Running Oak's Seth Cogswell on his Efficient Growth Strategy | S07 E40

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Which one's better? I don't know. We're debating when we start live streaming. I think we're live. So one side of my dashboard says we're still sitting out, but apparently we're broadcasting. So I'm Tobias Carlisle. As surprised as anybody. This is value. Let me try again. This is Value After Hours. I'm Tobias Carlisle, joined as always by my coast.

co-host Jake Taylor. I was going to say co-star, good grief. Ooh, co-star, I like it. Our guest today, our special guest today is Seth Cogswell of Running Oak. How are you, Seth? I'm great. Thanks so much for joining us today. Let's talk a little bit about your investment strategy and your philosophy. Let's get going. What is your investment philosophy and how is that implemented in your strategy?

So I'm going to describe our investment strategy in three words. It's consistently not stupid. That's based on a line by Charlie Munger. Charlie Munger attributed much of Berkshire's success not to being geniuses or the smartest guys in the room. It's more just being consistently not stupid. And it fits our strategy so perfectly. So when I read that, I was like, all right, that's it. I'm stealing this. Our strategy is clearly not stupid in that it's built upon

three very simple common sense attributes. So the first is maximize earnings growth because, you know, if you're investing in companies that are growing in value. Great. There's no arguing that that's not a positive. The second, though, is being very disciplined around valuations.

you know if you have a company that's worth this in the real world that's operating in the real world and then you have a stock which is the price of the stock is determined by price and or supply and demand which hopefully at some point is is equivalent to the company in the real world we want to buy when the stock is undervalued we want to sell when the stock is overvalued and really you know so again maximize earnings growth discipline around valuations it does not pay

to own assets that should go down let alone a lot over the long run and then the last is a focus on downside risk For the very obvious reason that you drop 50%, you have to double your money to get back to flat, which is very hard to do. as opposed to if you experience a 30 percent decline which is never fun you only need a 40 return versus 100 to be making new highs so again it's

It's not stupid. It's super simple, obvious, common sense. And then that consistently our process is rules based. So we do the same thing over and over, which makes for a reliable. portfolio or strategy that, again, any client or advisor can plug into portfolios and expect. They all have reasonable expectations for precisely what we will be providing over time. So again, consistently not stupid. Let's talk a little bit about growth. How are you thinking about growth? How are you diagnosing it?

What are the conditions for growth? Growth is tough, right? Because it's forward looking. One of the reasons why our strategy is a little more quantitative in nature and rules based is because my father created our strategy. started out in the 70s at a large bank doing discounted cash flow models, which anybody that's ever had a pleasure doing that, you're basically trying to predict the revenues of a company.

three to five decades into the future, despite not actually knowing what those products are. So good luck on any of that. And so the strategy was largely a result of going a completely different route and really trying to focus on what's known.

versus unknown but again growth is looking forward so it's certainly unknown and that ends up being a smaller part of our of our approach but regardless the way we look at growth and there's a number of ways you can look at it but we focus on earnings um you know earnings can be manipulated so maybe one could argue that cash flow is a good Good, good metric to look at. We choose earnings because again, that's really what's coming back to the shareholders over time.

you know we measure growth in a number of ways we look at the one year expected return three and five um you know the goal is again it's inherently faulty but we want to position the portfolio in a way so that the so that it is consistently on average creating uh more value for clients over the long run so historically our portfolios averaged 12 to 13 percent earnings growth versus six to seven for the s&p so that's six percent gap we would expect to provide value over time

So do you think that it sounds like you're looking often for predictability in the business? And do you think that the market tends to overprice or underprice predictability? I would say underprice, actually. Predictability is boring. Really, the sweet spot that we're looking for, the inefficiency, is companies that are, again... growing at a good rate. They're high quality, which I describe as just well run. So they're profitable. They're not taking on crazy amounts of debt, which

I think will matter a lot in the near future in that you can get them at an attractive value. Usually if you're getting something that's relatively undervalued, it's because they're not exciting. right you've got money flowing into the most excited names, whether it's the Mag 7 right now, which everybody knows. Everybody either owns the product or uses the product or at least knows the company. Their hairstylist probably told them they should invest in it just the other day, right?

And so you've got all this money flowing into these names not because of numbers. It's flowing into these names because of popularity. And that popularity takes those companies up. It takes the index up. And then the companies that are less popular just sit there because they're not receiving, you know.

an appropriate amount of money and so that creates that undervaluation but again growth is is inherently unpredictable trends are kind of unpredictable let's not say that we shouldn't pay attention to them but they but be hard to predict And so the things that are most predictable, such as, let's say, like industrial companies that are just rolling along doing their thing, nobody cares about them. And so it creates that relative undervaluation.

