he get there?

Bezos has a drive for innovation and is driven by instinct. He has a preparedness to take risks and is able to embrace create thinking; all things we have noted as similar traits in other great business Mavericks.

I always enjoy listening to what Jeff Bezos has to say. And lucky for all of us, he was recently interviewed by David Rubenstein, the billionaire founder of Carlyle. Rubenstein always provides a great line-up of guests on his namesake show, ‘The David Rubenstein Show’. I’ve included some of my favorite snippets from Rubenstein’s latest peer to peer conversation with Bezos.

Don’t Think About The Stock Price

“I say when the stock is up 30% in a month don’t feel 30% smarter, because when the stock is down 30% in a month it’s not going to feel so good to feel 30% dumber. I never spend any time thinking about the daily stock price.

The Stock Is Not The Company - The Company Is Not The Stock

“[The whole tech bubble] is very interesting, because the stock is not the company and the company is not the stock. So as I watched the stock fall from $113 to $6 I was also watching all of our internal business metrics: number of customers, profit per unit, defects, everything you can imagine. Every single thing about the business was getting better, and fast. So as the stock price was going the wrong way, everything inside the company was going the right way. We didn’t need to go back to the capital markets because we didn’t need more money. The only reason a financial bust makes it really hard is to raise money. So we just needed to progress.”

Operate In The Future - Don’t Focus On The Quarter

“All of our senior executives operate the same way I do, they operate in the future, they live in the future. None of the people that report to me should be focused on the current quarter. When Wall Street congratulates us for a good quarter, that quarter was baked three years ago. Right now, I’m working on a quarter that’s going to reveal itself in 2021. That’s what you need to be doing. You need to be two to three years in advance.

Start and Think Small

Everything I have ever done has started small. Amazon started with a couple of people. Blue Origin started with five people and the budget was very small. Now the budget approaches a billion dollars. Amazon was literally ten people, today it’s half a million. For me it’s like yesterday I was driving packages to the post office myself and hoping one day we could afford a forklift. For me, I’ve seen small things get big and it’s part of this ‘day one’ mentality. I like treating things as if they’re small; Amazon is a large company but I want it to have the heart and spirit of a small one.”

Decision Making and Intuition

“I believe in the power of wandering. All of my best decisions in business and in life have been made with heart, intuition and guts. Not analysis. When you can make a decision with analysis you should do so. But it turns out in life your most important decisions are always made with instinct, intuition, taste and heart.”

Different Kinds of Smart

The older I get I realize how many kinds of ‘smart’ there are. There are a lot of kinds of smart. There are a lot of kinds of stupid too. I see people all the time who I know wouldn’t have got A+’s on their calculus exams, but they’re incredibly smart.”

Focus on the Customer

“The secret sauce of Amazon, where there are several principles, but the number one thing that has made us successful by far is obsessive, compulsive focus on the customer, as opposed to obsession over the competitor. I talk so often to other CEO’s and founders and entrepreneurs and I can tell that even though they are talking about customers they’re really focusing on competitors. It is a huge advantage to any company if you can stay focused on the customer instead of your competitor.

Identify Your Customer

You have to identify who is your customer. At the Washington Post, is the customer the people who buy advertisements from us? No. The customer is the reader. In the school, who are the customers? Is it the parents? Is it the teachers? No. It is the child.”

Seek Customer Feedback

“I got smart and I emailed 1,000 randomly selected customers and asked them, ‘besides the things we sell today, what would you like to see us sell?’ That answer came back incredibly long tailed. The way they answered the question was for whatever they were looking for at that moment. One of the answers was ‘I wish you sold windshield wiper blades, because I really need windshield wiper blades.’ I thought to myself we can sell anything this way. If you read the original business plan it was just books.”

Fix Problems Once

“[With customer problems] we try to find real route causes and then real route fixes. So when you fix it you’re not fixing it for that one customer but for every customer. That process is a gigantic part of what we do.”

Leverage Other People’s Capex/Technology

Amazon got started with only one million dollars of capital because I got to ride on the back of the credit card system, I got to ride on the back of the pre-existing transportation network that could deliver packages, and the pre-existing telecommunications network that could allow people to connect to our servers. All of that would have been hundreds of billions of dollars of capex but the heavy lifting was already in place.”

The Washington Post Business Model

“I wanted to be really open with myself and look in the mirror and be sure I was optimistic that it [the Washington Post] could work. If it were hopeless it would not be something I would get involved in. I looked at it and I was super optimistic. It needed to be transitioned into a national and global publication. There is one gift the internet brings newspapers and that is free global distribution. So we had to take advantage of that gift. That was the basic strategy. We had to switch from a business model where we made a lot of money per reader with a relatively small number of readers to a tiny bit of money on a very large number of readers. And that is the transition we did. I’m pleased to report the Post is profitable today, the newsroom is growing every year I’ve been there. It’s working. I know when I’m ninety, I always project myself forward to age ninety, it’s going to be one of the things I’m most proud of.”

Why Amazon? and Regret Minimization

“I came across the fact that the web was growing at something like 23,000% a year in 1994. Anything growing that fast, even if its base-line usage today is tiny, it’s growing so fast that its going to be big. I looked at that and thought I should come up with a business idea and let the internet grow around us. I made a list of the products I might sell on-line and I picked books because books are super unusual in one respect in that there are more book items in the book category than any other category. There are three million different books in print at any given time. The founding idea of Amazon was to build universal selection of books. The biggest bookstores only had 150,000 titles. I made the decision with my heart and not my head. I basically said, when I’m ninety,  I want to have minimized the number of regrets in my life. Most of our regrets are acts of omission. They are the things we didn’t try, the path untraveled. Those are the things that haunt us.”

Know Your Competency

“Whenever we have dabbled in something that’s a ‘me too’ service we tend to get beaten; it doesn’t work. Our culture is much better at pioneering and inventing. So we have to have something that’s different.”

Team Inventing. Love.

Team inventing is my favorite thing. I tap dance into the office. I love Amazon. Amazon is my full time job. I get to live two to three years into the future.”

Make A Small Number Of High Quality Decisions

“As a senior executive what do you really get paid to do? As a senior executive you get paid to make a small number of high quality decisions. Your job is not to make thousands of decisions every day. It’s different if it’s a start up company but we are not a start up.”


Getting it wrong isn’t that bad. When we make mistakes, and we’ve made doozies, the big winners pay for thousands of failed experiments.

Amazon Web Services’ Long Runway

“AWS completely reinvented the way companies buy computation. Then a business miracle happened. This never happens. This is the greatest piece of business luck in the history of business as far as I know. We faced no like-minded competition for seven years. It’s unbelievable. When you pioneer if you’re lucky you get a two year head start. Nobody gets a seven year head start. We had this incredible runway.”

Regulation and Big Companies

We are so inventive that whatever regulations are promulgated or however it works, that will not stop us from serving customers. Under all regulatory frameworks I can imagine, customers are still going to want low prices, they are still going to want fast delivery, they are still going to want big selection. It is really important that politicians and others need to understand the value big companies bring and not demonise or vilify big companies. The reason is simple. There are certain things only big companies can do. Nobody in their garage is going to build an all carbon-fiber fuel efficient Boeing 787. It’s not going to happen. You need Boeing to do that. This world would be really bad without Boeing, Apple, Samsung and so on.”


The main takeaway for me on Bezos’ early years was his focus on the business operating metrics and not the share price. Basically while those metrics were moving in the right direction, he totally ignored the share price - even when the share price dropped from $113 to $6. His philosophy that ‘the stock is not the company and the company is not the stock’ is a great learning piece for all investors, I feel. Had Bezos listened to the share price, particularly when it tanked like it did, he may well have panicked and sold. In which case today, he wouldn’t hold the title, ‘the world’s richest person’.

It almost seems like de ja vu, yet once again we’re looking at a highly successful business owner with the same set of success traits as all the others we have reviewed in recent posts. And given we have seen so many people who have succeeded putting customers first, learning from mistakes and not listening to the share price, it no longer comes as a surprise to me. I hope it doesn’t come as a surprise to you.

