Supported by Greenhaven Road Capital, finding value off the beaten path.

I can’t believe I read a book titled You Can be a Stock Market Genius. Normally I’d walk – or scroll – past it. If it even registered I’d think, vanity project or survivor bias. Of course, I’m writing this, so this appears to be a rare and unexpected extreme case (a black swan) where I am wrong.

Joel Greenblatt’s book was good. What I liked most was that Greenblatt talked through big ideas (which we’ll get to below) and walked through situations when he applied those ideas. It was never, ‘I have the golden touch.’ Greenblatt, like Phil Knight in his book Shoe Dog shared humble and honest reflections. Both fund manager and retail founder admitted to a mix of luck and skil (the two-jar model ).

Okay, this isn’t a confessional. Let’s get to it:

How to invest like Joel Greenblatt

Step 1: Be different.

Your edge, Greenblatt writes, comes from taking “knowledge and applying it in places off the beaten path.” You need to be able and willing to look in places other people don’t. Two ways stood out:

• Difference in deadlines. “Time and interest are your only constraints,” writes Greenblatt.
• Difference in size. Greenblatt has a friend named “Bob” who lacks your flexibility. Bob’s strategy is “imposed on him by the dollar size of his portfolio, legal issues, and fiduciary considerations.” You can be different when Bob must be the same.

Just be different. Easy peasy.

Being different is hard. “Everyone can’t be a contrarian,” Greenblatt writes. You have to, in Howard Marks‘s words, be different and be right.

Only recently I watched The Big Short. While only once have I enjoyed a movie more than a book, The Big Short showed the emotions in a way I didn’t remember.  Michael Burry’s investors wanted out. I thought Mark Baum might kill himself (or someone else). Charlie Geller and Jamie Shipley had everything they owned on the line.

Being different and right is interesting to read (and write) about, but doing it is so much harder.

Look at Harry’s. It’s a good business. Selling razors over the internet is different, but is it right? Maybe. There’s nothing proprietary and Amazon is making more private label goods. “You have to find a niche and differentiate on some dimension. You can’t hope to out Amazon Amazon,” said Harry’s founder Andy Katz-Mayfield. Will he do that? Time will tell.

Sam Adams did much the same thing said founder Jim Koch. His story is great, but do you know how big Sam Adams is? Koch said the big beer makers spill more beer than he makes in a year. Even being different and being right doesn’t mean you’ll be big.

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Step 2: Beware of GEEKS bearing gifts.

“Investors must never forget,” writes Seth Klarman, “Wall Street has a strong bullish bias.” Greenblatt has the same idea. You can, and should, listen, read, and pay attention to what is going on but you must “do your own work.” Mohnish Pabrai said this too.

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Step 3: Pick your spots.

My college roommate liked to play blackjack. He’d drive an hour to Windsor Canada to play. He tried to convince me to go (presumably to split the cost of gas) by explaining why blackjack was the best game. It was the game, he said, with the best odds for the player and worst for the house.

I never took him up on this offer, but my friend was onto something.

In Bringing Down the House, Ben Mezrich wrote about the MIT card counting team that worked Vegas. Their strategy was to have one person play at a table and “count” the cards. Low cards were minus one, high cards were plus one. If the count trended high, the player at the table would signal to a partner to step up and make a series of large bets.

The card counters were picking their spots.

Greenblatt makes this point by recalling a time he was at Lutece. A great restaurant where no matter what he ordered it would be good. Remember, Greenblatt writes, quoting Benjamin Graham’s idea of Mr. Market, he will knock on your door today, and if you say ‘no’ he’ll be back again tomorrow.

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Step 4: Margin of safety.

“Margin of safety should always top your investment list.”  “If you don’t lose most of the other alternatives are good.”  “Look down, not up.”

If it can go wrong, it will go wrong Mr. Murphy once said. Greenblatt once had an investment plunge because of a sinkhole. A sinkhole! “Risk of sinkhole,” Greenblatt writes, “was not one of my checklist items for determining whether or not to invest in a particular merger deal.”

Okay, okay, okay. I get it, but how much do I need?

“A margin of safety is achieved, writes Seth Klarman, “when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world.”

That doesn’t help much, does it?

The key is not paying too much, no matter how good the idea. Greenblatt writes, “I had no intention of buying my stock at the top end of the industry P/E range, justified or not.”

Margin of safety can be valuable in any investment. It’s having space, writes Greg Ip.  It’s haveing low costs like Sarah Silverman. It’s allowing for the worst case scenario in street fights and island invasions.

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That’s is all it takes to succeed as an investor.

1. Be different.
2. Listen to, read, and study others, but trust no one and do your own work.
3. Pick your spots.
4. Create a margin of safety.

Of course, your mileage may vary.

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Oh, and one more thing.

5. KISS

You have to keep it simple. “If it’s too difficult I’d rather skip it,” Greenblatt writes. Let it go if it’s too hard, or for things that move too fast.

This applies to your gear too. The Wall Street Journal, an internet connection, and a library card “can do the trick.” Your local library probably has all three.

My mistakes are actually white swans; common, easy to see, non-fatal, and expected. 

Mohnish Pabrai was on “The Investor’s Podcast” with Preston Pysh and Stig Brodersen. There were two parts (part1 & part 2 ) and they were fantastic.

My first post about Pabrai were notes from a talk he gave at UC Irvine ( mostly about Coca-Cola). This podcast covered new ground.

Before we jump in. The ~12:00 of part 2 had some ideas related to our thoughts on Moats and Podcasts.

Ready?

1/ Deep understanding. Pabrai said that many of his business classes were interesting but easy for him because he had spent his teenagers years working for his father. He and his brother “were like my father’s board of directors.” Pabrai had already studied the problem, made mistakes, and learned from experience.

“I very accidentally got an introduction to business,” Pabrai said, “during a period of time when my brain was optimized to pick it up.”

This was a theme of the interview, the formative years of brain development. I’ve heard about this as it relates to learning how to play instruments and speak languages but never thought of it in terms of business acumen (domain blindness on my part).

Gary Vaynerchuk may be our proto-contemporary example of this. Vaynerchuk spent his teenage years working in his father’s liquor store. There Vaynerchuk learned to sell, add-on, and study wine.

Pabrai mentions Warren Buffett as someone who did this too. Buffett would buy a six-pack of Coke for a quarter and sell each bottle for a nickel.

You and I are no longer teens (biologically), but we can still appreciate the value in a deep understanding.

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2/ Just do it. When should you think and plan and when should you do and act? I don’t know. Pabrai though has two suggestions for when to just do it.

a) If an interesting opportunity arises,“Take the plunge, you can always come back, so take the plunge.” “Life is a very random journey. I’m here talking to you because I picked up a book at Heathrow airport, and it could have been a book on a number of different subjects.” “No one is going to put up a headline that says, ‘take the left fork.'”

b) If someone wise tells you to do something. Pabrai said he “lucked out,” because he was exposed to Buffett’s letters early on. Pabrai was a blank slate, so he imitated Buffett and Munger. It’s worked out.

Yeah, but… NO! No ‘yeah, buts.’

“Some of these I understood when I was starting my own partnership. Other I did not understand the reason but I still just owned it because there was no other model available to me. What I discovered several years later was that every single one of the rules they followed were rules that had been very intensely thought through by these very smart guys. They weren’t random chance.”

“(Munger) told me that it’s very important for an investor to have people to talk to….(and)…When god tells you to do something, you do it.”

Just do it when you come to an interesting fork in the road or when you trust someone completely.

…

3/ Do your own work. Pabrai doesn’t have an analyst, advice he got from, you guessed it, Buffett and Munger.

“It is a huge advantage not to have an investment team,” Pabrai said, “Investing is not a team sport, it should never be a team sport.”

Why doesn’t it work? In part, because other people’s ideas fall outside your circle of competence. Pabrai explains that an analyst could come up with the best idea in the world, but if you don’t understand it, you won’t act on it. Analysts can also get boxed into an industry. That doesn’t work either says Pabrai. The ideal question is “where should we put our money in the entire universe of possibilities.”

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4/ Argue well. You don’t have to argue; quarreling, disagreeing, and squabbling all work too. They key is a pursuit of the truth. “What you do by talking to people not on your payroll,” says Pabrai, “is you get rid of vested interest and conflicts.” Norms, politics, and individual incentives are gone.

Bill Belichick has worked hard to create an environment like this. His assistant coaches are actually graded on coming up with good new ideas. Belichick also listens to his players, assistant coaches, and (what does he do here again?) Ernie Adams.

Good arguments “help round the corners,” said Wilbur Wright. Geniuses argue too.

