Michael Mauboussin on How to Read Stock Prices (Podcast)

Expectations Investing. What I love about Michael is how thoughtful he is, how interesting his approach to investing, thinking about markets, individual companies value UH and basically the approach he brings to research to the investment community. He's been writing and publishing about markets for literally decades, not just his many books, which I'll include in my notes, but the research papers

he puts out and shares with the public. They're always interesting and thoughtful, and I frequently find myself looking at these, reading these and going huh cock in my head, I hadn't thought about that. That's a really interesting take on a very fundamental idea, and I'm I'm glad I had the opportunity to give this a thought. I found this to be a master class in valuation and how to think about what a company's proper potential value is, what

your expectation for investing in that company should be. Uh, it's no surprise he's been teaching at Columbia for I don't know twenty years as an adjunct professor in the Business School. I'm gonna stop babbling and say, with no further ado, my conversation with Morgan Stanley's Michael Mobison. This is Mesters in Business with very Results on Bloomberg Radio. My very extra special guest this week is Michael Mobisan. He is the head of Concealing It Research at Counterpoint Global,

which is part of Morgan Stanley's investment management group. It's the bye side part, not the sell side part of Morgan Stanley. Previously, he was head of Global financial Strategies at Credit Swiss and before that, chief investment strategist at leg Mason Capital Management, working with the famed investor Bill Miller during his incredible streak. He is also a professor of finance at Columbia Business School and Chairman of the Board of Trustees at the Santa Fe Institute. Michael Mobisan,

Welcome back to Bloomberg. Awesome to be with you, Barry. Always a blast, and it's so good to be with you. You know, I don't do this. I don't throw my arms up when I'm doing it at home remote using a Comrex machine to jack into the Bloomberg machinery. It's nice to be in the studio and look at you. I I have four hours worth the questions for you, so we'll we'll see if we can get through some

of them. But let's start talking about your most recent book, which I hold in my hands, Expectations investing, reading stock prices for better returns. So you first wrote this twenty years ago with your co author is Alfred Rappaport. What made you decide to um revisit this and reissue this twenty something years later? Yeah? Why should first tell you a little bit about the background of the first book?

And and I was, you know, I was a someone had no business experience, coming onto Wall Street and read a copy of Owl's book Creating Shoulder Value in the late nineteen eighties, and it was for me a professional epiphany. And I say that because it really everything I've done professionally has come and rift off of this, so it's really standing on the shoulder of giants. And so al Rapaport has been an incredible mentor and collaborator for me. So that book, by the way, it was aimed at

corporate executives about building value. And there were three lessons in there that I always have taken with me. One is it's about cash flows and not accounting numbers, you know. And it's funny, Barry that we seem to relearn this lesson from time and time, but we'll probably get into

it in some degree. But I think today we're at a particularly interesting time and markets where because of the way the accounting works and because of the way the economy is moving, uh, you have to really follow the cash trail more than ever. The second thing is he said, you know, to do intelligent valuation work, you have to

understand both finance and strategy. And I think this is something else people feel very free throwing multiples around and so on and so forth without really doing the proper strategy analysis. And I think that was a second lesson. And then the third thing, this is my build up

to your answer your question. The third thing was the original book catch chapter seven was called stock market signals to managers, and the argument was, hey, executive, if you want to understand how to allocate capital judiciously, even set up incentives, you need to understand what the markets pricing into your stock. So that obviously has direct implications for investors.

And that ended up, you know, we end up collaborating on the original version aimed at investors called Expectations Investing. Now I'm glad you're sitting down because the original version came out September two thousand and one, like literally twenty years ago, the day before the Greatest that the greatest not natural tragedy, and by the way, much less significantly in the midst of a three bear three year bear market. Right.

So um, And by the way, I thought, you know, many of the ideas and the books stood up over time.

But I had been teaching from this these principles for a long time and so you know, and part of was COVID induced, but I was, you know, and I'm in constant conversation with with Al, and I said to him, you know, there's enough that's gone on in the world, uh that I think we it's time for us to take another swing at this, which is bring in what is new, freshen up our case studies and uh like, let's focus on what worked still and what's still is good,

but let's bring it in and make it more contemporary. So I just thought it was and and and and and in teaching it, what lessons have I learned? And how to communicate some of the ideas effectively, what matters and what. So we ended up only getting rid of one chapter, replacing one chapter altogether. But there's so much about it. So the bones are basically the same, but there's so much about it that's brand new in terms of the case studies and again reflecting how the world

has changed in the last twenty years. And for people who may not be familiar with Alfred Rappaport, he's a professor professor at Kellogg and and he's done a ton of work on how to create long term value and overcome short term is um amongst investors and corporate managers. Tell us a little bit about that background. Yeah, I mean that's it. I mean, look, I think that he um is gonna he is one of the great sort of academics, uh in this whole area in the last

half century. Um. His PhD is in accounting, by the way, I should mention, but he's made very important contra usians in accounting, in finance, and as I mentioned, was one of the great synthesizers of bringing together strategy and finance. He by the way, did a lot of the executive programs a Kellogg and had a literally a world famous

program called Merger Week. And if you were anybody in the mergers and acquisitions world, in the corporate world in the eighties and nineties, you the mecca was to go to Kellogg to do Merger Week and learn about this. And so yeah, I mean, he's just a tremendous a tremendous resource. Now he's in he is in his late eighties. Now, he by the way, could not be better. I mean I talked to him almost every single day and sharpened and you know, just intellectually, so curious, a very avid reader.

I mean, so really going, still going, really really strong. But um, and it's by the way, total delight. Is always total delight working with him, in part for for for the joint learning that goes on, but also to have someone to be a reality check when you're sort of going off a little bit and need a little of course, correction. He's the old professor that sort of brings you back into line, which is powerful. That's great.

Everybody needs a Jimney Cricket on their shoulder to make sure they're not, you know, they're not going off to never Neverland. So there are a bunch of quotes from the book I want to get into, but I have to start with one that that's so macro and all encompassing. It really talks to the theme of the book, which is when investors talk about expectations, they're usually talking about

the wrong expectations. Explain, well, I think that, Um, it's interesting that when people talk about what a stock is worth, and you should you should correct me if you hear something differently, it's almost always some multiple of some sort of earnings metric PE to say, the very least and then a million variations r P E or e VD

or something like that. Right, And so the basic argument is, at um, multiples are shorthand for what is a broader valuation process, and multiples embedding them lots of assumptions about how the world works, including assumptions about returns on capital and growth and so forth. And then as we'll talk about and probably more detail. Measures like earnings or even even daw themselves um can be very unreliable measures or

metrics of value creation. So so when they say, oh, at at X multiple, that it looks like low expectations, or it's cheap in quotation marks, or it's expensive in quotation marks, they're really they really don't know exactly. They haven't unpacked exactly what the story is. Whereas I think we'd all agree a lease in theory that the value of the business is the present value the cash flows. The argument I always like to make is, let's let's lay the lay bare on the table what those assumptions are,

what the underlying economic assumptions are, and then debate them. Right, we may not agree or come down in the same place on these things, but at least we note we're dealing with versus uh, these these these using putting together a multiple, these two things that are neither which on their own are very helpful. So so let me take a swing at this and you tell me if I'm

on the money or or off. So when we look at earnings, a lot of different things go into making earnings high or low, cheaper, expensive, And if you're just looking at that net number, you're blind to all the moving parts that might be temporary one offs or potentially reflect fast future growth. Just looking at the number itself relative to price doesn't give you a complete picture. Is

that a fair? That? That for sure is true? And then there's another component of it that's probably even more compelling, which is growing earnings is not synonymous with growing value. So saying that differently, if you invest in your business and your earning exactly your cost to capital, growth doesn't make any doesn't add any value whatsoever. And so uh so so so earnings growth be good, it can be bad, it can be indifferent, and so you just don't know that.