Further Reading:
’Learning From Jeff Bezos’ - Investment Masters Class

’The Master CEOs’ - Investment Masters Class

‘The David Rubenstein Show’, Bloomberg

 Keep learning on Twitter: @mastersinvest


Investment Stories vs. Facts


Who doesn’t love a story? Those tales of woe and drama, intrigue and suspense; and the better the storyteller the more we’re usually hooked.

Stories sell. We often believe them without thinking or questioning. And they can have an unjustified weight on our perceptions. Consequently, stories often impact markets and our investment decisions when they shouldn’t.

I’m sure you’ve seen a situation where an analyst or journalist writes a short story about a stock or sector? Then the market takes it as a given and the stock or sector plunges as a result. And I’m sure you can think of plenty of investment stories you’ve heard over the years. Just think about some of the more recent ones .. ‘bitcoin’s finite supply means it will be worth more’, ‘negative bond yields imply a global recession’, ‘the longest equity recovery in recent history portends a market crash’, or ‘value investing is dead’.

Why do we believe such stories? Why do we get hooked into these narratives that are neither factually correct or accurate? The answer is, we are wired that way; mankind actually hasn’t evolved much from the days we spent hunting and gathering. One of the key skills that allowed us to progress from these primitive beginnings and reach the top of the food chain was collaboration. And collaboration involved stories. Yuval Noah Harari made the point in his must-read book Sapiens.

"We are the only mammals that can cooperate with numerous strangers because only we can invent fictional stories, spread them around, and convince millions of others to believe in them." Yuval Noah Harari

In an essay titled ‘What Makes Us Human’, Lisa Mada notes “Humans around the world, from the very young to the very old, have been communicating and transmitting their ideas through stories for thousands of years, and storytelling remains integral to being human and to human culture.

Stories are everywhere. In a recent article in the FT, Jon Authers, provided a few examples of ‘stories’ in today’s financial markets.

What’s the story? US unemployment numbers are out, jobs are up, and wages are not growing as fast as they were. Does this mean we are back in “Goldilocks”, or should the narrative be “Making America Great Again”? And as for world markets, can we go back to the story that was looking so good until a surprisingly strong wage growth number brought it to a halt? That story was “Melt-Up”, after an extraordinary rally in stock markets.” Jon Authers

Mr Authers refers to the narrative fallacy, the tendency for humans to turn random or disparate data into stories.

“We think in stories. When applying the word “narrative” we often bump against the “narrative fallacy” — the human tendency to try to turn random or disparate data into a satisfying story. But that is how we make sense of the world. Any journalist will admit that to explain a complex story you must turn it into a narrative. Anyone selling you an investment similarly does so by telling a story.” Jon Authers

And our story instinct makes us vulnerable to believing narratives that just aren’t true. Joe Wiggins, of Behavioural Investment notes, “There are myriad behavioural pitfalls that blight value investing”, an obvious one is ‘Stories’. He provides us with an example in the context of value investing.

“We have an overwhelming desire to construct, and believe, coherent, simple narratives. Walter Fisher (1978) first posited the narrative paradigm theory, which argued for the pre-eminence of storytelling in human communication – compelling tales outweigh robust argumentation. Growth stocks often benefit from beguiling narratives, which we inextricably link to positive share price performance, whereas value stocks suffer from the reverse –‘cheap for a reason’ is the common slight aimed at undervalued stocks. As investors strive for consistency, it is hard to reconcile the typically negative narrative that accompanies a depressed value stock with the potential for strong future performance.” Joe Wiggins

Investing stories can be dangerous. It’s little wonder the world’s most successful investors are mindful of this.

"Most stock-picking stories, advice and recommendations are completely worthless." Ed Thorp

"Stories are more powerful than statistics because the most believable thing in the world is whatever takes the least amount of effort to contextualize your own life experiences." Morgan Housel

Of all the dangers that investors face, perhaps none is more seductive than the siren song of stories. Stories essentially govern the way we think. We will abandon evidence in favour of a good story.James Montier

“Humans are irrational. We’re not especially good at stock picking. We have a tendency to get caught by narratives and stories.” Raife Giovinazzo

Stories sell stocks: the wonderful new product that will revolutionise everything, the monopoly that controls a product and sets prices, the politically connected and protected firm that gorges at the public trough, the fabulous mineral discovery, and so forth.” Ed Thorp

Stories appeal to our emotional side and they often blind us to the underlying facts. Stories are quick and easy. It’s human nature to respond to emotion before reason. That’s how we’ve evolved.

"Our brain is wired to perceive before it thinks - to use emotions before reason.” Peter Bevelin 

"Information presented in vivid and concrete detail often has unwarranted impact, and people tend to disregard abstract or statistical information that may have greater evidential value.  Statistical data, in particular, lacks the rich and concrete detail to evoke images, and they are often overlooked, ignored or minimised". Richards Hueur

Stories are often formed from a single or limited number of observations transformed into a generalisation. Just the other day, the front page of a national financial newspaper I was reading carried the story about a man who had lost his job, whose wife had just had a baby, and could no longer afford his mortgage repayments. He sold his house and received less than he’d expected, which was also less than the amount an estate agent told him the house would sell for 3 months prior. The narrative was: people are being forced out of their homes as they can’t afford them, and house prices are falling. Therefore mortgage banks are in trouble. SELL BANKS. The market reacted accordingly despite a sample size of just one.

Relying on only a few anecdotes can lead investors to the wrong conclusions. The famous theoretical physicist, Richard Feynman, observed “The first principle is that you must not fool yourself and you are the easiest person to fool.”

Studied by many of the world’s greatest investors, Feynman understood the danger of relying on small sample sizes.

"You can't prove anything by one occurrence, or two occurrences, and so on. Everything has to be checked out very carefully. Otherwise you become one of these people who believe all kinds of crazy stuff and don't understand the world they're in. Nobody understands the world they're in, but some people are better off at it than others." Richard Feynman

"Many people believe things from anecdotes in which there is only one case instead of a large number of cases." Richard Feynman

Because stories often lack statistical rigour, they provide a false representation of reality. They can also suffer from wishful thinking, poor analysis, inappropriate analogies, or incorrect observations.

“The narratives investors use to explain the market or economy sometimes lack the statistical rigor required for a proper description. And as we have learned, if the description is faulty the explanation is likely wrong.”  Robert Hagstrom

Overcoming the pull of stories requires keeping an open mind, collecting all the facts and testing investment ideas. Before acting on stories and narratives it’s important to test their validity. This can be done by collecting more information.

“One also needs to learn to fight certain human biases such as buying into stories. The thing that gets fundamental discretionary traders involved in trade is stories, because we can grasp onto them. But in general, it’s good to step away from the stories and take it back to the numbers.” Jim Leitner

“My point about narratives is that if you’re so caught up in the story and in finding evidence that supports the story, you might not adequately process data points that could raise important red flags,” Jake Rosser

When false narratives and stories are prevalent, stocks trade at the wrong prices; the stock price reflects the narrative, not the facts.

“Because of a financial-community appraisal that is at variance with the facts, a stock may sell for a considerable period for much more or much less than it is intrinsically worth.” Phil Fisher

It’s when a share price that’s been supported by a false narrative is subjected to reality, that investors who acted on that false information suffer.

Investment fads and misinterpretations of facts may run for several months or several years. In the long run, however, realities not only terminate them, but frequently, cause the affected stocks to go to far in the opposite direction. The ability to see through some majority opinions to find what facts are really there is a trait that can bring rich rewards in the field of common stocks.” Phil Fisher

Such distortions in perception, or not seeing the world as it really is, can lead to serious investment mistakes. In fact, Charlie Munger considers seeing the world the way it really is, as the most important thing of all.

“I would argue rationality, which is seeing the world the way it is, instead of the way you hope it is, I’d say that’s the most important [thing]. If you don’t see the world the way it is, it’s like judging something through a distorted lens, you think the world is one way and it’s different. And of course, that leads to terrible mistakes. You want to think correctly.” Charlie Munger

“We should see the world the way it is, which is the same as seeking truth from facts.” Li Lu

So, before you jump into an investment or make a change to an existing investment, you need to ask yourself the following questions - “Do I have all the facts?”, “Am I relying on an unsubstantiated story”, “Have I asked all the right questions?”, and “What assumptions am I making?

The Investment Masters don’t act without ensuring they have all the facts. They let the facts do the talking and don’t get caught up in stories and narratives.

