In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Adam Mead discuss:
- Buffett’s Willingness To Be Wrong
- Watchlist Investing And The Neighbor’s House Analogy
- Regular Portfolio Cleaning Enhances Investment Focus
- Unlocking Investment Intuition: Lessons from Chicken Sexing
- The Hidden Global Reach of Nasdaq-100 Companies
- Berkshire Hathaway’s Transition to Greg Abel
- Shrink or Expand Your Circle of Competence?
- How to Spot Bad Businesses
- How to Analyze Banks For Investment
- Buffett’s Big Bets: Analyzing Decades of Berkshire Hathaway’s Acquisitions
- Being Anointed As The Next Buffett Is Like The Madden Curse
- How Greg, Ted, and Todd Will Shape Berkshire Hathaway’s Investment Future
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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Transcript
Tobias: Folks, it’s Value: After Hours. I’m Tobias Carlisle, joined as always, by my cohost, Jake Taylor. Our special guest today is Adam Mead. He’s the author of The Complete Guide to the Financial Statements of Berkshire Hathaway. What’s the proper name of that, Adam?
[laughter]Jake: Oh, strong out of the gates here.
Adam: The Complete Financial History of Berkshire Hathaway.
Tobias: That’s it. That’s a nice name.
Adam: Which I should have put an asterisk there, because now that title haunts me because the incident, it came out, it’s the incomplete financial history.
Jake: Up until now. [laughs]
Adam: Yeah. [crosstalk]
Tobias: You just need a new edition– [crosstalk] .
Jake: Yeah. New editions, that’s nice.
Adam: Well, we’re coming up on 60 years for Buffett. So, the book is structured in 10-year chapters. The last one was five years. So, it’s a natural breakpoint to a second edition. But you guys know how hard it is to write a book, so we’ll get there eventually.
Tobias: Yeah, indeed. So, Adam, for folks who don’t know you, what’s your day job? What do you do day to day?
Building a Robust Watchlist
Adam: So, I have an investment fund partnership. It’s run separate accounts. So, I have a focused strategy, not unlike you, guys. That’s Mead Capital Management. So, that’s fully registered, fiduciary, all that fun stuff. And then I get to let my hair down a little bit on the newsletter side with watchlist investing, and so that’s the whole premise.
They’re very symbiotic, because the whole premise of watchlist investing is to build that watchlist, regardless of whether they’re undervalued or not, and just follow them until they become undervalued with a decent enough watchlist, we can get there eventually.
Tobias: What does it take to make the watchlist? What are you looking for?
Adam: Really good companies. All the stuff that we’re all looking for, good returns on capital, management you trust, all those kind of things. Although it’s interesting, I’ve definitely found over the years, my circle of confidence has shrunk as I’ve gotten, I guess, more experienced.
I think I just realized that I don’t know how to analyze as many companies over time. But then I’ve really recently had this, I wouldn’t call it an epiphany, but it’s like, even if there’s an industry, people tell, “Oh, look at software or look at oil and gas or media companies.” I’m like, “I just for whatever reason those companies don’t resonate with me have increasingly found that–” My watchlist is my watchlist, and it’s through my filter. So, I’ve got Berkshire’s on there, obviously. But a lot of banks, I have a background in banking, a lot of beer companies, industrial companies.
I like these companies where I can almost feel the physical volume going through them. And so, I have companies like Fastenal, Old Dominion, some of these companies where it’s like, “Okay, Buffett tells us to like capital light,” but a capital-intensive business can actually create one hell of a moat. So, it’s a little bit all over the place, but it reflects my personality.
Tobias: US only, or international?
Adam: No, I’ll go all over the place. In fact, I own some Heineken, which I guess would be my biggest international holding.
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The Hidden Global Reach of Nasdaq-100 Companies
Jake: I read something interesting recently about and I might be getting this a little bit wrong, but the Nasdaq-100, the derivation of revenues for the Nasdaq-100, has the same international exposure as ACWI, I believe. So, [chuckles] when we talk about where is it domiciled, of course, that matters for rule of law and all those kinds of things. But where the companies actually are doing business can be crazy different than what the domicile looks like. So, just different ways of slicing it.
Tobias: What’s ACWI, ACWI? What is that?
