Kyle Grieve and Stephen Clapham discuss using “laterals” to find great ideas, testing investment hypothesis, avoiding investing frauds, investing in businesses with properly incentivized management, importance of value of a business’s debt, role of stock charts in fundamental investors toolbox, and simplicity in valuation.
Stephen Clapham is a professional investor educator, a former analyst, and a regular on BBC’s Today Programme. He runs courses on forensic accounting and advanced valuation, and has been featured in several publications including Financial Times and Sunday Times. Stephen also writes for City AM and Investors Chronicle, and hosts his own podcast called “Behind The Balance Sheet.”
IN THIS EPISODE, YOU’LL LEARN:
– How to detect frauds
– Management red flag
– The pitfalls of ESG investing
– The best ways to build investing skills
– The importance of market perception
– How to utilize your friends as an investing filter
– Why it’s important to have the skill to detect frauds
– How to find interesting ideas in different geographies
– Why you should place a heavy emphasis on back-of-the-envelope evaluations
– How charts can help you identify great opportunities even if you are a fundamentally focused investor
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(00:00) but if you don’t overlay the real world interpretation understand why the stock market view that business in the way it does you’ve only got half the story and it just makes it more difficult to make [Music] money I recently finished your book The Smart money
Method and I enjoyed learning about the subtle nuances and specific degrees of depth that you go into in a business that you discuss in your book I really enjoyed learning about laterals which you say is how all of your best investment ideas were created laterals
(00:37) are quote taking a stock idea or theme and apply it to a different stock industry or geography why do you think this method was so powerful for unveiling great ideas for you um but honestly I don’t know why it was so powerful I you know you often don’t know
Why something works you just sort of gravitate to the things that work and I can’t I I mean can’t really explain it other than well if you’ve seen something work before it’s got a high probability of working again and I can’t remember (01:14) the it’s so long since I wrote the book
And you know I haven’t read but um I think the one that I used in the book was the the Discounters the the supermarket Discounters setting up in the UK Aldi and little and they rolled out a huge
Increase in the number of stores and obviously that put significant pressure on incumbent it was quite czy oligopoly up until that point and then so when they moved to Australia you could predict with a high degree of confidence what would happen because these you know these German Discounters
(01:53) are they’re very effective I believe that you know they’ve started to come into the East Coast now and um you can you’ve seen the Playbook before so I I guess the the the reason why it’s affective is it’s harder to predict something that you’ve not seen before than something you
Have seen before so it that I guess that’s the simple reason but I wanted to ask you why is my book not on your shelf how how do I get my how do I get that front up placement oh it definitely
Is on my shelf somewhere where is it don’t (02:29) worry no I’ve only get it in that sort of top right [Laughter] corner it’s definitely up there I promise you um so one thing you really mentioned that I one thing that you just mentioned now that I liked and that I
Quoted was about geographies and moving from one geography to another geography so how do you like how do you help with the analytical process of of understanding when you think uh a product or uh you know a product Market fit is right for one geography and
Right for another geography even if let’s say (03:03) it’s in a different a whole different continent and has a different culture and stuff like that well I wouldn’t necessarily be be making that assumption I mean you know if it’s worked somewhere else and you obviously you’re
Hopeful but that isn’t how I would NE necessarily classify um how I’m looking at it wouldn’t be the transfer of a product necessarily it would be more like the theme the the the discounting theme that was disruptor in one geography then moves to another geography and that would be more you
(03:37) know you you could predict with a a degree of confidence what the impact would be I’d be less sure that you know Tesco opening up in California I generally wouldn’t think oh Tesco is successful in the UK therefore be successful in America because I can’t name a UK reta ER
That’s gone to America and and made any money and sure enough you know Tesco burned hundreds of millions trying to to set up in in the US because they thought they were the best food retailer in the world turned out that they were were (04:15) very good but they couldn’t compete
In in in the US which is you know the most efficient most competitive market for almost any any product so I I I’m not confident about the application of a product to a very different geography unless it’s something very simple but you know when you go to China or you go to America
There are very very different markets and um you you you you can place a great deal of of Reliance on that and also Carl what you’ve always got to think about is what’s in the price so (04:56) you know management have said oh we think we’re going to go you know we’re going
To this new market and we’re going to do really really well and there there’s some anticipation of success and um you you got to be very careful with that so another simple way that you outlined for finding great ideas was to follow the market and by this I mean looking at the
Market to see what is currently out of favor the market often overreacts to things like earning misses negative guidance litigation decrease (05:25) growth rates departure of key Executives and increase leverage but these events can also be very short-term in nature and offer
Incredible buying opportunities to those who have some patience how do you use this strategy on a business with limited knowledge of where the price value Gap May close faster than you can finish your research well you know if you’re trying to deploy a very large chunk
Of of cap so you’re you know I was partner your head to research at two multi-billion doll hedge funds and you know you don’t (05:56) have that many positions so when you’re when you’re deploying capital you’re deploying it usually in in quite significant
Size particularly in on the long side and in order to do that you need to be confident that where where you’re going to deploy the where it’s going to work and you can only generate that confidence
By doing a lot of work so you’ve got to spend a lot of time it just you know people in the stock market they’re always looking for quick wins and quick wins are I I’m not saying there isn’t such a
(06:32) thing as a quick win I have made quick wins but they’ve been very very rare and you know usually it’s been a long and painful grind to to find an idea so you don’t have any guarantee that where where you’re doing a lot of work the stock price won’t move in the
Meantime but ironically and paradoxically in spite of the fact that it to would take me quite a long time we were usually too early because if you’re thinking about you know if you and I are buying
