VALUE: After Hours (S08 E27): I Studied Every 100-Bagger Stock in History. Here’s What I Found | Chris Mayer

During their recent episode, Taylor, Carlisle, and Chris Mayer discussed:

• The Real Secret to Long-Term Investing
• What Makes a Potential 100-Bagger?
• The Four Things Chris Mayer Looks for in a Stock
• Jake’s Veggies: Why Investors Should Stop Trying to Be So Precise
• Why Starting Small Can Make You a Better Investor
• Why One Giant Winner Can Transform Your Portfolio

TRANSCRIPT

[Tobias] And I believe we are live. This is Value After Hours. I’m Tobias Carlisle, joined as always by Jake Taylor.

Our special guest today is Chris Mayer. He’s a portfolio manager, author of 100 Baggers and author of a new book, The Investor’s Odyssey. Welcome, Chris.

How are you?

[Chris] I’m doing well. Thank you for having me on, guys. It’s good to be with you.

[Jake] Tell us a little bit about- We’re remiss for not having Chris on earlier at this point. It feels like an unforced error on our part.

[Tobias] Tell us a little bit about the new book.

[Chris] Well, sure. I mean, I wrote 100 Baggers. And then after that, I’ve done, of course, a lot more thinking about long-term investing and what it’s all about.

So I’ve put this book together. And I think the core, there’s a story I tell in the beginning that kind of inspired a lot of thinking. And that was that there was one year when I was on a, I was headed to the Berkshire meeting in Omaha.

And I sat next to this woman. She was bumped from business class. And there was an empty seat next to me.

She was placed next to me. And at the time, got chatting with her. And it turns out she’s like one of the original investors in Berkshire.

And she’d been to every meeting. And she knew Buffett. And she had just invested with him and basically left the money there.

And she became very wealthy. And then she lives in Nantucket. And she’s giving away chairs to her grandchildren.

And I thought to myself, wow, that’s, she basically made one decision, which is to buy this stock and just left it alone. And she’s got a track record that beats most every active manager anywhere on the planet. So it got me thinking about, well, what is, what’s a good investor?

What’s a real, what’s, we say someone’s a good investor. What does that mean really? So I started thinking about that and kind of using her story a little bit to unpack that journey.

I was thinking, well, long-term investing is kind of like a journey. And we were talking a little bit about before we got on the air that, you know, I had read the latest translation of the Odyssey last year that came out, one by Daniel Mendelson. And so that was in my head as well, while I was writing this and sort of inspired thoughts about how, yeah, all the obstacles to holding onto a stock for a very long period of time.

And, you know, reminiscent of Odysseus and his journey and all the temptations, all the travails he has. So I use that too, as a kind of organising metaphor for the book and just kind of talk about this journey. So it was fun to write, it was fun to put together and yeah, I hope people like it.

[Tobias] You refer a little bit in the title to the avoiding the siren call. What’s the secret there?

The Real Secret to Long-Term Investing

[Chris] Well, I mean, the sirens kind of, you know, metaphorically for anything that is calling us off the course of holding on to our investments. So, you know, all the media that we have to put up with as investors all the time wants us to take action. That’s sort of the bias, right?

Every financial programme or show or newsletter or whatever always makes it, makes it want to seem that whatever’s happening now is really important. And, you know, you have to do something about it now. All these headlines about things that are happening.

And so those are the sirens, those are the things you have to sort of ignore. You know, if you’re going to own a business for a very long time, it’s a lot about ignoring the things that don’t really have much to do with your business over the long period of time. So that’s really a good metaphor for the sirens.

What’s the secret to ignoring it? Yeah. And there’s a lot of, I mean, there’s no secret per se.

I think a lot of it’s commonsensical. And I go through some of them.

[Jake] Asking for a friend, right, Toby?

[Chris] Yeah, right. And go through, you know, I go through a number of ways in the book and some of them people have heard me say before, you know, focussing on the business itself and, you know, every business you can probably boil down to a handful of key essentials and just tracking those things. And as long as those things are, you know, within a reasonable range of performance, that you expect, then you continue to hold on.

And there are a lot of bad habits investors pick up on as well. So, you know, checking stock prices every day or multiple times a day would be, you know, one. Doing that makes stocks seem a lot more volatile than they are.

And like I said, those little blinking, you know, green and red colours are kind of calls to action. So you don’t want that. So you have to avoid those temptations and you have to regulate your, you know, what you pay attention to.

So there’s a lot of, and I talk about this in the book, years ago, I used to read like, you know, every day I’d read the Journal of Financial Times, I’d read all this stuff. And, you know, now I don’t do any of that. So you can cut back on your media diet as well, which helps from getting too distracted.

[Tobias] There’s a current example where AI is going to disrupt a very large number of businesses and a very large number of good businesses, but it’s going to take a little while for that to propagate out. There’s probably some people who are using it more than other folks, but given five or 10 years, it’ll probably be much more widely dispersed. And some of those impacts will be seen.

Do you have a view on how you separate out, you know, threats that are not real and threats that are, you know, probably more real?

[Jake] Existential versus manageable.

[Tobias] There’s no evidence in the results yet, but you can see that it could impact them at some point.

[Chris] Sure. And yeah, I mean, that’s going to be something you have to evaluate case by case, business by business. But I do think it does remind me a little bit about investing in the 90s when you had, you know, the Internet and then anything that might be under threat there was getting hammered or ignored.

And I think you’re in a somewhat similar situation. There will definitely be casualties. You know, there’ll be businesses that are just zeroed out as they were with the Internet.

You know, Amazon has taken business from a number of old brick and mortar retailers. So it was an existential threat for a lot of them. But what I mean is today, like nobody would say, you know, claim they have a competitive advantage because they have a website.

You know, it’s just a ubiquitous technology. Everybody uses it. And we’re probably like that.

I imagine AI will be something like that. It’ll be so ubiquitous that everybody will have something. We’ll use it in some way, but no one’s going to claim, be able to claim that we use AI and that’s our competitive advantage somehow.

So I think we’ll be like that.

[Jake] We have a toaster. No one else has a toaster.

[Chris] Yeah. No one else uses electricity. I don’t know.

There’s lots of examples, I guess.

[Jake] Chris, how do you make sure that you’re tying yourself to the right mast?