Jake: That’s the all-country world index, I think, something like that. It’s an MSCI product that’s pretty commonly used as a benchmark.
Tobias: So, you’re getting global diversification through the Nasdaq-100.
Jake: Yeah. S&P, I think, is somewhere around 40% of revenues are derived from outside the US. But I was surprised that you think of Nasdaq-100, like it’s these huge tech companies, but actually they do a ton of business overseas. Anyway.
Adam: It makes sense. The one that comes to mind to me always is Coca-Cola. It’s like 80% international, domicile in the US.
Jake: Yeah.
Tobias: That’s one of the risks that folks like Med Faber, etc., point out, that you get the home country bias, but it’s interesting. Because that’s been one of the more surprising ongoing things that the US just continues to outperform so massively over the rest of the world, the indexes. The argument has been exactly that, “You’ve got to be careful because there’s going to be some mean reversion at some point.” But it sounds like it’s got a pretty good geographic spread.
Jake: Well, it’s more nuanced, then purely where are headquarters? Hey, before we move on from, I wanted to talk about Adam’s book. I’ve said this multiple times over the years that it’s come out, but I believe I would trade my top 25 MBA school, my MBA that I got, for the combination of listening to the Berkshire annual meetings while reading Adam’s book on a year by year stepping forward basis as a business education. I think it’s that valuable.
Adam: Oh, thanks, Jake.
Jake: Absolutely.
Tobias: Let’s talk a little bit about the book. I interviewed you when the book first came out, but let’s talk about the instrument– There we go. [chuckles]
Adam: It’s a light reading.
Jake: Yeah.
Tobias: Adam’s holding it up. It’s as thick as the Bible. What was the inspiration for writing it, Adam?
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Buffett’s Big Bets: Analyzing Decades of Berkshire Hathaway’s Acquisitions
Adam: It really was the book I did not. I always wanted to read, but couldn’t find, which was Berkshire A to Z. Really, really delve into the nitty-gritty geek out on the details. Buffett would– before he took it out of his letters, he would write the MSR businesses generated a 15% return on equity, and I’d say, “All right, well, where did that come from?” So, I go into the financial statements. We’ve sold, I think, right around 15,000 copies at this point. I really thought there was going to be a dozen people who wanted this level of analysis.
[laughter]Adam: I’ve been blown away at the response to it. Because really, you go deep into every single year, every decade, just take a step back and see what the major decisions and capital allocation have been. I guess we’re coming up on 60 years for Buffett at the helm of Berkshire Hathaway. So, imagine if you’re that new MBA student, Jake, and it’s like all these people, us, we’ve been following Berkshire for at least a couple of decades now, it’s like, how do you get up to speed on this company?
So, in a relatively modest 750 pages, [Jake laughs] you can live that history year by year. So, for that new student, it’s a way to live that, relive the history. And then for you, guys, it may be a reference guide that you want to go back and say, “Geez, what happened during the 1970s? What happened during the 1980s?” that kind of thing. So, two very different audiences. I think it’s been pretty successful at filling that little niche.
Tobias: Did you discover anything you didn’t know as you were going through and putting it all together?
Adam: It’s interesting. So, it took me five years in total. Not all full time, probably three years of full-time work, but I went year by year. And so, when I started to get to the editing process, it was actually interesting just reading it all the way through. I think it’s Chapter 8. I have this table where I show the two largest acquisitions of every single decade. And in each case, I think there’s no less than 15% of equity capital was the largest acquisition.
So, Berkshire has been this continual series of big bets. Largest acquisition was actually in the 1960s with the Illinois National Bank & Trust at 44% of equity capital, even bigger than national indemnity. But roll forward, you’ve got Furniture Mart, Scott Fetzer, BNSF more recently. And then you just look at the balance sheet today, you get over $500 billion of equity capital. Well, to do 15%, that’s an acquisition of at least $75 billion. You can see that this universe has really shrunk for Berkshire Hathaway.
So, it banks the question of what’s next? Will they be able to bag the next elephant, which you might argue that the elephant it’s bagged is itself, because it spent something like $55 billion over the last year and a half on share repurchases. But in terms of an actual acquisition, it’s pretty tough. It’s going to be pretty tough.