A stock we can you know wait for it to bottom (07:07) bounce a bit and then buy it once the you know once the base is set in if you’re want to if you’re a large hedge fund you’ve got to buy
It on the way down and you don’t know where the bottom is and usually the bottom was way lower than what we thought so if anything it was quite the reverse rather than being late we were being early but um you might not buy on the first profits warning but you might not
Wait for the third one you know if you thought that there was a good longer term opportunity (07:40) I mean typically I wouldn’t have done I wouldn’t have gone and bought a stock that had had a profits warning because the risk of it turning around usually stocks that have profits
Warnings have a second have a third and I would only ever sort of start to get confidence once I’d seen you know that there was some evidence that thing that thing was going to turn WR so
That wouldn’t be my sort of thing I also you know changes of management people and look there’s all sorts of ways to invest successfully and (08:22) I’m not I I can only tell you what works for me and I I think this an extraordinarily personal um Endeavor I don’t think people place
Enough emphasis on it I mean I had a cup of coffee with Anthony Bolton last week Anthony bolon one of the world’s best investors and you know he said that what I hadn’t put in my book which he he
Thought was a was was a was was missing is that you need to know yourself and it’s actually very true I I mean I think you knowing understanding what you’re good at and what you’re not
(08:57) good at is is actually very important so you know what I start off the book by saying you know my speciality was forecasting company profitability and that’s what I I focused on and that company profitability might be about to go down because Audi and um little are about
To enter the Australian Market or it might be about to go up because there was some pricing power hidden that the stock market hadn’t perceived or there was demand you know in a in a different sect that was going to generate demand for this sector but I wouldn’t really
(09:34) get involved in sort of very obvious things because I think you know if it’s very obvious then there’s usually a good reason behind it I mean finny I’m writing my substack um for next Sunday about an idea that was presented at s ideas competition and it was one of these of
Discount to the to some of the parts coming with a lot of stakes and other companies and I said you know really generally I don’t like these ideas because anybody can add up but so you know how could you have an edge with that although this particular one is so
(10:12) compelling it’s such a large discount it’s hard to see you know you got such a margin of safety but it’s very very unusual to to get that and things are things that are obvious usually
Don’t work so I know you like to draw wisdom from contrary views when T in your thesis for an idea you talk about how these are much harder to come across like a a be report so for investors
Investing in more obscure or less followed businesses what are the best ways to try and poke holes in your thesis when no bearish report (10:43) exists well go down the pub with your mates tell them your idea and you know watch them laugh at you and rip rip it apart that’s
That’s one way of doing it I mean the I think it’s very difficult to be completely solid as an investor and I think being able to balance ideas around I find to be quite helpful and so you know at the hedge funds um we would discuss you know it wouldn’t it wouldn’t
Be you know you would come up with an idea and just put it in the in the portfolio it would be there would be quite a rigorous (11:27) debate and I think that’s a very very healthy thing because the discussion re forces you to you know examine the strength
Of your thesis and figure out you know are there any holes in it so I mean I was usually deploying a lot of capital so by definition it was in a large cap stop and by definition it would
Have a number of people people looking at it and there might have been you know 25 buys but there’ll be one guy that had been a seller in the past or there would always be somebody that was less enthusiastic uh and so I would (12:12) really spend my time if I was looking
At along I’d really spend my time trying to poke holes in my own argument if you’re looking at a small cat it it’s it’s clearly more difficult and you you the only thing I think you can do really is to say are there any sales of comparable companies maybe not
In the same sector but something with similar characteristics and and and just to argue with your friends I mean I think you know that I mean I I was being slightly forious to go down
The pub but actually the debate down the pub is (12:48) could be quite helpful and I I was at an investment conference a couple of weeks ago and the most interesting part of the investment conference is usually the chat in the bar love it I know you’ve done a lot of work
On a case study of ptis Valerie a chain of cake focused cafes you had a really good point about the fact that it wasn’t a particularly fra uh difficult fraud to identify your simple measure was to look at it and you could instantly see that its margins were higher than
That of Starbucks for instance so why does that (13:21) matter because coffee is a high margin business and there’s simply no way that cakes that are consumed in store can compete with the margins that a business like Starbucks who you know people can just take their drinks and
Go would have so one part of this case study I found particularly scary was the fact that the CEO Luke Johnson was unaware of the fraud and was never prosecuted he also owned 37% of the business and had his Equity wiped out investors looking for Quality businesses might have been
Attracted to a business like this that (13:46) had appeared to have some sort of competitive advantage on top of looking at financial statements and comparisons to other businesses what are the best ways for investors to limit the risk of fraud well I mean the the
Johnson case is quite an interesting one I mean l actually lived around the corner from me and um at the time our children were at the same school and I was quite puzzled because I thought you
Know he’s a very smart guy how’s he not spotted this and the the day the week it I think it went (14:17) bust on the Tuesday and then the Friday morning I was dropping my younger son off at
School and who should I bump into very early on obviously not want to see anybody he was Luke Johnson and he could speak you know it’s not every week that you lose 150 million quid so
You know at the time that would been 20 something million dollars that’s not a good week right even if you’re very rich and he wasn’t you know he was rich but that must have been one of his
Biggest Holdings so you know it was clear that (14:50) he hadn’t been aware and I I think I I think he was doing an awful lot of things and he he he was executive chair chairman but there was
A CEO who was running the business and I think you know he was there in the board meetings and he was told oh it’s all going fantastically well and he probably never visited the stores and if he visited the stores he would have seen that I mean there there was aery Valerie
Next door to the cafe Nero another coffee chain um very close to one of the officers I worked at we always used to buy our (15:29) coffee in caffero we used to do a coffee run every day and um we never went P Valerie the caffero was always full the ptis
