VALUE: After Hours (S03 E32): Hail Mary Investing, Social Thermo-Dynamic Equilibrium, Supply Chains

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In this episode of the VALUE: After Hours Podcast, Jake Taylor, Bill Brewster, and Tobias Carlisle chat about:

  • The Hail Mary Portfolio
  • Average Up & Bet Hard
  • You’re The Average Of The Five People You Spend The Most Time With
  • Michael Burry Long Shipping, Short $ARK
  • Buy The Most Expensive Stocks
  • Social Thermo-Dynamic Equilibrium
  • How Much To Allocate To China Stocks
  • The Death Ground Strategy
  • Don’t Truncate Your Winners
  • The Wrinkle In Never Selling
  • Supply Chains
  • The Call Option Portfolio
  • Fantastic Fungi

You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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Full Transcript

Tobias: Here we go.

Bill: Yeah.

Tobias: I think it’s going to work now.

Bill: Hey, I got a notification.

Tobias: Me too. That’s a bit odd.

Jake: Nice.

Tobias: I think we’re live.

Bill: Dang on time.

Tobias: We may be even be– in a fraction– Yeah, we’re on time. [crosstalk]

Bill: I don’t like this, man. I don’t like this. We’re training people to expect stuff. This is terrible.

Tobias: Competence.

Bill: Oh.

Tobias: Training people to expect. That’s a bad move right there.

Bill: Yeah, it’s terrible.

Tobias: [laughs]

Jake: Setting the bar way too high.

Bill: Well, don’t worry.

Tobias: What’s happening, fellas?

Bill: We’ll let you down next week.

Tobias: Well, inconsistency is the name of the game here.

Bill: My man, like value returns.

Jake: [laughs]

Tobias: Oh, my God. Value returns. That’s a horror movie right there. That’s what it would be called, Value Returns.

Bill: This right there is the dip that gets people thinking that our value show will actually come on time all the time, and then next week, we’ll rip their face off.

Tobias: [laughs]

Jake: That’s right.

Bill: Yeah.

Jake: [laughs] Yeah, 10:45 AM, won’t even be going yet.

Bill: What’s going on? Not much is going on. I spent the weekend in Boston. When’s the last time you heard somebody fly from Florida to Boston and then have to change their flight back to avoid a hurricane?

Jake: Hmm.

Bill: Not often.

Tobias: Yeah. Usually going the other way, right?

Bill: That’s right. Rough morning for this guy, Sunday. [crosstalk]

Jake: Just hurricanes following you around, huh?

Bill: Yeah, dude. Yeah. Then, I come back here, COVID land. People are fucking out of their mind. Oh, well, anyway, I digress. You asked me, I told you.

Tobias: I’m going to do some shoutouts for some people because I haven’t done that for a little while. Oakville, Ontario, Canada, how are you?

Bill: Oh, yeah. Geographies.

Tobias: Camas, what’s happening? Camas, did I said it correctly?

Jake: Ah, Camu?

Tobias: Everybody’s here for the night. It’s not spelled that way.

Bill: Should we do the throwback intro? Welcome to Value: After Hours.

Tobias: Yeah.

Bill: I’m you host, Bill Brewster, with my cohosts, Tobias Carlisle, and the esteemed Jake Taylor. What’s going on today, guys? What’s your topic, Toby?

Tobias: Yeah, I had a chat to a gentleman has recently written a new book, William Silber. It’s called The Power of Nothing to Lose, but it’s basically about Hail Marys, when people throw them, why people throw them in football and outside of that. I think that there’s some interesting ideas that come out of it, particularly in relation to stuff that I’ve been writing about and working on. So, that’s going to be my topic.

Bill: JT, what’s up?

Jake: I’m feeling good. I got a new microphone set up. So, everyone can stop complaining about me being too quiet. That hopefully is going to be a game changer. I’ve got a little topic prepared that I’m titling Social Thermodynamic Equilibrium.

Tobias: Wow.

Jake: So, we’re going to get into it. It’s probably a two-parter. [laughs]

Tobias: I did not expect that from a helicopter part. I’ve got to say.

Bill: Yeah. [laughs]

Jake: There’s layers to the ship, player.

Bill: [laughs]

Tobias: We’ve got Wenatchee, Woodinville, Belgium, Orlando, Las Vegas, Toronto. Utah, baby. What’s happening? New Jersey, Nashville. Everybody’s in the house. This is [crosstalk]

Bill: Shoutout to Orlando. Don’t drink too much water. They need it for the COVID treatments according to the news. True story. True story. That’s what they said. They said conserve water because they need it. I will not be doing something nearly as smart as Jake. I will riff off of Toby’s topic and probably talk about supply chains a bit.

Jake: All right, Toby get–

Bill: You want to start it out, Jake?

Jake: All right, we can eat veggies.

Tobias: Why don’t we kick it off with– Because we’re going to too. We’re going to do you and I and then I want people to listen to the end of– [crosstalk]

Bill: [crosstalk] after, man.

Tobias: JT puts in the work.

Bill: Yeah, that’s fair.

Tobias: I want people to hang around for the good part.

Bill: Yeah, that’s right.

Hail Mary Investing

Tobias: The podcast that I have up at the moment is William Silber. I think he was a NYU professor of finance, and he’s written a book on the Hail Mary effect, which is basically– his definition of a Hail Mary is when you have nothing to lose, then you take a high-risk gamble that typically doesn’t pay off, because you’ve got nothing to lose, and it can pay off. He gives lots of different examples of Aaron Rodgers can be pretty reliably throws this deep bomb, if they’re behind, if the Packers are behind. Everybody knows that it’s basically, it’s a goat rodeo, like there’s chance it connects, there’s a chance it doesn’t connect. That’s the idea of the Hail Mary. Everybody’s pretty familiar with the Hail Mary. But it turns up in lots of different contexts. Anytime, you have nothing to lose, it makes sense to buy a lottery ticket.

I slightly disagree with William. I put this to, Bill, I should say. We’re good friends, now. So, I put this Bill on the podcast that behavior is a thing that– That’s just a lottery ticket buying behavior. Many, many times, our instinct is to buy a lottery ticket anyway, and you have to suppress the instinct to buy the lottery ticket and to buy the surer option. But according to the definition of this book, within that, there are certain circumstances under which you can throw and say, Aaron Rodgers throwing at the end of the game, if the game is lost but if you connect, and you get a touchdown, and you can win, then it makes perfect sense.