Tobias: What did you learn?
Jake: Yeah. Not too many businesses that fit their criteria at that size.
Adam: No.
Tobias: What did you learn putting it all together? What did it teach you?
Adam: I guess it’s just simple on the surface, and Buffett has taken all of these lessons and really distilled them for us. Buy good companies, trust management. But man, the day-to-day stuff, it is messy. They think of national indemnity, the insurance business going through that hell, trying to build that up, trying to figure out how to take, say home and auto business, which was in Chicago. They tried to replicate that business in Florida and completely fell on their face. They didn’t have loss estimates in a quick enough period that they get the information back to headquarters, so they were losing money. Started all these home state companies. Some did well, some didn’t. National indemnity, I think it was 13-year period of every single year declining premiums. We look at that like, “Wow– [crosstalk]
Jake: Like, falling that down to nothing.
Adam: Can you imagine living that period though? So, it was never easy. There was very messy day to day. Throwing the Salomon scandal in the 1980s, and dealing with the shoe companies, and early 1990s, Gen Re had a big award on it when they bought it. So, it really just goes to show that– I think if you aim high for these really good businesses, you’re going to fall short. But even if you do, you can still come out with a pretty darn good track record. So, that’s how I’ve modeled my own philosophy.
It’s like 99 out of 100, I’m looking for that better business because I know I need to maintain that humility. I’m going to be wrong. And hopefully, if I’m correct on the business and I’m wrong, I think maybe I’ve overpaid my compounding rate is a little bit lower, but hopefully not a total loss of capital, if I can help it. But that’s one big lesson I took out of Berkshire.
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Buffett’s Willingness To Be Wrong
Jake: Anything appreciable on something we’ve talked about before is the idea of statistical time versus behavioral time. So, you can look at things on a chart, and it’s like, “Oh, underperformed for five years.” Well, that seems like it’d be easy to live through. Like, look how it turned out on the other side. But to actually live it behaviorally in real time color is a much different experience, and being able to survive it and keep your head and keep your wits about you. Anything from going through Berkshire’s history that brought that out?
Adam: I guess one thing that came to mind, not so much– Well, I guess it’s this willingness to be wrong or do your own thing. One thing that comes to mind, I think this was in the 1980s. I’m not 100% sure on this. Berkshire bought– It was Washington Public Power Supply. It was bonds. There was I think five different projects, and there was just the nuances of them that Buffett identified two or three of these things. I forget the amount that they put in, but it was a meaningful amount of Berkshires capital, call it 10% of equity capital.
Buffett even said, “We’re doing this, because we think the odds are favorable. We could be wrong, we can embarrass ourselves, but this is where the facts have led us.” And so, I pulled that example out, because they were willing to do what they would do if no one else was watching. I think that’s a very hard thing to do too. So, you’re not only having these times of underperformance, but having everyone watch you and comment on it.
Buffett’s as close to investing sainthood as there is. He’s still reading the newspapers. He’s still wondering what people are saying about him. Maybe he has to. So, I think that just makes it that much more impressive.
Jake: Yeah. And how many times did he have to read how he’s lost it? The games passed him by [Jake [laughs] probably 10 different periods of time now at this point where he’s lost it.
Tobias: He probably gets excited when that happens, because it means that it’s almost over.
Jake: The end is near.
Adam: [laughs]
Tobias: Finally, they’re saying it. Ring the bell.
Adam: Yeah. [laughs]
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Tobias: Let me give a little shoutout to all of the folks at home. Mac in Valparaiso What’s up? Toronto. Brandon, Mississippi. Petah Tikva, Israel in the house. Mendocino, California. Bendigo, Victoria. Good early effort. Haacht, Belgium. Moscow, Russia. Bellevue. Porto de Mós, Portugal. You’ve won. Rochester, New York. Santo Domingo. Farmsen, Hamburg. Cincinnati. Toronto. Tampa. Nashville, Tennessee. Jupiter, Florida. You’ve won too. Bangalore, India. Oxford, UK. Congrats to everybody. Dublin, Ireland. Tikitaka, Peru. I think that’s it. It’s amazing. Great spread. London. What’s up?
Jake: [chuckles]
Tobias: That’s cool. Where are you dialing in from, Adam?