Valery was always empty no it could have been just that street you know in central London but the the the capero margins started off at 2/3 of TI Valery and fell in half whereas po valeries
Margins went up that seems a bit bizarre um but the I think this tool I really recommend on my students you know I I I train um professional investors in forensic can I have an online school which allows you to learn um about (16:18) investing about reading financial
Statements and I’d say look the one really powerful tool is look at the margins versus the peers and understand why your company’s margins are where they are relative to their peer group and if you think I really can’t understand how could making cakes where it’s
Very labor intensive there’s a lot of material costs there’s a lot of wastage because they’re full of cream and they go up coffee is the highest margin product you can get just about I mean it’s got a 75% gross margin if you (16:58) include the cost of the electricity
I mean it it is a really you know well the beam cost topens and the cappuccino cost $350 you know it it it it’s just a a very very profitable product and if you’re making a higher profit than selling coffee then you’re doing really really well and there must be some
Trick to it and you if you can’t understand why the margins are where they are then you probably shouldn’t buy the St so looking at stock charts is not something that I find particularly interesting myself but you gave a great (17:43) quote by Stanley dren Miller on
How it can be used to help improve abilities as an investor he wrote up an investment paper to his research director who after reading it said quote this is useless what makes the stock go up and down that comment acted as a Spur thereafter I focused my anal Anis on
Seeking to identify the factors that were strongly correlated to a stock prices movement as opposed to looking at all the fundamentals frankly even today many analysts still don’t know what makes their particular stock goes up and down (18:11) unquote I agree with you that I’m
Not sure it’s necessary to completely ignore the fundamentals just to identify what makes the stock go up and down but I am interested in whether you think this is a worthwhile exercise to add to a fundamentals based investment process well I mean absolutely I think you know a lot of people write
All technical an so they’re just drawing squiggles on charts but you know the the chart is the single encapsulates in one measure what the market thinks about the share and you know if you’re trying to (18:48) make money out of the difference between perception and reality which is
What effectively what an investment analyst does then you need to not only understand the reality which analysts tend to be reasonably good at but you also need to understand the perception and you need to understand why the perception is wrong and what might change it
If you don’t understand that then you’ll never make any money and how do you understand the perception well that’s quite difficult isn’t it I mean how would you know what’s in the price (19:25) and the best place to start is the share price and the share price has been going down and
Down and down and down and down and down then there is quite a good chance it will continue to go down and down and down and down and you’ve got to understand what is going to make it go up
Then you know I I mean a lot of people you know Focus their energies on valuation and say well I buy if if it’s cheap enough I buy it cheap L up then I’ll be I’ll be safe and you know what
Happen Happ they’ll lose money and they’ll lose (20:02) money for a period and then they’ll get bored and they’ll they’ll right off that loss and go or and and buy something else the the the fundamentals and the valuation are obviously terribly terribly important but if you
Don’t overlay the real world interpretation understand why the stock market views that business in the way it does you’ve only got half the story and it just makes it more difficult to make money I’m not saying you can’t make money by buying a stock that’s very very
(20:38) cheap obviously if you buy stops that are very very cheap the chances are that they will that they’ll go up but they might go they might get quite a lot cheaper and understanding timing is is important the problem in car is that you know we don’t get everything right
So you know eliminating obvious simple mistakes is quite a good strategy in my view and you know knowing when to buy something is actually quite is actually quite important and so I view charts I’m not you know a great believer in you (21:19) know oh it’s it’s broken out and
You know Fibonacci and I mean you know I don’t even look at Candlestick because you know all that stuff I think is it’s not that I don’t believe it it’s just that there’s you know I
I want to just get the basics right I don’t want to get to Encompass in all the detail about the charts but what I do want to understand is is the market becoming more favorable or less favorable
Towards this company and why and once I’ve understood that I you know say oh well is cheap (22:01) and the the Market’s warming to this company if it’s cheap and the market doesn’t like it and shows no sign of liking it I might be able to find something else that is equally
Cheap and the market is showing some signs of interest in and that’s where I’ll I’ll go all other things may equal obviously you know when you’re running a professional portfolio one of the other things you’re looking for are complimentary stocks so that they reduce
Your over all portfolio risk so you know (22:31) you might you might buy the one that still you know that’s unloved and still hated and shows no sign of interest because it also gives you something else in the portfolio there’s all sorts of things that you might be be
Thinking about but ignoring the charts I think is why why would you ignore the most useful piece of information and it’s funny that we’re having this conversation because I was in um uh the offices of of uh a hedge fund in London yesterday and I was pitching my forensic accounting training
(23:04) course to them they said they were interested in it so I went into jacksam and one of the guys said this to me he said I don’t understand why people are so anti- charts because you know what you say is that it tells you the psychology of the stock market and
Why wouldn’t you want to know that I like it so in the smart money method you wrote quote return on Capital and incentives are generally recognized by investors to be more effective than EPS targets and this is borne out by academic as well as cide research I was
(23:36) wondering if you could elaborate more on any research you’ve come across on this as well as what you’ve observed from any salside research that you’ve looked at oh it’s a long time since I I looked at this stuff I mean Goldman’s did a piece and I think they’ve done some some
Follow-ups saying look uh the best in incentives you can have are returning on Capital incentives and it’s just obvious right um if you’re if you incentivize people on EPS they’ll go and do stupid Acquisitions they’ll gear the company up (24:13) they’ll cheat on the accounts look I mean
Earnings for share is quite important the stock market pays very close attention to it so I don’t mean that you should ignore it and I don’t mean that people shouldn’t have have it as some part of their incentives but returning capital is a much more important um Criterion so you know you