[Chris] Well, some of it is, you know, there, I mentioned this in the book, there’s some different studies you can look at that what drives long-term stock performance and return on invested capital is a good North Star. Companies that can reinvest or earn high returns on capital over a very long period of time tend to be good investments. And so I think that’s a key metric somewhere in there in your business.

What you’re analysing is ultimately what’s return on capital and their ability to continue to do that for a very long period of time. And that’s what’s going to help, you know, create value. So businesses, and you can also look at sort of inverted, like Munger would do, you know, so what things we know probably don’t work out well.

You know, businesses where there’s lots and lots of competition, it’s going to be difficult. Businesses that are very heavily leveraged, you know, that could be a problem next time there’s some sort of financial crisis or something like that. You know, unscrupulous insiders, you know, there’s lots of things we can knock out.

So those are all clues and those are all things I talk about as well in the book, different ways you can kind of get at those ideas.

[Tobias] What ideas carry over from 100 Baggers to the current book? What hasn’t changed, I guess I’m saying.

What Makes a Potential 100-Bagger?

[Chris] Yeah, what hasn’t changed? Well, that’s a good question. What has changed too?

But I’ll say what hasn’t changed. I think that the core premise of just holding on to businesses that generate high returns on capital for a very long period of time, that’s kind of been a core it’s hard to get away from. And then, which always plays into this also is the quality of the people involved in the business.

So, and there are more examples I go through in this book where you have an entrepreneur, a particular entrepreneurial person who makes a difference. You know, I remember there’s one specific example I talked about the New York Times and News Corp. And I think it’s like, I think they both had the same market cap at one point.

And then like 30 years later, I think the New York Times basically had the same market cap. And you know, News Corp is like an 80 X, 80 X. And while you had a very entrepreneurial person, whether you like them or dislike them, did a lot of things and create a lot of value that way.

And there are other examples of that too. So that’s another thing that hasn’t changed. Because I also talk a lot about that in 100 Baggers about how the biggest winners are companies you can readily put a name to, you know, if I say Walmart, and you know about Sam Walton, his story, say Apple, you know about Steve Jobs, his story, you know, Charles Schwab, you know about Charles Schwab.

So there’s a lot of businesses like that.

[Tobias] What’s the, what has changed? I guess that’s the, that’s the logical next question. Yeah.

[Chris] Well, I mean, what’s changed is some things like, I didn’t talk about much at all in 100 Baggers, I talk about more now. So let’s say, you know, growing by acquisitions comes to mind. And I think I have much more favourable view of companies that grow by acquisition than I did back then.

And part of that is, you know, just more reading, there’s a book, deals from hell, that summarises a lot of good research on M&A. And it goes against the grain. Yeah, goes against the grain of what most people think about M&A as a basic conclusion is that it’s no worse off than anything else that companies invest their money in.

And then personal experience, you know, I’ve had, I’ve learned about a group of companies that people call Swedish serial acquirers. So there’s companies like Lifco and Lagercrons and Agtech and these names I didn’t hear about and knew nothing about when I, you know, wrote 100 Baggers. And those are companies that have proven to grow very well by acquisition, including something like Constellation Software, which is, again, something when 100 Baggers came out, maybe I was vaguely aware of, but otherwise didn’t really know or appreciate.

So those are a couple of big ones, for sure.

[Jake] How about the rise of intangibles in business as something that’s changed maybe more so and how to think through that?

[Chris] Yeah, I mean, that’s certainly true. I mean, there’s, you know, yeah, I mean, there’s a lot of research about that as well. More and more companies creating value by the intangibles and the way accounting is not, you know, doesn’t capture that value as much.

So I don’t know if that’s changed so much because I do remember talking a little bit about that in the first 100 Baggers. So I don’t know that I have anything incremental necessarily from that 10 years ago. But yeah.

[Tobias] I think the M&A question is kind of an interesting one because for a long time, it was just common wisdom that you wanted to short the acquirer by the seller. You know, that’s the arbitrage, but then they tended to underperform if they were sort of acquisitive, either because they were overpaying, you just have to pay more. And I think of something like Valiant as an example of that, like the acquisitions get proportionately bigger, they get proportionally more expensive, performance sort of disappears, they’re heavily levered, they need probably a promotional CEO to work.

But then something happened over the last like 10 or so years where that’s not really the case anymore, where the acquisitions seem to be maybe just this crop, maybe something has happened in the market that the acquirers seem to have done very well. And it’s come along at the same time as there’s been this rise in these serial acquirers. You know, Berkshire’s always been an acquirer, but then Constellation Software sort of become more prominent in the investor’s consciousness in any case.

And I agree the Swedish, I wouldn’t have heard, I didn’t know nothing about Swedish acquirers maybe five years ago, and they seem to be much more prominent now. What do you think? What’s causing that?

Is that phenomenon real? Am I making that up? Or is that?

[Chris] I think some of it is, you know, some of it is that the large deals get all the attention. So we know the big deals and their spectacular failures are well documented and well known. And nobody writes about the little kind of humdrum acquisitions that happen behind the scenes or are not in the front pages.

Yeah, the little bolt-ons. And those are the ones, I mean, they’re successful. And you started talking about M&A is not successful.

You mentioned a couple of things right off the bat that the research will support as red flags in M&A. One is leverage, that’s one. Size, when they’re really big and they use leverage, you know, odds are against you.

But there’s smaller bolt-ons, you know, lots of companies have been able to grow sustainably with good returns doing more programmatic smaller acquisitions. And you can think of like, I don’t know, it’s like Watsco and Ropers of the world and these, you know, Heiko, 100 plus acquisitions in this time. So those companies have been enormously successful, but they’re out of the limelight.

They’re not the big splashy acquisitions that’s getting all the press. And so those ones, I think, you know, skew our perception of M&A.

[Tobias] There’s often like an era-defining acquisition too. So in the 80s LBO boom, it was Nabisco. Nabisco got the big block.

[Chris] Of course, that was a great book.

[Tobias] And then Time Warner in the dot-com boom. I don’t know what it’s been more recently. What’s the big acquisition this time around?

[Chris] Maybe we haven’t had it yet.

[Tobias] It’s not over yet. Paramount hasn’t had it yet. Yeah.