…

5/ See it to believe it. Pabrai thought he was dumb. Well, actually, he said he was 67th out of 70 in his third grade and there were probably three carrots in the group. Pabrai needed a catalyst. Lucky for him, one was coming.

Pabrai moved to a new and better school (no carrots there). He took an intelligence test and scored at the top.

This created some cognitive dissonance. How does someone not smart get a smart score? Pabrai went to the test administrators, and was like, ‘umm, you know I’m not smart, right?’ They said to him, ‘no, actually you’re very smart, maybe brilliant.’

This was a big moment. “I felt like after that two-minute conversation in ninth grade I was like Seabiscuit. I just took off.”

Richard Thaler had this see-it-to-believe-it moment when he read Daniel Kahneman’s paper. Ezra Klein had this when he read Matt Yglesias. Judd Apatow had it when he saw Steve Martin.

A recent example – to me – is told in the book The Song of the Dodo where David Quammen writes that Charles Lyell, Charles Darwin, and Alfred Russell Wallace were having this see-it-to-believe-it moment together. They were peeking at evolution by natural selection. A notion that, Quammen writes, “was going to incite a shitstorm of resentment in Victoria’s England.”

We all could use a nudge where we go ‘holy shit, I didn’t know this was possible.’ In fact, it might be necessary.

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6/ Does the glove fit? Okay. You’re excited. You’d never heard of Pabrai, but this sounds like someone you’d like to emulate. What’s next?

“The first question investor need to ask themselves is ‘Does the glove fit?’… after you read an annual report you have to ask yourself, ‘you know, I spent two hours reading that, would I have preferred doing that or watching a Star Wars movie?’…you have to ask what type of activities give you the greatest satisfaction.”

If something takes a long time there better be good rewards for it. Steven Johnson talked with James Altucher and said that he has high motivation to play music, but no ambition. That’s what it feels like when the glove fits.

Pabrai has – if I’m reading the tea leaves correctly – a very philosophical approach. If you’re going to spend your life doing something and you have some autonomy over what that thing is, choose something you enjoy.

We’ve seen this before, it goes by different names. Love the grind like Gary Vaynerchuk. Be relentless like Bezos, Belichick, and Buffett. Tinker like Phil Knight and Peter Thiel.

Warning: Tangent ahead.

I’ve been thinking about this as; no work, good enough work, and great work.

My theory is that many “good enough” skills are achievable. Take cooking. Buy Mark Bittman’s cookbook and learn the basics. That’s good enough and it’s not that difficult. If you want to move to great work, well then, it’s off to culinary school and years of hard work.

Good enough is attainable. Guitar? Four chords. Fitness? Walk more, sit less. Investing? Index, minimize costs.

Great work is hard. We get off the s-curve ascent and face the slog known as “diminishing returns.” This is roll-up-our-sleeves, put-our-heads-down, and dig in for the long-term territory because that’s the only point where results show up. Delta only shows up over time.  This is why Pabrai wants to know if the glove fits. To get to great work requires a lot of energy, effort, and time. Great work has a high opportunity cost.

It’s why we say here that you can actively invest/be an entrepreneur, but you can’t do either of those things AND have a hobby, be a soccer coach for your kids, and show up to dinner. A lot of things in life are worth a little work for big returns. The great work though, those pursuits are more limited.

[/Tangent end]

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7/ Decentralized command. Berkshire Hathaway owns stock in Southwest Airlines. This makes total sense. Here’s the CNBC synopsis of how Buffett feels about airline stocks:

He called the US Airways investment a mistake in almost every annual letter from 1989 to 1996…. ‘if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.'”

Wait, this makes no sense. How did this Berkshire end up invested in airlines?

The answer is decentralized command. “I think this is a good example of how Warren only selects the manager and does not interfere with what they do,” says Pabrai. Buffett knows he can’t make every decision, so he creates smaller units that can make better decisions.

Jocko Willink has articulated how the military is organized like this. Amazon calls them “two pizza teams.” Andy Grove wrote about it too. Need more?

“Perot later told Fortune magazine, “I come from an environment where if you see a snake, you kill it. At GM, if you see a snake, the first thing you do is go hire a consultant on snakes. Then you get a committee on snakes, and then you discuss it for a couple of years. The most likely course of action is—nothing. You figure, the snake hasn’t bitten anybody yet, so you just let him crawl around on the factory floor. We need to build an environment where the first guy who sees the snake kills it.” – Jeff Gramm

“Hire the best people you can and leave them alone.” Tom Murphy

“One reason, I think, is that most other companies don’t really understand the concept or its scope and limitations, while many others are loath to grant the freedom and independence from management control that really are necessary ingredients for running a successful Skunk Works enterprise.” – Ben Rich

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8/ How to learn from mistakes. “First of all, mistakes are a blessing. Adversity is a blessing.” Pabrai goes on to paraphrase Marcus Aurelius, noting that to have misfortune and prevail is good fortune. “We don’t learn when we do well.”

It’s football season, so in that spirit:

Pabrai points out that this is nice to say, hard to do. “The lessons don’t sink in very well if they are other people’s mistakes. It’s unfortunate. This is one of Munger’s and Buffett’s great strengths, they are really good at learning from others mistakes, so they try to avoid most of them…Learning from other people’s mistakes is so much cheaper.”

Okay, learn from others, got it. What else?

Don’t learn too much from others.

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9/ Alternatives to school. When asked about books, Pabrai says that Poor Charlie’s Almanac, “(is) a book that I try to re-read every year and every year when I re-read it, I find brand new things that I swear were never in the book before, someone just put them in there…That one book, in my opinion, is better than a college degree.”

Better than a college degree! Why!? Because college has a huge opportunity cost (but also a potentially huge payout).

I could have been more efficient in my time and money budget in college. sigh (and graduate school)

College – and especially graduate school – isn’t always a better option. Failed start-up founders consistently pointed out that they learned a hell of a lot. David Chang eschewed graduate school in favor of opening a restaurant. Elizabeth Gilbert, Tim Ferriss, and Seth Klarman (“I learned an enormous amount there (Mutual Shares), probably more than in my subsequent two years of business school.”) note the value in non-college learning.

What college does well is provide a structure for learning. Patrick O’Shaughnessy said, “Almost everything I learned in college you can go read and do it for ten cents at the library.” Joel Greenblatt said to mix in the WSJ and you’ll be okay. The question is, will you?

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Thanks for reading. Despite the length there were some things I left out so if you made it this far you’ll like the podcast.

Supported by Greenhaven Road Capital, finding value off the beaten path.

Charley Ellis had a short, but valuable interview with John Authers of the Financial Times.  What I liked most about the interview was how many human elements were involved. How you feel. What you believe. Why do something you know is bad for you. 

One analogy for life is that it’s like sitting at a blackjack table. You have your cards. You have a strategy. You know the odds of when to hit and stay. You also have three college students, free drinks, and that guy next to you that hits at 15.

Ready?

1/ How to beat the market.  It helps if your competition isn’t very good.  “The secret to great success in business is to choose competition that’s not very good. The same thing works in sports, it works in lots of different things.”

An easy way to do this is to find places with no competition. Instagram did this when they became a photo app rather than a check-in app.

Ellis had competition but it was “doctors and lawyers and Indian chiefs with much more important things on their mind. This was a recreational sideline.”

They were competing with Ellis said, “(I would) finish reading a 50,60, 70 page study that told you quite a great deal about what was going on in the past, currently, and what was likely to happen in the future. It was an unfair competitive advantage and we took advantage of it.”

Investors and entrepreneurs have little time for hobbies or coaching youth soccer. If you’re going to spend that much time doing something you better love it. Gary Vaynerchuk loves it.  Joel Greenblatt wrote, “if you’re not going to enjoy the ‘game,’ don’t bother: there are far more productive uses for your time.” The chase should be fun (see #3).

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2/ Habits and urges.  “There’s a huge argument for not smoking under any circumstances, but there are still some people doing it.” “We know that gambling is designed to entertain people enough so they won’t  mind losing ten or twenty percent  of their money every wheel turn.” “They’re not actually gambling, they’re gradually losing money.”

Did you eat any cookies over holidays? (Be honest). Diet, much like smoking and gambling is one of those things where our habits and immediate satisfaction trump our goals and long-term rewards. It’s hard, but we can do better.

• Jocko Willink suggests more discipline in your life. “Discipline equals freedom,” Willink says.

• Tadas Viskanta and James Osborne proposed planning as a way around pitfalls. If you think something will cause problems; create a substitute or avoid that situation.

• Jon Stein told Patrick O’Shaugnessy that the Betterment service will display potential tax costs associated with trades. This extra bit of information stops three out of four people.