Don’t want people to sell off growth parts of the business in order to improve the ret return in capital you know you could have a you’ve got to have a a a mix of incentives but there (24:49) there’s all sorts of research and and there’s lots of academic research on this on on
This topic that companies where the management are incentivized all on returns and other metrics tend to do better no you know show me the incentives I’ll show you that come you’ve got Charlie’s
Arm and out behind you and it if it’s it is so true and the other thing that you know I look quite carefully at incentives and you know if if a company’s like a resource company an oil
Company or a miner if it doesn’t have a safety (25:24) incentive for the CEO I’ll be very um concerned about that I you know I wouldn’t say I wouldn’t buy it but I’d be much more reluctant to
Buy a a stock who in those sorts of Industries if the CEO isn’t rewarded for ensuring his staff for safe because it just seems to me a fundamental Criterion of a good business that you would do
That and I I mean it was I actually did some research on this I was I was quite staggered because not every minor as the CEO paid to not kill his staff you would imagine that would
(26:09) be quite a good quite a you know simple starting point I I and some quite big mins it was quite some time ago that I did it but I was I was staggered W how do you get started with
Stock Investing I’ve put together a course to teach you everything I wish I knew when I first started investing in stocks let’s start at the beginning and ask what is a stock let’s zoom on in into what it’s actually like to buy a stock a few options are Charles Schwab TD amera
Trade Ally E Trade fortunately you won’t have to (26:44) necessarily calculate all of these taxes yourself I’ll outline a few main ones to be aware of throughout your lifetime investing Journey as Warren Buffett says your best investment is yourself there’s nothing that compares to
It by the end you’ll be savvier about Stock Investing in personal finance than the vast majority of people even if you’re not a total beginner I’m confident you’ll get a lot out of the principles and strategies I outline which we’ll build on throughout link to the course is
(27:13) available in the description below see you there so another great point on management that you made was that you look for quote consistency honesty and Common Sense unquote you list a few red flags such as continuous restructurings and frequent mentions of extraneous issues now to some
Extent extraneous issues do affect the operations of a business but at some point management needs to take responsibility for the outcome of their business how do you determine when a management team is spending too much time making excuses (27:42) for the shortcomings of their business
And view it as a red flag when they mention the weather they mention the weather you know I just I’m I’m gone I’m not interested I mean obviously weather does affect outcomes and performance and ironic that we were talking about P Valerie I mean in 2018 we had a very hot summer in
The UK I mean it it was the hottest summer I think since 1976 and as a consequence of that you know the ice cream vendors did very well and people selling tea and cake did less well so obviously it does at the extreme (28:22) it has it does have an outcome um
And an influence and and you know is a fair thing to include but um I think generally um people that look for excuses rather than blaming themselves um tend to be people I’m less comfortable about investing in you know I I’d much rather hear the CEO say we missed
Our numbers and I was stupid because I’d assumed that we were going to have a a a mild summer and I should I should have had more slack in there and I’ve been a bit over over ambitious in in
In the projections I I mean how often have you (29:15) heard a company say that rarely no so you know companies that that companies that use extraneous things weather is a a good example um obviously you can predict the weather but you shouldn’t be assuming that the weather will be
Perfect either so when you make a forecast you should have some slack in the forecast and that these sorts of factors won’t kill you and um there’s all sort there’s all sorts of um issues that slightly annoy me you know oh we hadn’t expected our competitor to cut his
(30:05) prices well you know you’re in you know you’re in a competitive industry then that is what your competitors are going to do and you you it’s not it’s obviously it’s not easy when you competive the Cy your prices to grow your profits uh and that can it can sometimes be a
Surprise but often you you hear management make the not the same excuse quarter after quarter but there’ll be a different excuse there’ll be a new excuse every quarter I don’t really have time for that sort of thing I mean it’s different (30:42) if you’re you know if you’re a long-term
Investor and you you think well you know three or four quarters of bad results aren’t going to affect my long-term disposition towards this share I mean I completely sympathize with that and and you know I quite get that but if you’re you know doing Special situations at a hedge fund you get
Paid not to buy the stock that disappoints for three or four ques in a row you get paid to short that stock and buy buy something good that goes up and then you you know I I (31:15) wouldn’t I just wouldn’t hang around um in in that role I wouldn’t hang around for
Those perennial disappointer I I mean I have um been responsible for money that’s been longer term money and then I might take a different attitude but the excuses always make me feel just may undermine my confidence in people you know obviously things don’t go according
To plan all the time yeah that that but the way you the way you present that I think is is is quite important so you had a great sentence on (31:54) debt that really spoke to me quote if
Debt is quote and trading at a discount it is often a critical indicator of failing Financial Health unquote I recently spoke with Matthew Peterson who discussed his experience with hsee head Holdings and he said if he’d only looked at the discount to the debt that the business
Was trading at it would have helped him stay away from the business that ended up being a major dud what’s the simplest way to add this to the investing process and what resources are best to get a better understanding of (32:20) the value of a corporation’s debt
Well I mean I can’t understand why anybody would buy a stock with quoted debt not look at the value of it then why would you do that especially if it’s got a lot of debt that seems bizarre
Because the credit markets are are you know quite good at spawning Financial Risk that’s what you know they’re they’re paid to look at the downside and we’re paid to look at the upside so I would
Always look at the value of the debt um I mean I used to just do do on Bloomberg but if you don’t (32:51) have Bloomberg then there are ways you can you can do it because youve go to stock broker and
Say you want to buy the buy the credit and say how much you know what’s the share what’s the price and this broker will have a how Bloomberg teral be able to tell you um there are quotes
For these things I mean there are V you know I have proprietary systems you know that I I key to you know to get access to the to the the price of credit um and those aren’t cheap you know they