That’s struggling a little bit.

[Chris] Yeah.

[Tobias] That one’s regulatory reasons.

[Chris] That’s a good question. What’s been the big flashy M&A deal?

[Jake] That’s going to, everyone’s going to point to and laugh at, you know, 10 years from now.

[Tobias] Do you think it’s companies staying private for longer and coming on the boards as much bigger than they did in the past? I don’t know if that makes much difference at all, but.

[Chris] Well, that’s definitely a real phenomenon that the companies, obviously the, you know, IPOs are much more mature now and bigger than they were.

[Jake] A lot of times it comes to from, it’s a big incumbent who is desperate to change the narrative and feels like they’re left behind and they need to grab onto something that looks like the life raft to the future.

[Chris] Yeah. Like when Time Warner bought AOL, right? The top of the cycle.

So what, it’ll be somebody buying some AI related thing or chip maker or right at the top.

[Jake] Maybe it’s SpaceX buying Cursor. I don’t know. That one’s probably not big enough, but.

[Tobias] The last one was probably something like one of the big private real estate transactions, the big leverage real estate transaction. It just escapes me at the moment, but it was Samsel selling, right? Samsel selling to the PE guys.

[Jake] Yeah. Maybe that’s part of it too, is private equity. You don’t see the, there’s not like the stock price a year later to show like how much it blew up in your face yet.

So maybe it’s just still sitting on a private equity balance sheet today.

[Tobias] Yeah. What are you looking for, Chris? In sort of in general terms, you’re like a high return on invested capital and there’s got to be some protection.

There’s some reason for that beyond sort of a cyclical.

[Chris] Yeah. That’s good. I mean, I spend most of my time when I find something that I like, like that most of the time on competition and how they’re able to defend that moat and earn those returns.

So there’s a lot of time spent on that and a lot of time spent on analysing the incentives.

[Jake] Let me redirect the question. Where are you willing to compromise on things and where are you not willing to compromise?

The Four Things Chris Mayer Looks for in a Stock

[Chris] Yeah. So I’m certainly not willing to compromise on the people, character of the people. I mean, I’m not known to get involved in anything where I think, you know, they’re bad capital allocators or there’s any question of their integrity or, you know, taking advantage of minority shareholders or stuff like that.

So steer clear of that. For me also, you know, the return on capital is important, but that can also be something where, you know, if it’s, if it’s something that is getting better. So there’s like a look through, you know, you kind of look forward a little bit.

It doesn’t necessarily have to be something that’s earning high returns right now, could be, you know, decent returns now. And then there’s some underlying scale or some other parts of the business that are going to improve over time. They’re pretty reliable.

So that, and then for me, yeah, I mean, I’m always scared of like dealing with high leverage balance sheets because I’ve, you know, I’ve been burned by that in the past. And I can remember even like during the 08 crisis, even if you had something that an okay balance sheet became problematic in a short amount of time. So I just prefer to just, you know, sleep well at night and have great balance sheets.

And when things get crazy, then I know my companies will be fine and maybe have the ability to take advantage and do something during those distress periods. So I would say those are kind of the big three for me. You know, I know I haven’t mentioned valuation yet.

[Jake] Where’s the compromise?

[Chris] Yeah. So, you know, obviously everything you run through, I run through some sort of analysis where I’m looking at what kind of IRR I expect and that’s got to make sense as well. So I think all four of those things are pretty good, pretty good little stool, if you will.

[Jake] How far out are you typically looking?

[Chris] Like five to 10. Okay. Yeah.

You know, five is not that long, but it’s long enough. I mean, you know, if something works pretty well in five, and then it looks even better over 10. But you got to be careful because obviously we all play around with numbers and you can make something look really good over 10 years.

And whatever you want to say, whatever you want to say, you can say, so you’d be careful about that kind of stuff. And what kind of multiples you assume. But yeah, I’d say kind of five to 10 is what I’m looking at.

[Jake] Where does culture play over and above just management?

[Chris] Yeah, that’s huge for me. And, you know, I write about that in the book too, different ways you can look at culture. For a long-term investor, I think that’s really important.

You know, if you’re holding a stock for a year or two or three, who cares? You know, culture may not matter so much, but over the long-term. So what does that mean, culture, really?

It’s like, you know, it’s a hard term to define. It sort of involves the way a business does business, the way it treats people, the way it treats its employees. So you can look at things like employee tenure.

You can look at things like are the employee shareholders as well? You have some culture of ownership there. How do they treat their suppliers and their other corporate relationships?

And so there’s good studies that show that long-lasting companies also have long-lasting relationships with their suppliers. So it’s kind of like an ecosystem, you know? That could be another sign of good culture.

So yeah, a team that promotes from within has a lot of executives that have been around, worked their way up the business. That can be an indication of good culture, too. So we have all these little markers and you just have to sort of dig to find them out.

It’s not that easy. But I think over the long period of time that those things can really matter.

[Tobias] Is that the single sort of uniting trait beyond return on invested capital and other things like that culture?

[Chris] For me, I think it would be. Yeah, I think it’s important for me. You know, with all these things that we talk about investing, there’s exceptions to everything.

But as a general, I love to kind of get into the culture of the business and what’s it like to work there?

[Jake] How do you figure that out from the outside?

[Chris] It’s very difficult. Yeah.

[Jake] That’s what I mean. Put on a hat and sunglasses and apply for a job.

[Chris] Yeah, you really can’t. That’s what I mean. You have these little clues, little markers that we can look for.

But I make use of the expert networks and talk to people who work there and you can get some sense of that. But even that you have to be sort of careful because those people don’t work there anymore. And sometimes there’s a reason.

[Jake] Yeah. If the culture rejected them, then that’s that might be actually the inverse signal.

[Chris] The same thing when people go and look at Glassdoor and they see bad reviews or something, but they could just be disgruntled employees, very small sample size. So yeah, to your point, I mean, it’s very difficult to know for sure. You just have little clues and markers that we can look for and pay attention for.

Obvious red flags and I don’t know what those would be like. Lawsuits, workplace lawsuits and bad behaviour in certain ways that manifests itself that we can see it. But otherwise, yeah, hard to detect, but nice to have.