Adam: I’m in Southern New Hampshire. I’m about an hour north of Boston. Most people think of New Hampshire as cow, and pastures and all of that. That’s maybe another hour north where– I’m in what some of us have dubbed Massachusetts north, just across the border. It’s the Boston suburbs, basically.
Tobias: Nice. I got two more. São Paulo, Brasil. Bogota, Colombia. And now, I’m done.
Jake: Oh, God, glad you got those in.
Tobias: Where are you, JT? You got a nice backdrop there. Have we discussed that yet?
Jake: Yeah, I’m from undisclosed Lake [Adam laughs] North in Northern California. [Tobias chuckles] Living the good life, the lake life, for a few days with the family.
Tobias: Adam, how do you take the ideas from that huge project that you’ve done and reflect them in your own portfolio or in the portfolios you’ve managed professionally?
Adam: Oh, gosh, that’s a good question.
Jake: Buy Berkshire and get the hell out of here.
Tobias: I know I’ve asked the good questions.
[laughter]Tobias: Six years of this podcast, I got there. [Jake laughs]
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Being Anointed As The Next Buffett Is Like The Madden Curse
Adam: I do own Berkshire, full disclosure, but probably no surprise. It’s like going to the annual meetings every year. You guys go out there, and it’s like just this continual. The principles never change. Berkshire today, Berkshire’s history is really like security analysis. The book, it talks about railroads, and coal companies and all these old companies, like, “Okay.” But the lessons are largely intact. I feel like Berkshire is that today.
It’s quite astounding, especially in today’s day and age. Think about how big Berkshire Hathaway is. We’ve had, what, one scandal, if that was it, David Sokol. To have this history– Any others you can think of, Jake?
Jake: Give me a minute.
Adam: There’s been [unintelligible 00:18:14] and Salomon.
Jake: Salomon is a bit a good of a– Yeah, pretty minimal though.
Adam: To run this large of an organization and to have that culture, it’s just a shining example of the best in business. It’s my North Star, but that doesn’t mean I’m emulating Buffett at every turn. Like I said, I’ve got my own quirks, and my own biases and certainly shortcomings compared to Buffett or any of those guys running money inside of Berkshire. But to the extent that more people are operating in the Berkshire mold and following those lessons, it makes it tougher for all of us, but I think it’s good for society as a whole.
Tobias: Yeah.
Jake: Adam, who’s the next exemplar when we are post-Buffett?
Adam: In terms of what, the investment industry, who do we rally around?
Jake: Yeah. Who can we look up to for our moral North Star after this?
Adam: Well, there’s others out there. That’s a good question. All the guys that we already probably admire. Seth Klarman or Howard Marks, Mario Gabelli, and all these guys who’ve been around for a while have been shaped in the Buffett Berkshire mold. I’d like to think Greg Abel shows his investing skills, but I don’t think he’s going to be what we think of as “Investor and alpine” and on all of these things. I don’t know, it’s a really good question. But just ask, what is it Forbes or Fortune, whoever they put on the cover next, it is not that person.
[laughter]Tobias: Oh, the Baby Buffett?
Adam: Yeah.
Tobias: Yeah. What a kiss of death that is.
Adam: Oh, my gosh.
Jake: Yeah. There’s the Madden curse for football players and then [Adam laughs] the Forbes next Buffett anointment, you never want that one.
Adam: It’s really interesting though. We’re into this second, third phase, whatever you want to call it. There’s definitely, and I can think of one, I’m not going to say the name or entity publicly, but there’s imitators out there, and I think that’s the downside of it, whatever the opposite of a silver lining is. These people that are imitating Buffett and they say the right words and they get all this stuff, but they’re just not in various ways, and it might take time to come out. So, that’s the unfortunate.
But I think the upside is far outweighs any downsides related to that. He’s given us such a gift as a teacher for all this time, and another almost a month. A little more than a month, he’ll be 94, which I’ve known a lot of 90-year-olds, and even 80-year-olds, they just– That’s a little– [crosstalk]
Jake: Couple of them address president, even. [laughs]
Adam: You’re right. Keep your mind sharp, that’s the thing. Another big personal lesson I take out of it is like, “Love what you do. Just keep challenging yourself.” Look at Munger. Week before he died, sharp as a tack. That’s incredible. Incredible.