The Death Ground Strategy

Tobias: I think about it in the context of this book that I’m writing at the moment on grand strategy on Sun Tzu . One of the things that they say is that you should put yourself on, they described it as death ground, which is basically, there’s no way out and you perish, if you don’t fight hard on that ground. And then, that’s the circumstances when you’re likely to actually fight hard enough to win. The reverse of that advice is also true. There are points in time when you should observe the fact the other side is on death ground and that if you attack them in that place, then they’re going to respond and fight incredibly hard, and that you’re likely to lose a large portion of your force. So, a better idea is to when someone’s on death ground, allow them to escape. Give them an escape route. So, it changes the payoff from no downside, and now we have some downside we can get away.

I just think it’s an interesting– There are many examples of financial ideas crossing over into real life, and back and forth. I think that a good understanding of your own behavior and the risk-reward pair for any scenario helps you to better think through the likely outcome of these positions. I think that for the most part, you shouldn’t throw the Hail Mary. But before we came on, we were talking about someone who’s got a portfolio filled with Hail Marys.

Bill: Can we circle back to this idea of letting them off a death ground?

Tobias: Yeah.

Bill: The concept is if they’re on death ground, they will fight like they have nothing to lose.

Tobias: Because they have nothing to lose.

Bill: Yeah, because they’re dead. They’re on the death ground.

Tobias: Yeah, you will. You will die.

Bill: Yeah, you have a higher position or whatever.

Jake: It’s not ghosts.

Tobias: [chuckles] Not a ghost.

Bill: So, if you give them an out is the idea that they’ll retreat to save their life, and that you’ll be able to take the position anyway. Is that the theory that they’re talking about?

Tobias: The idea is that you need to have an overview of all of the things that play in what you’re doing. So, you need to understand the disposition of the other side. I don’t necessarily think in investing that there really is another side.

I’m just saying you need to understand the disposition of the market, you need to understand the disposition of other shareholders in a company, management, and so on. I think, in many instances, you can find a management team on death ground, and you might want to back those guys, because I think that they’re probably going to fight hard to get out of that scenario. I’m spit balling a little bit here. But that’s the idea that you just need to be aware of all of the influences or you need to be a little bit aware of the unseen forces in any kind of engagement. One of them is that they have no alternative. When they have no alternative, they’re going to fight a lot harder than you might perceive that they should, given the things that you can see.

Bill: This is going to be my second week in a row plugin non-GAAP. So, soon, you’re going to have to pay us, non-GAAP. But when he did his Regeneron write-up and those guys brought forward, I think it was like five years of pay, he was like, “This is a good sign.” I think that stock’s up like 150 bucks on a $500 stock within, I don’t know, maybe, whenever he and I recorded our episode. So, it’s definitely been under a year. I think proxies are probably a good idea to search to see when management teams are putting themselves on death ground.

Jake: Would you say that actually applies even more to a short situation, especially, if you think there’s fraud? I mean they’re effectively on that death ground. They’re going to do anything that they can to keep it going, and you have to maybe know that going in.

Tobias: Yeah, that’s a very good example. That is now going to appear in the book. Thanks, Jake.

Bill: I just prefer to not engage in that situation. I’ve seen that take too much brain damage in people’s lives to short that, right?

Tobias: Short frauds are, yeah, for sure. But it also depends on the size, you don’t want to be– I think it’s hard to be the lead short identifying all the problems with something, and then take a big short position in your fund. In that case, you’re so close to it. We’ve all seen what Tesla’s done to everybody for the last five years. I think that the shorts are probably right, no kidding. I have been one of them on occasion, but you just get too close to it, and you can’t see all the other factors at play.

Bill: Yeah, I’d rather be wrong and rich than short and right and poor, which is what some of those shorts are, if they didn’t manage risk right.

Tobias: Well, you can be you can be right in the fullness of time because you’ve got the path dependency you’re wrong, in the interim and you can be carried out feet first, which is why you want to keep them small.

Bill: Which is all that matters.

Tobias: Yeah.

Bill: I’m not saying you. I’m saying I know very vocal shorts, and it’s hard to argue that they’ve been right, just because if something goes up 5x on you in a short, it’s just very, very hard to argue that at a minimum, the timing was off. Oh, shit, there’s two Jake’s.

Tobias: Jake’s [unintelligible [00:11:27] [laughs]

Bill: Okay. It’s Dreamy Jake and Frozen Jake. That’s what I’m looking at least. All right, well, I guess you and I are doing the pod today, huh?

The Hail Mary Portfolio

Tobias: Let’s talk about filling a portfolio with full of Hail Marys. I don’t mind that as a strategy for the most part. We lost Jake now.

Bill: I don’t know that you would fill the portfolio. I guess the conversation that I was having today that was making me think of Hail Marys is, I think that there’s room in a portfolio for some Hail Marys. I go back and forth on this like, “Do you want to dilute your best ideas?” But from how would you want to manage your life standpoint, I think that once you get to a certain level of comfort, there’s a portfolio that is safe, and you’re not risking your life comfort, and if it underperforms a little bit, you probably deserve it, because it’s probably not as risky as the market. But then if you can find some really spicy stuff to throw into it as a Hail Mary, that makes sense to me. It’s just you’ve got to size it right, and it’s really got to have the potential to hit. Maybe you don’t want to do it. I would get that too. Buffett would definitely not agree with what I just said.

Tobias: You’re back, JT? How is your mic?

Jake: Hopefully, it’s okay.

Tobias: [laughs] Well, Buffett’s one of those guys who’s like there’s that– William T Ziemba has written that paper about Buffett saying that he’s been a Kelly-bitten investor the whole way through. We saw that in 2000–

Bill: A what?

Tobias: Kelly-bitten investor.

Bill: Oh, yeah.

Tobias: We saw that in 2018 or not. When did he really plow into Apple?

Bill: That’s not really a Hail Mary for him.

Tobias: It’s not a Hail Mary. That’s right. I’m just talking about what you’re just talking about. Then, I thought–

Bill: Yeah, I guess that’s right. Yeah, I think you’re right. Okay, I understand. I’m sorry to not make the connection on my own topic.