[Tobias] Buffett did a good job talking about the culture of Berkshire Hathaway while he was there. I think that’s probably the best example that I’ve ever seen.

[Chris] I don’t remember what exactly he said. What do you have in mind?

[Tobias] Just from dealing honestly with people. Don’t lose money for the firm. Don’t lose a shred of reputation.

Deal with people fairly. It’s not something that they discussed a lot, but it’s discussed in a handful of times through the letters as I’ve gone through. I put it all together for my last book.

And I thought it was a pretty good cohesive argument for Berkshire and for other companies. And I sort of looked at that as being a good example of, you probably won’t find anything as clear as that, but anybody else who’s talking in those terms I thought would be doing a pretty good job.

[Chris] Right. And I remember Buffett saying things like, he wouldn’t do business with somebody he didn’t trust no matter what or what the deal look like. And I remember learning that lesson early on in my banking career too.

People are like, it doesn’t matter how much collateral you have. It doesn’t matter. If you don’t trust them, forget it because they’ll find a way.

There’s always a way. And I remember one time I was a very young banker and I had a deal. I thought it was a no brainer.

It was like cash secured with a CD. I was like, this is a no brainer. And a wise old banker told me, I remember sitting down and talking to it.

And this guy was not a very trustworthy character. And he told me he wouldn’t do it. And I was just baffled.

And he said, he told me there’s always a way. You can’t think of it now, but if this person wants to screw you, they will find a way. They’ll take the CD, they’ll cash it, they’ll figure out a way.

Teller will be there. They won’t check. They won’t see that it’s tied to a loan or whatever.

There’ll be some way they can, and then you’ll be out. There’s a way. So I always remember that because I was thinking it was pretty shocking at the time.

I was like, wow, it was like a no brainer. And he said, no, because he didn’t trust the guy. And then there’s of course, that famous quote from JP Morgan as well, which said, he wouldn’t lend, what did he say?

He wouldn’t lend a dollar for whatever, against all the collateral in Christendom for a man he didn’t trust, something like that. Same idea that you don’t trust someone, they’ll figure out a way to screw you one way or the other. So I think Buffett had that ethic as well.

[Tobias] When you look at equity ownership, do you factor in stuff like share based compensation? Do you look at how they earn their equity?

[Chris] Yes. You know, the amount of, the power of dilution. Again, this is important.

Again, if you’re a long-term investor, this is very important. If you’re just going to own a stock for a year, what do you care? You know, a year or two even, what do you care if there’s one or 2% dilution?

If you’re going to own something for 10 years, you know, 1% dilution adds up quite a bit. 2% dilution is very significant. And some companies of course have way more dilution than that.

I mean, think about more, you have to grow just to stay in place. You know, that’s a, there’s a table in the book I have about that. You know, if you’ve got 2%, you know, how much more growth does that require over say five years just to stay even?

And it’s some surprising numbers there. So yeah, that’s why I love and admire these companies that have, you know, share counts that are unchanged over a long period of time. Constellation software obvious one, but there’s, you know, Lifco has the same number of shares when it went public, Swedish Serial Acquire.

And then perhaps even better, the companies that slowly shrink it, you know, over time, opportunistically. Those are pretty special.

[Jake] Yeah, I think that’s some of, I don’t know if Buffett talks about this. I mean, he talks about it, but not in these terms, but that there’s a lot of return to be had from buying a good company and then letting the company take out half of your other co-owners basically over a long period of time and just concentrating your share of it.

[Chris] Oh yeah. I mean, it’s all the whole analysis on cannibals and they can be great. I mean, I remember even from 100 Baggers, it was, oh, was it AutoZone?

One of those that just, you know, even though the business didn’t really grow that much over that period of time, the stock was phenomenal because they were just gobbling up so many shares year after year after year. And it ended up being very good. So yeah.

And I think that speaks more broadly to just the power of capital allocation. You know, what do the, what does the management team do with the cash that the business earns?

[Jake] That low price is a, low valuation is a gift over that whole time period, right?

[Chris] Yeah. You have a management team that takes advantage of it. And then Buffett has that famous quote where he says, you know, management team that earns a 15% return on its equity over the next five years will determine how, you know, all of the capital in the business.

Yeah, exactly. Basically, you know, the next five years they’ll invest all, they’ll invest the same amount of capital as the business has to that point in its history, which is remarkable, but mathematically true. And, but that speaks to how important it is.

[Tobias] Given how selective you have to be to find a potential hundred bagger and your bias towards holding.

[Jake] Wait, I thought those grew on trees, Toby. What are you talking about? Everybody’s got a whole portfolio full of them.

[Tobias] Potential hundred baggers. And given how you probably have to have a bias towards holding, otherwise there’s lots of opportunities in any given year to sell. How do you finally make the decision to sell something?

How, how sort of traumatic is the, is the sales process? What do you, what happens?

[Chris] No, I like that. Dramatic. Cause that’s that, I mean, I sometimes feel that way when I sell something like, you know, is this the right, is this the right thing to do?

I mean, sometimes you feel good about it and then you’re like, well, you know, thesis is way off from where I started. Something dramatic has happened and you gotta, you gotta cut loose. But I mean, I always say selling is like the hardest thing in investing.

I don’t know anybody who’s really like good at it. And if you’re buying, you know, good businesses generally, then, you know, what you’re selling is eventually going to be worth more at some point. It’s just a matter of kind of what you do with the capital instead, you know?

[Jake] So I remember Bunker saying when he was like 93, like, I’m still trying to figure out the right sale process. It’s hard.

[Chris] It’s very hard.

[Jake] I’ll never know the right answer.

[Chris] That’s right. The other thing is that, you know, you have to do this with all of your money. You could, you know, take some portion of your money and do this where you’re going to leave it alone, be long-term, try to just, you know, not trade a lot.

And then you have that itch you have to scratch. You have some other smaller portion of your money that you allow yourself to, you know, trade more or whatever. I mean, that’s another way to do it too.

But we have to find some way to sort of fight this psychological urge to do something, chase, do something. That’s the way I think gaps lay, yeah.

[Tobias] Let me just give a quick shout out. And JT, you want to do some veggies?

[Jake] Yes, sir.