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3/ Do it for the love of the game.When Ellis is asked what would happen to the investing world if you cut everyone’s pay in half he said:

“They wouldn’t leave. They’d still want to play because it’s fascinating, it’s really interesting, it’s very enjoyable and you don’t have to stop at 35…I know a couple of people over 100 who are still involved in active management…The rewards are really quite substantial.”

It’s fun. It’s enjoyable. People like the challenge.

There’s something enjoyable about the process that keeps people around. It’s kept Anson Dorrance in soccer. It’s kept Warren Buffett looking for investments. It’s kept Casey Neistat making videos.

Angela Duckworth wrote in Grit:

“Why were the highly accomplished so dogged in their pursuits?…They were satisfied being unsatisfied…It was the chase as much as the capture that was gratifying.”

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4/ Effort != Results.  “We all learned in school that if you studied harder you could get better grades, then we learn in our jobs if we do more work for the employer we get more promotions. Trying harder works in many, many places. It doesn’t work in straight jackets, Chinese finger puzzles…. and it doesn’t work in investment management.”

Seth Klarman gives similar advice in Margin of Safety:

“Investment returns are not a direct function of how long or hard you work or how much you wish to earn.”

Humans (you, me and Bobby McGee) tend to see things linearly. Non-linear instances, like when, unit of work != unit of result, is tougher.

 

 

 

 

Supported by Greenhaven Road Capital, finding value off the beaten path.

Yvon Chouinard is the founder of Patagonia. He was a guest on the How I Built This podcast and wrote the book Let My People Go Surfing: The Education of a Reluctant Businessman. Before we get into some notes, let me take a moment to point out my stupidity.

Remember Sophia Amoruso? I wrote about what happened to Nasty Gal using the framework from my research on failed statups. I was mistaken.

What if I had contrasted Nasty Gal to Patagonia? They’re both clothing companies built around a brand. Rather than rehash Nasty Gal, let’s start from scratch. Mohnish Pabrai said that when he was starting his investing partnership he just did what Warren Buffett and Charlie Munger did. Pabrai didn’t need to know the why, just the what.

Chouinard has given us that too.

Ready?

1/ Start with you. 

Chouinard started making hardware, not the apparel that Patagonia is known for today. How did he get started? He scratched his own itch.

“Every time we went climbing we came back with ideas to improve the climbing gear…so I became a blacksmith so I could make some of the climbing hardware that I thought would be better than what’s available.”

People who do the thing figure out better ways to do the thing. A better way also means a different way. Chouinard’s pitons were reusable compared to the (cheaper) European ones which were not. It was the same for clothing.

Chouinard’s inspiration was a colored rugby shirt he saw on a trip. Men’s gear was all one color, Chouinard’s wasn’t. His next item was a pair of stand up shorts. Why were they called that? Because the first pair stood up on their own (the fabric was so rigid).

The stuff was good because it had to be. When Chouinard made pitons he used the pitons. It was the ultimate instance skin in the game (SITG). Chouinard writes, “Quality control was always foremost in our minds, because if a tool failed, you could kill someone, and since we were our own best customers, it was a good chance it would be us!”

When Chouinard and his team moved into clothing they were also the ones that used that.

“We knew what we wanted. I heard someone say that if you wait for the customer to tell you what to do you’re too late. We were our own customer. I think that was the secret to coming out with products.”

2/ Make something for the ideal customer.  Chouinard writes:

“All our customers are not equal in our eyes. There are indeed some we favor more than others. These are our core customers, those for whom we actually design our clothes. To understand this more clearly, we can look at our customers as if they existed in a series of concentric circles. In the center, or core circle, are our intended customers. These people are the dirt baggers.”

That’s who you make stuff for, the dirt baggers.

Failed startups never found the “dirt baggers.” Those founders confused “sure” for “hell yeah” and “it looks good” for “OMG, shut up and take my money.”

Chouinard made these mistakes too. He writes that they tried a foul weather line for sailing, but it didn’t sell. There wasn’t enough of a market and he wasn’t a sailor. He didn’t know what to do because they weren’t the ones using it.

3/ You’ll never be ready. “I didn’t know anything about clothing. I learn everything by taking a step forward and see how that feels. If it feels good I take another step, if it feels bad I take a step back.” “I learn by just doing.”

Rather than plan out ideas and see what might or might not work, Patagonia puts their gear in the field. “We test until something fails,” Chouinard writes, “strengthen that part, then see what fails next.”

Gene Kranz noted this about the early space program. The Instagram founders pointed it out too. In his book about Amazon, Brad Stone wrote;

“By the first weeks of 1996, revenues were growing 30 to 40 percent a month, a frenzied rate that undermined attempts at planning and required such a dizzying pace that employees later found gaps in their memory when they tried to recall this formative time. No one had any idea how to deal with that kind of growth, so they all made it up as they went along.”

You’ll never be ready, but don’t mistake that for an excuse to go fast.

4/ Grow slow. At one time Patagonia was growing  50% a year. That was fine until one year they built out too much inventory, a recession hit, and Patagonia had layoffs. “That was really tough,” Chouinard said.

“We couldn’t get any loans from anybody, my accountant introduced me to some mafia guys who wanted to loan me some money at 18% interest.”

Now, “I wait for the customer to tell us how much to make.” It means that Patagonia grows slower, but grows safer.

This conservative approach is a way to apply Margin of Safety (MOS) thinking to business. Looked at one way, too much inventory appears to be a MOS but it is at the expense of cash. Whether it’s street fights, island invasions, or investing a MOS is crucial because there are possible futures you can’t plan for.

It’s easier to keep a MOS with a low overhead.

5/ Keep a low overhead.  “I’d live on fifty cents to a dollar a day.” “Before leaving for the Rockies one summer my friend and I bought a couple of cases of dented cat food cans from a damaged can food outlet in San Francisco we supplemented cat food with oatmeal, potatoes, ground squirrel, blue grouse, and porcupines.”

In tech speak, a low overhead lengthens your runway.

Jay Leno told Judd Apatow he kept a low overhead. “I was also a Mercedes-Benz mechanic at the time. I didn’t have any expenses. I didn’t have any lifestyle to maintain. I liked doing it. I would drive hundreds and hundreds of miles to work for free for four or five minutes. I didn’t know if I would ever really make a living at it.”

Jerry Seinfeld said much the same thing. “I was a minimalist from the beginning, I think that’s why I’ve done well as a comedian…If you always want less, in words as well as things, you’ll do well as a writer.”

6/ Deep understanding. Chouinard was a climber, fisherman, and skier. He’s not a particpant – he’s an instructor. He’s written technical books on all these subjects. He understood – through experience and through study – what the gear and his business needed to do.

As a climber, Chouinard knew what the gear needed to be:

“we used to make a small rock-climbing pack that had a thin foam pad in the back for comfort. The pad was removable so you could take it out and sit on it on cold bivouacs (BIV WACKS). My climbing partner broke his arm in a fall in the Tetons, and I was able to make a perfect splint with the sheet of foam and a few accessory straps.

He understood how the gear should be made:

“You have to choose such relationships carefully. The first thing we look for in a supplier or contractor is the quality of its work. If the standards aren’t high already, we don’t delude ourselves into thinking they’ll be raised for us, no matter how attractive the price.”

 

He learned how the business should be run:

“Once I decided I was a businessman I decided to really study up on it. I studied every book I could on Japanese management styles and Scandinavian business. I thought there had to be a different way of doing business. I still wanted to only work for part of the year.”

As Napoleon Bonaparte wrote;

“If I appear to be always ready to reply to everything it is because before undertaking anything I have mediated for a long time. I have foreseen what might happen. It is not a spirit which suddenly reveals to me what I have to say or do in a circumstance unexpected by others. It is a reflection, a meditation.”

7/ Decentralized command. “I call in maybe three times in the five months. People know that if the warehouse burns down, don’t call me. What can I do, you know what to do.” “I don’t care when you work as long as the job gets done.”

Pabrai said that Buffett learned early that his most important thing (MIT) was hiring the right manager for the business.

 

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There was more in my notes, but that seems like enough of a nibble to get someone interested. Chouinard inspires me.

Thanks for reading.

Update: An early version of this post misspelled Chouinard as “Chouindard.” I also forgot to note that Chouinard calls in “three times in the five months.”  Thank you to those who noted my mistakes. 

Supported by Greenhaven Road Capital, finding value off the beaten path.

I like reading things Howard Marks writes. There is the book The Most Important Things (which we looked at in this post. There are also Marks’s memos. And like Michael Mauboussin‘s documents from Credit Suisse, they are FREE!