So saying this differently, company A and company be same earnings growth rates, but the very different value creation prospects you can't tell. You know, the multiples are going to be different, and they should be different, but the earning the earning number in and of itself doesn't tell you the answer. And then the other question that comes out of this that I felt was really fascinating, what sort of expectations should investors have from reading stock prices? And

how can the ordinary investor read stock prices? Yeah? So this I mean this gets to the heart of it. And you know, Barry, I was trying to do a little bit even and working on this book, I was trying to get a little bit of the psychology of this because it seems fascinating to me that people love to think that they can figure out the value and

then they're going to compare the value to the price. Right, So there they feel like their job is to figure out why identifying intrinsic value sided discounts premium and what this The premise of this book is obviously just to reverse the whole process and just say, like, there's only one thing we know for sure, and that's the stock price. Right. Again, you may not may like it or not, like it doesn't matter. It is something we know for sure. It's

an objective number versus what's essentially an opinion. So then we say we're going to reverse engineer what has to happen for that thing to make sense, and then try to judge whether that is sensible. Now that to me, the most powerful and vivid metaphor is the handicapper. So you go off to the horse races to figure out and and presuming you'd like to make money, there are two things that are really important, right. One is the odds on the toe board, which is telling you which

horse or horses are likely to win. The second is how fast the horse is going to run, right, And so it's the combination of these two things that it's important. But often starting with the toe boards a very sensible thing because you say, all right, well, you know, is this a favorite or is this a long shot whatever whatever it is. So this is basically saying, let's do these things backwards. And by the way, there's a there's a fascinating guy who you by the way, you should

get him on sometime. He's really interesting and a kind of Stephen Christ. Do you know Steve? Do you know Stephen Christ? And the way he's a he's an interesting guy, um he and he's written a lot. By the way. He wrote a chapter in a book called It's called kristin Value is a thirteen page chapter which is one of the best chapters about investing I've ever read, even though it's about handicapping and Chris sort of talks about you know, it's it's about this miss pricing between odds

and and and performance and so forth. But one of the one of the lines in there he loves. He says that I love. He says, you know, everybody thinks that they're doing this thing, but very few people actually do. And I think that's the same thing for for investing. So when when you explain expectations investing the basic principle, people go, yeah, well, it's kind of what I'm doing, and isn't it And and the answer is that's known

and not really what you're doing. Right. So so there are really three steps in the process, which you'll probably get to you. But one is to say what has to happen for today's stock price to make sense, right, So that's just basically where is the bar set? And then step two is introducing you know, sort of more high falutin strategic and financial now to determine whether company's gonna outperform, that expectations underperform, or g it's going to

be I have no strong opinion one or another. And then step three is to make by cell and hold uh uh decisions as a consequence. So in the book you we're going to talk about earnings now, but I have to bring up the broad changes you identify in the market, and and we're going to circle back to these but I want to reference these relative to earnings. The shift from active to passive, the rise of intangibles, the move from public investing to private investing, and then

the major changes in accounting rules. All four of those things have changed since the first version of this book. How significant are they to how earnings are accounted for and valued by investors? So, I mean, maybe we can part these a little bit because I think the active too passive thing would affect you know, if it affects anything, would be things like markets more or less efficient and

things like that. So I don't know that that's a big thing for what we're talking about in terms of earnings. And the other one is public to private And you know, even since we wrote this book there I think there are a third fewer public companies than there were twenty years ago. But on that point, keep in minds someone there's been some studies done and a huge swath of those were penny stocks that got kicked off the nas

deck and onto the paint and nobody really cares about them. Yeah, that's that is absolutely correct, and so but the nature of these companies have changed, it in the market caps and so forth. But again that I'm not sure that's a big story for earnings. I think the one that I mean accounting changes, but I think the really big one is this rise of intangibles that you pointed out, And just to give well, first of all, let's go

back a little bit even further in history. Back in the nineteen seventies, tangible investment, so tangible physical things, think tractor factories and truck machines, drills, all that, right, those were twice the level of intangible investments and intangible by definition non physical, so think now branding, software, code, all these kinds. Okay, right, So two to one tangible to intangible. At the time we wrote the book so called two thousand and one, twenty years ago, they were the first

version of the book. They were at parody. And our estimate is, for one that intangibles will be more than two times tangible. So in the last twenty years alone, they you could sort of say they started the race basically neck and neck, and now it's much much more intangible. So why why is that important? Like why do we

care about that? That's important because tangible assets, the way the accounts record them is they're capitalized on the balance sheet, right, it's a it's property, plant, and equipment, which we then depreciate over time, so it does show up in the income statement, but primarily in the form of depreciation. By contrast,

intangible investments are fully expensed. Now. The most famous of these research and development, and we've known that since the nineteen seventies, the fast we decided that that R and D should be expensed, and there's debate about there's been builby about that for a very long time. But now R and D is only a quarter of total intangible investment. So there's lots of other stuff that's going on that's

all expensed. So what does that mean, all things being equal, The answer is earnings are a lot lower than they would otherwise be. I always like to point out that, uh, you know, great companies like Walmart, great companies like home Depot, for the first ten or fifteen years, they republic had negative free cash flow, right, which their investments were bigger

than their earnings. That they had positive earnings. Was that a problem, No, it's fantastic, right, because their investments had very high returns on on capital and so and by the way, Walmart, for example, it's first fifte years tripled the performance of the stock market. Right, it crushed it. And when you do the that's a substantial compounding advantage. Right. But the problem is now where we're conflating investments and

expenses on the income statement and don't see that. We can't unpack those things and just to just to jump in places like Walmart and Home Depot and those just they're buying land, they're putting up new stores, they're expanding, so that sort of tangibles does show up on the balance sheet, that's right, and that's the whole point. So they're there. And by the way, even Walmart, Walmart for

sure was an early user of technology. Right. If you read Sam Walton's book, which probably everybody should, it's a fantastic I reread that memoir just last year. It's just awesome. You know, they were early users of technology, so they were early intangible users as well. But you're exactly right. The vast majority of their investments were physical you can you can kick it and so and so forth, whereas

other other companies that is not the case. So yes, so that to me is a that's a watershed change, and that's why earnings Again, if you're focusing on cash flow, these things become much less important because we're getting to the ultimate route. Answer. Uh, but if you're simply using multiples or some sort of shorthands, you're gonna just miss

this very significant development. So so people love to point out how expensive the stock market is and how pricey that we used to call them fang but now with Facebook, I don't know what the alt call it anymore. But um, if we look at the top ten or twenty technology companies, or or the top of the S and P five hundred by market cap, those appear to be pricey. But these are all companies that have massive investments and intangibles.

So it's Google, it's Apple, it's Netflix, it's Microsoft, it's Facebook. Go down the list, it's in Vidio. All these companies are They own software, they own patents, they own processes. Does this imply that these pricey technology companies I left out Tesla from the list. Are are these so called pricey tech companies that have so much sunk into intangibles? Are these perhaps less pricey than the average stock analysts believes if you're using additional multiple as, you get a

very different picture. And you know, we recently wrote a report called uh, it's called classifying for clarity, where we talked about argue. We argued that certain things should be restated in the statement of cash flows. And we use

as our case study Amazon dot Com. Right, so, one of these companies and Amazon back, our calculation or our estimate is at Amazon's intangible investments in or forty four billion dollars and you, uh, they're if you amortize, if you build old schedule and advertise it, it it still comes out to nineteen billion dollars of net profit increase. Now,

Amazon's profits last year about twenty billion. So so just if you accept as you doubled the profits right now, if you know you we could quibble about the details of that so and so worth, but basically that is no, that's exactly right. And the IBADAT numbers don't quite double,

but they close to double. And so now the flip side of all that, that's you know, the earnings are better, but let's also recognize the investments are a lot higher than what is reported to And so I always say the job of an investors to understand the magnitude of investments and the return on investments, to understand future profits and so for a company like Amazon, they're earning a lot more than people, at least what they seem to report,

but they're also investing a lot more. So you know, there's still lots of judgment as to what those investments will pay off and so and so forth. But you're exactly right, it's a very distorted picture, you know, without commentary. So this is the whole thing about you know, the market used to trade at this multiple. You know, it's just the underlying uh nature of our markets. Our businesses are enterprises are so different today that I think that

those sort of comparisons seem to be very simplistic. And then just throw in the whole interest rate thing as another curveball to how do you calculate cause the capital is so cheap, does that artificially does that artificially enhanced ownings or our companies taking advantage of that. It's it's not a one off. Oh look, capital is cheap, therefore ownings are fire. It's our money is free, our companies

opportunistically taking advantage of that window when it presents itself. Right, I don't if that's a common But on a related note to the intangible, it's just popped into my head. Um. Joe Davis, who is the chief economist at Vanguard, did a research paper I don't know a year or two ago discussing the rise of intangibles as a predictor of which regions around the world, Which countries around the world

our prime for growth. When you start to see patents and software processes and copyrights expand in a given nation, you should expect their GDP and their stock market to subsequently respond to that, usually uh, in a positive correlation. I mean, I'd love to see that. It makes sense, it makes complete sense to me. And again, it's just

another indication of how things have changed. Right Whereas we may have said a generation or two before, if those factories are popping up and those good blue color jobs right now, you're something different is sort of a leading indicator of future wealth creat That's right. If you have a bunch of coders showing up in a particular area, that might mean something positive for for the economy and for that stock market. So so let's bring this back