“If you don’t know the facts don’t play.” Jim Rogers

“We’re not looking for opinions. We’re looking for facts.” Warren Buffett

“Opinions are a dime a dozen and nearly everyone will share theirs with you. Many will state them as if they are facts. Don’t mistake opinions for facts.” Ray Dalio

"Be obsessive in making sure your facts are right and that you haven't missed or misunderstood something."  Barton Biggs

“I’m quite capable of selling a stock when it goes down. I am quite capable of buying a stock when it goes down. It all depends on the underlying facts.” Warren Buffett

“Most people do not look thoughtfully at the facts and draw their conclusions by objectively weighing the evidence… When you’re approaching a decision, ask yourself: Can you point to clear facts (i.e facts believable people wouldn’t dispute) leading to your view? If not, chances are you’re not being evidence based.” Ray Dalio

“Both my failure in whiskey and my success in copper emphasized one thing – the importance of getting the facts of a situation free from tips, inside dope, or wishful thinking. In the search for facts I learned that one had to be as unimpassioned as a surgeon. And if one had the facts right, one could stand with confidence against the will or whims of those who were supposed to know best.” Bernard Baruch

“You have to come to your own conclusions, and you have to do it based on facts that are available. If you don’t have enough facts to reach a conclusion, you forget it. You go on to the next one. You have to also have the willingness to walk away from things that other people think are very simple.” Warren Buffett

“We must focus on facts – as Dragnet fans will recall, “Just the facts”, Stories usually have an emotional content, hence they appeal to the X-system – the quick and dirty way of thinking. If you want to use the more logical system of thought (the C-system), then you must focus on the facts. Generally, facts are emotionally cold, and thus will pass from the X-system to the C-system.” James Montier

“First you’ve got to get all the facts, and then you’ve got to face the facts. Not pipe dreams.” Paul Cabot

“Never act upon wishful thinking. Act without checking the facts, and chances are that you will be swept away along with the mob.” Jim Rogers

“In the 1950s, an early detective series on TV was Dragnet, starring the fictional Joe Friday. In the opening sequence to every show he would say: “My name is Friday. I’m a cop”. His other famous one-liner, usually delivered while trying to extract evidence from a hapless babbling witness, was: “Just the facts”. We would all do well to remember Joe’s witness interview technique when it comes to investing.” Terry Smith


The moral of this story is: be mindful of other stories and get the facts. And only the facts. Just because one homeowner can’t pay his mortgage doesn’t mean housing prices are going to crash and banks are going to be in trouble. Just because one person heard that so and so stock was going to tank doesn’t mean that it will.

Your task is to sift through the stories out there and find the kernels of truth, the facts that will determine if the story is correct. And while you’re doing it, don’t let other people’s emotional reactions or beliefs influence you to a different way of thinking. Don’t let urban myth dictate your investment activities. And whatever you do, look for evidence where stories are based on a sample size of one. Trust me when I say, they’re not hard to find, they’re just very hard to ignore.

Further Suggested Reading:
Sapiens - A Brief History of Humankind’ - Yuval Noah Harari
Narrative Economics’ - Robert J. Shiller January 2017

 Keep learning on Twitter: @mastersinvest


The Stock 'Business' Market



"That whole idea that you own a business, you know, is vital to the investment process." Warren Buffett


Between the ages of 11 and 19, Warren Buffett was a failed investor. Hard to believe, right?

And it wasn’t for lack of trying. By the age of ten, Buffett had read every investment book on the shelves of the Omaha library. He'd gorged on stock quotes and technical analysis, and whilst his education in investing could be said to have improved, quite simply he wasn't making any money.

But at the age of nineteen, Buffett picked up Ben Graham's 'Intelligent Investor' and everything changed for him. Within Chapter Eight of that book lay an alternative philosophy about investments. The author proposed that an investor was 'analogous to that of a silent partner in a private business' whose results would be 'entirely dependent on the profits of the enterprise'. Graham proffered that 'as long as the earnings power of [the] holdings remain satisfactory, [an investor] can give as little attention as he pleases to the vagaries of the stock market'.

It had been the 'vagaries of the market', the unexpected and inexplicable changes in stock prices that had obstructed Buffett from investment success. With this learning, a light went on in Buffett's mind. It was a seminal moment that would change his life. 

"From 11 to 19, I was reading Garfield Drew, and Edwards and Magee, and all kinds of — I mean, I read every book — Gerald M. Loeb — I mean, I read every book there was on investments, and I didn’t do well at all. And I had no real investment philosophy. I had a lot of things I tried. I was having a lot of fun. I wasn’t making any money. And I read Ben’s book in 1949 when I was at University of Nebraska, and that actually just changed my whole view of investing. And it really did, basically, told me to think about a stock as a part of a business." Warren Buffett

Like Buffett junior, the vast majority of market participants think of stocks as pieces of paper to be traded, not an entitlement or claim to the underlying earnings of a business.

"To many on Wall Street, both companies and stocks are seen only as raw materials for trades." Warren Buffett

These investors take their cues about their investment decisions and the company they’ve bought from short-term stock price movement rather than the performance and outlook of the underlying business.

"People buy a stock and they look at the price next morning and they decide to see if they are doing well or not doing well. It is crazy. They are buying a piece of the business.” Warren Buffett

As such, a stock price decline must imply the outlook is deteriorating, and vice versa. But stock prices move for all sorts of reasons, and many of them are unrelated to business fundamentals. And humans are emotional, they often over-react; psychological biases mean they often do the wrong thing at the wrong time. Consequently, stock prices can have little semblance to what a company is worth, be it too high or too low. Basically, stock prices are frequently irrational.

"The beauty of stocks is that that do sell at silly prices from time to time. That's how Charlie and I have gotten rich."  Warren Buffett

This is the beauty and the real opportunity in public markets. These markets are brimming with emotional participants who don't know what they own, what their stocks are worth and who buy and sell at the wrong times. Emotions rather that facts drive their investment decisions. Sometimes it's not even people, but two algorithms programmed to sell at market prices, come what may. No price is the wrong price for an algorithm. 

“When the price of a stock can be influenced by a ‘herd’ on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact market prices are frequently nonsensical.” Warren Buffett

In contrast, private market transactions are ordinarily set by astute, informed, rational sellers.

"In a negotiated purchase of a business, you’re almost always dealing with someone that has the option of either selling or not selling, and can sort of pick the time when they decide to sell, and all of that sort of thing. In stock markets, it’s an auction market. Crazy things can happen. You can have, you know, some technological blip that will cause a flash crash or something. And the world really hasn’t changed at all, but all kinds of selling mechanisms are tripped off, and that sort of thing. So you will see opportunities in the stock market that you’ll never really get in the business market." Warren Buffett

"The stock market will offer you opportunities for profit, percentage-wise, that you’ll never see, in terms of negotiated purchase of business." Warren Buffett

By acknowledging that stock prices could be nonsensical, Buffett overcame the powerful emotional impact that can derail an investors' decision making process. Buffett changed his perspective, he now looked to the business as his guidepost, not the share price.

"We don’t consider ourselves richer or poorer based on what the stock does. We do feel richer or poorer based on what the business does. So we look at the business as to how much we’re worth. And we do not look at the stock price, because the stock price doesn’t mean a thing to us." Warren Buffett

"You have to have an attitude that divorces you from being influenced by the market." Warren Buffett

“I think it’s almost impossible if you’re to do well in equities over a period of time if you go to bed every night thinking about the price of them. I mean, Charlie and I, we think about the value of them.”  Warren Buffett

Taking a step further, Buffett framed his purchases under the guise of buying the whole enterprise which provoked a different analytical lens than for share purchases. 

"When we buy a stock, we always think in terms of buying the whole enterprise, because it enables us to think as businessmen, rather than as stock speculators." Warren Buffett

Buffett even considered stock purchases in the hypothetical context of a stock market that was indefinitely closed.