Tobias: That’s not a Hail Mary, I guess. [laughs]

Bill: Yeah. I’ve always thought of him as the opposite of a Hail Mary investor. I think that people would maybe look at his position sizes and say, they’re Hail Marys, but I don’t think he has much downside.

Tobias: I think that’s right. I think that that’s exactly right. That’s why I think that this book is the inverse of the one that I’m trying to write, which is basically don’t throw Hail Marys you don’t need to.

Bill: Yeah, I just think that there are different people that have different capabilities. That said, I would rather have a quarterback like Tom Brady than one like Jay Cutler. Jay Cutler was a Hail Mary guy that lost all the time. Brady’s a not a dink and dunker but doesn’t have some canon on him. He’s just accurate. He wins. That’s who you want.

Jake: Do you think that there’s maybe some career implications when it comes to Hail Marys? Should you be throwing Hail Marys when you’re young, and you don’t have as much to lose?

Bill: Yeah, and you’re an anonymous account and just fold it and do another.

Jake: Yeah.

Bill: Yeah, for sure.

Jake: Or a fund even. That’s not uncommon to see somebody blow up a fund and then come back and start another one, right?

Tobias: Here’s the only problem with that behavior. Part of the reason that I am attracted to this subject, and the reason that I have written a book is, I know lots and lots of guys have thrown Hail Mary’s to start their careers. We all know people who take way too much risk. But within that group, I know lots and lots of guys who’ve connected and are now fabulously wealthy as a result. But within that group of guys who threw the Hail Mary and connected, a material number of them just never gave up the behavior. They just kept on throwing Hail Marys, and they’ve gone back to square one. That’s the thing that it’s that pattern of behavior that I’m interested in studying and interested in avoiding.

Bill: Yeah.

Jake: But what if you think you’re the exception to the base rate?

Tobias: One in a million.

Jake: Oh, was that a one in a million talk?

Tobias: But that [laughs] the first part where you throw the Hail Mary– I think you’re right. When you’re young, it does make sense throw some Hail Mary’s. But when you connect, you’ve got to change your approach. You have made the leap across the fiery chasm and you’ve got to [crosstalk]

Jake: You’re just handing it off three times in a row and then punting.

Tobias: Why not?

Bill: That’s the value strategy.

Jake: Yeah.

Bill: Then playing the prevent defense.

Jake: [laughs]

Bill: I guess as it pertains to investments. I think strategy of a lot of Hail Marys can work. I just don’t think you can size them big. So, then maybe it’s not even a Hail Mary. Maybe it’s just a deep pass in the first quarter.

Tobias: Yeah, I think that’s right. Clearly, you can run a book that way where you’ve got– [crosstalk]

Bill: [crosstalk] hit hits, right?

Tobias: You’ve got a 1 in 10 chance of whatever, I haven’t done these calculations. But I’d go and work it out what did I actually– [crosstalk]

Bill: Let’s go 40x because that I think our math will work. If you got a 1 in 10 chance of a 40x [crosstalk] you should like.

Tobias: But then how many positions should you have any portfolio to reliably guarantee returns– or you are not guaranteed, but reliably generate returns?

Bill: Yeah, you need the expected value to be in excess of one. I need to actually look at a paper and do this math.

Tobias: A 1 in 10 chance of a 20x is positive expected return. But if you have one of those, you’ve got a 1 in 10 chance of it paying off, you need some number of I don’t know what it is 10, 20 to–

Bill: Yeah, you think 10, right? [crosstalk] But then, how correlated are they, and how different are they, and it’s got to be truly noncorrelated bets in order for this theory to work. It’s hard to find those.

Jake: I’m not sure how many of those exist anymore. Feels like there’s a lot of correlated bets these days.

Tobias: You could have little special situations though, and you could you could do with an option, which really you could shape that payoff. You really could find those payoffs if you’re hunting for them hard enough, and then fill a portfolio. Victor has made the point that lots of Hail Marys in a portfolio, that’s like a VC portfolio. That’s what maybe even more aggressive than a VC portfolio where they explicitly say, “A small portion of our portfolio is going to hit. But the hit is going to be so big. It’s going to take care of everything else.”

Average Up & Bet Hard

Bill: Yeah, this is the David Gardner philosophy, I think. Then you let it run, and then you add to the ones that are working.

Tobias: Yeah, I think that the–

Jake: Is that going for two to after the touchdown?

Bill: Well, I think, and I don’t want to speak for him, my interpretation of why I say that is if you think that the market someday can be 20x, let’s say that you think a stock 20x or whatever, when that thesis begins to get proven, forget about whether or not the stock works, but when the business starts to work and the stock works, if you’re already right, I think you want to average up into those situations and bet those hard because that’s probably the situation that you see clearly in that strategy.

Jake: I think I remember Peter Thiel talking about this quite a while ago, and he said that he’s almost always re-upped invested in an up round, because it meant something was working and you just keep backing what’s working.

Bill: Yeah.

Tobias: That’s slightly different to a public markets position that right where– let’s just say there’s a random walk, and you put on enough– Let’s say for argument’s sake, and you’ve done all of your work on 10 positions and half work and half done, why would you size up into the ones that are working given that we’re just talking randoms over the next two or three years?

Bill: Yeah, but I don’t buy that it’s actually random. That’s the problem. You were fundamentally–

Tobias: There’s a Nobel Prize in that if you can get that paper out.

Jake: Hey, Bert, what are you talking about? [laughs]

Bill: Well, I don’t. I think they’re wrong. I think that companies that have cultures that compound value over time generate huge returns. I think we’d all agree that a lot of the market’s returns are out of a very few amount of companies. So, if you’re identifying that company with that culture, I don’t think it’s that random over a long term.

Tobias: But you could find an x– I saw this lots of times from 2005 to 2015. There were lots of very, very good companies that had just traded so expensive. They can’t control their stock price. You’re looking at the underlying companies saying this is a spectacular company. This is a spectacular business growing and compounding all the time. Management’s executing, Stock just hasn’t done anything. You could hold that for a couple of years and be backwards 50%. I don’t think you’ve necessarily made a mistake other than you might have overpaid for it.