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Watchlist Investing And The Neighbor’s House Analogy
Tobias: [crosstalk] When you’re constructing your portfolios, Adam, do you take that idea of taking the big bets? Do you like that idea of narrowing down to whatever the best idea is at the time and taking a big swing at it, 44% or whatever the case may be?
Adam: I do. Let me see. I’ll pull up my portfolio for you, guys.
Jake: Only someone wrote a book on concentrated investing.
[laughter]Adam: That would be a great addition to know. Rough numbers, 38% from position number one. 30%, almost 31% for the second position that I’m at nine, six, four, eight positions in total.
Jake: That’s pretty concentrated.
Adam: When I did my last letter to my investors, at the time it was 13. But over the last six years, I’ve only owned 14 stocks in total. So, it’s a pretty small universe. I just bought one company that I had this minimum threshold. I’m not willing to put at least 3% or something. I don’t know, there’s this idea of, “Okay, buy 1 share, buy 10 shares, you mentally become an owner.”
Tobias: Yeah.
Jake: yeah.
Adam: I’ve dabbled with that over time. I almost have this minimum threshold. It’s like, “Okay, if I’m not willing to put this much in it, just walk away,” a quasi-punch card type of approach.
Tobias: And you scratch that-
Jake: I’ve heard before–
Tobias: -itch by keeping a watchlist.
Adam: What’s that Toby?
Tobias: You scratch that itch by keeping a watchlist.
Adam: Yeah. I think it’s much more of enjoying the spectating, if you will. The fun is in owning businesses, that’s what we ultimately want to get to, is owning a really good business. Yeah, just following these companies and seeing what they’re doing, capital allocation have the forcing function for me to put something out every month. It might not be a brand-new company or a deep dive. It might be a couple of little updates on companies. But really getting to this habit of following industries, and you guys experience this is just pattern recognition. Just all these little qualitative cues that come out over time, “Okay, I’ve seen this guy over here, or this business looks like this.”
I like this approach of having a watchlist. Some people are good at looking at, “All right, let’s pull the 52-week low list and go down, boom, boom, boom.” I’d rather study my neighbor’s house. I’ve used this analogy in the past, study my neighbor’s house, find out which ones made of brick versus flammable material or whatever. And then if the house catches on fire, then I can make an offer to the guy. But to rush into a burning building that you’ve never looked at before and say, “Okay, I’m going to assess this and I have to do it quickly, right?” that’s not me. That’s not my game. So, others can do it.
Tobias: That’s a good analogy. I’m going to steal that analogy.
Adam: Yeah, go, right ahead. [Jake chuckles] No trademarks.
Tobias: JT, you had a good question there?
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Regular Portfolio Cleaning Enhances Investment Focus
Jake: I was just going to say, I know an investor who, if a position– He has a position, minimum, so if something falls below certain threshold, either you have to allocate more to get it back up to the target threshold or you need to sell it completely, but you don’t just let it sit there at 1% or 0.5% or something.
I think it’s more about just your bandwidth and being able to focus on what you own, which I know that I would periodically would go through and clean the portfolio out of some of those smaller positions that you inevitably just lose conviction in, and have a good feeling on the other side of that when you actually do get that fresh slate, and then I always would remark like, “Gosh, how come I didn’t do this sooner, every single time? Why did I let this go on for as long as I did?” [chuckles]
Adam: Yeah. I like keeping a clean portfolio. But I’ve had these positions too. I own Cimpress for almost 10 years. I was talking to another investor and he asked me a question about the business, and it made me realize that I didn’t understand the business as well as I should and I sold it. It’s gone up a couple times since I’ve sold it, of course, but just that feeling of like, “I don’t really have any business being in this stock right now.” [Jake chuckles]
When you have, I try to keep it under 10 positions. I don’t have any stated whatever metric or goal, but it’s just evolved that way. It’s like just keeping track of them or position sizing. If you really want to make a big bet, you got to be different.
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Tobias: Hey, Adam, a question from the crowd. In your watchlist examination, “Have you looked at Fairfax and could frame what to be next Buffett?” Those are two questions there. Have you looked at Fairfax, and what do you think?