Aren’t free I mean I’ve forgotten what the one (33:30) that I use how much it is not it’s not a ridiculous amount so you you would need to be doing enough trading or investing that it would pay you to to buy that I mean it’s quite an interesting thing because I did
A substack about you know what does it cost to be an investor and I I invited my readers to come back to me with what you know what they spent I was quite shocked how little people spend you know people just believe oh well you know I can buy or actually
There’s now some good products that are (34:07) free that you can get you know quite a remarkable am why would I why would I pay for $30,000 a year for Bloomberg when I can get XYZ for free and um kin you know um and you know I’ve got a certain amount
Of sympathy with that because you get quite a lot for free but you do need to invest in your tools you need to invest in your information sources and you need to invest in yourself you know you can’t be a comp competent complete allround investor without you know reading some
Books without having good quality periodicals (34:55) I mean I I don’t see how anybody could be an investor without reading the financial times and the Wall Street Journal and The Economist I mean I I mean if they can do it well done to them I’ve got no idea how you how how they
Could possibly do that so I like how you emphasize the importance of back of the envelope checks for valuations over more complicated models I also prefer this method although more complex models are important too it seems like different investors do this math in different ways
(35:23) can you give an example of a business that you’ve analyzed using back of the envelope math and what specific numbers that you would look at the the problem with spreadsheets is that they look like the answer is right and a friend of mine um was working with a major International
Oil company and at board level and they the the board couldn’t understand how the analysts came up with their forecasts and so he got three of the top so the II top three analysts on the oil majors and asked them for their models of this (36:04) company and they then had somebody audit
The models and every single one had not one error but multiple errors in the model and well that’s quite shocking but I can’t tell you how many times I’ve emailed an analyst at a BGE bracket firm and said I don’t understand how you get to this number and they’ve changed their
Forecast because their forecast their model’s been wrong right I mean this this isn’t like all once in a blue moon occasion this happens regularly um and you you can’t really blame the (36:46) the Southside analysts because they’ve got you know like huge amount of work to do and
It you know this is this is a difficult process so what I would do is I would always have very simple models and then whatever the model SP at the end I would ask myself does that make sense and you
Know we used to call it the back of the packet calculation so you know your cigarette packet you could there’s not much room for calculations so you you know you’re going to and you just asking yourself I’ve I’ve got this Stu that (37:27) down is growing at 25% so that means
10% Revenue 12% Revenue 12% on the on the margin is that is that realistic is that sensible what was they done in the past and it’s simply uh a case of comparing your own detailed knowledge of that specific stock with the likelihood of that sort of occurrence so Michael mobus San
When he’s at credit s produced it something called the base rate boook which was a sort of incidence of you know how fast the companies grow how fast do they improve their margins and and so on and (38:15) um those sorts of simple checks are very very important when you’re doing forecast they’re
Actually also quite important when you’re looking back in history I was talking to somebody a couple weeks ago who bought Estee Lauder and he said and it’s not a stock that I know or I’ve looked at but he was saying I wouldn’t I wouldn’t have done it if I’d thought
More carefully about they’d had very impressive growth in margins and I should have asked myself how sustainable was that growth because in (38:49) act fact what they effectively been doing is stealing from the future from the future so they you know these are his his
Words is analysis I’m not I’m not looked at it often you find often you find that and just asking yourself does this make sense is a hugely important question and if you just ask those those questions you’ll avoid all the frauds because none of the frauds make sense I like it
So I liked your emphasis on doing sense checking for evaluating business which you kind of just talked about now and I think this is an area (39:23) that many investors refuse to look at because it invalidates their to buy a business especially in Bull markets the other problem
That can happen in Bull markets is comparing one overpriced business to another an industry full of overpriced businesses this can help justify a purchase even though looking at historical average price to earnings valuations or whatever metric of your choice for the
Industry over the last 10 years might be 50% or cheaper than current valuations so how do you best combat making these mistakes when (39:49) markets are running hot and everyone is euphoric well you know I I can’t tell you how to combat making investing mistakes because
You know if I knew that I would be rich right I mean everybody makes investing mistakes the best investors make mistakes because this is a very very complicated Endeavor and you know even Warren Buffett the best investor in the world I mean he’s made mistakes you know he bought Tesco and um you
Know it’s just not possible not to make mistakes I think where I get um where I beat myself up is (40:30) where I make the same mistake a second time or a third time and then I get really annoyed
Myself I think you know you you you’ve you should have known because remember that last time there was a similar sort of situation but you know in overheated markets people get in excited they get enthusiastic so the most important thing you can do to protect yourself against that
Is to start off with a evaluation framework and so you know we teach that you should look at not only the valuation of the stock but the valuation of the market and there’s a (41:10) huge amount of garbage talked about oh it’s time in the market not timing the market
And I I don’t say that that’s garbage because it it obviously it’s a truism it is timing the market not timing the market but if you just keep buying irrespective of price level you might do
Well over the very long time term so if you’re 25 years old and you do that for 40 years you might be okay but if you keep doing it when you’re 65 and you’re wanting to retire at 70 you’ll
Lose your shirt and you know all these all these (41:56) truism are are I think quite dangerous in a way because people quote what Buffett says out of context and you know if Warren Buffett were
Giving advice to a 75y old a 55y old and a 35y old he wouldn’t give the same advice and what people fail to understand is You’ got to think about your personal circumstances I’ve got um my podcast I
Interviewed a guy called Sebastian lion who runs Troy Asset Management in London it’s about A10 billion firm and he looks at the valuation of the stock market and if it’s very high he holds (42:42) more cash and if it’s very low he owns more shares you know that’s what you should do