to trying to figure out value. What do earnings actually tell us about a company's value? Well, I mean, earnings are just part of the equation, right, and so Uh. We argue very early on the book that earnings telling you very little. In fact, the appendix to chapter one shows again that earnings by themselves do not even tell you about value or value creation. So the what we focus on is a very standard finance way to think

about this, which is free cash flow. And free cash flow is the pool available pool of capital available to all capital providers. You know, bury besides doing all the stuff you do, you're a business owner, so you know exactly how this. You have money coming in and money going out, and you sort of know how you have to think about this kind of stuff. We just roll all our cash into uh, you know, shibu imu and exactly dol coins and we just let it roll. So

we're that's it's been. It's been speculative, but it's been working out. It's been working out great. And that's the deep value analysis on that one. And so yeah, so um. The so free cash flow is basically net operating profit after taxes, which is a rough measure of earnings. Right, it's a little bit more formal, but rough measure of earnings. Net operating profits after taxes, and the key to net

this in the acronym is no pad. The key to notepad is that it's the unlevered cash earnings of a business. So unlevered means there's no reckoning for financial leverage at this point. And it's cash earnings, right, so you're taking out all the cash counts and that's a beautiful number to know. And then investment is all the investments of the company needs to make, including working capital changes and cap backs and so on so forth. So so free

cash flow sort of the bottom line number. And by the way, even when we make adjustments to intangibles, what we're doing is essentially making earnings higher, no PAD higher, and we're making investments higher. Free cash flow sort of the bottom line that does and change, and that's the number we try to keep our eye on. So you remember your high school basketball coach, I keep your eye on the hips, right, because everything's gonna follow the hips.

That is the hips of finance, right, which is free cash flow. That's the number you want to keep your eye on. So Howard Marks is fond of discussing second level thinking, and so what I'm hearing from you is that just looking at earnings or pe multiples is first level thinking and second level thinking is putting this into the broader context of earnings relatives to free cash flow relative to intangibles and growth, Is that like a wild

overstatement or no, not at all. I mean I think that the answer is the way I might say this differently, is it free cash flow is the ultimate thing that we care about. All the other stuff you just mentioned terms of earnings and multiples and so forth, those are all proxies that try to get to the same things. So they're short of shorthands, right, And by the way, I mean you've had you've had the great Danny Knemon with you. Right. What's good about shorthands? What's good about

heuristics as they save your time? Right, So that's why they're useful, and that's why we use them. What's limiting about heuristics or shorthand as they have biases? Right, And so the key is not to the key is not to never use them, the keys to understand where their

limitations lie. And I think that's where people get a little bit can be a little bit lazy around the edges and just sort of say like it's this thing has always traded at twenty times this, and so it should be twenty times that's not really you want to go back to the core, the core ideas. So so here's the pushback that I think we would get from a Robin Hood trader today who is looking at their

portfolio over the past couple of years. They would say something like, hey, this sophistic hidden analysis is interesting, but I haven't been using second level thinking. I've been picking the fastest horse the past couple of years without looking at the odds, without looking at anything else, and that's been working out. And I joke about dose coins and things like that, but if you bought the fair this back, the fastest tech ev company, the fastest uh crypto coin,

it didn't matter. Momentum seems to be driving those fast horses the highest. How do you respond to that sort of of pushback, Well, they're there's sort of two levels of comments. One is, UM, I think it's important. I'm gonna sound like an old, an old fogi here, but I think it's important to make a distinction between speculating and investing. And um, by the way, and this is

without any sort of moral judgment. So this is just you know, it's trying to make this demarcation without judgment, right A speculator or someone who buys something in the hope that it goes up. Uh an investor someone who buys a partial stake in a business. Right, it's a very different mindset. And so if the markets shut shut down for three months, three years or whatever, you wouldn't care because your own part of a business. Right. So this is almost again the Barry Berry is the investor

and versus Barry as a proprietor of a business. Right you think about the value of the business. It's a very different as you know, it's a very different mindset. Now, when I peer out of the world today, I guess I would actually think that I sort of think of the world in sort of three different buckets. The first bucket is sort of the normal bucket, where I think that, notwithstanding we have some obviously a little bit of zany stuff, most of the stuff out there is pretty pretty solid, right,

like pretty normal. And then the second bucket might be you know, where I put things like the meme stocks and so forth. These are be sort of the momentum. And you know, in our language we call these sort of diversity breakdowns. People correlate their behaviors in certain ways and by the way, there's there's some language in the book that helps talk about these things like reflexivity and so forth. You know, so this would be the game stops of the world in a MCS and so forth.

And by the way, many of these companies have actually done very sensible things, which is they've they've sold, they've sold raised capital, which by the way, increases the intrinsic value of the per share owners for ongoing holders. And then the third area is um cryptos decentralized finance. Part of what I think is going on with the electric electric vehicle market and so forth, and there's a very there.

I think what we're seeing is a very very old and very well known pattern, which is, as new industries develop the very common patterns, you see a huge upswing in the number of participants and really experiments. So it's lots of new entrants, lots of money flows in, lots of people trying out weird and wacky stuff. By the way, it wasn't that long ago, Barry, you remember this and the dot com the same kind of thing, right, and you know, people go this is all crazy and wasteful, right, Okay.

What happens is then eventually the market sorts this out almost think of it as a Darwinian process, and then you have the come down the back end. So there's a lot of exit through companies going bankrupt or consolidation and so so for the market determines what is legitimate what is not, and lots of things go to zero. But at the end of it, what what distills out is something new and something important. So until and this is sort of standard setting as well. So I think

that a good example. What's going on crypto. I mean to me, that whole complex something that's very real. It's gonna be It's gonna be with us. Um, much of what's going on out there is not going to survive, but there will be things that survive and will be making important contributions to our economy. You're about to say something, well, I was gonna I just wanted to put into context because you biased the audience like pulling yourself an old

fog and referencing the dot coms. But if you look at the history of bubbles, and I don't mean that in a negative way. In fact, um Dan Gross had a great book pop Why Bubbles Are Great for the economy. You can look at telegraphs and railroads and automobiles and televisions and computers and fiber optic can go through every one of these technological innovations and they all follow that

exact path. There's this Cambrian explosion of experimentation. Lots of companies, most of which don't survive, but the ones that come out of it are our game changes really move the needle, right, and we and the and the point being we don't know a priori which ones are going to succeed or fail, right, it gets sorted out. It's a sort of a big, messy sorting out process. So so I think that's a little bit of that's a big part of what's going on.

So things like I mean, electric vehicles, this is this is like the canonical example of how this works, right, And you know, the main academic on this, I know, Dance book is actually really good book and an interesting one, but you know, sort of the canonical the main the main academic on this a guy named Stephen Clepper who was a professor at Carnegie Mellon. And Clepper has wrote very seriously about this and documented, as you point out, all these these basics. So it's the flow of of talent,

it's the flow of money. It's the flow of entrepreneurs to try to solve problems with some new tools at their disposal, not knowing in advance what's going to work. By the way, I mean this is now will nerd out for just one second. I the first time I ever wrote about this, it was in actually the context of ners old development of children. And it turns out that like the number of neurons in your brain actually

don't change that much through your life. What changes radically is a number of synaptic connections between their the neurons. And so from the time you're borns some time you're about two or three years old, there's this huge upswing and synaptic connections. So a three year old, if you've ever met them, you know they're not super efficient machines, but they're they're really open to the world, so learning language is a lot. They're very curious about the world

and so and so forth. But they're inefficient. And so what happens then is this it's called the heavy and process. You use it or lose it. If the connection works, you use it, and if it doesn't, it gets pruned away and you have this massive reduction number of synaptic connections. So scientists were interested in this there, you know, so they documented this whole process. They're like, well, this is kind of weird though, right, because the brain is a

very costly mechanism. You know, it's twenty of your energy usage and this big thing on top of your head, and you're vulnerable and so and so forth. And it turns out that they sort of simulated this, and it turns out this idea of trying things out and then winnowing is one of the best ways to learn about an environment, Isn't that cool? Right? So in a sense, what we're doing is these are these these Cambrian explosions.