Bill: Yeah, I don’t think so either. But I do feel sometimes, when people talk about stocks, you’ve got– I’m trying to think of a good analogy that people would understand. It’s basically like, you’ve got a young Tom Brady and he’s winning Super Bowls, and people are like, “Well, how do you know he can continue to win, and how can you pay him more? Shouldn’t you just go sign some shitty quarterback because of mean reversion?” It’s like, “No, you dumb shit. You just continue to bet on the guy that’s really good.” I don’t think business is that different. I do fundamentally believe that there are teams of people that kick other people’s ass in competition. In business, it’s the same.

Now, I agree that there are competitive forces that in a perfect theoretical world are competed away. The problem is, we don’t live in theory and talent wants to join talent. That’s what I believe about the world. Then, I think that we’re at a point where we have entered an economy, whether it’s regulatory capture, or companies have gotten so big, or scale advantages, or whatever.

Tobias: The internet, probably.

Bill: Well, but maybe.

Tobias: Distribution network. Thanks for Modern Distressed Investing at Thomas [unintelligible [00:22:27] I can’t quite see the picture. But we just got a tip here, £20 tip. Thank, mate.

Bill: Nice, thanks for the tip. I do think that people underweight that, and then they’re like, “Well, theoretically, should this not be true?” It’s like, yeah, in theory, but the problem is, you don’t get paid on theory. [crosstalk]

Tobias: You’re missing my point. I’m with you that there are management teams and businesses that are superior, and that grow and compound over time. I think that the wrinkle is, though, that in the market, we’re all trying to handicap at the price that you’re offered, is this now fully accounting for how good these guys are or even overestimating how good those guys are?

Bill: I do understand you point. I do get it. I think what I’m saying is that, I think a lot of the times those companies are underestimated perpetually.

Jake: You’re trying to avoid that Bobby Bonilla contract. [chuckles]

Bill: Yeah, and yes, there are some times, obviously– look, I think if you look at my portfolio, it’s not like I’m making huge bets on these great companies. But how long has Google been undervalued for, and how long would people have said, “Well, it’s too expensive”? It’s like, you’re wrong.

Tobias: Google has been cheap on occasion.

Bill: I get it, but you probably could have bought it expensive and still outperformed if you bought it small enough is my point.

Tobias: I’m sure. Yeah. So, you’re just saying to put a starter position in when it goes backwards, buy a little bit more.

Bill: Yeah, I think that strategy is somewhat–

Tobias: [crosstalk] Isn’t that literally what I just said before? Isn’t that what I said?

Bill: [crosstalk] I don’t even know what we’re talking about.

The Call Option Portfolio

Tobias: We’re talking about pyramiding up into a position. I can give you an example of what when I mean like a Hail Mary portfolio would be– I think you could put together a portfolio for call options on– Let’s pick all the names that we really like. Let’s find them when they’re reasonably valued, and then buy an at the money or slightly out of the money call, a LEAP that goes for two years. Now, that portfolio should generate very high returns. But there’s also a risk that if you get a big enough drawdown in the market that you’re down on that entire portfolio.

Bill: Yeah. The problem with options is you have an asset-liability mismatch in my mind. It’s not actually asset-liability mismatch, but you’re putting an artificially short duration on an inherently long-duration bet and you can get fucked.

Tobias: 100%.

Bill: That’s where I do think like a two-year time horizon, the market’s probably pretty random. A day time horizon, for sure. 5, 10 years, I don’t know.

Jake: That’s why you need to only trade options that expire within a week or less.

Tobias: [unintelligible [00:25:12] [laughs]

Bill: I like that. You can actually make a decent argument that short-term options on some of those crazy stuff makes more sense than the underlying for some of that reason.

Tobias: Make it.

Bill: I just think once you bet in a lottery, you might as well bet the lottery.

Jake: Yeah. Take that lumpsum, don’t go for– [laughs]

Bill: Ain’t no such thing as halfway crooks.

Tobias: I think that with a LEAP going at two years or more, you can add on something cheap, you’ve transformed a portfolio that would be just a regular value portfolio that has no downside other than the equity downside into a portfolio that has a much higher expected return, but also has the risk of a complete downer. That’s what I mean by that. That’s a portfolio filled with Hail Marys.

Jake: Yeah, you must dream a little bigger, darling. You’re already pushing it back into LEAPs when you could go even crazier if you really [crosstalk] Hail Marys.

Tobias: I ain’t increasing– You don’t think I’m increasing my the chance that I’ll get it paid off in that scenario?

Jake: Yeah, but you’re also lowering what you’re going to get paid.

Bill: All I know is, I’ve got $540- [crosstalk]

Tobias: That must be true.

Bill: -paid on these LT LEAPs.

Tobias: Which one?

Bill: [crosstalk] In my retirement account.

Tobias: LP? LP LEAPs?

Jake: The poor.

Bill: no. LTs.

Jake: That poor gal. [laughs]

Tobias: Oh, LTs.

Bill: Yeah. She’s a volatile lady.

Jake: Just abusing that I read.

Bill: Yeah, I think I’ll tell you what it wishes this trade was none. That’s fine, whatever. I’ll get it back.

Jake: [laughs]

Tobias: All right. Have we have we beaten this topic to death? JT, you want to redeem us?

Social Thermo-Dynamic Equilibrium

Jake: Yeah, let’s get into it. So, social thermodynamic equilibrium, if you can stomach that mouthful, and of course, any good thermodynamics segment, it’s going to start off with Ludwig Boltzmann, who is this Austrian-

Tobias: Of course. Of course.

Jake: -physicist. He’s the one who used statistical mechanics really to explain the second law of thermodynamics. Refresher on what the second law of thermodynamics is basically, in an isolated system, entropy has to increase. Basically, you arrive it at some equilibrium, which if taken far enough, you start to talk about the heat death of the universe and whatever cheery topics.

Now, we’re going to keep going there, but there’s this other guy and also an Austrian physicist type of fellow who named Loschmidt. He calculated in the 19th century, the number of molecules in 1 cubic centimeter at zero degrees centigrade at 1 atmospheric pressure. Basically, if you just had one little cubic centimeter, how many molecules are inside of there? It turns out that it’s an insane number. It’s 2.687 times 10 to the 19th molecules.