I mean it it’s very difficult I think in you know these recent times where markets have become you know incredibly enthusiastic and you know older investors just kind of understand that they’re going to miss the ball not make as much money as they their younger peers but they’ll lose
Less money later I mean I was asked to look at um a Dutch company Aden in the payments industry I mean it was valued at100 billion and it had (43:30) $1.3 billion 1.3 billion euros pardon
Me of sales and you know I said okay payments is quite a good industry and they seem to have quite a good position in it what sales growth would they need to have for how long before I could you know
Think about that as an investment and the answer was 15 years at 40% now I don’t quite know what Amazon’s compound growth has been over the last 40 last 15 years but doubt it’s been 40% um you know
Just it’s just like an almost unachievable sort of sort of level and when you see that happening (44:16) you’ve got to ask yourself well hang on a second if this stock is at that level what what about all the other stocks because if people are are so enthusiastic about this maybe they’re being
Overly enthusiastic about other things when people are even in in for markets people were always overenthusiastic about something um but then that you know when you get very very very clear signs of fraud then you should just exercise a bit more caution and that’s the best discipline
I think that I can recommend I don’t have (44:52) any there’s no there’s no magic to investing you know know it is the same old thing every cycle my friend Russell Napier the famous Financial historian who he started the library of mistakes and the library of mistakes in Edinburgh
Is it if any any of your listeners are in the UK or in Scotland they they definitely should go and visit the library of M Stakes brilliant institution has got I think 4,000 books and lots of interesting memorability and even just to walk around and look at
The posters in the wall of past frauds and (45:31) so on um and just you know keep your feet on the ground you don’t have to make the money tomorrow you can make the money over the
Long Hall and I think you know a lot of mistakes are made because people have a desire to get rich quickly I know the motto of my courses is you know I’ll teach you how to get rich slowly I
Don’t know how to get Rich quickly like it so I think environmental social and governance is largely a buzzword used to generate interest and emerging and unproven business models but you had a really interesting three (46:07) question framework I think
Is actually useful one does the company have a purpose two will it improve people’s lives and three will it improve customers lives I think this is a great set of questions to ask to find out if a business is a true win-win-win for the good of the planet the customers and
Business but finding a business opportunities like these are quite rare but they do exist how do you incorporate these questions into your investing process if at all well you know I’m not an ESG investor and I’m quite you know an ESG (46:38) investor would be quite shock looking
At my portfolio today because I’ve got energy and I’ve got Mining and I’ve got diry companies and I think those diry companies are going to do well and you know I want to save the planet don’t get me wrong right I’m passionate about about that but saving the planet and making
Money are two different things and I think we should be devoting more attention to climate change I think the SG has been you know it’s been a bandwagon you know the ESG made money (47:17) because the tech stocks fitted ESG so if you had an ESG fund you overweight Tech and so
You did well and then in 2022 Tech fell and ESG funds all fell and everybody said oh maybe it’s the end of ESG and coupled with that there’s been the sort of backlash particularly in the
US municipalities where in Texas they don’t want you to own an ESG fund because then the ESG fund won’t be investing in oil and that’s not good for the local economy and there’s all sorts of political things com into it but I think (47:51) the you know when I look at the when
I look at ESG G governance I mean that is table Stakes if you buy a company with bad governance guess what’s going to happen they’re going to steal from you right so buy companies that are have good governance don’t I mean I used to invest with Crooks one of the things one of
The chapters in the book was about investing with Crooks but you know you have to be in the same side of the table as the crew you the um but so government a stable States the s I’m I’m quite dubious about the S I mean (48:31) I do understand the principles in the
Human Caple and people are the most important part of a business but it’s pretty obvious if you know you just need to look at the board and who’s on the board I mean whether you know you need to have a certain number of Executives that are female that is a that
Is a very interesting debate and you know I think that you can have a a company which has got a lot of women in senior roles and a company which has few women in senior roles and they can
Both be good companies and and not necessarily (49:14) discriminating I in either way and I don’t think I think it’s very difficult to to spend too much time worrying about their s and then the e um you know I want to say that planet and I want to invest in companies
That are are conscious of their responsibilities for one simple reason I think that you know the carbon price is going to go up a lot and if you are aren’t paying attention to the carbon price well you’re probably going to end up with a you know a lower quality investment because the carbon
(49:48) price will go up and you should be wary of your environmental obligations but that doesn’t mean to say I shouldn’t buy xon or BP because we need oil I mean I you know I’d be very happy if we
Had more electric cars and that we were producing less pollution um and I think that’s a very good thing I don’t happen to drive an electric car myself but um you know I I think the electric technology is perfectly fine but of course you can’t displace everything overnight I mean so
You know realistically we have to provide the (50:30) exons of of this world with capital because otherwise we won’t have any oil and we won’t be a we won’t be able to go anywhere because we had get enough lith lithium to make you know I mean the technological changes take
Time to work out so I think ESG has been an overused epithet I think it will disappear actually because there’s such a backlash against it but I would be very careful about ignoring the principles entirely and I thought the questions that I was
Asking are quite a good way of understanding (51:08) you know this is this isn’t an ESG question the the best investors incorporate ESG into their fundamental analysis and have done since the beginning of of investing you know before ESG was a thing people were practicing
ESG because they were asking themselves is this a sustainable business and the actual sustainability of it and the pollution and the climate change and the environmental all those things are part today of what is sustainability and you have to really worry about the fact
That you know I don’t know when was Al Gore’s (51:49) film so popular 2006 were 17 18 years on from when all gor pointed out what was going to happen to to the weather and we’ve done nothing
