The Exchanges

Q So what was the impetus for writing what became one of the greatest investment books with one of the most questionable investment titles relative to the quality of the book?

A Okay. Well, number one, you can be a stock market genius. And the original subtitle was even if you're not too smart was originally supposed to be any fool can be a stock market genius, but it turned out my editor at Simon and Schuster had the Motley fools and he wouldn't let me use the word fool. And not that it was a good title anyway, but it was slightly better than the one I ended up with. And he gave me 24 hours to change it. And my father came up with, you could be a stock market genius, even if you're not too smart. And I laughed pretty much. No one else did. After I wrote it, pretty much one of the worst titles of all time. Having said that, very proud of the book because I was sharing war stories. You know, I had learned from reading Buffett. I had learned from reading Graham. Who are willing to share. I started teaching around that as well after I gave back the money at Columbia in 96. And so I always wanted to write and teach. It's something I enjoy. And so I had a ball writing that book and it was very easy to write because it wrote itself. It was really just talking about war stories. What did I learn from that? What was I thinking at the time? I loved it also because it didn't involve doing a lot of research into theoretically, should I consider this or that it was really, no, this is what I was thinking. When we did this. And it was very honest in that way. I cou…

AI assessment note: “I always wanted to write and teach. It's something I enjoy.”

Q I think we can continue the tour through books you've written, and we talk about that, but there was the, the big secret, which is the little secret in terms of distribution, I guess, of the four books you've written, and that was back in 2011. So what was the reason for writing that book at the time?

A The Big Secret was really a continuation of my goal. It was called The Big Secret for the Small Investor, and you heard me say it's still a big secret because no one read that one. You know, I didn't say that, but it's true. But it was really a continuation of my goal for the little book. I think the little book, I was encouraged to write about the magic formula a little faster than I wanted, and I was building that up as a way to help people understand how to invest, and so The Big Secret was really a continuation to Help people understand in a more global sense who are just beginning investing a what the advantage for a small investor was, but also why I thought that. And so it was really just, uh, they're sort of compliments. If I would, I tell someone who wants to teach their kid, I say, read the first five chapters of the little book, then read the first five chapters of the big secret. That's one of the books I wanted to write, but the big secret, just so you don't have to buy the book, was the advantage of the small investor has is patience. There's much more data available. Time horizons are shrinking. They're not growing. I used to send out quarterly letters. Now, even the biggest institutions want to hear my returns every week. I don't know what they do with that information, but that's what they want to hear. You can check their stock price 30 times a second on the i…

AI assessment note: “The Big Secret was really a continuation of my goal for the little book.”

Q So what do you do with that? You read an article, you read more about Buffett, you're coming out of school. How'd you get started?

A I stayed to go to graduate business school. There was this program you could get your MBA in another year, so I did that, and I corralled a couple of my business school friends. One is Rich Pizzina, who is a well-known money manager, and now there's Bruce Newberg, who That's one of my smartest friends. And I said, Hey, we should really research this. And of course there were really no great databases and computers were sort of just getting started. I grew up, I lost in space with the robot. I don't know if anyone remembers that, but it wasn't very sophisticated. So the computer Wharton had at the time was about four classrooms big. Didn't do very much and needed punch cards. And of course we didn't have databases. So we actually found The Standard Poor's stock guides at the time had a little date on 5000 different companies, and we actually manually went through them. And I said, we got to test this, and we all tested together, and our study ended up getting written up in the Journal of Portfolio Management. And it was really a study of that first article I read with Ben Graham about buying stock selling below liquidation value, and actually went out and raised money from a bunch of my father's friends, not a lot of money, I still didn't keep me from going to law school, unfortunately. I dropped out after a year, so that was the good news, but during that year in law school, I …

AI assessment note: “I stayed to go to graduate business school... I corralled a couple of my business school friends”

Q Over that decade, did you have any positions that really went awry? In terms of downside more than you expected?

A Yeah, well, there are a couple of times that things didn't go well for us, and when I got started, and this is, uh, 86, I started in 85, so this is towards the end of 86, There was a problem on Wall Street with Ivan Bosky and Mike Milken, and Milken was financing a lot of the merger deals at the time, and so I had in my portfolio five or six merger deals that were going on, whether I had a piece of a security or I had some iteration of it, and I thought that was diversity. In my portfolio, but it turned out it was all the same bet. You know, is the financing going to go through or is it not going to go through? And at that time, I literally had six deals. It wasn't my whole portfolio, but I had six deals that broke at the same time, which I thought were independent bets. And so lost a lot of money. Luckily I had been up that year. I think I was up 80%. I finished up 30. So I guess you could say I was playing with house money, but that's a big drop and painful. And the great thing about that was that remember I said, get a little lucky. So I got a little lucky there in 87 before the crash, things didn't smell very well to me. And I liquidated a big chunk of my portfolio before. That's the only good market call I think I've ever had in my career. So I think you can be successful without knowing which way the market's going. But in that particular case, I got kind of cold feet, an…

AI assessment note: “I had six deals that broke at the same time, which I thought were independent bets.”