I’ve been thinking about the combination of free and valuable.  This blog is free and (somewhat) valuable. Marks’s and Mauboussin’s writings are free and valuable. The library is free and valuable.

So, we don’t need to pay for things that are valuable. Joel Greenblatt wrote that for many investors, “The Wall Street Journal, a phone to call for company information and news releases, and a library card can do the trick.”

But there are things that are free are NOT valuable. Some free things are anti-valuable. We’ll get to those below.

…

One final caveat before the notes. Your time may be better spent reading Marks’s memo Expert Opinion (pdf) than this post. I did my best to write something helpful, but, it’s like an appetizer where Expert Opinion is the main course.

For those who will continue, let’s begin.

1/ Entertainment or information?  Serendipitously I read Expert Opinion the day after I watched this:

In that video, Cal Newport suggests three reasons to quit social media.

• Social media is entertainment. Newport compares it to slot machines and when he said this I immediately thought of emoji. Recategorizing social media as entertainment may help us consume less/more of it. Richard Thaler writes in Misbehaving that people tend to use bucket budgets as a way to keep track of expenses. We can do the same thing with our attention. Imagine Twitter in the same bucket as television. How much of that do you want in your day?
• Social media is NOT important to your success. Newport’s thesis is that rare and valuable jobs require rare and valuable skills. The Moats and Podcasts post is an examination of this. Things anyone can do (e.g. tweet, podcast) are things that are not valuable. As Tren Griffin wrote, “supply is the killer of value.”
• Social media is actually hazardous. Newport says that fragmented attention can reduce your ability to do deep work, as well as increase depression (read that abstract and note the parallels to investors/investing) and anxiety.

Marks’s comments about the media suggest it too is more entertainment than informative. If media was more information we would have less hindsight bias like this:

“In particular, now it’s considered to have been a big mistake for Clinton to fail to address the concerns of white men and set out a solution for those who lost jobs and were omitted from economic progress. But during the campaign, no one pointed to this error.”

Information takes work. Consumers need fluency and an understanding of the background conditions. A knowledge of history would help too. If we’re making a list, let’s open up some cognitive space to think about the survivor bias and alternative histories too. It’s work.

“Biological creatures ordinarily prefer effort minimization in routine activities and don’t like removals of long-enjoyed benefits,” said Charlie Munger.

The media knows this. Daniel Kahneman wrote a book about our preference for thinking fast. That means thinking visually and seeking confirmation.

“Following the media experts, while entertaining,” writes Marks, “can be a waste of time intellectually.”

…

2/ You have to be there.  I’ll bang this drum as long as needed. You have to go to the front lines, the plantations, the place where the winds of the real world blow in people’s faces and get your information there. Alternatives don’t work.

Another story of serendipity.

The day before I read the Expert Opinion, I listened to Lisa Servon on NPR’s Fresh Air. Servon is a professor with a focus on consumer banking. She wanted to know more about unbanking – people without checking and savings accounts. One day she invited a payday lender (scurge!) to her class at Penn. This is her account (emphasis mine):

“This guy to come into class and tell us what was going on. And Joe Coleman showed up – he’s the person I’m referring to – was a very smart, interesting man who spoke very persuasively about why he believed his businesses were really serving the community. And it made a lot of sense. And so I was trying to really square Joe’s story with the data, and it didn’t add up, combined with my knowledge that, you know, my feeling and my experience that low-income people do make smart, economic decisions when they can.“

What?

Do you see what happened there? Servon’s not an idiot. She’s not reacting. She’s studied an idea, compared it to her own life, and drew a conclusion (that should sound familiar to you!). Then she found new information and found out she wasn’t quite right. To her credit, Servon wanted to know more.

She worked for four months as a payday lender. She WAS THERE. She learned a lot.

“that experience showed me why I needed to be behind that window because even though I was working there and dealing with people every single day, I still, with my own biases and having grown up using mainstream financial services, didn’t get that.”

It gets better.

When her four months were up Servon walked around the counter and told her customers she was a researcher and wanted to ask them questions. They told her EVEN MORE!

That’s what being there does.

Marks writes, “It’s clear that people who work in the media hadn’t understood many average Americans.” Bingo.

The most (positive) extreme example might be the story told in Mountains Beyond Mountains. Paul Farmer, our protagonist is a rural doctor in Haiti and says, “I would read stuff from scholarly texts and know they were wrong. Living in Haiti, I realized that a minor error in one setting of power and privilege could have an enormous impact on the poor in another.”

Here’s how that went. The predominate medical theory for how someone got AIDS was that they shared an intravenous drug needle or had multiple concurrent sexual partners. Farmer went to Haiti and saw that the people were too poor to buy drugs and had sequential partners (one at a time). What gives? I’ll leave the solution in the book because our big point is this: You have to be there!

I don’t know how right he is, but Chris Arnade seems to have the correct methodology:

https://twitter.com/Chris_arnade/status/816016061225168897

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3/ “What do experts know?” Half-way through the memo, Marks lays into the New York Post football experts. Their record was not much better than the flip of a coin. “Virtually none of the eleven experts’ overall picks added value after fees (sound familiar?)” Marks writes, “Even the average of the experts’ “best bets” wouldn’t have produced a positive return after fees.”

Oof.

It’s almost as if those experts were there to entertain rather than inform. It’s too bad there isn’t a system that would help us make better picks. Or put another way, to forecast results in a super way.

Actually, there is just a system that comes in a reusable, convenient, portable, form that purchasers are encouraged to write in and take notes (colloquially known as “book”). Superforecasting by Phillip Tetlock was a great book. We actually used Tetlock’s framework to make better sports predictions when we asked Is Bill Simmons a superforecaster? The answer was yes. Here’s why.

1. Superforecasters pick their spots. The NY Post experts didn’t do this. They picked every NFL game. Are you saying that the most watched market in the world doesn’t provide pockets of value? Yes.
2. Superforecasters break intractable problems into tractable subproblems. Marks writes that he had a lunch with Warren Buffett and they both agreed that information should be knowable and important. If an intractable problem cannot be reduced into tractable subproblems it is not knowable.
3. Superforecasters balance the inside view with the base rate. Are you saying that NY writers have a bias toward NY teams? Yes. Marks agrees, pointing out the mangy week 16 picks from the experts.
4. Superforecasters don’t overreact or underreact to new information. Are you saying that talking heads on television and in newspapers may overreact? Yes. #boatgate
5. Superforecasters distinguish some degree of doubt. They avoided, “granularity as bafflegab,” Tetlock writes. Are you saying that all these statistics I hear about winning records in a different time zone against a team with less than 40 games played together might be data mining and irrelevant? Yes.
6. Superforecasters balance overconfidence. As Daryl Morey reminded us, people don’t like to hear maybe this, and maybe that, but it’s often the best answer.
7. Superforecasters check for hindsight bias. Lol.

People can be more accurate than a coin. It’s going to take more information (like reading Superforecasting) and less entertainment (social media).

…

4/ Knowing and caring. Maybe my favorite part from the memo:

“People have been preoccupied with when interest rate increases would take place, and that’s the question I’ve been asked most often. My response has been consistent: How would I know, and why do you care.”

Jason Zweig gave similar advice as it related to indexing.

The ultimate beauty of index funds is that they get you utterly out of the business of guessing what will happen next. They enable you to say seven magic words: “I don’t know, and I don’t care.”

Will value stocks do better than growth stocks? I don’t know, and I don’t care — my index fund owns both. Will health care stocks be the best bet for the next 20 years? I don’t know, and I don’t care — my index fund owns them. What’s the next Microsoft? I don’t know, and I don’t care — as soon as it’s big enough to own, my index fund will have it, and I’ll go along for the ride.

…

5/ Metaphors. “The metaphor is a cover-up.” – Amos Tversky

Marks writes that people often ask him “what inning are we in?” This metaphor assumes that a lifecycle (market, stock, macro, etc.) is like a baseball game. If you know what point of the game it is then you can take advantage of the moment. It’s a simple way to convey a complicated idea. But as Tversky warns, it’s not the whole picture. Marks agrees:

“A standard baseball game consists of nine innings, so “second inning,” “sixth” or “ninth” has a clear meaning. But with the things we’re wondering about here, we never know how long the game will run.”

Metaphors can be good for somethings. Steve Jobs told Walter Isaacson:

“People know how to deal with a desktop intuitively. If you walk in to an office, there are papers on a desk. The one on top is the most important. People know how to switch priorities. Part of the reason we model our computers on metaphors like the desktop is that we can leverage this experiences that people already have. “

We use metaphors a lot. Pay attention and make sure you aren’t communicating too much.

…

6/ Certainty is a red flag.