Do you have any idea, like, have you modelled what growth you've actually received versus what growth you've expected? Do you find that you're on the money or does it fall short or do you sandbag it a little bit and you find that you're... surprised like how have you have you tracked it i wouldn't say that we've tracked it directly um but i will say at least from 89 to 2000

13 so before i i launched uh running oak in 2013. again my father ran the strategy prior to launch i actually ran it for five or six years from 2007 to 2013 or so um but regardless from 89 to 2012 2013 portfolio outperformed the s&p by roughly three and a half percent before fees annualized just top one percentile returns or so but again that what we have tracked is that

uh on average our growth rate was 12 to 13 percent so you know there is a gap there between if we're outperforming by six percent on a growth you know as far as growth goes but then outperforming by three and a half which is still great um you clearly there's a gap there so i don't really know how to answer your question other than to say there there definitely appears to be a little slippage there

yeah a little compression which is about what you'd expect to see that's what i would have expected to see anyway let's talk about valuation a little bit how do you think about valuation From what I've seen, and it's a big world out there, there's a lot of people in our industry. We value stocks very differently from most. And even just talking to you before the podcast, I would imagine you're taking a much more maybe discounted cash flow, really, but certainly a much more fundamental.

approach or a deep dive what we do is a relative valuation versus the s p 500 so we actually look at You can think of it as two ratios where we measure the wealth creation of a company versus the wealth creation of the S&P. And by that, I largely mean earnings growth. So over time, and again, this is five decades, over time, we have found that price.

will follow wealth creation or relative price will follow relative wealth creation. So if we see a company that's you know creating wealth or earnings at 2x the rate of the s p we would expect over the long term for the stock price to do the same and then in between you're getting you know again because uh stock prices are driven by supply and demand they're they're kind of swinging around that true value and one of the things that's really

illustrative to me to give me you know confidence just that we're moving in the right direction as you can see that sort of relative price swinging around that relative value so again it's different But we've been doing it for a long time and it seems to provide value or have merit. Is it like you're looking for like a market PE with a higher growth rate? Is that the way you think about it?

Or better than market PE with a higher growth rate? Is that kind of the mix? Kind of. I mean, PEs have been proven to be absolutely worthless as far as predicting returns. But... peas are also a helpful snapshot right like it gives you they're backward looking but it gives you a chance to kind of see where things

lie right now forward p you could maybe say is a little bit better um but again it's a snapshot right like it's just one year looking forward and and inherently it's faulty also because it's it's based on you know prediction um but yeah so it's that's a good way to sum it up it's it's different but but that's still a good approximation so

Do you favor a DCF type approach then? You don't like the DCF or you do favor a DCF? DCF is almost entirely prediction. And so our strategy is... is intentionally built on characteristics that we feel that we can rely on so again You have companies that are increasing in value intrinsically in the real world, right? Never mind the stock market, because that's going to do whatever it's going to do based on emotions and FOMO, especially right now.

But then also being where does that relative valuation of the company lie as far as the stock price versus what we determine the value to be?

in the in real life and then again we focus on a number of things that i'd say clearly lead to greater downside risk but again those they're three very simple principles are kind of Again, the valuation part of it is a, I don't really like the term proprietary because it sounds a little stuffy, but it's definitely like a metric or a calculation that I've never seen anyone else doing.

It's not DCF, but again, it's a more thoughtful way than looking at PEs or looking at price to book and allocating just...

based on whatever has the lowest P or the lowest price to book. Okay. Talk to us about downside risk. What sort of things are you looking to avoid or what red flags are you looking for in your downside risk assessment?

so over time i mean if you go back to 89 again our our portfolio has had basically 50 of the average drawdown of the s p which for me i feel the average drawdown is the best metric to really measure or gauge the discomfort that clients experience when a market goes down because it measures both how you know how much you're down as well as how long you're down there so for me average drawdowns

much better way to really again measure how a client feels risk than say downside capture or standard deviation or 13 or anything like that. The biggest driver of that, in my opinion, is avoiding overvalued companies. Valuing companies is hard to do. A lot of people do it in different ways. A lot of them have merit. Some probably don't. But regardless.

At least philosophically, you can't argue that owning a company or owning a stock at $100 when the company is worth $50 isn't begging for trouble at some point. there's a and there's a few great examples right now there's probably a lot of great examples right now but uh you know apple apple's an awesome company two of my closest friends work there i wish it well i love their products but its current p is 39 or so long term its p is 14 to 15.

That's kind of average where it's at for a long time. That means that Apple could drop 50% tonight, and it would still be really overvalued relative to its historic norm. Same with... Again, great company, but same with Microsoft. Microsoft has a price of sales of almost 14 now. And one of my favorite quotes, within the market is a quote by Scott McNeely, who is the former CEO of Sun Microsystems. And he said,

I think I believe he was getting a hard time for losing people's money. I'm sure he was sued for people investing at the peak of the tech bubble and then get mad at him. But he was like, look. i'm running the company you're the ones that paid 10 times price of sales that means that that meant that over 10 years we had to return every single penny in revenue just for you to break even

not make money for you to break even, which assumes that we have no employees. We're running a big company. We have a lot of employees. it assumes that we have no cost to get sold or r d we're a tech company we have to constantly innovate and also assumes you don't pay taxes if you go if you guys don't pay taxes you go to prison so don't come to me about

you paying 10 times price to sales. And the thing is, both Microsoft and Oracle are 40% beyond that. So 40% beyond the very peak of the tech bubble. Now we're in a dynamic time. I don't know how all this plays out with AI. I have a sense of how it plays out, but regardless, I don't know how it'll play out. But the main thing, to answer your question, is that's just...

risk, right? Like of 40% beyond the tech bubble, just maybe it works out, but what if it doesn't, right? And so that's our goal is to really avoid that what if. Because what I've almost always comes to pass, it does very often. And so Microsoft, again, awesome company, seems to be like leading the AI battle at the moment, but it could drop, you know. 70% and it wouldn't be a big deal. It would not be a steal if Microsoft dropped 70%. Maybe on a PE basis, it would be a lot more attractive.