You described our methods financial and technological and entrepreneurial methods to learn about the world and figure out what works. So, so two comments on your nerd ing out, which I'm totally loving. First, if you haven't seen American Utopia David Burns play, it actually starts out with that exact discussion of the the childhood, the infant brain making all these synaptic connections and then just letting a trophy that which

doesn't work. And so what you're left with is a very efficient set of things that the brain knows actually

are successful connections. But second, there's a fascinating book which you and I may have spoken about previously, called The Last Ape Standing, and it talks about how Homo sapiens came very close to not surviving the Last Ice Age because of how energy intensive the brain is and what works really well in most environments doesn't work in a in a resource poor environment, and the Ice Age turned out to be a very research poor so that the book kind of says, hey, we were not We were

down to about ten thousand Homo sapiens a couple more years of bad climate, and you know this might be uh, this might be in neanderthal world, not not a human world, which is kind of kind of interesting. Um, so we could we could walk out about a bunch of other stuff. But I want to bring it back to to um earnings and value. One of the things in the book you talk about is investors believe price earnings multiple determined value. But you argue that sort of backwards price earning multiples

are a function of value. Am I Am I getting that right? Yeah? I mean you are if you think about it. I mean the formulation is the um E times PE equals p right, right, And so what you're saying is, in order to forecast price, you need to know the price of which is the numerator of the pe right. So in a sense there's a bit of a circular argument. So um, I mean, I don't want to dwell too much on that. We've beaten up a

little enough on multiples. But the point being again, multiples are are not valuation their shorthand for the valuation process and with that shorthand or all the good things about saving time and with that shorthand or all the bad things about limitations and biases and blind spots. And so if you do not, if you are not aware of those limitations and blind spots, you're going to be I

think ill served by using simplistic measures. Quite interesting, Let's talk a little bit about modeling, and you use a number of examples in the book. Companies like Shopify and Dominoes couldn't be more different, but they each present a challenge to traditional analysts ability to understand the business and forecast using old approaches. Both companies have been incredible performers.

People don't realize Domino's is one of the best performers of the past twenty years, if not the best, it depends on where everything closes by the time people hear this. But right, Domino's top five, maybe even highest performer in the past twenty years, is that right? Actually don't know that, but yeah, that sounds right. It's a great it's an amazing business. So so let's talk about how do you model these in a way that gives you a better

insight into their future prospects? And what's the difference between expectations investing and the traditional way analysts have been modeling these? Right, so maybe we should take those will take those in turn because they're slightly different flavors of what we're trying to do. So Domino's Pizza was the case study. So the key is that when we go through the expectations investing process, understanding price and pliant expectations step one. Step

two is doing strategic and finance analysis. Step three is making buying cell decisions. It's really nice to have a case study to make it concrete. Now. Um, the case study for the original book was Gateway two thousands, which lasted for like three years after the boxes that were directed. Seemed like a good idea at the time. It was called so anyway, um, that's execution risk gateway and Dell

had similar models. Dell just executed, they did, they did, and so so the idea, so the truth of the matter is very like, this is how the smoke filled rooms, how decisions get made. We're like, let's find a business that's pretty straightforward to understand that we hope will be around for a while, right, and if they leave it'll be for reasons like they get bought out or so pizza pretty understanding. So so the nature of the business

is pretty understandable, and it is a franchise business. It's a it is a very beautiful business, and it's a nice business to explaining. Also strategically, because they made they have another they made a number of strategic decisions along the way that allow us to explain why their their business has been good in their strategic behaviors. And and by the way, strategy often boils down to things like

it boils down to trade offs. And one of the big tradeoffs that Domino's made early on which they were took to they've been taken a task from from time to time is that you don't eat there, right, you don't go to Domino's two. I mean, there's there's some there's some minor exceptions to that, but that's for the most part true. And so what are the upsides and downsides to that basic thing? So Domino's was, and and

again they are. They are a very uh intangible intensive business in the sense that the business we're looking at is the owns the essentially is the franchise or right, so they own all these things and their their primary function is basically to get ingredients and boxes to the different franchisees and then to advertise for everybody. So essentially

they're an advertising machine and that's what they do. Um it sounds like a lot of brands, marketing special not specialty know how, a lot of intangibles, and a lot of technology. So the the other thing is they're very good at technology and have always been very good at technology. So for instance, if I can help my franchise the understand their labor demands, their product demands, if I can make things uniform, in fact, they do a lot of

stuff that everything becomes very uniform in the kitchen. That allows for them to deliver efficiently, to work the work the kitchen, fit, to hire people efficiently, all those kinds of things, and those are those are really difficult advantages to to take away. And then they've been digital early, so what you know, ordering online, so and so forth. The second example is Shopify, and that's a little bit

of a different thing. So we have a chapter dedicated to US chapter eight, and it was called beyond discounted cash Flow. And so the the idea is that sometimes you you know, you look at the businesses you can touch and feel, and you run the numbers on it, and it just have a hard time coming up with anything close to the current stock price. And you might immediately say, okay, well this is this doesn't make any sense.

What we what we suggest is that for certain types of businesses they may be candidates for having some real option value. So what is a real option When we know about financial options, right, these are the right but not the obligations. Typically, for example, a call option is to buy a particular stock at a particular price at a particular time. A real option is analogously for a real investment in a business. Right, So this is for companies.

And so what we argue is at certain types of businesses and the conditions are things like you wanted to be an uncertain business, right, because where there's a lot of certainty, there's not a lot of option value. Rights of volatility is good for options. You want to management team that's thoughtful, so they need to know how to identify and cultivate and ultimately execute on those options. Market leaders tend to be good because often when there are opportunities,

the market leader gets the first call. And then finally, you need access to capital. When you say to we have a great option, we want to X your size it, you need to be able to finance it, right, And so when those characteristics, those sort of boxes get checked, you may have a business with some real options value.

Now in that case, our our our study from twenty years ago was Amazon dot Com and that was probably just dumb luck that we picked Amazon, but that was that turned out to be sort of one of the

great examples of a real options company. And just think about a WS wasn't even a twinkle on anybody's eye in two thousand and one when we wrote that version of it, but but we did identify it as a company that had a lot of uncertainty and what was going on on an executive who seemed to be pretty astute at figuring these things out, and along the way he I mean he made many many mistakes, Jeff Bezos did, but along the way he actually made a lot of

really interesting, good capital allocation decisions. So so that just shows like for all the mistakes that he made and many even great executives make that they they are able to allocate capital effectively. And Bezos talks about, hey, we're not making enough mistakes. If there aren't enough fire phones that are disasters, we're not trying enough new things. You know, Amazon Prime, next day delivery, Amazon Music and video and web services were all because they were throwing stuff up

against the wall to see what happens. If you're not taking a risk, you're not getting the upside. That's exactly right. And so so the question would be something like, um, if if you think that as a potential for a business, and it's obviously not in the touch and field today with things you can see today, should you be willing to pay for that? And how should you be willing to pay for that? So we have a little section on real options, and we talked about how to value

those and some more formal techniques. But but that is leaving aside all the numbers and all that the keys. It's a mindset, right and and so there may be you know, are especially although if you can get this optionality for free, that's fantastic, but even if you're willing to, if you need to pay a little bit for it. By the way, there are other people like you know, the Bary dealers of the world. He's just another guy.

I just think of Barry Diller, and I think that guy understands options as well as anybody out there, right and for the businesses, so there there's certain executives that tend to do it, really because he's managed to assemble a conglomerate of very disparate businesses that all seem to work very well in his portfolio. For lack of a better better word. Um, but he's not running a mutual fund. He's running a real operating business. So that's how you

would define optionality. Real optionality is identifying those opportunities and then taking advantage of it. I think that's right. And he's been doing this for a long time. By the way, this is not like a recent thing. This for a long time. So by the way, I previously had one of your colleagues on as a guest. Dennis Lynch was quite fascinating. He's really an interesting individual. Dennis is awesome. Yeah, not just is not only a great investor, but a

great a great guy. And this is these are things that tend to get underestimated, by the way, is that organizational cultures are really important. And you know, he's just created an environment that I think is is about a good environment for an investment organization as possible, and that's very challenging to do. People don't realize how hard, especially during COVID and everybody remote, maintaining that is really difficult.

I agree, and I think part of it is that, I mean, there are two things that I particularly admire. One is there's a clear drive towards learning, being a learning organization, so there's a premium on people thinking and learning and so forth. And second is I think he thinks a lot about trying to put people in a position to be as effective as they can be, so putting people in a position to do what they do

well and what they're passionate about. And yeah, great, great guy, and I loved I mean, I love that episode, by the way, and I think that he's he's really and he doesn't and he doesn't do a lot of those things. So it's great for you. That was No, that was a lot of That was a lot of fun. Um.

So let's talk a little bit about market efficiency. Uh. One of the questions that when we were kicking around some ideas for this is have the markets got more efficient over the last twenty years, given given the speed information moves around, given the integration of technology and unofficial intelligence, is the market the same market as the two thousand and one market? Yeah? I think the answer those questions are always know that they're not the same markets, and

they're almost always grinding toward more efficiency. Right. So, and I think that if you did one versus one and go back over time, right and for all the reasons you decided that information is is nearly cost costless to acquire and so forth. Now, um, the one thing else to say that And and I, by the way, I

am very enthusiastic about systematic strategies and quantitatives tools. I think these are all things that even as discretionary investors, we need to integrate these things in a very thoughtful way. All that said that, in active management, the notion of judgment is not going to go away anytime soon, and so and and judgment as distinct from like I'm just forecasting or you know that kind of stuff. But judgments are not going to go away, and so we need that.