"No matter what the stock was selling for — it just doesn’t make any difference — because we do look at the businesses. We really look at it as if there wasn’t any quote on the stock. Because we don’t know what the stock is going to do. If the business gets worth more at a reasonable rate, the stock will follow, over time. But it won’t necessarily follow week by week, or month by month, or year by year... So we really measure all the time by the business. We think of it as a private business, basically, for which there’s a quotation. And if it’s handy to use that quotation, either in buying more stock or something of the sort, we may do it. But it does not govern our ideas of value." Warren Buffett

“We bought See’s Candy in 1972. We haven’t had a quote on it since. Does that make us wonder about how we’re doing with See’s Candy? No, we looked at the company results. So — there’s nothing wrong with focusing on company results. Focusing on the price of a stock is dynamite, because it really means that you think that the stock market knows more than you do. Now if the stock market may know more than you do, but then you shouldn’t be in stocks. I mean, you should have — the stock market is there to serve you and not to instruct you.” Warren Buffett

Buffett recognised that over the longer term a company's share price must reflect the value of the future earnings of that company. 

"Sooner or later, the amount of cash that a business can disgorge in the future governs the value it has — that the stock commands — in the market. But it can take a long time." Warren Buffett

"Wild swings in market prices far above and below business value do not change the final gains for owners in aggregate; in the end, investor gains must equal business gains." Warren Buffett

What a stock earns depends solely on the business that underlies that stock. It's little wonder Buffett considers himself, first and foremost, a business analyst.  

"When investing, we view ourselves as business analysts - not as market analysts, not as macroeconomic analysts, and not even as security analysts." Warren Buffett

"The only way we know how to make money is to try and evaluate businesses." Warren Buffett

And identifying good businesses that can grow their earnings is key. 

"People have been successful because they've stuck with successful companies. Sooner or later the market mirrors the business." Warren Buffett

Which means its important to think about what makes a good business. Focus on the ones you understand.

"I think most of the people in this room, if they just focused on what made a good business or didn’t make a good business and thought about it a little while, they could develop a set of filters that would let them, in five minutes, figure out pretty well what made sense or didn’t make sense." Warren Buffett, Berkshire AGM 1997

"The way you learn about businesses is by absorbing information about them, thinking, deciding what counts and what doesn’t count, relating one thing to another. And, you know, that’s the job. And you can’t get that by looking at a bunch of little numbers on a chart bobbing up and down about a — or reading, you know, market commentary and periodicals or anything of the sort. That just won’t do it. You’ve got to understand the businesses. That’s where it all begins and ends." Warren Buffett

"I would just read the Graham and the Phil Fisher books. And then read lots of annual reports, think about businesses, and try and think about which businesses you understand and which you don’t understand. And you don’t have to understand them all. Just forget about the ones that you don’t understand." Warren Buffett

"I think you ought to learn everything you can about industries and businesses that — where you think you have the ability to get your mind around them if you work at them. And with that arsenal, you’ll do very well, and if you’ve got the temperament for the business." Warren Buffett

Paying the right price for the future earnings is what value investing is all about.

"What you’re trying to do is look at all the cash a business will produce between now and judgment day, and discount it back at a rate that’s appropriate, and then buy it a lot cheaper than that." Warren Buffett

Not overpaying is important. Although, paying too much for a great business is more likely to lead to waiting longer for results rather than the permanent loss of capital.

"Stocks are part of a business. If the business does well, they’re [the investors] going to do all right as long as they don’t pay way too much to join into that business... [If] you pay too much for them, [the] risk is usually a risk of time rather than loss of principal, unless you get into a really extravagant situation." Warren Buffett

And if you get the business analysis right, the investment will be right. 

"We figure if we’re right about the business, we’re going to make a lot of money. And if we’re wrong about the business, we don’t have any hopes — we don’t expect to make money." Warren Buffett

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

It also means not having to worry about the macro or political issues.

"I can’t remember any discussions Charlie and I have had, ever, going back to 1959, that where we would’ve come to the conclusion at the end of them that we would’ve passed on a great business opportunity — a business to buy — because of external conditions. Nor did we ever buy anything that we thought was mediocre simply because we thought the world was going to be wonderful." Warren Buffett

It shouldn't come as a surprise many of the Investment Masters think the same way as Buffett. While each Investment Master has their own style, a great majority consider themselves business owners rather than stockholders and consider stocks as 'pieces of a business'. 

“Forget the noise. Investing is about owning businesses!” Francois Rochon

"The number one idea is to view stock as an ownership of the business and to judge the staying quality of the business in terms of its competitive advantage."  Charlie Munger

“You have to think of yourself as an owner of a business, rather than an owner of a piece of paper." Li Lu

“Stock certificates are deeds of ownership in business enterprises and not betting slips.” J Paul Getty

“Stocks are ownership shares of businesses; they are not pieces of paper that bounce around on which you calculate Sharpe and Sortino ratios. They are ownership shares of businesses that we value, and either buy at a discount or short when they are overpriced.” Joel Greenblatt


I think one of the most important lessons from Buffett has to be this fundamental shift in his thinking. Prior to his discovery of Ben Graham’s book in 1949, he had been dabbling in the Stock Market and whilst having lots of fun, had not earned a cent. Once he had shifted his thinking towards Business Ownership as opposed to Stock Ownership, he began to make money.

And it’s a relatively simple lesson that is missed by the majority of the world’s investors. They live their lives based on what a stock price is doing rather than the future earnings potential of the businesses they own, and therefore often ‘create’ fluctuations in the prices of those stocks due to their emotions or thinking biases. Or even worse, the emotions and thinking biases of other people. AKA: the Herd.

So here’s some easy things to remember from all this:

1) Think about the stock as part of a business
2) Learn everything you can about businesses and industries
3) Identify good businesses with sustainable competitive advantages that are growing
4) Recognise that stock prices can be completely irrational and nonsensical
5) Apply Mental Tricks - consider you are buying the whole business and that the stock market will close indefinitely
6) Look to buy such businesses for less than they’re worth
7) Focus on the underlying performance of the business rather than its stock price
8) Provided the business does well over the long term, you will do well.

Sometimes the simple act of thinking about something in a different way can bring context to a situation.  Buffett's example is a case in point. It wasn't until he read Ben Graham’s book and changed his frame of reference to consider stocks as 'pieces of a business' that success came. And this approach has proven itself over time.

"I haven’t seen anything in the last 25 years, and I read — I glance through — most of the books. I’ve seen nothing to improve on Graham and Fisher in terms of the basic approach of going about investing, which is to think about stocks as businesses, and then think about what makes a good business." Warren Buffett

Further Reading:
‘Business Owner Mentally’ Investment Masters Class

 Keep learning on Twitter: @mastersinvest



Learning From Ray Kroc

We all know McDonald's. And we've all probably eaten there; it's a pretty rare person who hasn't dined at one of their restaurants at some point in their life. And given there is more than 35,000 of them in 120 countries, and that they serve over 68 million of us every single day, it's no surprise that they're so well known and so successful. 

Ray Kroc is the man behind the business. Like myself, you may have seen the recent film 'The Founder', which details the rise of this incredible iconic company. And like with the podcasts I listen to, having watched the movie, I was keen to find out more about Ray Kroc and how he came to grow the McDonald's brand into the most successful fast-food chain in history.

“I can’t think of anybody else who, before McDonald’s, ever did what McDonald’s did to create a chain of restaurants on such a scale, that worked.” Charlie Munger

Luckily for me there was a biography available which went into far more detail about his story and the secrets to his success. And I just finished that book, 'Grinding it Out', which is a fascinating read. Whilst the movie portrays Ray in a less than positive light at times, I found the book far more factual with some incredibly interesting parallels to other businesses and leaders I have reviewed in recent times. 

Which is also no surprise.

Ray began his career selling paper cups and milk shake machines and stumbled across the Californian Hamburger bar run by the brothers, Dick and Mac McDonald in the 1950's. Realizing the incredible potential of the company, at the age of fifty-two, he negotiated franchising rights with the brothers and launched the McDonald's franchise in 1955.

Since then, the franchise idea has been copied so many times that these days Restaurant Franchises are a dime a dozen. There are so many of them about, in so many formats and brands, its almost impossible to work out which is the best. I know people who have ventured into the world of franchising, only to be bitten by over promising and under-performance, which over time led to them closing the doors and losing their initial investment. And many of the bigger franchise groups simply don't care. There are so many people on the waiting list for a franchise, that they can just sell that failed franchise to the next person. And then the next. As long as they are taking their cut and getting their fees, its doesn't matter to them whether an individual franchise fails. It doesn't matter, until it does.