The focus on valuations and avoiding companies that should go down, let alone a whole lot, is probably our biggest, our greatest value add. But...

Another area where I feel will be very important over the next decade is debt. We all know that if we... mortgage our you know max out our credit cards to go buy a boat or something that it's probably not going to work out very well like it's it's it's we're headed for some pain And in the last decade, companies took on more debt than any time in history not to build better companies that could then pay that interest, pay down that principal, and make profit on top of it.

They just bought back stock. Buying stock has some benefits, but if you really think of it as most simplest form, basically these companies mortgage their futures because they got to pay that back at some point. And then they handed that cash to discerning individuals who were selling their stock. And so, again,

It's neither good nor bad buying stock. It could be both ways. But if you're mortgaging your future to do it, that's taking on risk. And they did that when interest rates were quite low. Interest rates are now a lot higher. More than likely, these companies are going to have a lot of them are going to have to refinance at higher rates, which will hurt profitability. Profitability is one of the main arguments for better or worse. I actually think it's a dumb argument, but.

one of the main arguments for higher P's or higher multiples. So if you see profitability decline, and you see multiples decline now you've got like a double whammy and contraction and and that just assumes the company is performing just as well as it always has right like that's that's not assuming any adversity that's assuming just reality and so avoiding that i believe will be a significant value add going forward it's starting to sound like i said

I think that's a compliment. Other than that, though, it's all good. What a crazy bear. Let's talk a little bit about passive. You're not a fan. I'm trying not to position it in that way, to say I'm not a fan. I think one of the issues that drives me craziest in the world today, both in real life and investments, is this tendency to see everything in black and white. It's either my team or the other team.

Most aspects of life are in the gray and passive is very much that. So, you know, I'd say that John Bogle had a very positive impact on the industry. Prior to Vanguard, many fund managers were charging massive fees and providing no value whatsoever. That didn't benefit anyone other than, I guess, a handful of managers, right? But in the end, any...

Any industry or any company that's not providing service or value to the end client shouldn't exist. They should just die quickly. And the investment management industry. didn't seem to be providing a whole lot of value for the most part. Bogle provided an alternative. He was like, look, if you're not even going to get market returns, or if you are, and you're going to pay a high fee for it, why don't you pay little to none for it?

Fine. There's no arguing that paying a lower fee for the exact same thing you were paying a high fee for isn't better. And that also had the benefit for investors of bringing fees down across the board. um so that's that's a positive the other thing is a lot of people made a lot of money in the last 15 years being invested in in passive which is a good thing now the issue is

Why did that provide so much value? And that's my concern is that people aren't really considering context. So again, lower fees, good. Investing in a strategy that... to a certain extent makes no sense that's bad uh and so when i started in the industry um you know passive and active that's really when this this this battle was really raging. And the idea of investing in a company simply based on size just seemed like the dumbest way to invest. I mean...

If you're looking at two houses, you're not going to pay 25% more for a 5,000 square foot house than you would for a 4,000 square foot house without at least walking inside the house, right? You're probably going to do a home inspection. There's no investment.

where you would just be like, ah, this is bigger. I'm just going to pay more. I'm going to put more of my money in it. But that's the way that passive works. Now, that said, as time has gone on, I've kind of... you know that my view has evolved and and one of the things that i've become particularly upset about and worried about is um whenever a manager anybody in investments

as well as advisors whenever we speak with a client about investment we speak about two things what are those two things that we would talk about the two main things oh that's a question for us returns returns and fees no what's the no return the fee matters but what's the other one risk yes yes which one matters more i would argue that risk

in the long run, matters more because that money matters. People have forgotten that risk matters because we haven't experienced a true downturn in 15 years. But when you need that money that you've worked so hard for and it's not there, that is a whole lot worse than if you have more money than you needed. And so passive. has somehow gotten away with completely overlooking risk. The only way that the passive narrative addresses risk is they say, ah, market goes up on average. You'll be fine.

That's absolutely ridiculous. What if you're retiring in the next three years and we go through a lost decade, which the odds look pretty high of at the moment. and you're having to pull out money after a big drawdown, which absolutely destroys your cumulative returns over the long run. There's a lot of data points. There's no arguing that.

The other thing is that's conveniently overlooked is the behavior gap. I am not immune to making dumb decisions when I'm emotional. I've made plenty of stupid decisions. And when. We, as people are stressed out, if we see our net worth drop 50%, we are inclined to panic. and sell because we don't want to experience any more. So, yes, we've got the people who sold us passive. We've got S&P saying, oh, well, you know.

it'll be okay just hold on you know are you going to want to pile more in no and you might sell and that destroys returns so conveniently completely overlooking that also bothers me Sorry, I'm getting a little long winded. I clearly am a little passionate about this. But the the other thing that I recently had kind of an epiphany on is.