So when you think about in the very short term, so short term trading, were systematic strategies are just gonna be They're just so powerful. You know, if tomorrow is gonna be a lot like today, or day after tomorrow a lot like today, systematic things are gonna are going to be much better than humans and those kinds of environments.

But again, if you look out five or ten or fifteen years, and we talked before about these patterns of how industries evolve and so forth, machines have a very difficult time understanding those kinds of things, and humans can be I think a little bit more thoughtful about understanding who might win, who might lose for what reasons, things like measuring culture and so on and so forth. So yeah, I mean, it's always it's always a tough game, and uh, I just don't see it's gonna be getting a ton

ton easier over time. So so the markets becoming more efficient, Let me, let me ask that slightly differently? Are are we quicker today to discount the future? So and and

we briefly talked about, uh, the electric vehicle makers. If we're looking at Lucid and Tesla and Rivian in those companies footnote A hundred years ago, there were ninety different automobile companies before we were left with five and then three and now in the US and now um, here we are with everybody rolling out e vs and lots

of new EV companies coming out. Are we better able to look at this group and say, oh, yeah, eventually everything's gonna be e V and therefore these companies have value? Or are these closer to the meme stocks? And and I'm not asking for an opinion about any specific company, I mean, how are investors generalizing with any of these sectors? But we can use evs as an example. I mean, it's a great question baring and a few things come to mind. Um, the first thing I should mention, there's

a fairly recent academic paper. This is within the last few months, and we can maybe posted on the show notes or something to this effect. And it was its studied about ten thousand I p o s since nine and and then it actually went and tracked the future earnings and discounted them back to a present value and said how close was the I p O price to the actual performance of the business over time? And it turns out, I mean probably not shockingly. Is it on average?

It was about right? But there is massive variants and there is massive skew. Right. So the answer is the market tends to get this broadly speaking, but for any particular company, uh, not particularly well. So that's my first comment, say, I will enter all this into with some some degree

of humility. The second thing is there's a concept and we talked about in this the book as well, but it's a very well known concept of reflexivity, right, And so we tend to think about fundamentals and price action as two separate things. Right, So people always draw that, you know, the prices that thing that's squiggling all over the place, and fundamentals is things sort applauds along, you know,

and and so prices sort of chasing around. Um. What George Soros and many others have talked about in the concept of reflectivity is these two things feed back to one another. So the very fact that when price is up and a company can sell equity that allows it resources to pursue fundamentals in a way that it may not have been able to otherwise. Right, and so on and so forth. Right, and by the way, the positive feedback works on the way up, and it also couldn't

work on the way down, just to be clear. So I think even in electric vehicles we've seen a big dose of this reflexivity. And then the other thing that makes it this all very complicated is what's going on with interest rates and discount rates, right, and just I'll just spend one moment to explain this, because it's actually quite interesting if you go back and look at the history of interest rates, so on the X axis you would draw, you know, the history of real interest rates,

so adjusted for inflation. And then on the y axis, the price earning is multip so we can use like a Chiller cyclically adjusted price earnings multiple as an example. If you plot what PE multiples do, it's actually an inverted you. So saying this differently, high interest rates are associated with low multiples. That's that makes sense. Kind of medium ones are associated with higher multiples. Yeah, that seems okay, but you would expect this to be a continued linear relationship.

So the low interest rates effective really high multiples, and in fact that's how it happened. Occurs back down and low interest rates are again effectively low uh low price earnings multiples. So what's going on here? And the answer is usually historically low interest rates have been associated with sluggish growth because the fet is usually cutting rates in response to a succession. It's it's when you look at

the causal relationship, how you end up at low rates. Well, in this case it's following the financial crisis or a pandemic, but historically most cases are because the economy is in the test sluggish, and go back to the late nineteen thirties and early nineteen forties was another episode of hilary low very low discarnage. So so the argument here is if you have companies that can grow strongly through this low interest rate or low discount rate environment, they actually

get the double positives, right. One is the growth actually they do put up the numbers, and second is they get the benefit of a low discount rate. So so

it's a combination. You sort of throw those things into the mix and you get sort of these these sort of somewhat weird outcum but but again, um, early whenever you're in early days, as we talked about before, for electrical vehicles or anything else, when you're in early days, you're gonna there's there's there's a lot of jocking around for a position, and it's often not crystal clear who the ultimate winners or losers will be. So so let's talk a little bit about share buy backs. You have

a whole chapter on that. There is some controversy about share buy backs. Some people like them, some people think it's a waste of money. Um, I'm gonna disclose my take. I think as long as they were showing share buy backs, it creates an advantage for the most of the companies doing the share buy backs, first of the companies that can't. Whether that's a cause or effect is arguable. Hey, if you can't afford to do the share buy backs, you're

probably doing something else wrong. But that said, tell us a little bit about share buy backs, what's the significance of them, and what does it mean for performance? But by the way, I just can't get over this controversial for some reason. I don't I just don't understand why people seem so flummix by this issue because It seems pretty straightforward to me. Because of the anecdotes. There are terrible,

terrible anecdotes. General Electric bought a ton of of stock back on its way towards this, and I could give you a dozen other memorable examples, but that's a little bit of availability bias. You know, we we that's what we've seen, and so people always tried out the worst anecdote. I think that my favorite anecdote is Dell spent more money when it was a freestanding public company on stock

buy backs. Then they earned in profits their entire existence up until they were take in private, you know, a decade ago. Well, now now we're going back to the intangible argument and there versus their cash lows. By the way, can I tell I'll just tell a little maybe this a little bit out of school, but it's okay, I'll

tell this a little lot of school story. So, um, in two thousand and ten, I was invited to give a talk to the senior executive team at General Electric, and uh, this is right on the heels of the financial crisis, right, so this is a near death experience, right, especially for GEF the financial services division and so and so forth. Right, So, this is not a good you know,

it's a very challenging time. And um, I don't wear the stock was at the time is all pre split stuff, but it was probably in the low teen something like that, right, And um so I'm getting a cup of coffee before my presentation, and I bumped into the chief financial officer and he says, Man, the worst thing and idea that

we did is we bought backstock in the thirties. And I looked at him directly and nice, like, dude, You've done a lot worse stuff than that, right, And so you might say, Okay, it's not the accounting and all the everything energy capital. It was the share of what

is even all that now? And I just said, leaving aside all that stuff, Actually, I thought my my thought was going on the back of my head was much more about broader capital allocation and M and A activity M and A like what they bought and what they sold versus the buybacks and what they didn't buy, the opportunities they chose to pass on. So let me let me okay, if I'm allowed to nerd out just a bit.

First of all, there there is some there should be some people should have some psychological equivalence between dividends and buy backs and and and execution. They're different and distinct, and if done properly, buy backs can be slightly beneficial relative to dividends. But let's just say that these are a mechanism return capital the shareholders, albeit only those people

who are sellers are willing to take it. So here's here's my nerd my nerd out moment, which is I called the value conservation concept, and this is really the key point. So let's say you have a company that's worth a thousand I'm just making this up, and you have you know, X number of shares outstanding, and they decide they're going to return two hundred dollars to shareholders, right of the thousand, two hundreds going to go to

shahoulders um. By the way, they could it could be a dividend, it could be a buy back, it could be anything. It could be they could burn the cash in the parking lot. Right. So the point is that the value of the firm after this is executed will go from a thousand to eight hundred period. Right. Again, it doesn't matter what they did with the doing, it's gonna go from a thousand to eight hundreds. Okay, so now let's walk through three scenarios. One scenario is the

stock is over valued. Right, Let's pretend that was the g E situation. The stock is overvalued, so they buy back over valued stock. Well, the value the firm we just established goes from a thousand to eight hundred. That doesn't change. What does change is the relative positioning of the selling shoulders versus going shoulders. In this case, the selling shoulders are getting in quotes more than they should

so they're benefiting and the ongoing shoulders are suffering. Right, so they're getting their per share value just went down, right, And we can demonstrate, and we actually do in the book. We can demonstrate that mathematicad scenario too is a buy back undervalued stock. Right, So what's happened now is the sellers are getting less than what they're supposed to be getting, so they're in a sense getting ripped off. And what's left is the per share value goes up, the interns

of guide goes up for the ongoing shareholders. Right, So one of the points always make the money managers I as I said, well, I presume you own stocks because you believe that they're undervalued. Is that a fair assessment. If the answer to that is yes, then you always want companies to buy back stock because the presumption is somebody is selling for too low a price and your per share value is going to go up. Now, Diven, end of course, just goes to everybody and leaving a