Marks writes, “there are no facts about the future, just opinions. Anyone who asserts with conviction what he thinks will happen in the macro future is overstating his foresight, whether out of ignorance, hubris or dishonesty.”

If you are certain about the future, Seth Klarman has advice on what to do:

“Those who can predict the future should participate fully, indeed on margin using borrowed money, when the market is about to rise and get out of the market before it declines. Unfortunately, many more investors claim the ability to foresee the market’s direction than actually possess that ability. (I myself have not met a single one.) Those of us who know that we cannot accurately forecast security prices are well advised to consider value investing, a safe and successful strategy in all investment environments.”

Thanks for reading. Hopefully this has been entertaining and informative!

Supported by Greenhaven Road Capital, finding value off the beaten path.

If you hadn’t heard, Michael Lewis has a new book out called The Undoing Project. I’m a Lewis fan and enjoyed it. If you’re curious about Lewis and the book, this Slate article, Basketball’s Nerd King – How Daryl Morey used behavioral economics to revolutionize the art of NBA draft picks is a good sample.

I took some notes. Ready?

1/ On certainty. Morey started his career as a consultant. Not because he didn’t want to be involved with sports, he did, that’s why he was a consultant.

His plan was to make a fortune at McKinsey, then buy a team. Ah, the naivety of youth. In Damn Right, Janet Lowenstein writes that Charlie Munger had a similar idea, only as a lawyer instead of a consultant. However, Munger saw in his day-to-day practice was that business owners not business lawyers who generated the real wealth. Munger switched paths.

Morey wasn’t aware of this thinking (yet). He was learning other things.

“From his stint as a consultant he learned something valu­able, however,” Lewis writes, “It seemed to him that a big part of a consultant’s job was to feign total certainty about uncertain things.”

McKinsey was billing clients $500K a year and those clients wanted predictions with certainty. They weren’t comfortable with what Phillip Tetlock calls “the wrong side of maybe.” Morey served his clients.  They’d ask for an oil forecast and “we would go to our clients and tell them we could predict the price of oil,” Morey said, but “no one can predict the price of oil. It was basically nonsense.”

We want confidence in our predictions. “Confidence is part of a complex (of competence)” that we want in people says Daniel Kahneman. “We want the people that we depend on to be competent and to be confident.”

Nate Silver wrote, “the amount of confidence someone expresses in a prediction is not a good indication of its accuracy—to the contrary, these qualities are often inversely correlated.”  This is what Morey felt.

We think confidence follows accuracy like a coal car follows a locomotive. This isn’t so.

2/ Extreme ownership. 

“Here’s the biggest reason I want to be in every interview,” said Morey. “If we pick him, and he has some horrible problem and the owner asks, ‘What did he say in the interview when you asked him that question?’ and I go, ‘I never actually spoke to him before we gave him 1.5 million dollars,’ I get fired.”

Morey practices what Jocko Willink calls “extreme ownership.”

3/ That’s interesting. Morey was 15 and the Cleveland Indians were on the cover of Sports Illustrated and predicted to win the World Series.

““I was like, ‘This Is It!!!! The Indians have sucked for years. Now we’re going to win the World Series!’ ”

The Indians finished last.

“The guys they had said were going to be so good were so bad…And that was the moment when I thought: Maybe the experts don’t know what they’re talking about.””

The next year Morey came across The Bill James Historical Abstract. He bought a copy.

These moments, where you go, that’s interesting are moments worth sniffing around a bit more. That’s what Benjamin Graham did when he found information on Northern Pipeline company. Judith Elsea does the same thing, only with an algorithm. Richard Thaler kept a list of stupid things people do.

We get that’s interesting moments from good pattern recognition. We see something, it doesn’t make sense, we dig deeper. And here’s where I disagree with Lewis who writes, “It was bizarre that it was even possible for a total outsider to walk into the game with an entirely new approach to valuing basketball players and see his approach adopted by much of the industry.”

The opposite makes more sense. Only an outsider could come into the game with a new approach that worked. Outsiders succeed all the time. Charles Lindberg flew mail routes in whatever plane was available. In The Outsiders the twist is in the title. John Boyd was a fighter pilot who developed ground warfare strategy.

4/ Measure the right things. Lewis quotes Morey:

“Obviously their performance statistics told you something about them. But which ones? You might believe—many then did—that the most important thing a basketball player did was to score points. That opinion could now be tested: Did an ability to score points in college predict NBA success? No, was the short answer.”

I realized after listening to Chris Cole and reading Dear Chairman by Jeff Gramm that superficial observations can conceal chaotic currents. Cole and Gramm approach this from an investing angle. They’re looking for situations where what we see isn’t what it is.

In basketball this was points. Points looked good. It told you something. It was easy. But to make good choices you needed more. What was the more for Morey? “Almost everything we looked at was nonpredictive.”

Hmm.  What to do?

Investors of money like Joel Greenblatt and Warren Buffett would tell you to wait for the right opportunity. Sam Hinkie’s firing in Philadelphia is a data point that tells you how well that works.

What do we do if we don’t know what the right things are? We find the wrong things and eliminate those. The Rockets learned this lesson the hard way when the player evaluators gave Marc Gasol the nickname “Man Boobs.” Whoops!

The problem was a bit of attribution substitution. Rather than answer (the harder) question of, “can Marc Gasol be a good NBA player?” The staff switched to (an easier question) of, “does Marc Gasol look like a good NBA player?”

Not only that, but scouts and coaches would overvalue things because one player was the same race as another. Or a player persuaded them in a meeting (tall guys are particularly charming it turns out). There were many things that did not contribute to the success of a basketball team but the staff acted like it did.

You have to get the MIT right. John Boyd taught fighter pilots how to reverse a position. Ross Perot tried to convince GM the MIT was quality not technology. In personal finance, says Morgan Housel, it’s car, house, and school.

The MIT for a basketball player is not race, “man boobs”, or (only) points scored in a game. There were better things to measure, Morey set out to find those.

5/ Barbell approach. 

“So long as it relied almost exclusively on performance statistics, the model would always miss DeAndre Jordan. The only way to see him, it seemed, was with the eyes of an old-fashioned basketball expert. As it happens, Jordan had grown up in Houston under the eyes of Rockets scouts, and one of those scouts had wanted to draft him on the strength of what appeared to him undeniable physical talent. One of his scouts had seen what his model had missed!”

Success would start to come with a barbell approach. Take statistics and scouts and mix them together. Lewis writes, “The trick was to listen to it (Morey’s model) and to the scouts at the same time.”

6/ The two-jar model. I love the two-jar model and it fit perfectly as the theory behind one of Morey’s rules.

When the Rockets had workouts with players the coaches tended to overvalue the things they saw (good and bad). Morey told them to weigh these evaluation sessions “really low.” It was hard for the staff. They saw things and those things meant something.

Or did they?

The two-jar model is a framework to view each outcome as a combination of draws from a skill jar and a luck jar.  If a player performs awesome or poorly in his workout what was the reason?  The two-jar model suggests we ask how much of the performance was skill based and how much was luck.  Morey understood this, Lewis writes, “If a guy was a 90 percent free-throw shooter in college, for instance, it really didn’t matter if he missed six free throws in a row during the private workout.”

Free-throw shooting is mostly a skill draw with very little luck. That’s an outcome that will hold up over time.

7/ Rapid fire. This post could go on forever. Let’s pull a few more quotes.

Finding the truth is not a popularity contest. “Who cares what other people think?” Rockets owner Leslie Alexander told Morey. John Boyd told his compatriots that “getting kicked in the teeth is the reward for good work.”

…

“Soon Morey noticed something else: A scout watching a player tended to form a near-instant impression, around which all other data tended to organize itself.” Daniel Kahneman suggests we use delayed intuition. “There is a need for disciplined intuition and what I mean by disciplined is delayed intuition. One of the many problems with our intuitions is they come too fast and we tend to confirm them.”

…

“Confirmation bias is the most insidious because you don’t even realize it is happening,” says Morey. “The normal mind takes out of the noise what it wanted to hear all along,” said Nick Murray.

…

During a lockout Morey took a class on behavioral economics that made him uneasy after seeing the anchoring effect in action. It can happen for the starters on a team writes Chris Anderson. Managers “wait until the evidence of flagging performance is undeniable. By that time it’s often too late.” Let anchoring help you and start with the base rate.

…

“You know,” one Rocket executive said, “if we had the pick we’re thinking of trading for and they offered Lowry for it, we wouldn’t even consider it as a possibility.” This was a great example of inversion, one I’ve heard Dave Ramsey use to give financial advice. If your car is worth $8,000 would you buy it if you had no car but eight grand?

Thanks for reading, I’m @mikedariano on Twitter.