You know, we'd have this active passive debate and everybody brings up the data, which I would argue is as henpecked as most data is. I don't think a lot of it's valid, but regardless. If you break passive into its simplest form, so if we just look at it on an individual stock basis, again, we're going to use Apple because everybody knows it.

Apple is a company. It's operating in the real world. It's selling products. It is worth this amount of money, right? If it's a private company, we would work with a number of auditors to come up with a value that somebody would buy it for, right?

it's a company it has a value now the stock is driven by supply and demand so if there's a lot of demand it goes up if a lot of people are selling it goes down whatever right it's swinging around let's say at one given point in time we used to think the market was efficient that many would argue that it's just broken now but regardless let's say at some point the market's efficient the price of the sock is equal to the value of the company somebody bought an imac two months ago

They're doing some sort of doing something on it. And they're like, man, my iMac is the greatest. I love it. And so they turn around and they buy, let's say a million dollars of Apple. They're pretty wealthy. Buy a million dollars Apple. That demand is going to push the price of Apple up. Again, nothing changed with regard to the company because they bought that iMac months before.

But now the stock price is higher. Because the stock price is higher, it's now a higher percentage of the S&P. And anybody that invests in the S&P from here on invests more in Apple because it's overvalued. Then... We were talking earlier about momentum. I can't imagine how much money is in momentum strategy at this point. But regardless, a momentum manager says, hey, Apple's flying.

We need that. And so more is invested in Apple. That's going to push Apple up even further, that demand. So now because Apple is even more overvalued, it gets an even higher percentage of the S&P, which means that everybody invests in Apple. now buys even more because it's overvalued. And that keeps going, right? We hit the 99.8th percentile in history in momentum last year.

That dynamic of paying more and more for companies, the more and more overvalued it gets is historic. And the thing is that... The S&P or passive never sells, right? They don't sell unless it gets to a certain point where the committee that runs the S&P says, you know what, we should kick this out. So it's literally the exact opposite. of buy low, sell high, which as a value investor or as anyone that's even remotely thinking critically about investing,

Everyone's hopefully looking to get good value on the buy and to sell when the value is positioned to maybe work against you or you've realized that value. Passive is the exact opposite. passive is neither good nor bad it's good in that it brought fees down it's good in that it's it really simplifies investing it's certainly better than chasing mutual fund returns or or day trading

But I do believe that there are far more thoughtful, far better approaches out there. And so it's, you know, it's in the middle. I would say to the abdication of responsibility of ownership. of all of these businesses actually adds a fragility to the future cash flows of those businesses. So you're kind of creating your own problem that you're going to eventually that chicken has to come home to roost.

That's certainly a concern, right? You've got the investment side of it and holding a momentum portfolio. When momentum just hit the 99.8 percentile in history and not recognizing that you own a momentum portfolio that just had the hottest period in history and not selling, if anything, people are piling more and more.

that's one thing and that that's a lot of risk the other thing to your point is the real life implications capitalism we can thank capitalism for the massive gains in um in our quality of living over the last 50 to 100 years and a lot of at the heart of capitalism is capital being allocated intelligently into companies that have a lot of upside and allocated away from companies that should disappear and that mechanism has been completely broken now

Part of that I would say is passive, right? You got a lot of money going into companies for no reason other than size or no reason other than popularity in this construction.

you also have a lot of zombie companies out there that should have died a long time ago but have been kept on life support thanks to massive fiscal stimulus and zero percent interest rates But but yeah, I mean, whether it's on the investment side or, you know, in real life economy, it likely has some very significant negative implications going forward.

I thought, yeah, I couldn't agree more, but I thought one of the interesting things that I looked at over the last, I've had the running deep value, I've had the stuffing kicked out of me for about a decade now. I'm quantity too. So one of the things I like to do, I've run data back to 1926 in the French data, and you guys can do this too. It's just a French size series.

If you run the top decile against the market, which I guess is about the fifth decile, or you run the top decile against the bottom decile, you clearly get massive outperformance by buying small over large. And it's about 0.8% a year.

relative to the market, 1.7% a year from largest to smallest since 1926. So that's a century of data. In that century of data, there are these six periods of time where you get this massive outperformance for size. And we're in one of them now. We're 10 years into... one now. So I did a count. There have been something like 10 that have been three years long, seven that have been five years long, and there's like five that were 10 years long.

what's the longest one was 1999 was i think it was 13 and a half years and we're currently or maybe it was maybe it was over 15 and we're currently in one that's 13 and a half something like that this is the second longest

So don't worry about it for a couple more years. So you're good to go. Close your eyes. JT, coming up to the top of the hour, let me do a shout-out to all the folks playing at home, then we'll do some veggies. Tomball, Texas, Petitikva, Bethesda, Cottage 7. That's a new one.

Welcome. Philly. Lewis. Delaware. Thanks for the pronunciation last time. Toronto. Valparaiso. Is there someone else in Valparaiso besides Mac? Limerick. Ireland. What's up, Colm? Breckenridge. Tallahassee. London. London, UK. Tampa, Florida. Dead Cat, Gully, New South Wales. Me too. New London. Mayfair, London. Milton Keynes. Men at Work. Nice, Les. You got me. Matt's in Australia.

madeira island portugal hunter valley new south wales what's up boise it must be daylight saving in australia the aussies are on still pretty early there philly Transylvania, what's up? Is that real? Paresh Patel, Ridgewood, New Jersey. Transylvania? That's a new one. All right, that's a good spread. Popular with the vampires. We score a while. They're the only ones who've seen value working.