[Tobias] Valparaiso, what’s up? Tallahassee, Bellevue, Toronto, Saratoga Springs, Sacramento, Toronto, Boise, Breckenridge, Surbiton, Luzon, Switzerland, Midasol, Austria, Toronto, Temecula, what’s up? Snohomish, Jamaica.

Wow. Is SpaceX buying Tesla? Is that real?

Has that just happened?

[Chris] Oh, that would be, that would be the defining. That’s a great one. If that happens, that would be great.

That is it.

[Tobias] Tampa, New London, Boulogne, France, Vancouver. I don’t know if that room is, I just read that off the, everybody listening at home confused about what’s happening. Glasgow, what’s up?

I think Brisbane, good. All right. JT, take it away.

Why Investors Should Stop Trying to Be So Precise

[Jake] All right. So before we get started, shout out to my friend Otto for sharing the white paper that inspired today’s little segment. So everyone is in love with the idea of fine tuning, you know, adding one more factor to the model, one more decimal place in the DCF, position sizing down to the basis point, you know, and it’s science, right?

And we have a trillion parameter models that we’re using, and it’s all very exact. Well, today I want to make the case for the opposite of that. What you might call coarse tuning, coarse as in like rough, you know, not fine.

And I want to start with a few animals that look like they’re quite bad at their jobs. Now, Toby, do you have any thoughts about the great tit?

[Tobias] Is it a bird?

[Jake] All right. Don’t take the bait. Okay.

It’s a bird. It’s this little songbird. And in a good year, if you run the math on the food and the territory and how many chicks the parents could feed, the optimiser would say that the bird should probably produce 18 eggs.

Yet she only lays about nine, half the chicks that could have been raised. Why is that? The next is a desert plant where many of its seeds stay in the ground and refuse to sprout, even after the best rains in a decade.

Every seed that stays dormant is a plant that never grows in the best year that it might ever see. Why is that? Songbirds will start migrating on the day length and not the weather, not the available food.

They’ll take to the skies on a warm autumn day with fruit still on the trees. Why is that? And then, of course, the cockroach, which should probably have its own segment at some point.

I’ll do that, I promise. Ignores everything it can see and smell and will always run from a harmless puff of air. Why is that?

Why would evolution put up with such sloppiness? Millions of years of selection, survivors seem like they aren’t all that dialled in. They’re not very good at their jobs.

I thought this was supposed to be survival of the fittest. In 1985, a business school professor named Rick Bookstaber and a mathematician named Joseph Langsam published a paper in the Journal of Theoretical Biology together. It was called On the Optimality of Course Behaviour Rules.

A fine-tuned rule or a behaviour, it carefully adjusts to the cues that are in front of it. There’s a new input, you change your response, you tweak it. It’s optimal inside the world that the animal can perceive at that time.

The issue is that precision is based on the assumption that today’s picture of the world is complete and final. This is it, tuned to this. Bookstaber called that gap extended uncertainty.

This is events that, in their words, cannot even be delineated, much less assigned probabilities. It’s not a low probability event. It’s not even on the list.

Rumsfeld’s unknown unknowns, basically. Against that, the fine-tuned animal isn’t just wrong, it’s wrong actually in proportion to how well-tuned they are to the old world. Course rules are very different.

It’s suboptimal in damn near every single environment, yet it’s satisfactory across all of them. The bird laying nine eggs isn’t really bad at math, necessarily. It’s betting on a tough winner that it’s never actually seen before.

The seed that stays down is betting on a drought that’s outside of the dataset, potentially. Mother Nature really knows how to hedge her bets and gives up some of the average to cut down on the variance. Across enough winners, that smaller clutch actually compounds further than doing bigger clutches.

Mother Nature really is playing the long game here. Maybe said more eloquently, 18 eggs is the arithmetic hero, and nine is the geometric survivor. Interestingly, animals actually know instinctively when to hedge.

If you take one out of the wild and you put it in a lab, somewhere it’s never been before, obviously, its behaviour actually gets more coarse. It’ll be blunter responses, including it’ll eat a broader diet in a lab because it’s not optimising. And the strange room that it’s in is a signal to itself not to fine-tune.

A little bit more on Bookstaber. He actually went to Wall Street. Funny enough, he ran risk at Solomon through the LTCM crisis in 1998.

He wrote it up. He opens with a thought experiment, which I think is actually quite interesting. Imagine you’re the CEO and you’re handed a perfect view of every risk that your firm is carrying or would be facing.

It’s all of the ones that you’ve identified and even the ones that you haven’t, actually. You have a crystal ball. But there’s a catch, one condition.

You can’t tell anyone what you saw. You can only build a structure that would try to survive. What do you do differently then?

And Bookstaber’s answer was, you spend less time investigating the risks you already know about. You simplify dramatically the models. You flatten the hierarchy.

You shorten the reports. You don’t over-optimise, basically. You don’t fine-tune.

You course-tune. Maybe less of a laser focus on risk and more 360-degree course radar coverage to look for incoming problems. Our world, obviously, is awash in fine-tuning.

Every allocator has a 40-page risk report. AI will crank out 10,000 pages if you want to read them tomorrow. And all of it’s tuned to the world as we currently see it, probably even just really the last 15 years, if we’re being honest, especially in finance.

And every decimal of that precision is a bet that the world will still hold today as it looked previously. So Toby, maybe this is a good time to take just a little break and talk about why EV to EBIT is such a useful course rule.

[Tobias] Why I like it. It takes into the enterprise value, takes into account the debt levels, the minority shareholders, the off-balance sheet liabilities. It’s a good view of what you’re actually paying and operating income, EBIT, EBIT doesn’t really matter.

Operating cash flow, good indication of what comes into the business. As a rough rule of thumb, it’s a reasonable proxy for a price earnings metric. And it’s hard to game if you’re doing those calculations yourself.

It’s imperfect. There are other things that you could do, but I like it as a rough cut.

[Jake] Good. So I did spend a little time daydreaming on five specific ways that we might course tune a little bit more, and I’ll just share those and then I’ll wrap it up. So first one is course measurement.

You know, Graham said the function of the margin of safety is to render unnecessary and accurate estimate of the future. It’s almost impossible to know the value of anything precisely. It should always probably be a range.