So, just to give a little bit of perspective of what that would equate to. In 450 cubic centimeters, which is basically a little under a half a liter, just think about like a two-liter bottle of soda and little under half of that just filled with air, there are more molecules in there than there are stars in the universe. There’s a fair number of molecules in the air that we breathe. And what’s crazy is that they’re all moving around at 460 meters per second, which doesn’t mean much to us, but it’s over 1000 miles per hour is how fast they’re moving.

Boltzmann’s equation, it described the properties of molecules, and how they average out over time. Picture like a box, and you add air to it for the first time, it was a vacuum, there’s going to be some particles in there are molecules that are moving faster than others. Those faster ones are actually by definition, higher energy, which means that they’re actually higher temperature.

These faster-moving molecules bump into the slower-moving molecules, and they give them a nudge and in doing that, they transfer energy from one to the other. If you can imagine– As they share energy, the higher energy one loses energy and the slower one gains energy to the point where you get equilibrium within the system. That’s basically what’s happening in one definition of entropy. Obviously, it’s a very swift process in a little liter of air because those things are moving around, and they have 4 million collisions per second on average. That’s why we don’t notice air temperatures being that much different within a little tiny box, is because they’re moving around so fast and sharing energy.

You’re The Average Of The Five People You Spend The Most Time With

Jake: So, let’s now take this whole concept of sharing energy and running into each other, and let’s abstract it out into a social context of– Jim Rohn has this quote that, “You’re the average of the five people that you spend the most time with.” Tony Robbins has taken that same quote and used it. Think about that. The other molecules in the box with you, that you run into on a regular basis, you share energy, you share values even. In part two, next week, we’re going to start talking about mimetics, and René Girard, and you start to actually share what they want. If you ever stopped to ask yourself like, “Why do I want what I want?”, it’s actually mind-boggling question when you think about it. So, thoughts on that before I move into the next little biology part of this segment?

Tobias: That seems to be right. I hate those pat things like, you’re the average of the five people you spend the most time, that’s probably true. That’s got to be true, right? So, why do you want the things that you want? Because your friends want them.

Jake: Well, this goes actually quite deep. I want to do a very good job of it. Well, we’ll carve out- [crosstalk]

Tobias: That’s coming.

Jake: -for it. That’s going to be next week. Yeah, we’re going to get into to mimetics, and why you want what you want. One thing though to hit on before is that there’s this thing inside of you called the vagus nerve. What it is? It’s really like the superhighway of your autonomic nervous system. That’s the thing that just handles stuff while you’re below the subconscious level. So, your heartbeat, your lung functionality, digestion, all the stuff that’s happening inside your body that you’re not having to actively think about is monitored mostly by this vagus nerve. 80% of the traffic on that vagus nerve is the brain sending signals out to tell your body what to do, and then the other your organs, and your glands, and all this machinery that you have inside of you. Then, the other 20% is going the other direction, feeding, sensory, input back to the brain to figure out what things to do next.

Vagus actually is Latin for wandering, and what that– This nerve system wanders all throughout your body. There’s this idea that you want to have good vagal tone, which means– and I know you guys always like it when I–

Tobias: Can you work that out? [crosstalk]

Jake: Yeah, exactly. [laughs] Literally, the electrical impulses that are pulsing in your vagal nerve, they get synched up with other people. That is one of the ways of developing vagal tone is to have a lot of social connections. So, it’s not just that we have this, you’re the average of the five people that you spend your time around, but there’s almost an electrical signal that is analogous to our little molecules bouncing around in the box. So, I love it when we go from physical world to social, and then actually back to the physical world. If I’m able to execute this mimetics piece well enough next week, I’m going to land mimetics back into thermodynamics. We’ll see.

Tobias: [laughs]

Jake: So, here’s some other things in case you are wondering about how to improve vagal tone other than doing your Pilates or whatever it is. [laughs] Cold exposure– [crosstalk] Yeah, frequent movement, obviously, being couch potatoes, bad for your tone of anything. Intermittent fasting, Omega-3s, and then probably one of the biggest things is actually community. So, back to that average of who you spend your time around.

Tobias: Can you achieve it over a podcast?

Jake: I don’t know.

Tobias: Or, actually go into the community?

Bill: That’s a good question. I’ve thought about this a fair amount actually, because I think it has important implications for culture building. My hypothesis is that, because so much communication is nonverbal– and we can see each other now, but how much of the total bandwidth of information about our social interaction between the three of us right now, are we getting compared to if the three of us were in the same room? Obviously, we’ve lost pheromones, we don’t have body language as much. We still have tone, we have the actual word choices. We’ve got a little bit of facial expressions, although it’s probably relatively muted to what we would pick up in person. I’ve got to think that is a relatively low bandwidth way of sharing over Zoom or whatever it is that you’re using relative to if we were in person together. So, I’m not entirely convinced that there’s not–

Tobias: It’s not enough.

Jake: It might not be enough, actually.

Tobias: Yeah, that’s interesting.

Bill: Got to smell each other to really understand each other.

Fantastic Fungi

Tobias: I saw a Netflix documentary on fungus. We’re all basically just full of fungus and breathing in fungus all the time, and it changes the way we think about everything. So, we’re probably missing out on that too.

Jake: Oh, yeah. I believe that.

Tobias: It’s on Netflix. I don’t know. I’ll get the name for next week. I wasn’t really paying attention but at the start– But I did start paying attention halfway through because I was like, “Oh, this is really interesting, because we’re descended from fungus, there’s fungus all over the planet. The oldest living thing in the world is a fungus.”

Jake: I believe you didn’t send that to me. Sounds right [crosstalk]

Bill: Sometimes, people eat fungus.

Tobias: I haven’t finished it yet.

Jake: Oh, okay. All right. So, let’s wait for part two and see if we can get into mimetics, which is a pretty interesting topic.

Bill: I like that you’re into mimetics. I think you’re going to do well with this.

Jake: We’ll see. It could be a total botched operation, but–

Bill: Then, you and Jim O’Shaughnessy are going to combine forces and you’re going to have —

Jake: Like a Voltron of bad analogies?


Bill: No, it’s going to be like FinTwits ultimate meme. It’s going to be beautiful.

Jake: Oof. That’d be sweet.

Tobias: I think that you probably are an average of the five people who spend the most time with. That’s probably also true in a professional context. So, what does that mean for investors?