JT hit us with some veggies make benefit glorious nation of value after hours. All right. So centuries ago, Aristotle wrote a short essay called on memory and recollection. And in it, he described memory as an imprint, like a signet ring pressing into a soft heated wax. Experience, he said, leaves behind a trace, not just an image, but a kind of echo in the soul. And when we remember, we're perceiving that echo again.

And when we recollect, when we actively try to recall, we're searching for the echo in the wax. It's very elegant, but it's fatally flawed in that the wax tends to melt. Time, distraction, new sensations, all of them. deform that original imprint. And memory fades because life keeps pressing new rings into the same surface.

That was the philosophy. And for nearly two millennia, memory stayed as this kind of mystery that was wrapped in a metaphor that Aristotle gave us. But then in the late 1800s, a young German psychologist named Hermann Ebbinghaus decided to do something. radical. He started measuring memory itself, and he turned this philosophical fog into actual data.

Ebbinghaus was born in Germany and earned his doctorate at the University of Bonn. And he was inspired by this emerging precision of psychophysics that was bringing tangible rigor to all of these mental processes. And he ran exhaustive self experiments. and gave us the first quantitative map of forgetting, the curve that now bears his name.

So Ebbinghaus wanted precision and he wanted to quantify what happens between learning something and then forgetting it. So he became his own little lab rat. And for two years, he conducted hundreds of experiments on himself. And to strip away the meaning and the emotion of the memories, he invented... these little nonsense syllables like

Z, Z, A, K, W, I, D, T, O, V. They didn't mean anything, but he was just trying to memorize them. And that way it prevented him from having these associations that might influence the memory. So he memorized these long lists of all these. these random things. And then he'd retested at 20 minutes at one hour, one day and one week. And he was measuring the rate of decay in, in the loss of the memories. And what he found was that.

would become one of psychology's most enduring images, this sharply descending curve that's steep at first, and then it gradually levels out. And this is Ebbinghaus's forgetting curve that they famously know. And he discovered that within 20 minutes, we forget about 40% of what we've learned. After an hour, over half is gone. By the next day, two-thirds of the materials evaporated. And after a week, we retain only about a quarter.

And that pattern is this exponential, right? But the same shape has replicated in study after study now over a century. So it's actually probably pretty good science. It's not just really a grim reminder of how fragile our memories are. It's also kind of a map. to guide us on how to resist that decay.

So he found that if you review the material, not consistently, but strategically at certain intervals, you fight that forgetting curve. Each repetition and each act of recall strengthens that trace in a memory. And he called this principle his savings method. So even if a list seemed forgotten, relearning it took less time. There was like a trace that remained that you could pick up the thread.

This insight became the seat of what's now called spaced repetition, which is a very common learning tool where you just learn things at certain intervals to recall before you forget. So what's actually happening when we forget? Ebbinghaus could measure forgetting on himself, but he couldn't really explain it. We need neuroscience today to give us a much fuller picture.

There's a few different theories on how this works. Trace decay suggests that memory traces, these neural patterns form during the learning. They simply just fade over time, kind of like footprints that are washed away by the tide. There's also interference theory, which says that new memories disrupt old ones.

And sometimes that old knowledge blocks new learning. Other times, new information is overwritten by the old. And there's also retrieval failure, which is you had that memory, but you can't quite find the right key to access it. It's like having the file in your brain. the label peeled off of it. And then there's motivated forgetting, and that's the mind's protective reflex to bury painful or useless memories. And sometimes forgetting is not really a flaw, but more of like a defense mechanism.

So like mothers forgetting about the birth of a child, then the pain of that, or, you know, value guys eventually forgetting the last 10 years. So anyway, let's. Let's fast forward to today. And we live surrounded by infinite storage. Every photo, every note, every message is archived somewhere in the cloud. And we can search through these archives with a keystroke, but that's not really the same as...

the knowledge in your bones. We forget faster than ever. We outsource recall to our devices. We rely on technology to remember for us. But that kind of changes how we know things. And we may have access to more information than any generation in history, but maybe perhaps less internalization of that information.

And to remember something is to really integrate it and to feel the pattern and not just recall the fact. And AI systems are becoming increasingly more of this external memory capable of infinite recall for us. They index and sort and retrieve without... fatigue. And when we set these algorithms to hold our memories, we're kind of trading retention for convenience, perhaps. So we know where to find things, but we don't really know what they mean as much as we might have.

The real danger of AI-assisted thinking is not amnesia, but really atrophy, like the slow erosion of the kind of interpretive subconscious work that connects memories to meaning and understanding. And we have to be careful on how we use these new AI crutches. At least that's the common refrain that we hear today. I'm going to try to play devil's advocate and posit that perhaps man plus machine might unlock an immense intellectual bounty for all of us.