So operate so that you don’t need to be exactly right. Like I personally try to leave out all decimal places in my note taking and analysis. I don’t want my brain to get subtle clues that there’s more precision in what I’m actually doing than really exists.

And this actually might be a good time to after this, Chris, to get into general semantics a little bit. But so I usually try to use round numbers as much as I can, because almost always that’s good enough and as close as the accuracy is, I can really expect it myself. Two, course sizing.

In 2009, three finance professors tested 14 portfolio optimisers against the dumbest rule that there is, which is a simple equal weighting. Out of sample, not one of these fancy algos beat the equal weighting consistently. So for a 25 stock portfolio, the optimiser needed something like 3,000 months of data to earn its justified precision, which is like 250 years.

I mean, you could effectively throw that in the garbage, right? So three, course clocks. What you might call the migrating bird rule.

Rebalance maybe on the calendar, not on some ever-changing macro signals. Reveal your rules once a year, not after every loss. Sometimes not immediately fighting the last war is important so that you don’t overfit your model of the future.

Four, course monitoring. Every blow up creates a one sentence afterword. Bearings bake, long-term capital, Archegos, situational awareness.

All these blow ups, they don’t require fancy Greek letters and explanations. Almost always they can be explained in one sentence and usually it’s like leverage and hubris. But it behoves you then to perform a simple pre-mortem.

And if you can’t say how a position dies in one simple sentence, the thing that actually is going to get you is probably still lurking off the page and you need to think about it more. And that also, the monitoring goes towards what Chris was saying about with don’t check stock prices every single second because you’re just introducing a lot of friction into your brain. Last one, course prompts.

We’re all in this rapidly changing laboratory environment right now of using AI. And two years ago, the best AI prompts were the most precise ones. We had to add, like, take your time and make no mistakes to your prompt to get it to work.

And adding think step-by-step took one model’s math score from like 20% to 80%. So we all built these little libraries of tricks and incantations that we were dorking around with. And that was tuned to the model of that year.

And now all these models have gotten better. And open AI’s own guidance says, keep it simple and direct and stop telling it to think step-by-step. So a precise prompt is a bet that today’s model will hold.

But they’re changing all the time. So be more coarse, perhaps. So what’s really survived every generation is a brief, like, what you’d give a new analyst if you were asking them the question, like, what do you want?

Why do you want it? And what does good answer look like? So tune to the task, maybe less so than the tool.

Because the best tool is changing every week. So now, of course, there is a premium to be paid for all this course tuning. There is no free lunch.

It underperforms in every year where the world still holds. And it does hold most years, right? So the fine tuner collects that premium every year until the year the picture isn’t complete.

And then it tends to hand it all back at once, which you think about like the turkey on Thanksgiving morning. They thought things were going well for a long time. And then all of a sudden, they weren’t.

So to wrap this all up, we humans, we love to fine tune. But Mother Nature very rarely fine tunes. And the survivors typically don’t do that.

Can’t really blame us. Like, we’re still a very young species. We’re still figuring things out.

You know, we fell in love with this fine tuning because precision like that feels rigorous. But it isn’t really. And the cost of our course tuning is quite visible.

Like, oh, we’re not updating the model to the new world. But you knowingly leave some performance on the table when the model is increasingly right, of course. But the benefits of course tuning are invisible.

And until the model is suddenly wrong in a way that you never specified before, that’s when you get your payback. And then you totally redeem yourself, to do a little pun from Dumb and Dumber. So anyway, there’s the veggies on course tuning for today.

[Tobias] Good one, JT. Chris, JT mentioned the general semantics. What is general semantics?

And what can we learn from it? How can we use it? Easy.

[Chris] You know, easy question, right? Let’s see. I mean, you know.

[Jake] Let’s preface this a little bit with it. Chris wrote a really interesting book that I read not too long ago called Dear Fellow Timebinders. And it’s all about general semantics and is a really great introductory exploration of the concepts that are otherwise actually quite hard to penetrate on your own without Chris holding your hand through the whole thing.

[Chris] Well, thank you. Yeah, that was the intent of the book, actually. Just to be kind of introduction to those ideas.

Because Alfred Krzyzewski was a Polish engineer type who came up with this idea in the 1930s and wrote a big fat 800-page book about it with lots of footnotes and math. And so yeah, it can be very difficult to get to. But the basic ideas are very valuable.

And they’re geared around how we use language and how that influences how we think about certain things. So you mentioned, for example, your decimal point example. That’s very Krzyzewskiian.

He would have loved that. I mean, because we do have this false precision when we say something as a PE of 25.2 or whatever it is, whatever number it is. Of course, it would be just as well served by just knowing that it’s sort of a guess.

We’d probably be better off if we didn’t know the number exactly. We’d just do a range. So that’s the basic thought of it.

And there’s lots of examples and little tools that gives you a way to check that out.

[Jake] Maybe the subscript of the date would be an interesting one to just talk about.

[Chris] I was just thinking like one example. Yeah, the date one is an interesting one, because that’s where, let’s just say, in the context of our business, you’re looking at Berkshire Hathaway, and you looked at it last year, and you came to certain conclusions. What Krzyzewski would say is that you actually put the date in there as a little subscript.

So Berkshire Hathaway 2025, to denote your thinking on it was from last year. But if you don’t actually put the date there, at least mentally, you know that last time you looked at it was 2025. So that’s your thought.

And not to get anchored onto that, thinking that there’s lots of new things that may have happened. And so it prevents you from getting attached to your ideas that way. Using a date makes you recognise that things change, and then you need to look at it again.

And that’s one very, very simple tool. And he has a number of tools like that, that I use all the time, and I think are very helpful.

[Tobias] The only Krzyzewski quote that I know off the top of my head is, the map is not the territory. That’s Krzyzewski, isn’t it?

[Chris] Yeah. Yeah, he popularised that term, map is not the territory. That’s kind of another good way to sum up general semantics.

So the map, of course, are verbal descriptions of things, which is not exactly matched up with the territory we’re describing. So his whole toolbox of general semantics is to kind of get behind and parse what people’s descriptions are, using the language, and to try to get at what’s really being described, what those descriptions hide, what they maybe say about the person giving the description, and so on and so forth. So it can be interesting, and applicable to lots of things in life, of course, not just investing.