side tax effects, everyone gets treated completely equally. So now what we talked about in the book is this thing called the Golden rule buy backs, which basically says you should buy back of stock only one is below fair value and basically all other operational initiatives have been met. Right. And again, Barry, I'll just let you put on your sort of owner of a business hat as well. You

probably think to yourself, all right, we've got financials. What I want to do is invest in all the ways in the business that I think would add value to our organization. And then there's something left after left over after all that, then we'll think about what to do with that money. Right, But your first inclination is let's invest back into ways to build value for our our

long term value for our franchise. Right, So so to me, uh okay, And then the last thing I'll say about buy backs versus dividends, which is really interesting and I think this is a very real thing, which is it's a completely different psychological thing for executives. So when they pay a dividend, they deem that to be a quasi contract, and they are loath to cut dividends. They want to raise the dividend, and the dividend is the sacred thing

that we want to preserve at all costs. As a consequence, by the way, if you look at a long term series of dividends versus other capital allocation things like M and A or CAPEX, where dividends are really stable series, I mean they do go down in recessions and so forth, but it's a super smooth series, right, because companies are really reticent to to cut them in there, and they're pretty conservative about growing them. By contrast, buy backs are

deemed to be sort of this residual. Right. Yeah, we paid all our bills, we made all the investments. We like, we got some money sitting around. What do we do with it. Let's buy back stock, right, and so the the the volatility of buy backs from one year to the next. So, so we went through COVID. What was the first thing that got cut. It wasn't dividends. I mean, dividends went down, but it was it was buy backs went from a lot to very little in a very

short period time. Someone did research showing that something like announced by backs are executed, a big swath never get completed because the world intervenes and sometimes you can't do what you said you were gonna do. Now that one we I checked that because that was true. That was that was true back in the nine nineties. That is not really in the United States. In the United States, most pro programs get executed. But that was that was a true thing, and it's more true internationally than it

is in the United States. Yeah. So so to me and bo Way, this is a whole another thing going back to how to think about markets. I mean, I actually think one of the very simple and many quantitative guys do this, but one of the very simplistic ways to think about markets is simply take take the SMPI, for instance, take the dividend yield plus the buy back yield and quotation marks, and then um and then that

that yield ends up being your return. Now, the last thing I'll say before I don't want to there's an e T f for that sharehold of value. That's a that's a good one. So the last thing lest I come across is totally like favorable by buy backs. Let

me just say, and you alluded to Dell. I mean, there are companies of buy back stock for the wrong reasons, right, and so the wrong reason would be something like to increase earnings per share or two offset to ocean from stock based compensation programs, and so and so from those net aren't necessarily bad, but those are not the proper motivation.

The last one, it seems that because of the way we treat stock options as a sort of non cost and it takes real capital buy back shares to make up for that, it kind of can mislead investors or it looks like you're hiding this dilutive thing you're doing in a way that isn't always transparent. And some companies have been more egregious than all, and I agree with that.

So I would just say that the stock based compensation discussion, and by the way, some SPC programs are great and others are not as good and so forth, so there's no one size fits all. But that's a separate discussion from the buy back discussion. So I would just say that those two things should not be intermingled with to one another. And I think your observation is exactly correct. They're are sometimes brought together in a way that may

not be productive. H But but you were gonna say one more thing about stock buy backs, which generally is you think it's a net positive for for shareholder price. Well, I think that that's uh, that's an empirical question which has been answered for decades. So the answer is that is yes. And and by the way, people have this perception companies pie back stock when they're high and they don't buy it when it's low. That's actually not true.

I mean, because I remember in oh eight No. Nine, nobody was announcing stock by backs, but I do have a vivid recollection of everybody was buying backs. Yeah, but if you do the numbers, the aggriant numbers are actually pretty good. And by the way, it's this is now not another a very big macro comment, which is companies are pretty good at selling stock when it's high and buying it when it's bad when it's cheap. Posatively, I mean, empirically,

we know that for a fact. That's so they're pretty good. So when they're retiring act, Yes, that's that's an interesting And by the way, that the reason I bring that up and why that's important is that when we talk about alpha, for example, alpha is a measure of excess returns, and of course it nets to zero by definition within

a closed group of the problems. Markets are not clos post right, They're actually open, and they're open that there are other entities interacting, and the biggest other entity interacting is actually corporation. So if companies are selling expensive and buying cheap, that means there's companies are gathering somebody alpha. So it's funny you say that, because I'm trying to remember which quant said it, and I don't want to

put words into Cliff Fastness his mouth. Somebody had written stock buy backs are legal insider trade, and you know how well the company is going to do. So if you're selling stock, it's you're less confident. And if you're a buyer, as a corporate entity, you should be doing so because you think the company's future prospects are bright and you know exactly why. Yeah. And by the way, the on thing I'll just mentioned is it just to be clear that buy backs were, I mean they're there.

There are histories like Telen's very famous for having brought back stock in the nineteen seventies and so forth. But buy backs were the wild West in the nineteen seventies, right, because you could be you could be charged with stock price manipulation. So the s the SEC put in a safe harbor provision in nine teen eight two, so there's

no real discussion. And by the way, people don't know right at the start of the best ball market, right is a really important day because you if you're thinking about returning capital to shareholders and you're thinking about the complete dividend plus buy back picks nothing before. There's no comparability before and after eight two. So the safe harbord

is important. So so even if companies have a symmetric information, the safe harbor assures that if they execute their trades in a certain way with particular volumes and stakes and all that, hence the legal insider hence they're good to go. They listen. Who better to know a company's own prospect than the management of the company. And that's probably a reason why quantz like buy backs and a lot of people track insider buying and corporate buy backs, because theoretically

there should be a pretty solid signal in there. Absolutely, So we talked about Shopify, we talked about Domino's I want to bring corporate management back to something you out and in a previous book, the paradox of skill, which states the higher level the level of competition, the more luck improves events. Now we know how that works in sports. How does that work in investing? How does that work

in business? Well, I mean I think it works across all these domains and just too And I'll just restate what you just said. The paradox of skill. Seys and activities were both skill and luck and tribute to outcomes most things. As skill improves, luck becomes a more important determinant of the outcome. So that doesn't seem to make any sense. And so the key is to think about skill in two different dimensions. The first dimensions absolute skill. And I think we'd all agree, and that was really

our comment about market efficiency. We look around the world, I mean, just look at the technology at our fingertips, that best practices of training for athletes and so over. I mean, I think we'd all agree without a doubt that it's as good as it's ever been in terms of how we are absolute levels of skill. And we can document that when we measure things versus a clock, so for example of running and so and so forth.

But the second dimension is really the key one for the paradox of skill, which is a relative skill, and the paradise the key to the whole paradox, as it says something like when what has happened over time is the difference between the very best and the average shrinks over time, so everyone becomes a little bit closer to

one another. Standard deviation of performance shrinks over time, and so um, you know, you know, because there you're a car guy, right, so you might you might appreciate this, but you know my understanding because I read one or two papers about this. But you know, the differential in the quality of car finishes in the nineteen sixties and seventies, I guess, was very high. So you know, you bought a Mercedes Benz it really was a better, right bank

versus you bought some other cheaper right exactly. And so now it turns out that you can buy pretty much any car. They may not they may not be bank vaults, but they're all pretty well put together. And they're finishes are all pretty good, and so on and so forth. So there's a good example of how you might envision how that's changed over time. So I think, yeah, in terms of you just when if you want applied to businesses best practices and businesses tend to be embraced until autuma.