Imagine an AI thought partner that doesn't just store facts, but really trains your brain and your memory and your judgment. It watches your projects, builds personal knowledge graphs, schedules space rehearsals when forgetting risk is highest. Turns notes into targeted retrieval prompts, surfaces contradictions and base rates at opportune times.

You know, running real quick simulations, proposing alternative hypotheses for you to consider, raising red flags before mistakes are made. It's like a prosthesis for your attention, not a replacement for thought, but, you know, raising perhaps both the floor and the seat. of what a single mind might be able

will bring the aims, the taste, the ethics, and perhaps the risk appetite. And the machine brings this relentless recall, audit trails, sanity checks, some guardrails for us. And every decision that leaves a record... has inside of it these assumptions and probabilities and rationales. And later, we can take those outcomes and score them against, you know, calibration of improving and feedback loops tightening. So I think teams...

perhaps could become even more anti-fragile working together, fewer forgotten lessons, faster learning cycles, more disciplined interactions. We don't outsource our thinking. We use AI to help provide a scaffolding for it. You know, humans get to choose the ends and the machines really strengthen the means for us. So AI doesn't erase Ebbinghaus's forgetting curve, but it turns it perhaps into a more viable training plan. That's brilliant, JT. Is that journalistic? Is that what's coming?

that might be something related there yeah that's a cool one i i read once that if you sever a long-term relationship like you get divorced or something like that you've stored a whole lot of information in your spouse's brain like you just don't know where things are because you know that they know where it is so you already use the external hard drive so that's uh that's good timely advice

You getting divorced? I don't know why I said that. Not that I'm aware anyway. Yeah, you've thrown me there, JT. Sorry. I love it. It was awesome. It was a very optimistic way to both optimistic and kind of, I don't know, humanistic way to look at AI. I don't know the right answer, but I think it's fun to try to just think through the positives and the potential negatives. Yeah, I'm an optimist for the AI. I love using that. I think it's incredible. Chat and the ones that I use.

We're talking AI with Seth. It's one of the topics that he suggested we take a look at. Yeah, let's hear your thoughts, Seth. You think that most people are thinking about it in terms of first-order thinking? You've got a second-degree view of AI? that you think's being overlooked? Yeah, I didn't see it going that route that Jake just took, but I loved it. Yeah, one of the things that I would like people to consider that I feel that they aren't.

is and what led to this is we reconstitute our portfolio several times a year we did it let's say three or four months ago in the result again our process is rules-based it's driven by numbers it's not it's not our decision or subjective the result was we ended up having less tech exposure than i ever remember us having we had more industrial exposure and some other things

but i was very uncomfortable with having less tech exposure during what appears to be a tech revolution um and and since then you know tech obviously almost every dollar that's going on the market it seems like is is piling into tech and not into other things. By the way, just real quick, I've heard a kind of funny, apparently now some allocators have a, they call it a completion portfolio.

which is maybe you have all your allocations and then you're like, oh man, I'm not long enough big tech probably to keep up with my benchmark. I need a completion portfolio. A little spec filler. Yeah, you just need to fill in the gaps so you don't underperform by too much. Yeah, I've spoken with a number of firms that are maybe regretting not having that.

Sorry, Seth, I didn't mean to interrupt. No, please. One of the things, I mean, right now, if you look at just a quick snapshot of the costs and the revenues of AI. it's nuts right like you know let's say a somewhat conservative estimate is that a trillion dollars will be invested in infrastructure and ai in 2025.

The native AI companies, so the company is really specializing on bringing AI to the market, currently have... roughly 20 billion in revenue i think that's annualized so we've got a trillion dollars in costs which aren't those are just sort of infrastructure we're not talking about like the actual cost to generate the service like the like the massive amount of electricity and whatever

else right um so we've got a trillion dollars versus 20 billion dollars in revenue right you've got this massive disconnect What I feel that many are completely missing is that 20 billion in revenue has a reciprocal cost, right? So companies are paying $20 billion for that service, which costs over a trillion dollars or so to provide right so the interesting thing about ai is it can be applied to pretty much anything to improve it it's not a tech thing you can apply

tech to financials, industrials, real estate, utilities, definitely healthcare, right? You can apply it to almost any approach. to ideally if you do it efficiently to actually provide value and again the companies that have that are using that are paying very little while the companies are providing are paying a whole lot. So everything around tech actually has the opportunity to immediately take advantage of AI and the services that these companies are providing.

and they get this massive value gap and so people are piling into the things that are burning cash like nothing seen in history and then they're completely avoiding the things that can most immediately benefit It's pretty nuts. And who knows, maybe that's philosophical and I'm talking my own book, but it'll be really curious to see how that plays out. For me, it seems obvious. But then again, I'm not always right.

You know, that's one of the things I'm really trying to get people to contemplate. I mean, we're all, everyone's going to have pink slips by Christmas time or what's the, where's the cost savings or. productivity increases that are supposed to justify all this spend. I mean, look, again, who knows? AI, I mess around with AI. Tobias just mentioned that he's a big fan in a number of ways.