Q So in this strategy that you later wrote up and became part of for a long time, a typical hedge fund playbook, if you will, what was it like fishing around in places where you weren't part of the crowd?

A I opened You Can Be a Stock Market Juniors with a story about my in-laws, about how they spent their weekends up in Connecticut looking at tag sales and country auctions and yard sales. And when they found a painting that they liked, they didn't ask, is this painter going to be the next Picasso? Their question was, are there similar paintings by this artist that have just gone up for auction or sold to dealers for two or three times what I can buy it for here? Totally different skill sets. So I wasn't really taking guesses. I felt like I was cheating. Like, all right, well, if you had done this work or look at this little corner, you would buy it too. It's just that I read page two, 27 of the prospectus, or this is a small cap thing that other people aren't looking at, or this is so complicated. If I take the time to analyze this ahead of most other people, eventually people will get there. But I know I'm only competing with a couple other people who are even willing to do this work or look in this place, and so it always felt like, I wouldn't say cheating, but I always knew it when I had it that it wasn't like I was a great analyst or anything. It was that any idiot who looked at this would see that this is selling 50 cents on the dollar, and I just happened to know where to look.

AI assessment note: “I felt like I was cheating. Like, all right, well, if you had done this work”

Q All right. Last one in this set. What life lesson have you learned that you wish you do a lot earlier in life?

A I did the best I could, but I really think enjoy the journey. There's no there there. Enjoy every day. Try to take the best out of every moment. Learn from what you see, but enjoy the journey. I remember just one story that a friend of mine's daughter was a skater when she was very young. They were sitting in the theater behind Pat Riley. The great coach. And he went up to Pat Riley said, Hey, my daughter's, you know, whatever, seven year old skater, any advice you could give to her? And he said, well, does she like to practice? Was the number one question. And I think, think about life as practice and just enjoy getting there and enjoy the journey. And I try to help my kids do that. And obviously there's so many pressures day to day that people don't remember that. And so I need that lesson myself as much as possible. But I, I like to, as I get older, I want to enjoy every day more and more and more. And I, the earlier you learn that lesson, the better.

AI assessment note: “I really think enjoy the journey. There's no there there. Enjoy every day.”

Q And what's the research process been, right, in this all-important task of valuing a business and trying to find cheap cash flows?

A The research process is really going over with a fine tooth comb. Each company going through their balance sheets, income statements, cash flow statements, trying to understand what's driving their cash flows. What are real cash flows? They take a write off. What periods do they belong in? Really? What is the true economics of this business? What are the normalized economics of this business regardless of what's happening in the short term? And see if we can buy them cheap, taking into account the balance sheet, meaning how much debt do I have to take on because I just bought this whole business. Just logical things. I think the easiest way to think about it is we take the perspective of a private equity investor buying the whole business. And we balance our portfolios using other risk metrics. And then the size of the business and how much it trades, how much we're going to own of it. It's not like, oh, if the cheapest business is a small cap, it may not be our largest position, even though it's the cheapest. We'll buy as much as we can of it. And then we have to see what's on the short side that may keep us balanced in that. So it's a little more sophisticated, but we have long only portfolios too, that just buy the cheapest companies. And we have something that says, you know, in a bow to the move to indexing that just says, Hey, Look, people can't take much tracking error, …

AI assessment note: “The research process is really going over with a fine tooth comb.”

Q So was there a moment in time where you turned off that concentrated model and turned on the more diversified model that we've talked about?

A Not really. It was really an evolution, but once again, we came up with the diversified model really for ourselves. And we fell into the fact that we should be more diversified, not less diversified, which is counter to what our initial intuition was because the alpha generation is very linear when you buy cheap to expensive. But when you go long short put on leverage, once again, more diversity is better. Insurance companies don't insure five people. They're better off being right on average. And that's what we found. And so we started slowly taking an outside money and just sort of evolved. And then once you take out on a certain amount of outside money, I felt an obligation to spend all my time doing this, so I have most of my money doing this, and I have other managers doing it more concentrated, but people ask me, hey, do you not like that other way of investing? And no, the answer is no, I like it just as much as I always did. I can't do both, so I'm doing this now, and if I want to teach my kids how to invest, I teach them both.

AI assessment note: “Not really. It was really an evolution”

Q How did you progress forward into it being more of a professional business?