[Jake] One thing I really liked about it was that it just really gives you an even deeper appreciation for that slippage between your map and the territory, whatever that delta is. You just should be a lot more humble, and have humility about how much you think you really understand something, because it’s quite difficult to fully, truly understand anything. Maybe impossible.

[Chris] I better myself, exactly. Yeah, I think that’s one of the benefits of studying it, and it does give you a greater dose of humility about your own ideas and conceptions, and being more open to being proven wrong. So those are valuable in themselves.

[Tobias] So the idea is just to retain the idea that what you’re looking at is a model, rather than the thing itself, and that your model could be wrong in various different ways, and you should be open to correcting.

[Chris] Yeah, I mean, or like Jake said, you’re not only that could be wrong, but you’re probably wrong.

[Tobias] Probably wrong, yeah.

[Chris] You know, it’s just how badly you’re off, or how Is it fatally wrong, or just? Yeah. No matter how good of an artist you are, you’re still not going to be able to capture the thing exactly as it appears.

So there’s always things that leave out. And the question is, how important are those things, and how they change over time? So, yeah.

Sort of an aid to critical thinking, you can think of, too, is another way to think of it.

[Tobias] How does that manifest in your process? Do you keep smaller position sizes, or what’s the practical implementation of that?

[Jake] I’m dying to see your notes now, for a typical, if you went through a 10Q or something.

[Chris] Yeah. I mean, one thing is you certainly, I mean, there’s lots of ways. So one other way I would say, you don’t get too attached to labels, what other people say things are.

Compounder. That’s a good one, compounder, or value stock, or whatever. I mean, I can think of even more conceptually, when people would argue about, what is Tesla?

Is it an auto manufacturer, or is it a battery company, or is it, what is it? And people say, and how you frame it, how you describe it really greatly influences how you price it, and how you think about it in your mind. So there’s a certain amount of getting past those things.

[Tobias] I would love to hear the answer to that question, by the way, because I don’t know the answer to that question.

[Jake] We’re still waiting to find out.

[Chris] Yeah. No, I just pose the questions, I don’t answer them.

[Jake] Exactly.

[Tobias] Well, how do you, like, just moving on from that a little bit, but from a practical perspective, how do you think about position sizing?

Why Starting Small Can Make You a Better Investor

[Chris] I mean, for me, I think, I mean, I, again, this is, there’s lots of ways to do this. So I’m not saying always the right way, but, you know, for me, I like to kind of start things small and get to know the business. And I always say, you know, it’s different when you actually own something versus then just following it.

I don’t know why. I just somehow, when you actually own something, you’re just much more in tune, you’re paying more attention, you work on it more, because you actually own it, as opposed to something that you’re following and saying you’re doing work on. It’s just different.

It’s a different level. So I feel like you know more about it when you own something for a year. And I like to keep it small, because then that, you know, stretch of time there is probably where you’ll make a mistake, it’s probably early.

And you might learn that a business isn’t quite as good as you thought a year in, it’ll be easier to get out of it. If it’s a smaller position, it won’t hurt as much and all that kind of stuff. Whether if you started really big, and then just stress level and everything is much higher, and it’s harder to pull out.

So this way, you start small, you kind of grow into it. And the way I also say with these things, if you just, if it’s real, you’ve got plenty of time, you know, you’ve got plenty of time. So you shouldn’t feel like you got to be rushed into something.

If it’s a really good business that you can own for 10 years, you could probably buy at the 52 week high this year, next year, the year after and still do very, very well. Not that you want, aim to do that, but it’ll probably work.

[Jake] I think that’s a really important point to highlight. And when you’re in year 15 of a bull market, like, and it’s always felt like you didn’t buy enough fast enough. Like, I don’t know if maybe not enough older people watching the show, but like, when you bought too early in 2007, eight, and it just kept going down and down.

And then eventually you’re like, I don’t have any more money to put to work. That was the opposite feeling. It was bad feeling, but in the opposite direction.

And it just hasn’t been that way in so long. I don’t, there’s like probably an entire generation that hasn’t experienced that.

[Chris] That’s right. That’s right. And then if you start small and that happens to you, then you can, it’s much more, at first off, it’s less painful, but then you can more readily kind of add to it, you know, as you’re kind of going down.

And so I feel like you get a lot more flexibility starting small and then whatever full position is for you, for me, I don’t know, somewhere around, you know, seven, 8%, I think. And then after that, I will just kind of let it ride. You know, I like to just sort of, you know, let the portfolio get unruly at that, at that point, you know, something compounds and takes over and becomes 12, 13% of the portfolio.

That’s good. That’s right. Yeah.

I don’t feel like I have to trim it or I have to manage it so carefully, you know. But everyone’s different about that. So, but that’s generally how I think about it.

[Jake] Is there a max size where you would be like, okay, just for prudence, I need to trim this back?

[Chris] Yeah, definitely. Kind of always debate what that is, but I know for my fund doc, it’s legal at 25%. I definitely have to cut at that point.

But I don’t know that I would take it that far. It might be a little, it might be before that. But yeah, there’s a, there’s a point, I think.

And again, that number is probably different for everybody, depending on what situation you’re in and what the rest of the portfolio looks like, you know.

[Jake] It’s hard though, when you read Bess and Binder’s 4% study and you’re like, okay, well, I’m just going to kill this one thing that’s probably going to, like imagine it’s 1972 and you have Berkshire and it turns into, you know, it’s the lady who you sat next to on the aeroplane. And if she had been trimming that whole time, she probably cut her result by huge orders of magnitude.

[Chris] Huge. Yeah. Yeah.

I mean, I remember there’s an example with T. Rowe Price’s fund, where they had bought Walmart early on and it was in like a small cap fund. So they were constantly cutting it back and cutting.

Yeah. And it was like, if they’d left that it was worth more than the whole AUM of the fund, you know, today or whatever. So obviously those are huge, huge mistakes.

I love Bess and Binder studies. I love how they make you, you know, think about things like that. But, you know, that’s the cost of investing.

I think for most individuals, if they had to keep chopping back when something that was huge like that, I mean, they’re still going to do very, very well. Maybe they wouldn’t do as well if they left it alone. And then every once in a while you’re going to have something where, yeah, you know, it didn’t work out or it turned out to be Polaroid and went to zero eventually or something like that.