But, you know, MIT did a study, I'm going to mess this up, but it was like 90 to 95% of companies polled have seen no return on investment in AI, right? How many silly pictures are being created with AI? I mean, I kind of wonder if that's 50% of the usage of AI at this point is silly pictures or memes or whatever. um it's great i mean i guess that improves life if you get some extra laughs out of it but or targeted advertising hooray sure great that's what we need more of but um you know so i'm

I'm less positive on AI than I'd say Tobias is as far as the impact on humanity. I think there's... positive implications i do worry a lot about this is getting really philosophical but frankly jake i blame it on you you went you just went that's fine you went straight on philosophy i mean you're quoting a philosopher so uh or a scientist Regardless, I worry that, you know, there's a phrase by Eckhart Tolle that's once a human surpasses survival.

meaning becomes extremely important. And I would say that more people have surpassed the needs of survival than any time in history, let's say in the last 100 years, and you've seen depression rates.

uh you know significantly increase we'll we'll just completely overlook um smartphones at this point but just even in the last hundred years you've seen that and and i think it's because people are looking for meaning but what if you start even then sucking out all their time that's used to be productive right they go to work maybe they do something of hopefully a value and now that's gone or it's even more efficient so they spend less time in that

But Jake, I love the way that you like position that in a way that could be positive, that maybe enables people to find more full fulfillment lives or maybe. you know, increase their capabilities. If so, that'd be awesome. If you had to think about that meaning and lack of meaning, perhaps, would you... imagine a world with UBI would have greater or less guillotine risk in it.

so everyone's getting paid everyone's like can stay at home and watch netflix or whatever like there's the machines are creating enough quality of life for all of us to survive and yet most people have no meaning in their life are they What are they going to do then? Are they angry about that or are they docile and happy to be in the zoo? I think that'd be horrible.

I have kids, but even pre-kids, I could probably quote Disney movies better than any grown man. WALL-E. Let's not unpack that one. Pixar, Pixar. Yeah, I love some Pixar. Pixar gets it passed. WALL-E.

you know you get to a point where everybody's just hasn't gotten up out of these like floating chairs where they're just being fed whatever um you know it certainly seems like that is not out of the realm of possibility right uh so and at least in that they were perfectly docile and not necessarily uh you know Starming the best deal. Yeah. But if people don't have a purpose, life is empty. So that's a major concern of mine.

toby about that these days yeah i couldn't agree more you need you need a purpose otherwise it's there's there's a lot of there's a lot of things wrong with the way that we've set up but let's let's just before we get too philosophical i just want to go back to uh There's a few things on AI. There's a little chart that's been doing the rounds showing there's a whole lot of layoffs that coincide with the rise in AI. And then that seems to be reinforced by the fact that there's a lot of...

excuses given by companies when they fire people, saying that it's an AI-related firing. But there was a little research report out today that says that that's not true, which is sort of the perspective that I have, that they've already been, they overhired during the... the little 2021-22 stimmy sugar high and now they're just letting people go and sort of we're getting back to sort of where we should be in terms of long term unemployment. Do you have a view, Seth?

Which way do you lean on that one? Is AI winning the race or is it something else? No, I completely agree. I completely agree without really numbers to back it. I think that there's some numbers, I guess, to back it. But it was next to impossible to hire people in 2020, 2021. wage inflation was skyrocketing because it was just so hard to get really good people. And I do think that firms very clearly overhired then.

And meanwhile, they did so when profitability was at pretty much all-time highs, which was partially driven by globalization, which is now reversing. You know, if we see a recession, if we see if we really see a meaningful change in globalization, if we see profit margins begin to decline. Then, you know, there's.

you're going to see unemployment rise. By many metrics, it appears like we might already be in a recession unless, of course, you look at the most uh accepted metric which would be like gdp growth and you know i think half of the growth that we've experienced this year is strictly due to basically capex investment in ai keep in mind we have no idea where that pays off anytime within the next 10 years but um well the chips won't be

Yeah, well, I saw a number recently where they estimated that maybe 80,000 jobs were truly cut due to AI. So, yeah, to echo what you were saying, Tobias, it seems like that number, especially if you consider in an MIT study, 90 to 95 percent of companies.

They're messing around with AI, but they don't really have any idea how to add value. So the odds that companies are making that decision, it's an expensive decision to let people go. So the odds that people are making that significant decision without actually... having a plan in place seems doubtful i saw that mike burry of the big short fame uh he released his i don't know if it's come out of his 13f or he tweeted maybe i think he tweeted

that something that I think Jim Chaness might have said something like this six months ago. I don't actually know where I got this idea from, but it's something that I've been aware of for a little while, that if you look at the rate of CapEx...

which is not then expense, of course, it's depreciated. So the lag is, there's a little bit of lag when it gets recognised. And we're now at the point where the depreciation, amortisation, whatever, it's going to run through the income statement. And the numbers are quite... uh you know they're hard for them to overcome even in terms of revenue let alone in terms of so like we're just not paying back the the ai spend and you can already see it

free cash flows falling off for a lot of these bigger companies they're very very expensive and at some point it starts running through the income statement so that's how you get sort of a normalization i don't i don't think it's going to

i don't think it's going to collapse i don't think it's all over for those companies i think they're almost certainly bigger in 10 and 20 years time but i do think it's an interesting kind of data point do you have any just shift the useful life out another 10 years and that's not as big a deal 50-year mortgages a big deal like this is just that can baby extend and pretend everything