One of the most striking things about the success of the McDonald's model is that Ray worked out that for the business to be ultimately successful, the franchisee had to make money. If the franchisee was making money, then the franchisor would, too. Warren Buffett, who once owned more than four percent of McDonald's, identified this trait in successful franchises as well.

"You want a franchise operation — you want the franchise operator to make money and you want him to create a capital asset that’s worth more than he’s put in it. That’s the goal." Warren Buffett, Berkshire AGM 1998

"Whereas Dairy Queen will, in most cases, receive 4 percent of the franchisee’s sales, in terms of a royalty, at a McDonald’s there’s more than that percentage, plus rentals and so on. So they’re two different — very different — economic models. They both depend on the success of the franchisee in the end. I mean, you have to have a good business for the franchisee to, over time, have a good business for the parent company." Warren Buffett, Berkshire AGM 1998

"A successful franchisee can sell his operation for significantly more than he has invested in tangible assets. And we want it that way, obviously, because that means he’s got a successful business, and it means that, over time, we will have a successful business." Warren Buffett

I have mentioned many times that the Investment Masters learn from their mistakes. Buffett himself has espoused the value of it and also mentioned that he made a mistake with McDonald's. A Billion Dollar mistake.

"The portfolio actions I took in 1998 actually decreased our gain for the year. In particular, my decision to sell McDonald's was a very big mistake." Warren Buffett, Berkshire Letter, 1998

Source: Bloomberg

Source: Bloomberg

Following on from the recent posts about Walmart, Les Schwab Tires, Panera Bread, Nucor, Home Depot and Starbucks, I have added my favourite quotes and points from Ray Kroc's book below...

Love What You Do

"For me work was play. I got as much pleasure out of it as I did from playing baseball."

"There's nothing more fun for me than rubbing elbows with a bunch of operators and talking shop."

"In many corporations when the top guy moves it's to a figure-head role. He becomes chairman of the bored. Not me."

Early Experience

"I spent a lot of time thinking about things."

"I learned that you could influence people with a smile and enthusiasm and sell them a sundae when what they'd come for was a cup of coffee."

"No self-respecting pitcher throws the same way to every batter, and no self-respecting salesman makes the same pitch to every client."

"Too many salesman, I found would make a good presentation and convince the client, but they should have stopped talking. If I ever noticed my prospect starting to fidget, glancing at his watch or looking out the window or shuffling papers on his desk, I would stop talking and ask for his order."

"I stressed the importance of making a good appearance, wearing a nicely presented suit, well-polished shoes, hair combed, and nails cleaned. "Look sharp and act sharp," I told them. "The first thing you have to sell is yourself. When you do that, it will be easy to sell paper cups."

"There's almost nothing you can't accomplish if you set your mind to it."

Keep It Simple

"My first motto for McDonald's - KISS - which meant, 'Keep it simple, stupid.'"

It's About People

"[My management style] proceeded on the strength of my salesman's instinct and my subjective assessment of people... I've been wrong in my judgements about men, I suppose, but not very often."

"I liked to get people fired up, fill them with zeal for McDonalds, and watch the results in their work."

Tone At The Top

"I've never been too proud to grab a mop and clean up the rest rooms, even if I happened to be wearing a good suit."


"I've never submitted a personal expense account to McDonald's in my life. In the early days, of course, it would have been an empty exercise. I didn't take a salary; I was keeping the thing afloat with my income from Prince Castle Sales, But even in later years it never entered my mind that I should be reimbursed by the company. I pay most of my company expenses out of my own pocket, although, of course, I do use my company credit card. But by the same token, I have purchased a fleet of nineteen customised Greyhound buses, outfitted with kitchens, rest rooms, telephones, colour television, and lounge-style seating and I rent these to the corporation for one dollar a year. Each of our district books the use of one of these Big Mac Buses to its operators for worthwhile activities such as taking disadvantaged children and senior citizens on outings. I also bought the company plane, a Gulfstream G-2 jet. McDonald's rents it from me for the same low price, one dollar a year."

"I couldn't give [my first two employees, Harry Sonneborn and June Martino, who worked tirelessly and neglected their families] them raises to compensate them for their past efforts, but I could make sure they would be rewarded when McDonald's became one of the country's major companies, which I never doubted it would. I gave them stock - ten percent to June and twenty percent to Harry - and ultimately it would make them rich. At the time, of course, Chicago Transit Authority tokens would have been worth more." 

Risks And Mistakes

"You have to take risks. I don't mean to be a daredevil, that's crazy. But you have to take risks, and in some cases you must go broke. If you believe in something, you've got to be in it to the ends of your toes. Taking reasonable risks is part of the challenge. It's the fun."

"If you are willing to take big risks, and I always have been, you are bound to blow one once in a while; so when you strike out, you should try to learn as much as you can from it."

"None of this is meant to sound as though I think I've never made a mistake, Far from it. I could probably write another book about my mistakes. But it wouldn't be very interesting. I've never seen negatives add up to a plus."

"I learned then [with early set-backs] how to keep problems from crushing me. I refused to worry about more than one thing at a time, and I would not let useless fretting about a problem, no matter how important, keep me from sleeping."

"A good executive does not like mistakes. He will allow his subordinates an honest mistake once in a while, but the will never condone or forgive dishonesty."

"Achievement must be made against the possibility of failure, against the risk of defeat. It is no achievement to walk a tightrope laid flat on the floor. Where there is no risk, there can be no pride in achievement and, consequently, no happiness."

No Master Plan

"There is a certain kind of mind that conceives new ideas as complete systems with all their parts functioning. I don't think in that 'grand design' pattern. I work from the part to the whole, and I don't move on to the large scale ideas until I have perfected the small details. To me this is a much more flexible approach. For example, when I was starting McDonald's, my original purpose was to sell more Multimixers. If I had fixed in my mind as a master plan and worked unswervingly toward that end, my system would have been far different and much smaller scale creation... At the risk of seeming simplistic, I emphasis the importance of details. You must perfect every fundamental of your business if you expect it to perform well."

Customer Comes First

"I thought of the customer first."

"My philosophy was one of helping my customer, and if I couldn't sell him by helping him improve his own sales, I felt I wasn't doing my job."

"[When you] Look at it strictly from the customers point of view, which is how I do it, because this guy is our real boss - you see the importance of every penny."

Look After The Stores

"There is a basic conflict in trying to treat a man as a partner on the one hand while selling him something at a profit on the other. Once you get into the supply business, you become more concerned about what you are making on sales to your franchisee than with how his sales are doing. The temptation could become very strong to dilute the quality of what you are selling him in order to increase your profit. This would have a negative effect on your franchisee's business, and ultimately, of course, on yours."

"Many franchise systems came along after us and tried to be suppliers, and they got into severe business and financial difficulty. Our method enabled us to build a sophisticated system of purchasing that allows the operator to get supplies at rock-bottom prices."

"Convincing [suppliers in California] that we were an honest operation, that we protected our operators, and that we would take no kickbacks, was a big order. They could not be persuaded that if they would supply McDonalds restaurants with items the way we wanted them at prices that would allow us to sell hamburgers for fifteen cents, our growth would put them on Easy Street."

"I said [to Harry of Interstate Foods when he wanted to show his appreciation by giving a sign or a clock for the stores.] ".. let's get this straight, once and for all. I want nothing from you but a good product. Don't wine me, don't dine me, don't buy me any Christmas presents. If there are any cost breaks, pass them on to the operators of McDonald's stores."

"[I told Frank Cottee when he was drafting the franchisee licensing agreement ..] "you can hogtie these guys with all the ifs, buts and whereases you like, but it's not going to help the business one goddamn bit. There'll be just one great motivator in developing loyalty in this operation. That is if you got a fair, square deal, and the guy makes money. If he doesn't make money, I'm in a peck of trouble. I'm gonna lose my shirt. But I'll be right out there helping him and doing all I can to make sure he makes money'. As long as I do that, I'll do just fine."

"We are an organisation of small businessmen. As long as we give them a square deal and help them make money, we will be amply rewarded."