[Jake] Right.

[Chris] And then you’re glad that you at least took some off. So, you know, it’s always have to be vigilant about this stuff. And, you know, owning stuff for a long time doesn’t mean you just ignore it completely.

But it’s not easy. Otherwise, a lot more people would do it.

[Jake] Yeah. Power laws are hard to handle.

[Chris] Really hard.

[Tobias] The corollary to the buying too early during 2008 was probably 2020, 2021 when the market went up very rapidly and a lot of these expensive names become very, very expensive. And there was this meme that was doing the rounds on Twitter, at least the NeverSell. You want to be in club NeverSell.

And around that time, I did some research where I just said, let’s just take the cheapest free cash flow names from, you know, 1999, 2000. And then I did that for 10 years until 2010 and then just hold them and never rebalance those portfolios. This is all back test, of course.

And then at the end of that period of time, you find that the portfolios start looking like all the biggest names, of course, are the things that have done the best, that everybody agrees are the best stocks to hold. And so your portfolio becomes dominated by the big good things. But at the beginning of the period of time would have been very difficult to predict.

[Jake] And you look like a genius, like, oh, this guy saw Amazon early.

[Tobias] I had it for 25 years. I knew 25 years ago that they were going to have this, that Steve Jobs was going to come back and turn this whole thing around.

[Chris] I knew Amazon wasn’t going to just sell books.

[Tobias] Down 95%. I mean, that’s a great example. You buy that down 95%.

[Jake] So being a collector of like just snapshotting and then letting it roll forward, and like whatever you get, you get.

[Tobias] There’s an error rate in your buying. There’s an error rate in your selling. And you look at something like the S&P 500 committee famously underperforms, like just if the S&P 500 committee didn’t exist and you just bought whatever the largest 500 were, or you admitted things into the portfolio when they should, you know, they’ve kept things out on occasion for, they have some discretion.

I think Tesla might’ve been kept out for a year or so. They reversed that decision with SpaceX and that’s worked out spectacularly. But it’s, I just think it’s an error minimisation.

I don’t do it, but I just, I think it’s an interesting idea that like the never sell, it’d be very, very hard to do. But if you could, if you could persuade someone that it would work out in 25 years time.

[Jake] Hard to do, but easy to market. Is that what you’re saying?

[Tobias] I think it’d be hard to market.

[Jake] You think so? You get to look like a genius.

[Tobias] But 25 years hence, you don’t know if it’s worked out. Yeah.

[Jake] Yeah. You should’ve started a while ago.

[Tobias] How do you justify fees? Yeah. We’re just gonna do nothing.

Well, to be fair, like you get it because you’re buying on a free cashflow basis and you’re getting buying things that have a fat free cashflow yield, you get about a third of the capital back over the first five years. So you do have to reinvest. And I was just saying, you just do the same thing.

You just buy the cheapest and then you never sell. And these are names that like, they all have real problems. Like they’re cheap because they’re not doing very well.

They’re cheap on a free cashflow basis. So there’s still pretty good businesses producing free cashflow, but there’s no selectivity in buying them. You’re not buying them because they’re good businesses.

They’re pretty bad and something has to change for them to become good businesses.

[Jake] Yeah. You’re making a call on terminal value basically.

[Tobias] Right.

[Chris] Or just in playing a statistical game, at least some of them in there are going to work out. Once in a while you’re going to find, I don’t know, Philip Morris is trading and just continues to compound and do well. So yeah, there’s always- You get plenty of zeros too.

[Tobias] You get plenty of things that people say, you’re an idiot for holding that all the way to zero. But the portfolio does pretty well. And then it ends up like you’re concentrated because you haven’t changed anything in the biggest names.

Why One Giant Winner Can Transform Your Portfolio

[Chris] Yeah. Yeah. I mean, that reminds me of the coffee can portfolio and other ideas where you’re holding on and things and just tolerating that some of them are going to go to zero and suck.

But statistically there’s going to be something in there that makes the whole thing work. It’s the interesting math behind investing is that the winners really make a huge difference. I mean, it can be the difference between beating the market or not.

It’s that one giant that takes over.

[Tobias] I mean, that was true of Claude Shannon. Claude Shannon famously had that. He was the guy who invented the binary.

[Chris] Yeah.

[Tobias] He had this portfolio. He had a whole lot of VC investing that he had done through MIT or something like that, or Bell Labs, wherever that was based. And he ended up with like Motorola and a few of these other absolute monsters, but he just didn’t ever sell a share.

And that was the secret. Right.

[Chris] Yeah. And that’s the coffee can thing Robert Kirby writes about when he was managing this woman’s account and for however many years it went on, 10 years, 20 years. And then he finds out when the husband dies and he gets his account, his wife gives him the account to manage.

He finds out that the husband has been like piggybacking on all his ideas, but never sold any. And so, yeah, there was one stock that was worth more than all the money he was managing for the wife. It happened to be Polaroid or whatever it was with some mega winner.

And so, you know, exactly. There’s a whole bunch that went to zero, but the winner’s more than made up for it.

[Tobias] Hey, Chris, we’re coming up on time. Tell us a little bit about the book and where folks can find it.

[Chris] Yeah. So the book, Investor’s Odyssey, it’s, you know, what’s the phrase available where find bookstores or whatever. So Amazon is your probably your best bet.

You can get it there. And yeah, let me know what you think. Just came out.

So.

[Tobias] I just bought Dear Phil a time bind as well. We were on this call. So.

Okay. I’ll get to that afterwards.

[Jake] It’s rare where you get, you know, kind of new big ideas these days. And so to find one like that, I was very appreciative.

[Tobias] And if someone wants to follow along with what you’re doing or get in contact, what’s the best way of doing that?

[Chris] Well, you know, I’m not really on X very much anymore, but you can, you know, occasionally I’ll put things on there about books and things like that. That’s probably the best. Yeah.

[Tobias] JT, any final words?

[Jake] No, just happy to have Chris on and good to catch up and looking forward to reading the Investor’s Odyssey.

[Chris] Cool. Thank you. Thanks for having me on.

Good fun conversation.

[Tobias] Thanks, Chris. We’ll be back next week. Same time, same channel.

See you folks.