 The story about Gasol made me laugh out loud. Anyone who’s played pickup basketball has met the big guy who looks overweight, slow, and clumsy and who anything but the last two. At a slim 6’2″ I guarded these guys all the time and they unconditionally kicked my butt.

Supported by Greenhaven Road Capital, finding value off the beaten path.

In late 2016, Chris Cole joined Patrick O’Shaugnessy to talk about investing. It was not what I expected.

I had Cole’s paper, Volatility and the Allegory of the Prisoner’s Dilemma queued up but couldn’t get through it. After listening to the podcast, the big ideas were loosened and easier to consume. Cole’s paper became simpler. These are my notes.

Ready?

1/ -1, 0, +1.  “(Value investing is) a valid classic strategy, but value investing extracts an equity risk premium. During large-scale declines in markets, value investing is not immune to the crisis that can envelop a market…the irony is that value investing needs these crises because it results in all this behavioral inefficiency that allows for the value risk premium to be extracted.”

A lot of the podcast was about volatility, convexity, and figuring out how to act once you figure out what might happen.

This conversation reminded me of a key that unlocked Taleb for me. When I first tried to read Antifragile I was bogged down. The words were too big. The history too old. The ideas to dense. What freed me was when I realized that Taleb’s triad could be summarized as: -1, 0, +1.

My mistake was in thinking that the opposite of -1 was 0. That’s not it at all. It’s true for Cole’s ideas too:

• Long convexity is antifragile
• Value investing and cash is robust
• Short convexity is fragile

“Cash might protect you,” O’Shaughnessy says, “but you’re not going to earn a big positive by sitting in cash.”

We think a lot about inversion here. Bill Belichick, Mohnish Pabrai, and John Boyd all think forward and backward. They invert.

Sometimes we (mostly me) stop short at the absence, not the opposite. This was my misunderstanding of Taleb. For example, the opposite of spending isn’t saving, it’s earning.

Cole doesn’t want to weather a crisis, he wants to profit from it.

2/ Small Vol.  “We have this false stability and underneath that we have this incredible potential for volatility. We see this every time people try to suppress smaller volatility. It’s true with marriage counselors. They say the people most likely to get divorced are the ones that aren’t fighting. The ones that aren’t fighting at all have the most tension because they’ve given up on one another. It happens with avalanche prevention on ski slopes. The forest service will blow up portions of a mountain.

One of my favorite books, though not of 2016, is Deep Survival by Laurence Gonzalez. (Sidenote, did you Gonzalez was Michael Mauboussin‘s editor for The Success Equation?)

The book opens with Gonzalez – of all places – on the deck of an aircraft carrier.

“If you could see adrenaline, then you’d see a great green greasy river of it oozing off the beach at San Diego tonight. You’d see it flowing one hundred miles out toward the stern of the boat – that’s what pilots call it, a boat, despite the fact that it displaces 95,000 tons of water, has a minimum of six thousand people living on board at all times, and is as long as the Empire State Building is tall.”

How’s that for the opening of a book!

Gonzalez is there to find out how pilots don’t die. How do they land an F-18 on the deck of boat. Part of the secret is not repressing ‘small vol’. Briefing officers use “dark, dark humor,” a ritual Gonzalez writes “in which everyone was reminded how to look death in the face and still come up with a wry smile.”

Forests have controlled burns. Snowpacks have controlled avalanches. Marriages have fights. Fighter pilots have humor.

Trouble sparks when flammables accrue.

Cole suggests that current macro mechanizations are borrowing returns from tomorrow for today. Risk from today is being pushed into the future. As snow on a mountainside builds up, it may be a dangerous system.

3/ How much does your insurance cost?  “It’s one thing to have convexity but if it’s incredibly costly, then you end up in a hole that you can’t come back out of.”

O’Shaughnessy asks about how someone can be long convexity. Cole explains how to mix value investing so that it pays for the long convexity premiums. It reminded me of a landlord.

Imagine that rather than financial instruments, it’s physical ones. You own an apartment complex and collect rent (Cole’s value strategy). The rent doesn’t make you rich, but it covers your expenses. One of those expenses is a colossal insurance policy.  Your hope is that the buildings burn to the ground – while everyone was out, of course – and you collect on insurance.

This theoretical strategy is insurance fraud, but I think the financial version is what Cole looks for.

What’s key is paying the right price. If you pay too much for fire insurance, you’ll never last long enough to see a fire. If Cole pays too much for options, he’ll never last long enough to see the convexity.

Howard Marks reminds us, “there’s no such thing as a good or bad idea regardless of price.”

4/ Cheerleaders (what to do) and Coaches (how to do it). “I’ve always felt that macro investing is so hard because you need to get two things right; accurately forecast what’s going to happen, but more importantly you need to position your portfolio in a way that will actually benefit if your forecast come true.” – O’Shaughnessy

What to do is easier than how to do it.

5/ Argue well. “I ask myself and my staff that question all the time. ‘What if we’re just wrong?’ This is an existential question if you’re a long volatility manager.”

The best managers of money, sports, and people all try to be proven wrong.

Bill Belichick evaluated assistant coaches based on their pushback and ideas. The Outsiders compared meetings to wrestling matches. Jeff Bezos and Andy Grove argue well with their subordinates. Danny Kahneman had Amos Tversky and Amos Tversky had Danny Kahneman.

No one person knows all. Arguing well, said Wilbur Wright, “rounds the corners.”

6/  Are we all artists? “I hate this idea that people segment left brain right brain. Some of the investors I admire the most are truly creative. Particularly if you look at the global macro space, someone has to envision a reality that is different than the reality we have today and understand how to structure instruments to profit from that potential reality shift and assign probabilities on that. Intellectually I don’t see that as that much different from some highly technical artists.”

We often come back to Howard Marks’ idea that you have to be different and you have to be right. It’s easy to read, but harder to do (see #4 above!). How do you think differently?

Look at the iPhone. Why in the world did Apple make it without a keyboard?

Look at Tesla. Why in the world did Elon Musk start a car company?

Look at Sam Adams. Why in the world did Jim Koch start a beer company?

Maybe the why is in the who.

Maybe they’re artists.

Amanda Palmer makes this case. You’re a performer whether your stage is a BMW dealership, a blog, or Carnegie Hall. You’ve props, an audience, and expectations. You have to show some creativity.  What is sales but performance and what is performance but art?

Read this Ben Carlson post about selling and think singing rather than selling. The ideas still stand.

The problem is if you stop at being an artist and fail to roll up your sleeves and make the trains run on time. This is the other brain that everyone talks about. There’s the creative side and the practical side. Jobs, Musk, and Koch would have been footnotes if they didn’t do the work.

Sonal Chokshi had a tweetstorm that helped me think about the balance:

Thanks for reading, I’m @mikedariano on Twitter.

This blog is supported by Greenhaven Road Capital, finding value off the beaten path.

My tallest reading hurdle is ignorance. Not willful, but present nonetheless. We all need a ledge to stand on and hoist ourselves up to new ideas. Podcast are great for this, so are YouTube videos.

Daniel Kahneman’s Thinking Fast and Slow is an accessible, though thick, book (we’re reading it here if you want to join us ). If you want to sample to the big ideas, his 2015 conversation with Michael Mauboussin is good.

Here are my notes and quotes from there:

1/ Intuition. You stink at predictions. You’re biased by recent data. You’re biased from a focus on survivors. You’re biased six ways from Sunday.

We all are.

Yet we have to make predictions in our lives. We have to use intuition. What to do?

Like a mat that teaches tango, there are beginning steps for good intuition. (1) Kahneman says to start by asking, “Is the domain one with enough regularity to support intuitions?” That is, does it pass the Hickory High test? Is the basketball hoop ten feet no matter the gym?

Coach Bill Belichick has a good intuition because he operates in a domain with regularity. If someone can develop good pattern recognition skills then that domain has regularity.

Kahneman also says (2), “did the individual have an opportunity to learn those regularities?” This moves the question from can someone to did someone? Warren Buffett did it after many years. John Boyd did it after many flights. The key, says Kahneman, is immediate high-quality feedback. (True for Buffett and Boyd). Toward the end of the YouTube video, an audience member asks about why some rules like traffic lights work better than others. “Unequivocal feedback,” says Kahneman “you know if you violated that rule or not.”

Good intuition is also delayed. (3) “There is a need for disciplined intuition and what I mean by disciplined is delayed intuition. One of the many problems with our intuitions is they come too fast and we tend to confirm them.”