Adam: So, short answer is, is not really. I’ve had this conversation with a couple people before. Every time I’ve ventured off into these other mini-Berkshire’s, whether it’s Fairfax or Markel– I respect both of those companies immensely. But every time I venture there, I say, “You know what? I just know Berkshire better and I feel more comfortable with it.” I just turn around and go back to Berkshire. So, I guess I have nothing to add there to borrow a Mungerism. I really can’t opine on Fairfax. You guys have a opinion?
Jake: The counterargument and my experience of owning all three of those companies at different points has been that, actually the volatility of results of something like Fairfax relative to Berkshire and the valuation changes that that volatility creates actually allows you to buy cheaper and maybe sell more deer round trip and get actually, paradoxically a better outcome than the steady 8% to 10% ROE that Berkshire is going to produce with a very minimal band of price movement around that intrinsic value growth.
So, if you’re keeping track of all of them, and periodically they’ll sell off and you can buy them cheap, and maybe sell them when they get closer to fair value and rinse and repeat, you could actually end up doing better than owning– The ostensibly on every measurement, better version, the gold standard, which is Berkshire.
Adam: I wouldn’t disagree with you. I think that’s a perfectly rational way of going about it. I think it’s one my personality, and then whatever it is, I just haven’t really taken the time to do the work necessary to get as in depth. I’m under no illusions that Berkshire is going to do as well as it has in the past.
I think you’re right, Jake, that variance around intrinsic value is much tighter, but it’s the foundational piece of my portfolio. It’s always that opportunity cost. It’s like, “All right, I know this really well. I can accept a little bit lower return. But I’m always trying to do better.” Berkshire is one of the biggest positions, The biggest position. I’d love to work it down to a smaller percentage over time. That’s ultimately the goal. Who the heck am I to run a low millions of dollars in AUM thinking that this is the best investment? I know it’s not, but it’s just a matter of finding what can replace it.
Tobias: Prem got a lot of bouquets when he had a lot of the insurance on everything blowing up in the great financial crisis. And then there were plenty of brick bats on the other side for continuing to hold some of that stuff or being a little bit more bearish. I don’t know what his positioning is these days. Do you have any idea, JT, where they are these days?
Jake: All the hedges are off, so they’re no longer doing that.
Tobias: Philosophically, or because they can’t find them?
Jake: I think philosophically drifted from driving around with the parking brake on for a decade, [Adam laughs] basically. I actually didn’t mind it as owning Fairfax in 2016, 2017, 2018 when I felt markets were fully valued and that I was looking for ways to address whether be short anything. I liked it like that. It didn’t turn out very well, but as a bet, I didn’t think it was bad.
Tobias: We lost you in the matrix a little bit there, JT.
Jake: That’s okay. I wasn’t saying anything that smart anyway.
Tobias: [laughs] Do you have veggies for us this week?
Jake: I do, and it’s going to be a fun one.
Tobias: I’m a little bit worried that you’re going to go into the matrix– [crosstalk]
Jake: We are doing chicken sexing.
Tobias: Oh, this is exactly the sort of thing that people come for.
Jake: Yeah, for a bad production value. So, this is not going to be like the chicken lover episode of South Park. Sorry to disappoint you, TC. Chicken sexing is something different. I read this book about memory called Moonwalking with Einstein. That’s rather fascinating. I think, actually, I can highly recommend it. It’s about these memory champions.
Tobias: I think you’re–
Adam: He’s frozen on me.
Jake: -could spend less than two minutes with a deck of cards and then recite– Ah, am I freezing up?
Tobias: Yeah.
Jake: Let me try to turn my video off to see if that helps a little bit. Is that better?
Tobias: So far. Chicken sexing.
Jake: Chicken sexing. I read this book about a memory called Moonwalking with Einstein. That’s rather fascinating, and I can highly recommend it, and deck of cards, and then recite every card back in order. How do they do that? It’s a great question. It involves this concept of memory palaces. Basically, you walk around in a known environment or house in your head, and you leave yourself clues about how to remember. Apparently, this is ancient concept that modern man has mostly forgotten about. Humans evolved to have really good spatial memories. We–
Tobias: I think we’ve lost you, JT, unfortunately.