Bill: I don’t know. I think it means– [crosstalk]

Tobias: Spend time with people who are throwing Hail Marys.

Bill: No. Look, I’ll tell you what my takeaway is be very wary of hanging out with five people that think exactly the same as you. I actively try to talk to people that think very, very differently and I don’t always agree with them, but I can’t– [crosstalk]

Tobias: Fantastic Fungi, thank you. [crosstalk]

Buy The Most Expensive Stocks

Bill: I can’t stop talking about him, but David Gardner, the reason I’m obsessed with that way of thinking is it’s just so different. When I read it, it made me angry because it’s so not what Buffett teaches, and I was like, “But this is the canon I believe in.” How can somebody else say something so disgraceful as you should buy expensive stocks like, “Fuck you, man.” But then I started to actually listen to what he said. I said, “All right, you know what–” It’s a different strategy. Like the 80, whatever. Like the old school bears teams. That would beat you up on defense and run you down, and the line was badass, and then all of a sudden, somebody’s throwing passes 50 times a game, but this isn’t how you play football. But it turns out that you can play football that way. They’re just different views of the world. I think that, I’m just trying to marry some different views of the world together and come up with a melting pot.

Jake: Yeah, I think that’s really smart, actually, because you get a tiny, tiny little sliver of perception into everything that’s happening around you, especially conscious perception. Then you call that reality, and then you think that you have some domain over what reality looks like. But maybe someone else’s perception is just tilted a little bit differently, because we’re all sampling such small, low-resolution versions of actual reality, it’s not surprising that there’s lots of different truths that seem contradictory, but don’t necessarily have to be– Almost like that touching the elephant in different places, and then people assuming that it’s a different thing. It’s because we have such limited perception bandwidth that, of course, you’re going to have people with different views that can be totally diametrically opposed, and yet still right, both of them.

Tobias: Yeah. What is it about David Gardner’s strategy that’s so distinct from what Buffett does? Because I think that David Gardner has a lot–

Bill: Dude, Gardner wants to buy the highest price stocks in the market for the most part. His theory of the case is great companies never trade at multiples that people say make sense. So, he gets really interested when somebody says like, “That stock is priced absurdly high.” He’s like, “All right, I’m interested in that stock.” And then, he– [crosstalk]

Tobias: The basis that the market has priced this thing so high, because the underlying fundamentals are going to grow so rapidly, it’s such a good– he’s saying this is a signal to go and have a look.

Bill: Yeah, and to be very fair to him, he is a fundamental guy. He’s all about company, and strategy, and culture like that. I think is accurate to say permeates the Motley Fool, the way they talk about things. But I think his theory of the case is for truly great companies, the market is never able to actually model them as bullishly as they’re going to be in part because of career risk. Because if you’re a cell sider and you’re like, “I actually think this is going to be this way,” and then it comes out, and it’s a little bit flat, you look like an idiot.

Jake: ARK begs to differ.

Bill: It would be really nice to be able to have the conversation with this guy, so I can ask these questions. But they have some stupid rule, and he’s supposed to be the rule breaker, but he won’t break the rule.


Bill: I don’t know what it takes–

Tobias: Not going to break that rule. Is he retired or stepping back, or is he’s just writing the thing anymore?

Bill: I don’t know. I’m so tired of even wanting the conversation that it may never even happen. It’s a shame.

Jake: Is there a poor man’s version out there you can get to instead?

Jake: Well, I’m not going to call it a poor man’s but I interviewed Brian Feroldi and I think Brian has a really interesting outlook at the world that somewhat rhymes.

Michael Burry Long Shipping, Short $ARK

Tobias: You know what we’ve forgotten to talk about and that’s Michael Burry being short ARK.

Bill: Oh, yeah.

Tobias: Michael Burry is short ARK just in case if everybody know–

Jake: Well, there you go.

Tobias: Probably, everybody knows.

Jake: [laughs]

Bill: He’s also super long shipping and couple cyclicals.

Tobias: Burry doesn’t spend enough time on FinTwit. I don’t think he knows what he’s doing.

Bill: No, Well, he did.

Jake: Following zero. [laughs]

Bill: He did and then he stopped. Rest in peace to Michael Burry’s old account but then he came back, didn’t he?

Jake: For like a week I think and then it was gone again.

Bill: Rest in peace his second account. Did you come back again?

Jake: I don’t know but–

Bill: It’s like a cat.

Jake: I kind of lost interest after that.

Bill: Fincat.

Tobias: It’s a little bit hard to stay off Twitter. You can limit your exposure to it, and you can delete it all but you’re a junkie, you’re going to find your way back. You’ve got to do it in a different account with a different– You just don’t put your name on the account. That’s probably the smartest way to do it.

Supply Chains

Bill: Yeah, he’s probably someone anon, he’s just trolling people. Yeah, I don’t know. Look, it’ll work or it won’t and be interesting. I’m more interested in long the shipping companies than I am short ARK simply because there is so much tension in the supply chain right now. Do yourself a favor and just drive through some car dealers, like pass some lots and take a look at the empty space versus the car is in there. Dude, read Builders FirstSource, D. R. Horton, Toll Brothers. I sound like Mike now but imagine this like we talk.

The amount of what is a parent demand versus the labor that is supplied to fulfill that demand, there’s just shortages everywhere, and shipping is part of this. I think part of the shipping thesis and I’m not deep in it. So, do your own work. Don’t listen to thing I say. I say that one off but I mean it every time I say it, is that they’re not replacing the boats I think because of some environmental issues.

So, there’s a bunch of issues, but I think that’s a big part of why it may continue for a long time. If those management teams actually distribute capital to shareholders and don’t waste it, those can be really interesting bets and nobody’s interested. If you were to ask me what’s the maximum pain trade in the market, cyclicals absolutely rip for five years and the sexy stuff stays flat. That’s how you incur the most pain and I always fantasize about the most pain because I’m sick.

Jake: In your portfolio.

Tobias: [laughs]

Bill: Yeah, well, I live that. I don’t have to fantasize.

Jake: Yeah.

Tobias: Have you ever looked at Burry’s portfolio?

Bill: Not in a while.

Tobias: One thing that really stands out to me is everything he does– well, not everything, but there’s a lot of his capital seems to be in options, calls or puts. Why do you think he runs it that way?