A I was out in California, really by myself, out at Stanford for a year. I figured I got in. I should go. It can't hurt me, but Pretty soon after I got to law school, I said, Hey, listen, I never wanted to be a lawyer. I just didn't want to get one of those hundred hour a week Wall Street jobs out of MBA school. That didn't look appealing. And I figured I like school. So I went, I went out there and realized, you know, if you don't want to be a lawyer, this is really a dumb thing to do. And so when everyone else was looking for summer jobs, I went looking for a summer job on Wall Street instead of at a law firm and found one at Bear Stearns Trading Options. And after summer doing that, which was very handy and trading options at Bear Stearns at that time was pretty cool because it was pretty archaic where I could run across the trading floor to get a computer print out, run back to my desk, call in and do arbitrage, you know, options versus stocks. And so it was a great way to learn about that and all the cool things you could do with options. But I certainly didn't want to do that for a living, but I knew I wasn't going back to law school and I ended up through a friend of mine. Who had just taken a job on wall street. One of the people he had talked to was leaving a firm called LF Rothschild at the time, setting up his own firm. His name was Alan Slifka. And that looked appeali…

AI assessment note: “I went looking for a summer job on Wall Street instead of at a law firm”

Q So have you continued to do that just outside of taking a stake?

A Here and there, I either have students or people that I met through the Invalued Investors Club that I've given some money more to To be honest, more to help them out because I see talent and I'd like to nurture it, but we run most of our own money. So we're the wrong guys for that. You know, we think we're good. So I'd rather give it to ourselves, but we have found people who do close to what we used to do, you know, six or eight ideas or 10 ideas or the bulk of their investment. And that's a little different than what we're doing. There's nothing wrong with that business. We'd be doing it too, but it's a full-time job. And so is doing what we're doing coming up large. Group of companies. There's also a full-time job, so we chose to go along here, and part of it was they're both great, in my mind, ways to invest, but I did the one way for quite a long time, and I like doing new and different things and trying a new challenge, so we've been putting this team together, and I love working with all these smart people who are trying to do a good job, so that's fun, too.

AI assessment note: “Here and there, I either have students or people... that I've given some money”

Q So let's turn to the book that you've just put out. It's an investor's guide to some topics that are not necessarily investing, but of great importance. What's the perspective of what that means?

A Well, bottom line is, politician will look at trying to solve some of these policy problems. It's called common sense, the investor's guide to equality, opportunity, and growth, and so you're not thinking of an investor for those. Those are really policy issues about education, and what should we do about living wages, and immigration, and banking reform, helping small businesses, and then our problem with retirement savings is more related to investing, but the whole The background of it is that a politician or an economist looks at the world a certain way, or an academician looks at the world a certain way. An investor, a long-term investor looks at the world a certain way. If you look at solving a problem, what's the long-term payoff to doing something, as opposed to the way a politician may look at it? It's very, very different, and I thought I could bring that perspective. It doesn't mean I'm right. It means that it's a perspective that isn't usually used to try to solve these problems, and I try to apply them to places like, most importantly, education, which is teach a man to fish, the ultimate long-term investment in someone, and the payoff is over the The long term. And that was probably the most exciting chapter that I wrote about because I really think we can make a lot of progress there, and it's something I spent a lot of time and effort working on in my personal l…

AI assessment note: “An investor, a long-term investor looks at the world a certain way.”

Q What have you found in the context of going back in and not only taking other people's money, but clearly a broader swath in terms of numbers of client base compared to what you did the first iteration?

A I like managing money, not raising money, and so when I got started, if a few people could fill the coffers of the fund, I was happy with that as long as we had an agreement, and I think that worked out well over time. On the other hand, we run mutual funds with thousands of investors, and there's something nice about that as well, that, you know, is, I think, the only people, for the most part, that stay with us over the long term are people that I had a chance to talk to, and I'm usually talking to advisors who I can explain what we're doing, why we're doing it, and things of that nature, or institutions that can understand what we're doing over the long term, and Can understand what we're doing and those turn out to be the best longterm investors for us. So there's something having a broad range of investors as well. You know, if you're not in the business of just accumulating assets, but whoever I can talk to who likes the story and likes the, the premise of what we're doing and we can keep explaining, this is what we're doing and they can understand that those make good longterm investors. And I just like having partners and I don't care whoever I get a chance to talk to who likes What we're doing, I'm happy to have them as a partner long-term, and most people actually are very sincere about it and try to be long-term investors.

AI assessment note: “we run mutual funds with thousands of investors, and there's something nice about that”

Q Yeah. So I know you spent a lot of time in charter schools and Success Academy and others. What have you seen that works?