Jake: We remember where the watering hole is or where medicinal plants were growing, and we have a really fine-tuned spatial memory and how–
Tobias: We might have to save the chicken sexing for next week. It’s a shame. It’s probably– I was really looking forward to that one, even if it wasn’t what I thought it was going to be evidently, it’s about finding out the sex of chickens.
Jake: [laughs]
Tobias: I’ve got a question for you, Adam. Have you looked at Constellation Software? Do you have any thoughts on Constellation?
Adam: That’s another one. Just, again, for whatever reason, I haven’t– I felt like I missed the boat, and I said, “You know what? I don’t know if I’m going to spend the time to really go deep on this one.” A good friend of mine, Carter Johnson, has studied Constellation. He’s in love with the company. He just knows everything about it. He’d be great for you guys to talk to. No, I haven’t really gone deep on Constellation. Certainly, I understand their operating model and how they’ve developed.
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Berkshire Hathaway’s Transition to Greg Abel
Tobias: What about a Berkshire question? Do you have any thoughts on what happens when there’s a change and Greg steps in?
Adam: I think it should be a non-event. Really, it’s going to get the headlines. But in terms of actual impact, yeah. Greg has been taking over more and more recently. I think we were even talking about this maybe a little at Markel. It’s like this year, Buffett was just like, “Greg’s handling it. Greg’s handling it. Railroad, that’s Greg’s business.” Just really shedding these things.
I think Charlie said a few years ago, “If we were to get to this point, whatever that was, and not figure out this endgame, we haven’t been doing our job, basically.” So, I think it’s already happening right in front of our eyes. It’s just Greg taking over the day to day. I really like how Buffett has signed his final will and testament, if you will.
He basically just did publicly state, but almost forcing the board’s hand to say, “Give Greg the investment portfolio in terms of ultimate responsibility. Give him all this responsibility.” From all the managers that I’ve talked to, every year, I try to go around and talk to some of the managers on the floor, they really respect him. I don’t know how he operates with every entity, but some of them say, he’ll go month, three months without talking to them. But if they need something, he’s right there. He’s on top of their business. He understands the economics of their business, the financials, ask them tough questions.
So, I think it’s like the Socratic method almost, where Greg’s walking around, well, “You know, what about this?” I think he certainly earned the chops. He’s got the chops. He’s earned it. I think there’s this perception that he just comes from the energy business and that’s just, “Okay, that’s easier in some way.” Gosh, for Buffett to basically almost write a blank check to this guy and say, “He’s taken over my baby,” that’s a hell of an endorsement. So, I think for those of us paying attention really up close, it’s like this is already happening.
I think Buffett’s mother lived to maybe 93. I could be wrong on that, but Buffett’s almost 94. He joked a decade ago or whatever that Charlie was the canary in the coal mine, because he was seven years older. We have no guarantee that Buffett’s going to live another seven years. We could wake up, and find that he’s gone or decides to step down. I don’t know, I think it’ll be a shock either way, but I don’t see it meaningfully impacting Berkshire.
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Unlocking Investment Intuition: Lessons from Chicken Sexing
Tobias: JT has got closer to the router, so he’s going to have another go. JT.
Adam: I’m dying to know. [Tobias laughs] We want to know Einstein memory palaces and chicken sexing.
Tobias: Chicken sexing. Yeah. I don’t know, land the plane. JT. You there?
Jake: Yeah. Let me give it another shot here. So, it’s a little better. Okay. So, these memory palaces is this concept that taps into our apparent superpower of having better spatial memories throughout the [ audio cut] So, what’s interesting is that these memory champs, they’re not really this neuro atypical like rain man that you would think of. They’re pretty regular people… training. Am I back in?
Tobias: Yeah. No, you’re cutting in and out a little bit, but it’s okay. Keep going.
Jake: Okay. Sorry. So, the book also explores expertise more generally, and how do humans get really good at things. And so, of course, that then naturally leads to the sweetest researcher, Anders Ericsson, and he’s one of the godfathers of human performance and expertise. He’s a psychologist that worked on deliberate practice, and in achieving high levels of skill requires focus, intentional practice over really long periods of time, which has been summarized as the 10,000 hours rule, which was then made popular by Malcolm Gladwell in a book called Outliers.