Cultivate Win-Win Relationships

"Fred would go out to Milwaukee or Molina or Kalamazoo or wherever a new operation was starting, and he'd call on a baker there and tell him about McDonald's and the buns we would like him to make for us. Fred had the figures laid out cold, so the baker could see why our way was better and how it would save him money. He'd never heard of the kind of box we wanted, so Fred would set up a meeting with the box manufacturer. Supplying buns to McDonald's was the break of a lifetime for many of these men."

"Our stores were selling only nine items, and they were buying thirty or forty items with which to make the nine. So although a McDonald's restaurant's purchasing power was no greater than any other in a given area, it was concentrated. A McDonald's bought more buns, more ketchup, more mustard, and so forth, and this gave it a terrific position in the marketplace for those items. We enhanced that position by figuring out ways a supplier could lower his costs, which meant of course, that he could afford to sell to a McDonald's for less. Bulk packaging was one way; another was making it possible for him to deliver more items per stop."

"Whenever Fred came up with a better idea of handling a product, I'd see to it that our suppliers implemented it in all their operations. My years of experience in selling paper cups and Multimixers paid off here, because I knew exactly what hands held the strings I wanted to pull to get the job done. I didn't start McDonalds until I was fifty-two years old, and then I became an overnight success. But I was just like a lot of show business personalities who work away quietly at their craft for years, and then suddenly, they get the right break and make it big. I was an overnight success all right, but thirty years is a long, long night."

"I've always dealt fairly in business, even when I believe someone was trying to take advantage of me. That's one reason I have had to grind away incessantly to achieve success. In some ways I guess I'm naive. I always try to take a man at his word unless he's given me reason not to, and I've worked out many a satisfactory deal on the strength of a handshake." 


"I like people who level with me and speak their minds. I always say exactly what I think; it's a trait that's gotten me in trouble plenty of times, but I never have problems getting to sleep at night with a guilty conscience."

"[When I re-asserted myself as Chairman and President] I removed that misguided moratorium on building new stores. In reviewing our real estate picture, I discovered all kinds of locations we had purchased and sort of stockpiled for future development. When I was told we were waiting for the local economy to improve in those areas, I hit the ceiling. 'Hell's bells, when times are bad is when you want to build!' I screamed. 'Why wait for things to pick up so everything will cost more? If a location is good enough to buy, we want to build on it right away and be in before the competition. Pump some money and activity into a town, and they'll remember you for it."


"It has always been my belief that authority should be placed at the lowest possible level. I wanted the man closest to the stores to be able to make decisions without seeking directives from headquarters."

"Authority should go with the job. Some wrong decisions may be made as a result, but that's the only way you can encourage strong people to grow in an organisation. Sit on them and they will be stifled. The best ones go elsewhere. I knew that from my past experience with [my boss] John Clark at Lily Tulip Cup. I believe that less is more in the case of corporate management; for it's size, McDonald's today is the most unstructured corporation I know, and I don't think you could find a happier, more secure, harder working group of executives anywhere."

Focus on Your Core Competency

The first Indiana McDonald's opened in 1956. Source: McDonalds Corporation

The first Indiana McDonald's opened in 1956. Source: McDonalds Corporation

"Another judgement I made early in the game and enforced through the years would be no pay telephones, no juke boxes, no vending machines of any kind in McDonalds restaurants. Many times operators have been tempted by the side income some of these machines offer, and they have questioned my decision. But I've stood firm. All of those things create unproductive traffic in a store and encourage loitering that can disrupt your customers."

Innovate & Experiment

"A well-run restaurant is like a winning basketball team, it makes the most of every crew member's talent and takes advantage of every split-second opportunity to speed up service. Once our bun-box was finalised, Fred kept coming up with refinements on it."

"Fred applied the same sort of thinking he'd used on the buns [individual rather than clusters and pre-sliced] to all the other supplies being purchased. It's important to make clear Fred wasn't buying these items on behalf of the corporation and we weren't selling to the operators. We set the standards for quality and recommended methods for packaging, but the operators themselves did the purchasing from suppliers."

"The purpose of all of these refinements [for the beef patties - i.e. specific wax packaging paper, optimal stacking etc], and we never lost sight of it, was to make our griddle man's job easier to do quickly and well. All the other considerations of cost cutting, inventory control, and so forth were important to be sure, but they were secondary to the critical detail of what happened there at the smoking griddle. This was the vital passage in our assembly line, and the product had to flow through it smoothly or the whole plant would falter."

"Some of my detractors, and I've acquired a few over the years, say that my penchant for experimenting with new menu items is a foolish indulgence. They contend it stems from my never having outgrown my drummer's desire to have something new to sell. 'McDonald's is in the hamburger business,' they say. 'How can Kroc even consider serving chicken?' Or, 'Why change a winning combination?'

"Of course, it's not difficult to demonstrate how much our menu has changed over the years, and no-body could argue with the success of additions such as the Filet-O-Fish, the Big Mac, Hot Apple Pie, and Egg McMuffin. The most interesting thing to remember about these items is that each evolved from an idea from one of our operators. So the company has benefited from the ingeniuity of its small businessmen while they were being helped by the system's image and our co-operative advertising muscle. This, to my way of thinking, is the perfect example of capitalism in action. Competition was the catalyst for each of the new items. Lou Green came up with Filet-O-Fish to help him battle against the Big Boy chains in the Catholic parishes in Cincinnati. The Big Mac resulted from our need for a larger sandwich to compete against Burger king and a variety of specialty shop concoctions."

"I keep a number of experimental menu items in the works all the time. Some of them now being tested in selected stores may find their way into general use. Others, for a variety of reasons, will never make it."

"Back in the early days when we first got a company airplane, we used to spot good locations for McDonalds stores by flying over a community and looking for schools and church steeples. After we got a general picture from the air, we'd follow up with a site survey. Now we use a helicopter and it's ideal. Scarcely a month goes by that I don't get reports from whatever districts happen to be using our five copters on some new locations that we would never have discovered otherwise. We have a computer in Oak Brook that is designed to make real estate surveys. But those print outs are of no use to me. After we find a promising locations, I drive around it in a car, go into the corner saloon and into the neighbourhood supermarket. I mingle with the people and observe their comings and goings. That tells me what I need to know about how a McDonalds store would do there. Hell, if I listened to the computers and did what they proposed with McDonalds, I'd have a store with a row of vending machines in it."

The first McDonald's fast food franchise c.1955 Source: Time Magazine

The first McDonald's fast food franchise c.1955 Source: Time Magazine

Complacency And Humility

"Business is not like painting a picture, you can't put a final brush stroke on it and then hang it on the wall and admire it. We have a slogan posted on the walls around McDonald's headquarters that says, 'Nothing recedes like success. Don't let it happen to you'."

Embrace Change

"Change has been our history, and you can't consider our growth without taking into account the context in which it occurred, an America in which tremendous social changes were taking place. McDonald's is vastly different now from the company it was back in the early days, and that's good."


"You can learn all you ever need to know about the competition's operation by looking in his garbage cans. I am not above that, let me assure you, and more than once at two o'clock in the morning I have sorted through a competitor's garbage to see how many boxes of meat he'd used the day before, how many packages of buns, and so forth. 

"My way of fighting the competition is the positive approach. Stress your own strengths, emphasize Quality, Service, Cleanliness, and Value, and the competition will wear itself out trying to keep up. I've seen it happen many times."

"My attitude was that competition can try to steal my plans and copy my style. But they can't read my mind; so I'll leave them a mile and half behind."

"The thing that has made this country great is our free enterprise system. If we have to resort to this - bringing in government - to beat our competition, then we deserve to go broke. If we can't do it by offering a better fifteen cent hamburger, by being better merchandisers, by providing faster service and a cleaner place, then I would rather be broke tomorrow and out of this business and start all over again in something else."


I like what Charlie Munger says about McDonald's and the impact its educational style has had on people.

"I had fun once at a major university when I said I thought McDonald’s succeeded better as an educator than the people in the university did. And what I meant was McDonald’s hires a lot of people who are quite marginal at the very start of their working career. And they learn to show up on time for work and observe the discipline. A lot of them go on in employment to much higher jobs. And they’ve had an enormous constructive effect about educating into responsibility a lot of people who were threatened with not making it. So I think we all owe a lot to the employment culture of McDonald’s. And it’s not enough appreciated." Charlie Munger

In over fifty years of investing, there just isn't a lot Buffett and Munger haven't worked out. Which means that their ideas and opinions on business and investing are usually on the money.