About it why have we not spent billions trillions of dollars on carbon capture and storage it just it is beyond my comprehension the government should have been forcing us to investigate and and the UK government I mean they had a competition um 15 years ago to design a you know
A CCS scheme never been implemented I mean just B I mean just pathetic so I really enjoyed reading (52:31) about your history in the investing industry when you first started in one of your recent suback articles you discussed how you couldn’t sleep or yeah you discussed how you
Couldn’t sleep because of a buy note that you published you were fearful you’d be wrong and you wouldn’t make a positive impression you then discussed how you got over imposter syndrome by building skills to outperform your peers now many listeners are not professional investors
But love the art of investing so what are the (52:54) biggest bang for your buck areas to build skills on when you are a newer investor well I mean that that was I I still have impostor
Syndrome you know I think it’s very hard to get get away from and you know that was early in my career and it was a i new sector new company very important company big call and you know
If it’ gone wrong you know my career was at risk and so the night before you you worried don’t you you you can’t sleep and but the there’s all sorts of ways of gaining skills so if you’re a private
(53:35) investor today you don’t even need to spend a lot of money right um but you you you should because taking things for free creates two risks one is the risk that it’s robish because there’s a well you laugh but there’s a lot of really really good stuff on the internet
Whether it’s on substack or YouTube there’s some great quality content so I’ve got some fantastic uh videos on YouTube but if You’ have not heard of me and you just arrive at my YouTube channel you get no idea whether I know (54:13) what I’m talking about or not so you know
It’s very difficult to know where to go it’s said that the trick with the the free stuff is knowing where to go so um and that’s you know very difficult to resolve there’s quite a lot
Of good free stuff on on subp I mean I’ve got my I save my best stuff for my paying subscribers I put out quite a lot of free stuff that’s quite useful and lots of other people do the same but finding
The you know finding the right ones is quite tricky and you’ve got to worry about what the (54:48) value of your time is because the you know free I think is a false economy because you spend so much time on garbage that you shouldn’t be wasting time on that that you
Know that you spend 10 times the amount of time so you get 10% of your of of of the of that the time that you you put is it output and that you’ve got your time’s going to be pretty cheap to make
That worthwhile so I recommend reading books so I’ve got a list of books I think there’s 10 or 20 books in my website I think are a must (55:25) read for every investor I believe and look
I’m very biased in this because I’ve got an online school but I believe that online education is a very very effective way of improving your your investing skills because if you do you know one of my courses you not only get the the videos from an experienced practitioner telling you here’s how
I went about it and here’s some tips we also get exercises to do so you download a model you you can fill out that that particular exercise and then you can look at the the model answer and
(56:08) in my school I have a community so you can ask me questions um so that you know if you don’t understand something you can get some some proper help and we’ thought quite carefully about this but the sadly there aren’t too many any of these types of opportunities
I mean there are a few people I I came across somebody yesterday who a German guy who has got an investing school I I mean unfortunately he’s in German so you limits the the audience um but I’m told his stuff is quite good by German (56:46) investing friend of mine and so I
Wouldn’t discount using that as an approach so and and find some good substacks and you know substack published the most popular um Finance substack so it’s kind of like the the the the to top charts and some of them are good some of them not quite as good but you know if
You’ve got somebody that’s got a big following on substat the chances are that they’re that they’re reasonable um so newsletters be very careful about the newsletters though because there are a (57:30) lot of charlatans in the newsletter world I think substack is probably a better safer place
Than some of the other um sources of newsletters and online courses I think are a good way and you know going to University is a good you know a good way of learning uh I I’m less keen on the CFA
I’ve been getting a lot of flak for criticizing the CFA I think the CFA is does a good job of teaching you about the theory of investing gives you three letters after your name but only after an immense amount of effort and work and (58:13) I I really don’t know that that’s
Worthwhile and the problem with investing is the theory is all rubbish you know Theory gives you like I mean completely the wrong answer so I I don’t really understand why people are so keen
On investment Theory I mean in my in my courses I teach you you know here’s what the theory is and here’s why it’s rubbish so I do it very quickly you know we do Theory very because you know you
Don’t need the capital pricing model the beta you complete not I mean I think it’s garbage (58:46) leads you to wrong answer as often as not so why worry about it so you recently attended the London quality growth conference and you shared a very interesting photo of the drop off in quality
Businesses and an even more severe drop in quality plus growth I’m interested in your opinion on the drop in quality business over the past five years what factors do you think are driving this drop I’m trying to remember the the the chart that you’re referring to I mean I
Think the what we were trying to look at was (59:20) the Persistence of quality so that was a it’s quite quite a new conference it was reasonably well attended now but I was interested to go along just to see how people Define quality and I think 14 of the 17
Speakers something like that I don’t quote me on the the exact numbers um Define quality as sustainable competitive advantage and I said well what is what is that how’ you find what and you know the reason that Berkshire has been so successful I mean the problem that buff and Monger
Obviously genius um or were M was a genius um the (1:00:12) the reason is that seiz candies today is as successful as it was when they bought it 50 years ago it’s a lot bigger and it’s still making exceptional returns now even Warren buffer today would have a much harder time
Identifying stocks that were going to be winners in 50 years time but you might say oh okay Apple’s going to be a winner in 50 years time but I mean don’t get me wrong when he bought Seas candies
It wasn’t obvious that it was going to be Seas candies and you know but people were we’re still (1:00:55) going to be buying chocolate in 50 years time will we be using the iPhone in 50 years time i’ very I’d be very surprised I mean it may be that we’ll have implant in
Our ear that is an apple implant I mean I you know who knows and it may be the Apple will be in the Forefront of creating that technology it certainly has as good a chance as anyone a