Manufacturing might be one example that managerial best practices tend to find their ways and to keep people's minds training through school, business schools and so on and so forth. So yeah, I think broad broadly speaking, this is a universal concert. So let me have you addressed two examples of this that I think are instructive. One is allocators of capital. If you're in the investment management business, there really shouldn't be giant outliers and performance over long periods

of time. There might be over a couple of quarters or even a year, but for the most part, and we've seen some of this over the past couple of years, a few funds have exploded, done really well, some some hedge funds that have been all in on crypto, some people that were way early to the work at home work from homestocks or Tesla or what have you. Is the expectation when you see like somebody leading the pack by an extraordinary amount that eventually that just mean reverts

and and there's a degree of lucky timing. I'm not even saying luck, but just lucky timing versus skill. How do we look at outliers and market performance? Yeah, I mean part of the the the answer if you're if you're trying to avoid getting uh consumed by the paradox of skill in other words, where is the answer is to look for easy games? Right, So you're if you think you're a skillful person, you don't want to compete with other super skillful people. You want to find games

where your skill tends to be the highest. Right, so you know you're Annie Duke. Instead of playing with a high stakes table, maybe you play at the next leg stakes down where your profit per hours higher because your skill differentials higher. So you may be making less money, but you're higher skill differential. And so that might be that this is the interesting uh sort of almost come back to that idea that when there are new markets that open up, it can be the case that lots

of people are sitting at the table. Right. If you wanted to continue with this poker analogy, lots of different people with varied skills are sitting at the tables, some of who know what's going on in others who don't, and that those those those can be actually easy games, and that's an opportunity set that you're not gonna get

if you're only buying sp FI fund, that's right. And then that those those eventually get tightened up, right, so the people that are not the losers end up losing money and then they leave the table for for whatever reason, and then those seats get filled by more skillful players and so on and so forth. So eventually that gets

sorted out. But you there's there's a long history of markets, even as we've evolved toward more efficient broadly speaking, where they're these easy games have popped up, and you know, even like I was talking to Buddy Mine, who was an early options trader, and he's like, you know, they was like, it's like the eight is like the eighties, Yeah, the nineteen eighties, And he's like, oh, they introduced options on certain commodities, right, and they hadn't traded them before

in this particular exchange. He's like going, and he's like, so people start putting up you know, bids and offers for things, and he's like, you start figuring out he could put he could put on like these costless spreads at a guaranteed profit, and he's like, this doesn't make any sense. It's not gonna last very long. But like my HP twelve C works. And I remember, I'm just take advantage of it while I while I get it right.

So part of the answer, I think that the response, the careful response, would be something like, don't don't say like these people are automatically just lucky people. The question is are they playing in an easy game where they bring something to the table that others don't have. They've identified the opportunity and I'm taking advantage of it. Now.

The problem with the problem with easy games, generally speaking, is that the last well, ay, they don't last, but be if they do last, they tend not to be super scalable. So in other words, it's often you can't make billions and billions and billions of dollars in an easy game because people you know figure it out, so they usually tend to be smaller and nicheer and so forth.

I mean, I remember I was talking to a quant firm based in London, and they said that there they had some little strategy that was dealing with Chinese retail investors, and they said, this thing is like a little money machine, like every day we money on this thing, he goes, but little it just can't. We just can't do it in bigger size. But it's such a nice little thing. We just let it keep going, buddy like. But but it's it's just like, you know, steady, steady drum beat

of process. So we see that all the time when a firm returns capital to their limited partners and say they say, hey, we have enough money to mind this inefficiency, but it's not big enough to share with other people. And the exceptions when people try and push the envelope is you get a long term capital management situation where they leveraged up these inefficiencies and eventually the chickens come

home to roost. So let's put aside the investment side of luck versus skill and talk about how does this manifest in business. You you have you have lots of professional consultant companies mackenzie and go down the list. You have all these great business schools turning out these nbas and these j ds that are super smart, super insightful. They're they're steeped in all the wisdom of the business

cases that have happened into that environment. Do we really see luck playing a role in what companies end up being successful? Maybe for a few quarters or years? Um does that happen? Oh? Yeah, I mean I think for sure. It's actually funny because I are participated in an academic seminar where like like a non academic but academic seminar, and it was literally about this exact topic, which is how much what is the roles skill and luck in

UM corporate strategy setting? And and interestingly there is an academic that took this luck side and academic took the skill side. And you know, answer, of course is somewhere in between those two. I think your question you're asking is a slightly more subtle one, which is has it changed over time? And I think that the answer is um. That again as right, that's the basic principle is there's

more uniformity in the skill levels it becomes. Now. Look, the answer is for many famous business breakthroughs, and clearly this is very true for example, drug development, that almost seems like it's I mean those are I mean, I don't call them luck, but we'd say that there's a high degree of randomness and it's not exactly And so you know, you think about although, to be fair, some of the new technologies the I forgot what it's called the nose on a chip that allows the testing of

these jillion variations using semiconductors and software rather than RNA. What about RNA was an amazing You think about that's a decade plus in the making. Two people think it's a recent discovery. It's almost twenty years. That's amazing, Like you said, twenty years of and d sort of ready like all dressed up with no place to go just yet. And then when it became time to go, it went.

And by the way, that thing, I mean, my understanding is that these guys had that thing ready to go probably a couple of years ago, March of April four, specifically March of April and other words, it was ready to go, like almost right away, which is astounding. It's you know, there's one o the thing I'll just add Barry that you know, and we wrote a piece. It was in a slightly different context, but the piece was called Turn and Face the Strange, and it was about

why organizations are slow to change. By the way, the inspiration for that piece was actually a presentation that Dick Taylor gave at the m I. T. Sloan Sports Analytics Conference. So this is going to seem a little bit weird

that a behavioral economist talking into sports conference. But Dick's point was something like this, which is, there are certain things that we know work analytically is sports, You know, the three point shot, going forward on fourth down, stuff like that, and uh, it seemed to have taken forever ever for teams to actually embrace. And the question is

why don't teams do it much faster? So this is an interesting one where they're there, you know, we know that it works in quotes, we know and um, and yet the answer is it's not part of the conventional wisdom, and it's not part of the coaching guild. It's not what you learn as a player when you've grown up. And so it takes almost a generation or two for

these things to get woven. And now, now if you watch the NFL going forward on fourth down for the most part, and it's not it's for the most part, but it's happening much much more frequently so people have gotten the memo on these things, especially the younger coaches and so forth. The interesting story UM about Taylor is when Michael Lewis's money Ball came out, Taylor sends Lewis an email or letter saying, Hey, you're talking about Knomen

and Diversky's work. This is all behavioral finance, which is what eventually led to Lewis's book ten years later. Uh. The undoing part objects because he didn't realize he had really written a work, a book about their work. Kind of fascinating. And even with money Ball, it still took a decade or two UM for teams like the Boston Red Sox to start using things that Lewis had written about years and years before and ultimately led the Red

Sox to a championship. You know, it's interesting. My understanding is that UM, Danny and Thinking and writing Thinking Fast and Slow, which came out about a decade ago, talked to a number of other writers to potentially collaborate with him on that. One was Jason's Why, and I think Jason's edited about three quoters of Jason I spent thinking that thinks about a long time with him on it.

But the other one was Michael Lewis. Interestingly, so I think he actually spent a fair bit of time with Michael back when he was thinking about this, and I think he obviously went to ultimately and by the way, Danny is a beautiful writer, so I recounted writer to

and ended up doing it on his own. But that's an interesting but I think, like you said, between the failure thing and spending time with Conum and himself, I think that that sort of made it clear to Michael Lewis, who's just, by the way, insanely I love that podcast you did with him too. He's just an insanely talented guy. And anyway, yeah, he's he's been a regular. Some of the stuff he's written about finance is just so unique

and comes from such a special angle. There's there's nobody else who has his ability to identify the consensus, find the band of misfits that are challenging the consensus and are ultimately proven right. And it's just such a great story.

It works so well whether you're talking about baseball or finance or um high high freakingcy trading, or like I love that in premonition, it's the Bush white House's strike team that essentially creates all of the uh COVID response that was ready to go, and we really this really didn't need to be three quarters of a million deaths. It's quite fascinating. Well, we are way off topic, and I've allowed you to allow me to, um disrupt myself.

So why don't I jump since we're since we're already talking about all sorts of other things, why don't I jump to our favorite podcast questions? Um, and since we're talking about COVID, what have you been doing to keep yourself entertained during lockdown? Tell us what Netflix or Amazon Prime shows or podcasts you've been been staying busy with besides masters and business besides Yeah, um so so Bury My My, My confession is what you probably know is I don't watch a lot of tea and so I

don't have any good answers on that. Um I do. I do enjoy podcasts, and you know, I probably the one I listened to the most frequently is um is Patrick O'Shaughnessy's invest like the best, and I think he's done it really nice. But I'm also a big fan of like Tyler Tyler Cowen's conversations with tyler Um, Russ Reynolds, Russ Roberts, part of me. Rus Roberts. By the way, Russ Roberts has been doing these sorts of interviews before any of us started. He's been doing it for like

twenty years. So I'm fans of all those guys, but I usually go. I usually go if there's someone who pops up who I find to be an interesting guest. That's usually what motivates me to do that. So that's mostly what I do. And then I do. I have to say that I it's been an odd thing. I'm a I'm a fairly big sports fan, so I do

enjoy watching sports. So I have to say that one for example, even the NFL, I've enjoyed it probably more this year than I have in a very long time, just for whatever reasons, you know, because there, I mean, they play at the games, but it was a very different environment. Just feels like it's a little bit back to normal, and I've really enjoyed that. So let's talk a little bit about your mentors who helped shape your career. Well, there are a number of them that come to mind.