That's the problem with the chips though, right? Like the useful life is so short. I think I saw some people who have been installing them in the centres and they say even three years is aggressive because they run at such high heat, they seem to break down a little bit faster than...

people have been expecting it's hard to know how much is like fud the fear uncertainty and doubt and how much is like a real take on these things you gotta i think at face value you've got to accept that the useful life is as the companies are saying that it is but even then it doesn't

the hurdle is too high for the revenue generation they're going to be some diminution in profits anyway over the next few years do you have a view seth is that something that you're encountering as you're looking at companies i have i'm really excited that you mentioned that because i think it's very pertinent so burry actually also he had a post yesterday i believe and it um laid out the

period of time or the the life expectancy for these infrastructure investments and the life expectancy has been growing so if you track it from 2020 to today a lot of these companies the life expectancy has gone from three years to six years which means that as far as their income statements in the earnings of reporting at least according to him, they might be 30% higher than they really are. So he's arguing that they are.

base i don't know if this counts as fraud but certainly that they're playing aggressive accounting there's some financial shenanigans going on and what really backs that up exactly what you just mentioned to bias although i'd say it's it's actually a little crazier where these chips are improving in capability so rapidly, at least the way I've read the

the life expectancy is probably a year and a half to two years now what you mentioned as far as the heat that's a whole nother thing uh and it's you know it'll be fine i'm sure that you know one other thing to think about is how many towns are gonna be perfectly fine with waking up one morning to turn on their water and there's no water because a data center is sucking it up. I find it hard to believe that that's going to be perfectly fine for everybody.

Regardless, there's so many things that seem very unsustainable about all of this. But the again, it seems like. Especially according to what Burry said, he clearly knows more about this than I do. What companies are doing seems... unethical is probably not the right word but there's definitely some tweaking of the numbers and that's what i i had someone the other day asked me what

how this sort of all ends. And it's really just a realization at some point, right? It's slowly and then suddenly all at once, right? It's the realization by many that this isn't sustainable. that there are shenanigans going on which it appears there very much are again the life expectancy has according to their their um you know income statements has doubled even though we know that it's actually shrinking

And that, by saying it doubles, it has a very significant positive impact on earnings when we know there's actually a negative impact on earnings. It's crazy.

I think you're right on. I think that it'll be really interesting to see how this all plays out. it's entirely possible we go through like a dot-com style uh like we're just too far ahead of ourselves and we we crash but the next 25 years like clearly the dot-com businesses have gone in directions that nobody we're so much

We've done so much more than people I think even could have conceived in 2000 to get to this point. And I'm sure that AI will be the same. We'll be using it for things that we cannot even conceive of now in 25 years. But that doesn't mean that in the interim.

that there's not a lot of volatility or that it all accrues to the companies. Consumer surpluses are a thing. It's entirely possible. It's a huge consumer surplus. But I will say that if the AI is going to consume all of that energy and fresh water, then we need nuclear.

There's just no other way to generate enough power and enough fresh water. Although Amazon has come out with an anti-jazz. He had a tweet today where he showed they've had some innovation in the back end of the... data centers where they figured out a way to cool the chips uh a little bit beyond me but they're getting cold directly on the chip and that separating the water away from it so it circulates it's quite water efficient

Sounds like a really impressive thing. I mean, that'll be good, but keep in mind how much money has already been dumped into data centers, right? So now we have to redo all of them to potentially provide that, right? It's constantly evolving, which again goes to your point that the...

Life expectancy is getting shorter, not longer, because of innovation. We're not at a point where there's a steady state. We're not at a point where we're not improving efficiency. Efficiency and innovation brings... the current life expectancy down because of that trend um i was at a a conference a few weeks ago and a gentleman was speaking that is very much

in the know like he's he's in the ai in the very thick of it and he made a comment that i haven't heard anybody else really um focus on but it really stuck with me which was these let's say the biggest companies the mag seven companies in particular cai as an existential crisis that's what he said which means life or death um

If you are backed in a corner and you feel you're in life or death, is there anything you're considering other than just purely survival? You will do anything to survive. And that... If you actually take that perspective into account, then that begins to actually justify or help these silly numbers make sense. Because if these companies believe it, it's either we either are all in.

or we lose and we're done, they're going to be all in. And profitability and all these other factors don't matter. The only thing that matters is survival. I just don't think any of these numbers, for the most part, make sense in the short term. And the problem is valuations are crazy. Valuations mean higher risk or more downside, further to fall.

and so it's it's a kind of a confluence of a number of factors that i wish people were paying more attention to because it seems almost inevitable how this ends but maybe i'm wrong

On that cheery note, Seth, that's time. If folks want to get in contact with you or follow along with what you're doing, what's the best way of doing it? feel free to email me at seth at runningoak.com you can also check runningoak.com runningoaketfs.com and then uh i'm begrudgingly i've begrudgingly been far more active on linkedin so you can hit me up there as well i'd love to talk to or hear from anyone uh jt any final words just uh

Be excellent to everybody. Embrace our AI overlords. I, for one, welcome our new AI overlords. Seth Cogswell, Running Oak, thank you very much, everybody. We'll see you folks next week.