Bill: I don’t know, dude. That dude’s a genius. I don’t deserve to opine on how he runs his stuff.

Jake: Well, I think a lot of times in those, you can make the argument that you’re going to be right within a year or two or you’re probably not going to be right. If that’s true, then why not try to get a little gearing on it if you can and then just position size? I don’t know. I can see the logic behind that.

Tobias: I was talking about a little before about having a portfolio filled with calls. As long as you’ve got a variety of different strikes over a period of time, you’re probably reducing some of that and keep on rolling it. You’re probably reducing some of that risk that you don’t add on the whole portfolio.

Bill: Yeah. I don’t know. I really don’t. But short sexy and long cyclicals seem to be his trade and it’s an interesting one.

Tobias: You can’t hang a guy for that. I know somebody else who runs a portfolio that way.

Jake: [laughs] In a very systematic way.

Tobias: Yeah. All right, dudes, hit us with the questions, hit us with the Qs. We’ll take a shot at it.

Jake: Dudes only?

Bill: Yeah, ladies, please.

Tobias: It’s dudes.

Bill: Ladies first.

Jake: Ladies first.

Tobias: I call my daughter dude.

Jake: Oh, okay.

Bill: [crosstalk]

Tobias: She calls me dude too. I don’t know if that’s good for everybody, but that’s what we’re doing.

Bill: I think it is.

Tobias: That’s what we’re doing at the moment.

Bill: You’re Australian. You can get away with that.

Tobias: She’s not.

Bill: It’s fair.

Don’t Truncate Your Winners

Tobias: If you own a security, why not sell a LEAP on it for a price you would happily exit at?

Bill: I don’t like that. I don’t like truncating wins. It doesn’t make sense to me.

Tobias: Yeah, that’s right.

Tobias: If you want to sell it though, this is instead of selling, I guess, what price would you be happy to exit at?

Bill: I don’t mind if a security gets to a valuation that I don’t really understand. I’m okay selling LEAPs higher than that, but I’ve seen too many securities get the prices that I don’t understand to start truncating wins. That’s fundamentally the answer. I think even Charlie Munger would agree with me.

Jake: Kind of depends on that whole right tail, and what do you think you’re owning, and do you think that the good thing can be even better than you could have imagined, and you’re chopping that all off all then, it just goes against all the Besson binder study. It’s like, “Hey, I’m going to lock in this tie and make sure I don’t win.” [laughs]

Bill: Yeah.

Jake: Play it for the tie here.

Tobias: Graham used to say, 50% or two years, which I think is bad advice, because you get those winners and the winners are what pays for the whole portfolio. If you hold for long enough, particularly– One of the things I like about Graham–

Jake: Fairness to Graham. Different time periods where he was just shooting fish in a barrel, the base rate was really high on success for each one relative to probably today. So, I think a little bit of– he deserves a little explanation there.

Tobias: But I think that Buffett has taken his idea about entry and then ignored his idea about exit. That’s probably part of the reason why it’s done so well which is one of the things that I like about David Gardner’s approach even though– because I think that Gardner’s maybe– I don’t really know what he’s talking about when he’s saying “looking at high prices.” I don’t know if that’s a–

Bill: That’s just like a multiple. But he’s trying to be the first guy to buy it, the last guy to sell it. So, he’s talking about high multiples on small stuff, and just let it run.

Tobias: I get the multiple idea. I just don’t know what that means in practical sense. Does it mean he won’t buy anything with less than a 3% free cash flow? I’ve got no idea.

Bill: Yeah, I don’t know. I don’t sub. Somebody should give me a sub. You give me a sub to the Motley Fool. I’ll sell it harder than I already have.

Tobias: But if that’s the pitch and so that’s not that expensive. But then, the part that I’m interested in is not so much how he gets into them, because you can probably follow someone like Phil Fisher and get that. He’s a Fisher guy, right?

Bill: Yeah, I think that’s probably right.

The Wrinkle In Never Selling

Tobias: Then the interesting wrinkle is never selling. I’ve been looking at this as a little research project I’ve been doing, I’ve been looking at that. You get this really interesting phenomenon in your portfolio where you do catch these things that get red hot and go on these monster runs. I don’t know how predictive it is. I don’t know if it’s more likely to happen from this pool that you’re selecting or just that’s if you randomly select a whole lot of stocks, you’re going to get some monster winners in there. But if you hold these things, to get 10, 20, 30, 40, 50, 60 plus times on your money, your holding period has to be decades. You have to be thinking in those terms. So, if David Gardner has a way of constructing a portfolio that allows him to hold stuff for decades, that’s probably a winning portfolio.

Bill: Yeah, I think that’s right. I guess the other thing is, I’m pretty sure David Barr told me that he thinks about it in the way of– sorry if it’s not him, but I’m pretty confident. There’s a difference between reraters and compounders. Compounders things you think the business can continue to generate good returns on capital and grow, those you probably don’t want to sell LEAPs and options on, that’s me speaking, not him speaking.

Tobias: This is truncate– Yeah, just to get out of them. To get out of them.

Bill: Yeah. But he then has things that he plays as a rerating and I would say a rerating is probably where I’d be more comfortable selling an option.

Tobias: Yeah.

Bill: Because you don’t really have this long right tail that you think you’re truncating.

How Much To Allocate To China Stocks

Tobias: Yeah, that makes sense. I saw a tweet today about China that– I may get the names wrong, but Amazon has the same market cap as like JD, Baidu, Tencent, and Alibaba. But that collective four or whatever it is generates materially more free cash flow than Amazon does.

Bill: Yeah. The only question that people need to answer is do I want to take the VIE risk? If your answer is yes, buy the shit out all them, I think.

Jake: Not investment advice.

Bill: That’s right. Yeah. Also, don’t listen to a word I say. But yeah, I don’t see how anyone can look at what’s gone on with those stocks, study those businesses, and if you have confidence in the Chinese government not taking away your derivative claim on ownership, I don’t see how you don’t buy it. Whether or not you want to have that confidence is fine. I see plenty of snark in the debates on, “Oh, well, it’s like partnering with communists,” like, “Okay, then don’t do it. I don’t care.” But it’s not really evaluation discussion. That’s a binary, I’m going to or I’m not going to.