A So I appreciate the question. So here's the problem. If you live in a top urban center, top 50 urban center, and you are low income or a minority, your chance of graduating college are one out of 11. We know that college graduates earn 70% more than high school graduates and high school graduates earn 30% more than dropouts. So, 10 out of 11 failure rate isn't very good for these kids. So now, if you look at the best charter schools, so it's Success Academy, which I've had the privilege to be involved with and helped start. Eva Moskowitz runs it. We now have 20,000 kids. The vast majority, close to 90% are minority low income kids. They're only in New York City. And if you look at the 20,000 kids as a group on the math and English state test, they outperform the wealthiest suburbs. So they outperformed the kids in Scarsdale. They outperformed the kids in Great Neck. They'd be the number one district with this group of kids. Also, if you just look at the kids who are unfortunately currently homeless, they outperformed the kids in Scarsdale. The kids with disabilities, the kids that are English language learners, they way outperform the kids who don't have disabilities in English language learners. So that brings up a problem. It says that the kids can do it with the right supports. The kids can do it. And of course there are some advantages the charter schools have, but that's w…

AI assessment note: “if you look at the best charter schools, so it's Success Academy”

Q You've sat really on all sides as a manager, as investing in managers, and then on boards. Where have you seen opportunities to create a process from that allocator's perspective that's a little bit different?

A That's a great question. I guess I smile as an investor, because I know the opportunity set. There's, there's that one, whether it's time arbitrage, you want to call it, or that one opportunity for an enterprising investor, as Ben Graham called it, to always have an opportunity to outperform. And that's because everyone is stuck in this mold where they have to answer to these short-term goals. And if you can stay true to yourself without worrying about What other people think or how you perform in the short term. And that's almost no one in a professional standpoint. I would say it's no one in a professional standpoint. Then the individual investor will always have an advantage. The enterprising investor is someone who's working for themselves or for a small group who understand what they're doing. We'll always have the opportunity and I'll keep things fun and interesting for those people. As the world gets more and more efficient, getting rid of some of those short term inefficiencies, We'll make things harder, but having a long-term perspective, I always give the example when my kids at Columbia ask the question, I say, hey, let's go back when you guys learned how to read and take a look at the most followed market in the world, United States, most followed stocks in the most followed market, that's the S&P. Let's take a look at what's happened since you guys learned how to r…

AI assessment note: “whether it's time arbitrage, you want to call it, or that one opportunity”

Q at the two sides of that, the quant as it started with kind of return on invested capital is probably quant light compared to a quant shop. And the fundamental I imagine couldn't possibly have been as deep as what you were doing when you were running six to eight names. So how did you approach both sides of that to create what you felt like was doing the work?

A Okay, so that's a great question, and I guess here's an easy way to look at it. There are quants, and there are people who realize these things are ownership shares of businesses. And they don't think alike. They don't think alike at all. And what we wanted to do is say, we actually understand that we're owning a share of a business and that there's a true north a few years out, whether it's one, two, three years out where I'm going on a little journey. If I do a good job valuing this business that I make a promise to my students every year at Columbia, I taught there for 23 years. I promised each class that if they do good valuation work, the market will agree with that. I just never told them when could be two weeks, could be two or three years, but that's what I told them that the market will eventually get it right. And that was our premise that if we could do good valuation work somewhere, there's a true north out there, whether it's a couple, three years, that's a very different premise than a quant. The other difference is that there are certain factors that have worked traditionally, maybe not so recently, but For a value investor, low price book, low price sales investing. And. I would argue that no private equity firm would buy a business because it's low price book or low price sales. They're looking at cash flows and how much they're going to grow and how secure tho…

AI assessment note: “what we wanted to do is say, we actually understand that we're owning a share”

Q It's sort of a fascinating thesis, and I'm wondering, in the context of coming up with it and writing it down, did you have a chance to dive in and either talk to those companies or companies that might provide the testing services to figure out at all how that flywheel gets going?

A Well, that's a great way to put it, the flywheel. We have to get the flywheel going, and I think it comes with setting those standards. So one of the reasons I wrote the book Was to help get the flywheel going. One of the reasons I'm talking to you today is to help get the idea out there to get the flywheel going. I invest a small amount of money in a computer test that tests your programming abilities. That's a very easy place to start. And we tested 20,000 people this, this site and, you know, it tells you how you rank against an MIT grad or the top 10% of MIT grads who took the same test. And, you know, it tries to get that out there. But that's a very technical test, and I go through the legalities, what you're allowed to do and what you're not allowed to do in testing, because if you give a test that one minority does worse than another group, That's literally illegal. So I talk around the end run around that system in the book. So it's totally doable, but you have to be very careful about that. And so they're already existing. Some of these it's getting started. Like I said, Google has certificate programs. IBM has some certificate programs, but that's the tip of the iceberg and it doesn't have to be just with programming. It can be companies use data all the time in a very sophisticated ways. The Apple Two computer, which cost 2000 dollars when it came out, ended up disr…

AI assessment note: “I invest a small amount of money in a computer test that tests your programming abilities.”