Daryl Morey saw this, writes Michael Lewis, “Soon Morey noticed something else: A scout watching a player tended to form a near-instant impression, around which all other data tended to organize itself.” Morey had to tell evaluators to under-weight what they saw during a tryout. We can take a second look at Belichick and see that his success in “player evaluation” is less consistent than his success a “teacher of football skills” or “leader of men”. Head football coach includes multiple domains, some of which are better for intuition.

2/ I ♡ STORIES. “Why do smart women tend to marry men less smart than they are?” Kahneman asks. As someone with firsthand experience let me answer this for you, good jokes and cooking go a long way.

These things aren’t actually true. While “it sounds like a topic worthy of discussion,” Kahneman explains, it’s “an effect without a cause.”

“There is no causal explanation. You have to rid yourself of the idea of causation to understand that result. This is extraordinary difficult to do.” – Daniel Kahneman

Let’s rephrase the question to see the mess. Why do tall women tend to marry men less tall than they are? Duh, because most people are shorter than them. We don’t always see this logic, we sometimes make up stories instead.

Stories aren’t all bad. They are the yin to the yang of numbers. Good thinking requires a balance.  Bethany McLean and Barry Ritholtz both praised “left and right brain” thinking. Chris Cole said that the best macro investors have creativity like “some highly technical artists.” Buffett wrote that the big money is by being right qualitatively, but that the sure money is made being right quantitatively.

Our best results come from a balance of strategy. Stories and numbers pinch out falsehoods. Problems start if we get too focused on one end. If you too ♡ stories too much, there’s a simple tool to use.

3/ You know I’m all about that base rate, bout that base rate, bout that base rate. (#notreble)

“I will count on the fact most people here have not read what I wrote about this,” Kahneman said, “because it’s in a chapter that – frankly – many people who bought the book never get to.”

This comment got a laugh. Kahneman goes on to tell the textbook story. It’s a good one – that we covered in the third Michael Mauboussin post.

What I found most interesting was what Kahneman said next.

“I had the information. After that we should have quit that day…Even though we’d been given the outside view, we didn’t act on it. The inside view, the feeling that we were doing well, that this was a good team, and that we were going to succeed overwhelmed.”

Knowing != doing.

Ben Carlson put it this way:

“However, as anyone who has ever tried to diet or get their personal finances in order can attest, knowledge alone is not enough to change behavior. If it was, we would all be rich with six-pack abs.”

Charlie Munger wrote, “We started coping better with reality when it stopped waving the danger flags at us and started using them to poke us in the head and stomach.”

Knowledge alone is not enough. Thankfully we can turn some of our biases around and use the in our favor.

The anchoring bias is a pesky rascal until you anchor to the base rate. That’s a start. Then take the two-jar model and figure out if the thing is based more on luck or skill. If it’s more skill, you can move your expectation away from the base rate. If it’s more luck, don’t you dare touch it.

4/ Balancing optimism and objectivity.  On the one hand, you have the objective; base rates. On the other you have the subjective; like optimism. People are often optimistic, says Kahneman, because “they don’t fully appreciate the risk they are taking.”

That’s the truth.

While researching 28 Lessons from Startups That Failed this surprised me. Many founders lamented how difficult it was. Not just the start-up, but everything. Founders lost friends, relationships ended, and their diets and health went to hell. Funding was slow, if it came at all. Products orders were magnitudes more expensive in money and time. Feedback was kind but sales were nasty.

It was like founders had signed up for a marathon. They looked at race form, saw distance and knew it was hard but thought they could do it. After committing they got a call (late at night) and were told they couldn’t train more than ten miles a week and couldn’t sleep more than five hours a night. In addition, they were competing against elite runners who had years of experience, personal trainers, and supportive families.

Oh, and they were doing it barefoot.

In the business world, this is good for the whole but bad for the parts. It’s why Nassim Taleb suggests a holiday for entrepreneurs. Kahneman too believes in optimism:

5/ Are advisors inoculated against biases? Well, your personal biases, yes. Kahneman says that when a principal acts for an agent, loss aversion and the endowment effect recede.

6/ “That’s one thing I hate! All the noise, noise, noise, noise!” – The Grinch

“Noise,” says Kahneman, “is costly.”

Yes! Damn the noise!

Or maybe not. Didn’t we just say that a balance of tactics is often a good course?

• Intuition (#1) balanced with base rates (#3).
• Stories (#2) balanced with stats.
• Optimism balanced with objectivity (#4).
• Scouts balanced with algorithms (post-Moneyball).
• Arm strength and football smarts (Tom Brady).

How then can noise be helpful?  “Noise-free environments end up being too sterile and predictable in their output,” writes Stephen Johnson. “The best innovation labs are always a little contaminated.”

Taking reading as an example. One reading model is to only read books on the NYT list. If  is on the NYT Bestseller list, then read.

No thanks. Instead, read whatever you’re excited to read. If you don’t want to trade a few minutes a day on activity X for reading a book the problem isn’t activity X. The problem is the book.

7/ Success and luck. I enjoyed this:

“Success = talent + luck. Great success = talent + a lot of luck.”

And this:

“Success has a lot of luck in it. We can say it differently because that can be misleading. Talent is necessary, but it’s not sufficient.”

Thanks for reading, I’m @mikedariano on Twitter.

Supported by Greenhaven Road Capital, finding value off the beaten path.

Tren Griffin wrote a nice post that explained why some restaurants do and some don’t have moats. Or, why can some businesses raise prices? While Disney can charge more for stuffed animals and Nike can sell $28 socks, Nasty Gal couldn’t raise prices. Why? Is there a big idea behind all this?

Griffin explains profitability in terms of restaurants. We will extend the exercise to podcasts.

These are murkier waters. Restaurants have a simpler revenue and cost structure. Podcasts are more of a patchwork. This American Life is produced “in collaboration with Chicago Public Media.”  Hardcore History has a sponsor and accepts donations. Entrepreneur On Fire has ads and a membership community.

We’ll try to answer the same question as Griffin, can podcasters make money?

TLDR; they can, but not by only podcasting.

Before we jump in let’s remember the two-fold goal. We want to think about the thing and think about the thinking. We’re thinking about podcasts, but also how these ideas apply to any business.

Ready?

1/ Conditions of the environment. In the Galapagos Islands, there are seasons with more rain and seasons with less. When it rains less there are fewer plants and the finches with the larger beaks do better because they can open the Caltrop seeds.

In seasons with more rain, the smaller finches do better because their caloric needs are more easily met by what is available. The larger finches must work harder.

Conditions matter for finches and they matter for restaurants and podcasts.

• The barriers to entry are low. Restaurants begin as food carts or caterers. Podcasters can do everything from a smartphone.
• Limited opportunity.  People have only so much disposable income to spend at restaurants. People have only so much time to listen, read, and watch things.
• Ample alternative supply. Chipotle doesn’t compete against other “fast casual” restaurants like Panera, but also McDonald’s and eating at home. Podcasts have to survive in the attention economy against Westworld, Carrie Underwood, and Instagram.

Like the finches, it’s easier to grow when conditions are good. Milton Hershey had this good fortune.

• There were barriers to entry. To learn how to make caramel, then chocolate, young Milton apprenticed with different confectioners across the country.
• There was a growing opportunity. Hershey started to make chocolate at the right time. “In 1870 America had begun an immigration boom that would last fifty years and triple both the country’s population and the number of potential customers for products like Hershey’s caramels,” wrote Michael D’Antonio.
• There was little competition. Hershey was one of the first to create a good milk chocolate in the United States.

“Supply is the killer of value,” writes Griffin and for podcasts there is a lot of supply.

2/ W-T-P is the M-I-T. In Paul Johnson’s short biography of Winston Churchill he writes, “Churchill had an uncanny gift for getting priorities right. For a statesman in time of war it is the finest possible virtue.”

WTP stands for Wholesale Transfer Pricing, an idea Griffin got from John Malone.

Griffin writes:

“Wholesale transfer pricing =  the bargaining power of company A that supplies a unique product XYZ to Company B which may enable company A to take the profits of company B by increasing the wholesale price of XYZ.”

Griffin elaborates. Restaurants that rent their space are vulnerable to rising rent (WTP). When Apple sells songs for $.99 they are NOT vulnerable to rising costs from labels and artists (they make their money on the devices).

Thanks to digital transfers, podcasters aren’t captive in the same ways. Podcasts and blogs can redirect consumers to a different location. When Morgan Housel left the Motley Fool he changed his Twitter handle without a loss of followers. Unlike a restaurant then, podcasts can move to a new location (domain, RSS feed) and maintain the same traffic.

However, they aren’t fully immune. Companies like Midroll service the ads for podcasts like WTF, The Ringer network, and Doug Loves Movies. If Midroll charges more for ads they don’t have to pass on the revenue to the podcasters. These podcasters are vulnerable to WTP.