Likewise, if I found just one company that had succeeded using the successful and ethical traits I have listed above, it would just be an anomaly. Its a sample of one and whilst unique, could hardly be called a trend. But when you have so many businesses from so many different industries who have those same traits and beliefs, and are successful because of it, its kind of hard to refute don't you think?



Further Reading: 'The Master CEOs' - The Investment Masters Class

Keep learning on Twitter: @mastersinvest




Learning from Les Schwab


"If you want to read one book that will demonstrate really shrewd compensation systems in a whole chain of small businesses, read the autobiography of Les Schwab, who has a bunch of tire shops all over the Northwest. And he made a huge fortune in one of the world’s really difficult businesses by having shrewd systems. And he can tell you a lot better than we can." Charlie Munger, Berkshire AGM 2004

Every successful company that grows and prospers in an industry that has both powerful competitors and relatively low barriers to entry must have an edge. They've got to have a differentiator that sets them apart, something unique that gives them an advantage in an otherwise crowded economic space.

It's in studying these sorts of businesses and then identifying the characteristics, systems and/or circumstances that allowed them to succeed that can help you formulate your own mental models. These characteristics are typically unconventional, unique and qualitative in nature and often combine to produce results in a non-linear fashion; what Charlie Munger refers to as 'lollapalooza' results. 

Of course, information on these companies is now readily available to us all in a plethora of forms. I'm still a fan of books, though, particularly those that educate me to different ways of thinking, or more importantly those books that are recommended by greats such as Buffett and Munger. In that regard, you can't go past Les Schwab's memoir, 'Pride in Performance, Keep it Going!'

"It’s an interesting book, and, you know, selling tires, how do you make any money doing that?" Warren Buffett

In a speech at the University of California in 2003, Munger drew on the Les Schwab story as a case study to highlight how he combines mental models with a checklist approach to analyse investments.

At 15, Led Schwab was an orphan. At 30, with a $3,500 investment he built the most successful independent tire chain business in the US. Schwab was a straight shooter whose story parallels many of the businesses and leaders we've reviewed recently; Walmart, Home Depot, Panera Bread, Nucor and Starbucks. And like those stories, his lessons have stood the test of time. While the book was written over 30 years ago, the lessons are as relevant today as they were then.

Les Schwab's extraordinary success can be traced to his fanatical nature combined with a business philosophy of empowering, sharing and rewarding staff. Other success traits include a long-term focus, absolute transparency, a win-win culture, continuous innovation and prioritising front line employees. His generous profit sharing plans started with a deal he offered his second employee in 1954, and are probably the most unique sharing plans ever created for employees. A staff retirement fund incentivised employees and provided the capital for the business to both support those staff and grow. It also secured retirements for thousands of employees. It's these characteristics which made the Les Schwab Company almost impossible to compete against. 

I've included some of my favourite extracts from the book below.

Tone at the Top

"I am 68 years old now. And I've run it in overdrive my whole life."

"It was not unusual for me to drive 600 miles or more in one day and make many stops."

"I think the biggest misconception the public has about a successful businessman is he is working for more money. You won't find many truly successful ones that are greedy."

"I am seventh or eighth down the line if you consider bonuses. I have never taken a bonus from the company."

"I've always wanted to be the best tire dealer, not necessarily the largest tire dealer."


"Our company is a large family."

"I told my managers .. 'If you don't do for your employees what I have done for you, then this company will die when I die'."

"Mary Kay, founder of the very successful Mary Kay Cosmetic Company has a saying .. 'do good for people and it will come back to you ten fold. Do bad and it will also come back to you tenfold'."

Love your Customer

"Love your customer, give him top service, give him the best available price the first time and stay with it, and don't let your customers run your business."

Pricing Power

"People don't buy tires on price, they buy from someone they trust and from someone who will smile, and from someone who will give service and stand behind what they sell."

Share Profits with Staff

"I encourage you to share profits with your employees. I encourage you in every way possible to 'build people'. This is good for America, it is good for you, and it is good for your employees."

Les Schwab [Source: The Bulletin]

Les Schwab [Source: The Bulletin]

"[The sharing plan that I started in 1954] was the start of the profit sharing plan we still use today. We still share 50 percent of our profits, but we share with all employees in the store. The manager now gets 25% of what is left after sharing with all other employees."

"My thinking has always been, if I give away half the profits I still have half left; if I share $10,000,000 with people, I still have $10,000,000 left over before taxes. I don't understand why businessmen can't do this, as it is unselfish for good reasons. It helps a lot of other people."

"'Unselfish for good reasons' has been a slogan of mine for nearly 34 years."

"I believe in sharing with those who helped me. The more you share, the more you have left for yourself. I don't like to think about having it left for myself. I like to think about it as having it left to expand the business, and to create more opportunity for more young people."

"[When competition arrived that operated for lower cost and somewhat lower prices] after thinking about this for a year or so, wondering if I should cut wages and benefits, I finally made the decision. That decision was, 'If I couldn't be proud of my company, If I couldn't pay good wages, if I couldn't have good benefits, if I couldn't have the best employees, then why would I even want to stay in business, as I had all the money I wanted personally'. So we did nothing, and we won. The customer likes us best. Life is hard .. for the man who thinks he can take a short cut."

"With our programs the employees leave a lot of their money in the company, or Trust, and this too can be used to expand the programs. It's self perpetuating."

"I can't remember one single man leaving our company and doing better outside."

"We have a need to continue to make our company the best employee company in the area. I've never been sorry for my desire to be a good employer. The more I've done for my employees, the more successful our company has been."

"There's something in our program that makes a man, several hundred miles from the main office, be at the store at 7.30am and stay there until 9.00pm. If needed. It's not a thick policy book, it's not a lot of supervisors, as we don't have them; it's something that our programs created in him right in his heart. That is opportunity, the right to be successful, to be a good family man and hold his head high."

Build People

"People are the success of our company. Most anyone can sell tires. The only difference between a Les Schwab Tire Centre and most any tire dealership is the people working there.. And that's why we must continue to ask ourselves .. how can we do an even better job?"

"What is the best route to follow to continue to be successful? What should our company do to to build for the future? The answer is, as it has always been ... BUILD PEOPLE."

"How can you make people feel important? The best way is to believe that they are important. Really believe it!"

"The success of any company is in direct proportion to the ability and motivation of its people, and that fits anything."

"We teach our managers to believe in making the men under them successful."

Empower Staff

"I ask our people to reach for goals that they think are way beyond what they might think possible"

"In our 34 years of business, we have never hired a manager from the outside, nor have we ever hired an assistant manager directly to that job. Every single one of our more than 250 managers and assistant managers started at the bottom changing tires. They have all earned their management jobs by working up."

"We are different from most of the American corporations, as we think the most important people in the company are the people on the firing line; the ones who sell, do the service work and take care of the customer. Most American corporations have the fat salaries and outrageous bonuses for the top people, and treat people at the end of the line as peons. I guess that is why, if you are on the ball, you can beat them on any type of fair competitive basis."

"The office and all the computers, all the records in the world just tell the stores and the other departments what they did last month, last year. Too many corporations think all the brains are in the main office and all the bonus money is paid to the four or five high people. All the others are peons, or just numbers, and if you have a union, that really makes them a number. The truth is that the success is at the other end. The office merely keeps their records and tells them how they are doing. The real job for the office people is to provide motivation, to create programs that make it possible for them to be successful, to be fair, to be open, to have really open communications, to have no secrets, to support them."

"Our managers have much more leeway than any chain type operation that I know of. But the manager, in no way, can take a free ride."

"I'll make a prediction that if our top four or five people in the [head] office start to make more than our top four or five store managers, then our company won't be the company it is today. They won't as long as I am alive. This is an unusual way to run a business; but more businesses would be successful if they gave more attention to the people on the front lines."

Correct Incentives

"We already had an excellent Trust fund set up for our warehouse company which was the same as the stores. I didn't want a bonus based upon the profit of the retreading shop or warehouse, because we could name our own profit. We had captive customers, our stores and member dealers."