Many many of them are great. H Well, I'll rap report we've already talked about, and that I mean he would be sort of first and foremost, UM, and not just as someone who was a mentor and a teacher to me, but also a collaborator. And you know, so that that's the whole package. Bill Miller has to be up there. You know, Bill, Bill introduced me, for example,

to the Santa Fe Institute. And I don't know if you saw this, but Bill Um recently made very large a million dollars, which is a transformational gift to that place because it's a relatively small place. And uh so that will ensure that sort of complexity science is on the scene for for for a long time to come, which was really extraordinary. But you know it's not just Um. I mean, I think Bill is another one of these guys.

It has uh an insatiable intellectual curiosity, has a good has good taste for ideas UM and just a very thoughtful guy. Um. The two other come to mind, you know, it's gonna sun a little it on. One is a guy named Brady Dougan, who is was a former CEO of Credit sweetz Um now has his own firm. But Brady, when I was growing up in at equities in the Credit Sweeze back in the day. It was always a

big supporter. And when I went back to Credit Switez in two thousand and thirteen, it was because he was there and he offered me a really exciting opportunity to do that. And probably the last guy I've mentioned is Dennis Lynch. You know, I think Dennis. You know, it's interesting as I was thinking about what to do next and just sat down with Dennis, and you know, he had been early reader of a lot of stuff we've done, and again creates an incredible environment for work. Every day

is super exciting for me to get going. I can't wait to get going every single day. And as usual, I have a longer list of things to do than the things I can get done. It's just it's like one of these really fun sensations. So those are people I would mention that's fantastic. So I know you read a lot, So let's talk about what you're reading now and what some of your favorite books are. Oh Man alive, So I should be more prepared for this one. Uh

and p Us. I normally shoot these questions over to people, but you've you've been through this fourth appearance, so I figured out, let me, let me just wing it. I know that's bad. So well, what I'm reading right now is actually two books simultaneously. Richard Rhodes has a new biography of E. O. Wilson, the very famous biologist and and you know Richard Rose a very famous, talented biographer. And it's just a beautiful book. And I'm familiar with

el Wilson. By the way. El Wilson wrote a book called Consilience, which is you mentioned you keep saying consilient head of Concilient Research. And I assume every time everybody hears that, they go, I don't know what the heck he's talking about. So that's where let's connect that. We'll close that and we'll close that loop right there. And so I really enjoy that book. Um. I'm also reading a book now by Page Harden called The Genetic Lottery, So this is really about genetics and uh what we've

learned about and edics, inequality. A couple of books I really enjoyed this year. Stephen Pinker's book on Rationality has been wonderful. I don't know if you read that or know it, but I was familiar with many of the ideas in there. So it wasn't like it was brand new stuff. But he presents ideas in a very clear and compelling way and ways actually would help me even pedagogically as a teacher to explain it to other people. And probably I would say my favorite book this year

was a book by Fred Lodge of all On. It's a biography of JFK. So. He's embarked on a two part series on JFK. So this is the first one from the time he was born in v to when he wins the Senate in the nineteen fifties, and then the second piece will be obviously sort of packed in the last roughly eight or ten years of his life. But uh, I you know, and I obviously knew the basic profile of Kennedy, but it was I learned just

a ton about him. I learned a ton about his family, which I found to be and it's just beautifully written. So I let you learned a lot about world history along the way, and so and so forth. So those are someone's el mentioned. So those last two scientists EO. Wilson A Life and Nature and then JFK. Coming of Age in the American Century. Um, those are the two

books you just you just mentioned. So our final two questions, what sort of advice would you give to a recent college grad who was interested in a career in either investment management or a financial research Well, by the way, in many ways, it's a very exciting time. And when we talked about these intangibles and you know, from a point from the point of view understanding how those work and so forth, it it would be pretty exciting. But you know, the key for me is always too there.

There's sort of two things and they're probably a little bit hokey, but the first thing is you really have to set out to try to learn as much as you can, and so a lot of that is reading and studying on your own. You know, whenever my kids graduated from college and I sort of give him a hug and say congratulations and then say recognized. Tomorrow morning you wake up and your education begins, right, So it's

it's an ongoing process. Um. And then the second thing is it's it's tricky to do when you're young, but the key is as soon as you can is defined an organization where you feel comfortable and can contribute, and just the culture of the organization where you work is such a big deal. I guess the thing that maybe is what people are asking for more overtly is it would go back to this thing on easy games. So if you're st of saying, like where where are things exciting?

The answer is to try not to do what everybody else is doing. Are their pockets or areas where you can do something it's a little bit different, a little bit maybe more niche for now, or something that might grow or evolve quite quite interesting. And our final question, what do you know about the world of investing management today that you wish you knew thirty or so years

ago when you were first getting started. Yeah, I mean I think that the I mean I don't think that I didn't know this, but I think I underappreciate it, which is just the central importance of people for all this stuff. And you know, one of the pieces that's in one of our cues, so something we're or write on I've very fully outlined in this report is a report about feedback. So one of the really difficult things in our world is to get feedback, especially in investing.

So if you're buying selling stocks, ultimately it's about the stocks performing well. But you know, there's there's very little quality intermediate feedback. But I start the piece off by talking about riffing off of work by Phil Tetlock at the University of Pennsylvania on the super forecasters, and what they were able to sort of figure out is that these super forecasters have certain profiles and those profiles tend to be a key part of what makes them effective

at what they do. And there are lots of aspects of it, but one only one that I'll mention it's really important, which is this idea of being actively open minded. Active open mindedness is the key, right, and that means that you're not not only willing to pursue contemplate points of view that are different than yours, but you're actually willing to seek them out. And I'll just say that, you know, we all like to think that we do this.

The answer is no, not really right, Because once you've made up your mind about something, the past least path least resistance is just like look for stuff that confirms it and just keep on moving, right, because if you're confronted if you have to change your mind or two things, when you have to change your mind, which itself is a pain, and then you may have to change what you do right, which is actually another pain right, so most of us would rather not be bothered with that.

So so that would be the one thing I just say, investment management is is it's this drum beat, but it's the people and the culture is becoming really the secret sauce to long term success. Really good answer. It's funny we we started talking about we started talking out about

inflation and never got back to it. When I have my um, I have my expectations in my viewpoint, and whenever I want to share a chart that supports that view part I that viewpoint, I always try to describe it on Twitter as today in confirmed firming my priors here, something that agrees with something already said. So at least there's a tiny hint of recognition that hey, you're not thinking, you're just you're just finding something that agrees with you

and sharing it, which we all do. But at least if you admit it, you're you're part of the way to us. I would say, Barry, I don't know exactly when we met, but I remember one It was an early instance where I wrote something and then you wrote me back and you said, hey, man, you wrote this thing and it's not right, and you know you you

got this basically thinking wrong. I think it was like weapons of mass destruction, you know, prediction market or something that there was something like a weapons and I wrote something about weapons of mass destruction and and you know Iraq or something. You go that this is not right. And I thought to myself, like, you know, first of all, so of course it's someone's telling you're not right, But but the way you did it was really interesting, and

I thought, really constructive. So it was not like, dude, you're an idiot. It was It was not like that day. Maybe maybe maybe at least that's not the way you came across. You came across saying like, hey, I think you got this thing wrong. Are some other stuff that you may want to consider when you think about this topic going forward. And I was like, you know what, I'm down with that that that's good. Like right, it was shot. Maybe it was shockingly diplomatic, but that's the

way to do it. So it wasn't about you took it immediately away from being about me and immediately about there might be other ways to Did it change your minds? Did it affect you? It did change. I think it did change my mind because I think and I think you end up being sort of the front end of what ended up being the correct interpretation what was going on,

and well that I do all the time. It's a lonely place, but I will tell you the challenge is when you're right about that sort of front end stuff, you're not always right. We thought you're gonna be wrong frequently. You have to be ready to say and that's why every year I put out, hey, this is what I got wrong here in my mea culpus, because if you don't do that, you have no right to say to a Michael Mobson, hey dude, I think you're not right about this. Take a look at a look at that anyway.

I appreciate that because you actually did it in a way that was tactful and respectful, and that was I think just take credit for I'll definitely, uh, I definitely will. Hey, Mike, this has been just fantastic. Thank you so much for being so generous with your time. We have been speaking with Michael Mobison. He is the head of Concilient Research

at Counterpoint Global at Morgan Stanley's investment management group. If you enjoy this conversation, Well, be sure and check out any of the previous three hundred and nine two ones we've done prior. I promised by the time we get to four hundred, will we'll start getting these right. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. You can follow me on Twitter at rid Halts. Sign up for a

daily reading list at rialts dot com. I would be miss if I did not thank the crack staff that helps us put these together each week. Paris World is my producer, Michael Batnick is my head of research. Atika val Bron is our project manager. I'm Barry Rihults. You've been listening to my student business on Bloomberg Radio.