Better chance because it’s you know got more resources to throw at it but it’s not it it there’s no guarantee that it’ll be successful and (1:01:28) there’s no guarantee that it will even identify the right resources the right technology and I I think technology is so pervasive today
There’s barely a business in that you can look at in which technology isn’t a critical component even seiz candies I bet you well I don’t I mean I’ve never I’ve never eaten a seiz candy i i i
America is a wonderful country and I love it we go there and in holiday and my kids love it but the chocolate’s terrible it really is I mean there chocolate doesn’t hold a I mean it’s not (1:02:05) nearly as good as chocolate in Europe you’re probably going to get all sort don’t invite
That anti-American guy on but anybody that knows chocolate and I’m a great chocolate fan knows that if you want chocolate you go to Belgium not to United States but even C candies I bet you you can as we have a website and you can order it online and you know there’s a technological
Aspect to every business today and I think that makes the idea of a sustainable competitive Advantage a a much more ephemeral thing it’s much (1:02:40) harder to get your hands around and I’d love to hear Buffett being interviewed about about that I’d love to hear what he his what
His perception is and as a consequence of that I think the sustainability of competitive advantages is probably eroding and that’s kind of what the research that we looked at told you was that although companies that have high returns in capital that tends to be persistent the the
Duration of the persistence from here I would question obviously looking back is easier um but the the problem you’ve got (1:03:30) is it’s very easy today to look back and say Amazon’s a great company or Google’s a great company or whatever but
At the time we didn’t know how good Amazon was going to be or how good Google was going to be or Facebook Messa whatever they call themselves this this week me you know Facebook came to stock
Market in 2012 and I refused to invest in it because I just said well I don’t know what it’s going to be able to do on mobile I don’t know anybody that is you know spending more time in
(1:04:11) faceebook kids don’t want to go on it I don’t see what its m is and I didn’t buy it when I bought it when it had the the the very controversial setback where the Cambridge analytica Affair where the stock collapsed and then I understood that it could do mobile and that
Kids didn’t like it but older people did and that I and I saw that you know my own business used it to advertise and that it was quite cheap and quite effective and I thought oh actually it’s a better
Business than I thought and I I then was given the (1:04:53) opportunity to to buy it but um I wouldn’t I wouldn’t have done so otherwise um I just think that um sustainable competitive Advantage is easier said than analyzed and delivered and I’ve got great admiration for
People that are you know that are excellent at the qualitative aspects of investing are understanding the sustainability of an an advantage is it I’m a numbers guy and so I tend to look at things through through a financial data lens and the sustainability of the advantage
It you can look back and see have the (1:05:41) returns been very high in the past and if they have been you tend to pay very high price unless you get like those temporary setbacks and understanding a business that’s still Dev veloping a sustainable competitive advantage
That will be there in five or 10 years that I don’t think is one of my particular strengths and I don’t know how you do that except from your own experience as a customer so you say oh well I bought that because it’s that product miles better than this competition but then you
(1:06:15) know if you look at so take an unquoted company as an example Dyson the UK technology manufacturer makes vacuum cleaners and hair dryers and all the rest of it you pay a high price for a Dyson product will they be able to maintain the price differential in 10 years time will they
Be able to keep the same technological lead these are very difficult questions to to to answer and I don’t have I I don’t have any real magic solution for that um I think you know and owning quality businesses is obv something we all aspire to and (1:06:58) personal experience I think is an
Amazing help in that I did a competition for my substack readers I they I did a like a mini course which like 10 bux and there were three three things you had to to to watch and then you
Had to create examples from your own experience it was about how’ you find good stock ideas I should do that again because probably be more interest in it and I I I said the winner got a free course and
The winner was a lady in in the UK and she had taken some brilliant examples from her personal (1:07:38) experience and she said oh I tried to you know I tried to buy this product and
I found you know this one had did this and this one did that and this one was by far the winner because it wasn’t that much more expensive it was much better quality and she really understood the
Product and she really understood why the company could have higher margins than its peer group and um and she explained why the valuation was competitive because they would continue to make higher returns and that’s what I kind of (1:08:09) look for and she did it brilliantly
Stephen I appreciate you so much for joining me today before we say goodbye where can the audience connect with you and learn more about your book and your course well the book is available sadly not all good bookstores but it came out in November 2020 when all
The book stores were closed but you can get the book on on Amazon the book’s called the smart money method um by Steven Clapham you best place to to see what I do is behind the balance sheet.com if you on the top right of the (1:08:46) homepage there’s a sign up button and
You can go you can sign up for the free subat I also have all investing courses on there so there’s courses online and iners inperson courses I only do for institutional investors but I charge quite a lot money but online courses are are there’s a whole range
Of of different courses um my favorite is the analyst Academy which is everything you need to become a serious investor and there are some investing resources on there so some of the videos that we’ve done about you know we did a (1:09:23) series of videos on investing tips a
Series of videos on Academy red flags so you know those are things that you know I’ve tried to put into the public domain just to help investors and um you can find me on Twitter I’m very not there very much these days because it doesn’t seem to generate much engagement and we’ve got
A company page on LinkedIn which I have a social media a person who helps me who puts a a a lot of content on that is worth worth following and um I just want to say thank you very much
(1:09:59) for having me on I’m hoping that when I next watch your podcast that I’m going to see my book up there in that poll position top right corner and um thank you for your questions I
Really really enjoyed talking to you steephen so how do you outform well you have to be where other people aren’t you have to be you have to have some variant perception as Michael price calls it you have to you have to be doing something distinctly different from what everybody else
Is doing and one of the ways that you can (1:10:30) do something distinctly different is to go into those things that are particularly scary looking
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