Screen Shot 2018-08-28 at 9.19.36 PM.png


"A company starts, it grows, and as it grows, more and more of the decision making moves to the main office. And this is one hell of a big mistake. The decision making should always be made at the lowest possible level... Give your manager the authority to make his own daily decisions, under certain guidelines of course, but let him run his show."

"Let the people at the store level and your manager know you are behind them. They are the ones who make you successful, not the person in a nice office who has nothing to do today but to send out another damn directive. If it doesn't help the store, tear it up .. tell the store to tell the office to go to hell."

"[We tell store managers that] we expect you to run the store. You are on your own, and you will sink or swim according to your abilities."

"Each store operates as a separate entity and each store operates as a separate business. The store employees share only in the profits of the store they work in."

"The thing that held it together [in the early days] was that we ran each store as a separate entity."

"We have had over the years some people in the [head] office that sometimes think they are more important than the stores. The office serves only one purpose, and that is to serve the stores."

"If the store manager runs his store right, he doesn't have to spend hours and hours looking at the office reports; if he's doing okay the records will show it. In fact if he spends too much time in his office reading the mail, it is a sure thing his store will suffer. Sell tires, give service, keep expenses low, make sure everything is billed out, keep good communications with employees, be careful with credit, watch for leaks .. do these things and you'll come out all right. The damn computers can't run a tire store, they can only tell you what you have done."

"I've told accountants .. you tell us where the pencil has gone; but, if you were smart enough to tell us where the pencil should go, you would really earn the high fees you charge us. The same goes for lawyers."

"Stay out of a store 30 days and you've forgotten 50 percent of what you know."

Look After The Stores

"I never allowed any company to give spiffs directly to our people. Give it to the company, and we'll decide what to do with it."

"Our theory has always been to make the store, or our Member Dealers successful. That if they were successful, then the home office just had to be successful. The big bonuses, the most opportunity, I feel should be at that end. The large corporate policy is that the large bonuses, and the most opportunity, is in the home office. The men at the so called' bottom end' were only numbers. Then I asked 'Who is right? On one side we have the large corporate theory, and on the other you have the Les Schwab theory. Are we smarter than those huge companies? ..  and I think the answer is, you're darn right we are."

"[In response to new lower priced competition I asked] should we attempt to lower our cost by taking away benefits, pay lower salaries? By doing this, we could milk the stores and Member Dealers and pull this back into the home office. Sounds good, but it doesn't work that way. We took the opposite approach. This was the start of our program to make better jobs for the men down the line. We increased wages, we changed and improved our medical, dental and insurance programs. We increased our cash bonus making it 12 percent to be shared instead of 10 percent... The results proved us right. We had better employees than our competitors. We gave better service. I don't have any way of really knowing, but I don't think our percentage wage cost was any higher than our competition because our people just plain 'put out out more'."

"We know that our stores that sell the tires must be successful, and they are more important by far than the main office.

"The large rubber companies turned out to be our best friends. Why? Because, their ways, their policies broke their dealers, often leaving us as the only deter in town in a position to give service."

Invest in Your Own People

"It is rarely that we accept new member dealers. They have to already be in business; they have to be the most successful dealer in the area, and they should be in good financial shape. We get calls constantly wanting to start what they call a franchised store. Actually, we are not a franchised company, as we don't charge a franchise fee. Sometimes they do have the money but don't have experience. If we are going to take the time to do this, we would rather spend it on our people. We have the money to start more stores, and we don't want to gamble on inexperienced people. Also, if they (a prospective member dealer) expect us to finance them, then we would rather finance one of our own people with one of our own stores."

Innovation and Change

"I told my managers at a meeting that we were going to modernise all our stores, we were going to have tiled restrooms and we were going to have men's and ladies' restrooms. They laughed. Who had ever heard of tiled restrooms in a tire business?"

"When we create programs [eg. profit sharing contract, free-flat tire repairs for ladies, TV advertising approach, employee Trust fund, cash bonus program, 'More Mile' retreading program, centralised retreading plant etc], we are successful. Our future depends on us creating our own programs for the future. If we fail to create, then we will die on the vine, like so many other companies have done in the past."

"Just as sure as the sun will rise tomorrow, our customers will change. We must take into consideration changes as we plan our future advertising, our promotions, our themes, our future image in the marketplace."

"Things, ideas, and people change. If we wait for things to happen the right moment may have passed and the market will have slipped by. We must continue to build enthusiasm into our company. Without enthusiasm out company is dead."

Transparency & Honesty

"All major decisions are made at our store manager meetings. This is the place to argue like hell, but once the decision is made you must follow."

"I've always believed in the complete open book policy. I haven't any reason to hide our profit statements, or to hide anything."

"To me an important element in establishing a happy, prosperous atmosphere is our insistence on open, free, and honest communications in our business meetings. We owe each other our honest opinions at all times. No one wants to follow a weak leader. We build strong leaders with open and honest communications."

"I really do think that young men who work for the Les Schwab Company for three or four years is almost as good as taking three or four years of business schooling. The reason for this is the complete openness of the company. Every employee in every store is encouraged to read and study the Profit and Loss Statement of his store. Each store has a monthly meeting around the P&L Statement. They are encouraged to ask questions."

"[I tell managers] be honest with the people we work with. Be honest with your customer. I've told you before, I'll tell you again .. 'There's absolutely no excuse, no reason, or cause for you to be anything but 100 percent honest with the people you work with, or with the customer you serve."

Humility & Complacency

"If we become complacent, brother it's all over with"

"One thing we must guard against is complacency"

"If we think there is a free lunch, if we rely own last year's results and ask for pay for non-productive items, then this company will turn the corner, too, and then we too will start down the hill. And once you start down, it is mighty hard to turn around. Remember this in years to come and if we do start to fail, remember today, because there will be an association."


"All people must carry their weight or move aside; and that includes me."

"We must earn our way every day. And those not earning their way must have the limb sawed off the tree, as cruel as that may sound.. and that goes for Member Dealers, you must earn your way or we must saw off your limb and drop you from the tree."


"I don't want my company to take advantage of anyone."

"I talked about our operation as being a three-way partnership. The stockholders as one unit, the corporations and its people as another unit, and the employee Trust Fund as the third unit. Our company will always be successful as long as all three units work in harmony. Greed can come from any of the three, but most likely it would show up first with the stockholders, it usually does in any company."

"A company, any company, should work up programs and policies that are fair to stockholders, to management and to the employees. And then we should have very open communications, follow the open book policy. If you can't defend it, it must be wrong. If it is wrong, then make it right."


"I found out early in business life that there was power in volume buying. I think this was one of the main reasons I had such a desire to get big. I know today, right or wrong, that our company can buy tires for much less than the small independent dealers. Many times we could sell at their cost and have the profit we needed."


Its no accident that we can draw similarities between the likes of Nucor, Panera Bread, Walmart, Home Depot and Starbucks with Les Schwab's Tire Business. Whilst they are all in vastly different industries, each of these business mavericks have struck upon the same ideals when determining how their businesses should run. And whilst all of these appear very similar in terms of things like culture and business ethics etc, the truth of the matter is that as an investor, these things are not easily discovered; they're not evident upon first glance at these organisations.

Ok, its fair to say that their income statements will probably reflect positively because of these traits, but in reality the income statement doesn't tell you why. It also doesn't tell you what to expect in the future - which is what investing is all aboutYou can't peruse pages and pages of spreadsheets or P&L's to determine that front line people are empowered or that the company has a humble culture. These things are discovered by spending time learning about the business, doing channel checks and considering the factors that make them successful. And by that I mean real time, not time just sitting behind your computer analysing numbers. I can't stress enough the value to be gained from a truly deep dive into organisations to understand what makes them tick; the answers are not to be found on the income statement.

And its not just me espousing this idea - if Munger and Buffett do it, then the rest of us should, too.



Further Reading:
“Academic Economics: Strengths and Faults After Considering Interdisciplinary Needs”, Charlie Munger Speech, University of California, 2003 [courtesy Tilson Funds]
CEO Series - The Investment Masters Class
"A sad day in Les Schwab country", The Bend Bulletin 2007


Keep learning on Twitter: @mastersinvest