3/ Opportunity cost. Few people run restaurants just for the fun of it. The hours are long and hard. As we say about investing here, you can actively invest, or passively invest and have a hobby.

Restaurants have high opportunity cost. Podcasts have almost none.

Patrick O’Shaughnessy, James Altucher, and Barry Ritholtz all seem to genuinely enjoy podcasting. Like a restaurant, they earn money, but also get compensated with prestige, recognition, education, and good conversations.

David Chang compared opening a restaurant to graduate school. Both cost about the same, required similar work, and would demand his attention. He chose the former at the cost of the latter.

Marc Andreessen said that opportunity cost is something he thinks about in his investments. It wasn’t that smart investors missed Facebook, he told Tim Ferriss, but that some couldn’t invest because their financial and professional commitments were elsewhere.

It costs a lot in time, money, and energy to start a restaurant. With long hours and small margins, it’s a full-time job. Podcasting is closer to a hobby. The commitments are small, the payoffs multiple, and opportunity cost low.

4/ But what if you REALLY want a comparative advantage? There are five moats (read: ability to raise prices/charge less).

1. Supply-side economies of scale. McDonald’s buying trucks of potatoes.
2. Demand side economies of scale. Waze users reporting traffic flow for other Waze users.
3. Brand. Field Notes, Yeti tumblers.
4. Intellectual property. Lipitor, Marvel superheroes.
5. Government regulation.

Restaurants have access to brand (#3) (Jimmy Buffett, Five Guys Burgers, and Buffalo Wild Wings) and supply side economies of scale (#1) (fast food franchises) and maybe IP (#4).

Podcasters are limited to brand. Sort of. Look at this top podcast list. Some podcasts have more than one brand.  Gimlet, NPR, How Stuff Works, WNYC, Panoply, etc. is one brand. Hosts are another.

Podcast branding is a catch-22. Podcasting is intimate because the person is in your head, but it’s hard to build a brand around a person. As Kevin O’Leary likes to ask on Shark Tank, “What happens if you walk out of here and get hit by a truck?”

Instagram passed this test. (when I wrote about them I had to look up who the founders were) Nasty Gal did not.

It’s hard to imagine Hardcore History without Dan Carlin. Malcolm Gladwell’s name is the biggest thing on the podcast icon.

My guess is that branding similarly to word of mouth testimonials. If a friend suggests a restaurant, you’ll probably try it. If a brand like NPR suggests How I Built This (which is exactly how I found this great show), you’ll probably try it. The host is like the food, if it’s good you’ll come back for more.

5/ The public good problem. Podcasting is nonrival. You, me, and Bobby McGee can all listen to a podcast at the same time. One person using it doesn’t stop others from using it.

• Rival goods;  a physical book, hammers, (eaten) apples, domain names.
• Nonrival goods; music, podcasts, roadways (to a point).

Podcasts are also nonexcludable. Anyone can listen.

• Excludable goods; private concerts, satellite television, private beaches.
• Nonexcludable goods; public concerts, public television, public beaches.

Podcasts are (mostly) public goods because they are nonrival and nonexcludable. Podcasters know this because like musicians (another area Griffin has written about) they supplement their income. Maron is a stand-up comedian. John Lee Dumas has a membership program. Gladwell and Ferriss write books.

Conclusion.

1/ It’s hard for podcasts to be profitable. Low barriers to entry allow anyone to start, and anyone will.

2/ If a podcast does get large enough for advertising, it can be better to farm out the ad work. “Focus on your strengths,” someone might say, but this makes a provider vulnerable to WTP.

3/ The good news is that podcasts have a low opportunity cost. They’re cheap and simple to start and multifaceted rewards.

4/ Podcast moats must be built on brand, but personal brands fail to answer the Kevin O’Leary question.

5/ Podcasts face the public good problem. Fortunately “talking into a microphone” is similar to “talking to a theater” and “talking words onto a page,” two excludable services.

Griffin began his post about restaurants:

“Investing is about owning a partial stake in a real business. You must understand whether the actual businesses in which you own stock earns a return on capital to be a successful investor. The more different types of businesses you understand in this way, the more skill you will acquire in understanding another new business.”

Thanks for reading. Hopefully, we thought in a few new ways.

 

One bit of housekeeping. This blog has a sponsor! It is supported by Greenhaven Road Capital. Thanks to Scott for his interest in clear thinking, making better decisions, and finding value.

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It’s a new year, a new you, and blah, blah, blah about resolutions.

People sometimes email me and ask how I read so much. After some self-congratulating about my work ethic, early alarm, and productivity – I realized it wasn’t really any of those things. What actually matters is that it’s my job to read and write and I enjoy doing it.

In hopes of finding a better answer, I emailed Patrick O’Shaughnessy. He shared this tweet storm:

I agreed with most of it. But that really doesn’t matter to you.  O’Shaughnessy’s reading style can’t be your reading style. Copying won’t work. Cherry picking, however, is encouraged.

At the beginning of Charlie Munger: The Complete Investor, Tren Griffin writes:

“The point is not to treat anyone like a hero, but rather to consider whether Munger, like his idol Benjamin Franklin, may have qualities, attributes, systems, or approaches to life that we might want to emulate, even in part.”

Here are a few things that help me read more. Remix please.

1/ When to read. It starts here. If you don’t have time to read you won’t read. Seneca’s words inspire me most:

“It is not that we have a short time to live, but that we waste a lot of it. Life is long enough, and a sufficiently generous amount has been given to us for the highest achievements if it were all well invested…So it is: we are not given a short life but we make it short, and we are not ill-supplied but wasteful of it… Life is long if you know how to use it.”

Odds are good that you can find some time. Books have never been more portable, recommend, or easier to find. It’s the time that you need to find.

If you need instruction beyond Seneca,  168 Hours and How to Invest Your Time Like Money both led me to better returns on this investment.

2/ What to read. Podcasts are great samples for books. When I heard Greg Ip on EconTalk I understood the big ideas in his book. The actual reading was faster because of it. Ditto for Eric Weiner’s Geography of Genius, and Jocko Willink’s Extreme Ownership.

I also like to read books in a cluster around a theme. In 2016 that meant reading a lot of book about biology and evolution; On the Origin of Species, Full House, The Beak of the Finch, and Darwin’s Dangerous Idea.

The same was true for when I wrote about Bill Belichick’s red teams.

Clustering will mean an overlap around subjects. That’s fine. Those parts are an extra reminder or a part to skip.

Skipping sections or entire books is underrated.  It took me a few cracks to read Taleb. I still haven’t read the books I own on Chaos and Complexity. I didn’t know enough the first time. I’ll take another crack at them soon. If I’m ready, I’m ready. This isn’t school. There’s no deadline.

3/ How to read. However you’d like.

O’Shaugnessy reads one book at a time. Bully for him.

I do multiple books at a time, but none too similar. A typical mix is one science book, one business book, a biography, and a fiction book.

Polymaths, well, I don’t know what polymaths do. Go read Marginal Revolution to see what Tyler Cowen writes.

Michael Mauboussin said he likes physical pages, me too. Morgan Housel, O’Shaughnessy, and Sanjay Bakshi use a Kindle. Jason Zweig reads with a red pen.

Financial advisors write that the best investment plan is the one you’ll stick with. That applies to reading too.

4/ Create hurdles and remove obstacles. One of my favorite books on psychology is Mindless Eating. The book is about food but the lessons apply to everything.

• If you make something slightly easier (i.e. Nudge(s)) people will do it more often.
• If you make something more difficult, people will do it less often.

To combine the ideas of Jocko Willink and Steven Pressfield, you’re flanking resistance. Make reading easier and something else harder.

Reading is easier when you have good books and have the prerequisite knowledge for them (#2). Reading is easier when the Kindle app is more accessible than the Twitter one. Reading is easier when you sit down with a book and leave your phone across the room.

5/ Reading is cool. Years ago I emailed Shane Parrish to thank him for teaching me about learning. When I graduated college I thought I was mostly done learning, at least from books.

I was wrong.

Reading Farnam Street was enlightening. What is this and who are these people?! There was all this interestingness and excitement, it was almost palpable. I hadn’t learned it all. Heck, I hadn’t even scratched the surface.

Successful people – in any domain, by any metric – have a growth mindset. Casey Neistat talked about this when he sold his company to CNN. He says that his career is like swinging through vines in a jungle. You have to let one go to reach the next one. You have to keep moving forward.

Reading is one way to do that.

Thanks for reading, I’m @mikedariano on Twitter.

If you want some books to read, I send out a monthly list, http://eepurl.com/bgRZOX. I also shared my favorites from 2016.