Tobias: Yeah, that’s fair. So, how much do you allocate to China?

Bill: I don’t have any allocate– [crosstalk]

Jake: Hail Mary, all in.

Tobias: Yeah.

Bill: No, I’m dicking around with these melting ice cubes, Qurate, according to Greg, who doesn’t know anything about debt. But that’s fine.

Tobias: Yeah, the valuation is tempting, but you have to get comfortable with that VIE risk. I don’t know if there’s any way that you really can. I think you’ve got to view it as an unknowable problem and then the returns aren’t going to be very good if you’re right, and they’re going to be disastrous if you’re wrong. So, that’s how you size it.

Bill: Some people I’ve heard are favoring the Hong Kong shares to the VIE structure. I guess that makes sense, but to me, I don’t know that the game theory of China saying these VIEs are not okay, I don’t know, man. I just don’t know that I buy that they’re going to do that. It seems hard, farfetched.

Tobias: That they would end them all? That would just crush it all?

Bill: Yeah, well, they’re not legal. They’ve never been approved. But they’ve also not been crushed. I guess that there is some regulation might this is really just hearsay.

Tobias: Spit balling.

Bill: Yeah, [crosstalk] some regulation introduced to regulate the VIEs but that’s probably a positive. Because that’s not to shut down the VIEs. That’s more of an acknowledgement that the structure is here to stay. So, I don’t know.

Tobias: As JT has pointed out to me last week, there’s more– the exact technical, regulatory environment, how it all gets achieved, that’s one thing. But the other idea is that do they really want to just cut off access to international capital?

Bill: Yeah, it’s crazy.

Tobias: China has done that before. China’s gone [unintelligible [00:54:43] for 500 years, but I don’t know that has really worked out that well. So, it’s entirely possible that they learned from that experience and don’t want to go into it, and want to keep access to international equity markets.

Bill: Yeah, well, dude, you’re talking about– This is a global scale game right now. These big companies are playing for global scale. China’s just going to cut off international capital so that the west can win a global scale game? That doesn’t make sense.

Jake: And crush your national hero companies?

Bill: Yeah. Just cede the world to the west or the east, or whatever? Yeah, the west, whatever. It doesn’t make sense. I just don’t understand other than fear, why people think they would do it?

Tobias: That’s an interesting point that international champion type companies, does that change their calculation? Is that one of the reasons why we haven’t seen antitrust being– although Google is going to go through that process but it hasn’t seemed to have been enforced.

Bill: I think it’s a huge reason.

Tobias: In the States, yeah.

Bill: Yeah, because who can invest more in the stuff that we’re going to need to defend them ourselves than Google and Facebook? We need them investing in AI. The government’s not going to do it. There’s no company big enough to do it outside of those guys. So, some fucking political pony show that never turns into anything. Sorry, I’m cursing a lot today. There must be something in my heart.

Jake: I like it. It’s your vagal nerve.

Bill: Yeah.

Tobias: It’s the– Sorry.

Bill: I don’t know. I don’t have anything. I’m not an expert. That’s how I see it.

Tobias: But some of these things, I don’t know if anybody is an expert. I think that nobody really knows what’s going to happen. You’ve got to have both possibilities. You’ve got to consider both possibilities and what happens is either one happens. But I’m coming around to the view that it’s hard for China to destroy these companies outright and [crosstalk]

Bill: Why would they want to?

Tobias: Yeah.

Bill: I think what Charlie would say is, if you look at the history of China, they think long. If you think long right now, why would you crush your greatest technology companies and truncate the access to capital from the rest of the world? Why now do you pull that card? So, if your investment horizon-

Tobias: If you feel like you’re in the ascend–

Bill: -is 10 to 2o– What?

Tobias: You feel like you’re in the ascendancy?

Bill: Yeah, but they don’t even have sufficient capital to back all of the companies that they need to back within the country, according to somebody that I talked to. So, they need access to outside capital, and they’re just going to screw over everyone outside? I don’t know. That would be very uncharacteristic of my understanding of how they think.

Tobias: It’s one of the more interesting questions out there at the moment, I think. I don’t have an answer for it either, but it’s worth watching. It’s interesting, because they are incredible businesses, I think they’re probably going to be incredible returns to it’s just– You do have that risk that metaphysical risk hanging over your head that something might happen.

Bill: Yeah, I don’t know, man. It just feels like a lot of people are overweighting it because of where they were born. I really think there’s a lot of home country bias in these conversations.

Tobias: For sure.

Jake: People are mad too about coronavirus, and it’s just– I think there’s a fair amount of–

Tobias: Just got demonetized.

Bill: Damn it.

Jake: Ah, shit.

Bill: At least Thomas sent us the tip. Shoutout to you, man.

Jake: He probably gets a refund.

Bill: Oh, yeah.

Jake: I think that there’s a lot of anger that wants to find an outlet somewhere and a scapegoat, and I think China is a pretty ripe target for a lot of US if you wanted to drum up some hate and rally your political base.

Bill: Yeah, it feels like Russia back in the day. I guess even with the recent election, but I’m thinking Cold War Russia.

Jake: Yeah.

Bill: It just feels like we need some an enemy in our minds to rally the tribe and China is going to be that.

Jake: Wolverines.

Bill: Yeah, I just don’t know that I buy it.

Tobias: I think it was funniest when it was North Korea.

Bill: Yeah.

Tobias: All the movies were anti-North Korea, like North Korea is going to do anything.

Bill: They ain’t shooting missiles, to be fair. You don’t want a missile they hit your ground, but I don’t disagree with you.

Jake: Into the ocean.

Tobias: And they did not fire.

Bill: I agree they had problems.

Jake: [laughs]

Bill: The execution left a little to be wanting if– [crosstalk]

Tobias: I just think it was funny– [crosstalk] It was like, we’re going to make this movie and there’s a chance that we can sell it in China, so we can’t make China the bad guy. We’ve got to make North Korea the bad guy.

Bill: Yeah. Censorship, it ties into a lot of political thought. I understand why people have strong emotions with politics. But I think you don’t get paid in this game for intertwining politics and money.

Jake: No. Don’t let that come into your portfolio. That’ll cabbage up your thinking.

Tobias: And on that note, that’s it, fellas. This was fun.

Bill: Peace.

Jake: Bye, everyone.

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