So, anyway, back to chicken sexing. One of the stories in the book is about these Japanese chicken sexers. And yes, that’s a real thing. Baby female chickens are valuable, and the males are not at all. The males don’t produce eggs, and they make for really stringy meat. And so, farms don’t want to waste feed on male baby chickens. But it’s hard to tell the difference between a male and a female when they’re first born.
So, here’s where things get a little bit funny. People could be trained to look at a chicken’s ass and somehow tell if it’s male or female based on the patterns of bumps or not, even if it’s just a few hours old, that this is apparent. Japan became the hotbed training place for chicken sexing. They’re very proficient, but it requires extensive training. It could take up to three years of rigorous practice and mentorship to master the skill.
So, due to this exceptional skill, the Japanese chicken sexers are in high demand globally, and they’re really well paid. They travel internationally and provide their services. It’s a totally respectable profession with a long tradition. It really shows the Japanese culture more generally of precision and discipline and craftsmanship.
So, here’s the crazy part. People do this chicken sexing, they can’t explain to you how they know the sex. It’s this intuition about which chick is male or female, and it’s this subconscious feeling about it. But when it comes from thousands and thousands of reps to get this subconscious pattern matching– They’re able to get over 90% accuracy, so it’s not luck. But just by flipping a baby chick over, pinching part of it and then looking at its cloaca, basically. [chuckles]
So, what does that mean for us in the investment world? Like, how can we ever trust our intuitions? I suppose, first, you’d have to ask yourself, “Have you paid that tuition of 10,000 hours of dedicated practice? Have you looked at 100,000 chicken asses in the market to separate male from female? [Adam laughs] Have you really gotten enough reps with the immediate feedback to hone your intuition?”
The lag time between investment decisions and consequence can be so long, often measured in years, so it’s really hard to tell male versus female in the investment world. Is the pattern that you’re matching stationary enough in the environment? Like, chicken butts don’t have a habit of rapidly evolving in appearance, but it’s going to be tough to develop intuition in markets where things are evolving, and integrating new information and opinions all the time rather quickly. So, markets evolve, I think, much faster than chicken asses.
But I do believe that there’s room for intuition in the investment world. If Warren Buffett said that he liked an investment, because it matched some pre-existing patterns that he’s seen before, I’d have a really hard time arguing against that. But in general, I think we should be very careful in understanding where and when we can trust our intuitions. Perhaps, these chicken sexing experts can shed a little bit of light of what it actually takes before you could trust your intuition.
Tobias: One of your best, JT. Unbelievable.
Jake: Thanks. I’m sorry it was broken up a little bit.
Tobias: Well worth enduring the little bit of lag there to get there. That was fantastic. Phenomenal. Directly applicable.
Jake:[chuckles] One of the rarer sticking the landings. [laughs]
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Shrink or Expand Your Circle of Competence?
Tobias: Suck it so well. Beautiful. I’ve got some good questions here from the crowd for Adam. So, let’s work through some of these. Tyler Faris, who’s our informal producer, he’s got a good one here. You alluded to this earlier, Adam, but “Have you found more value in clarifying your circle of competence or in working to expand it?” I know you said earlier that it’s shrunk as you’ve gone along, which is probably true, but a little bit counterintuitive.
Adam: Yeah, that’s a good question. Have I found more value? I think if you operate in the investment business at all and you’re looking for companies, even if you’re staying within your circle of competence and you just put some hard edges around it, inevitably you’re going to find a drift. Not a drift in sort of a bad sense. It’s just, “Okay, here’s this company over here– I don’t know, one of their suppliers is this company, or there’s another business that’s a competitor that has an adjacent business.” You probe the edges, I guess, a little bit.
I’ll use an example. So, I found two different industries almost merge into one, in a sense.
So, I mentioned earlier that I spent some time in banking, so banking is a natural place for me to hang out. So, I look at banks. I also looked at Old Dominion Freight Line, there’s SIA, FedEx is in this business. So, I’ve looked at LTL trucking, a little bit in the truckload business. There’s a company called Triumph Financial, TFIN. This is a bank that has developed a payment system for the trucking industry.
So, what they’re doing is taking this antiquated process where a $2,000 invoice, they’re making it so that it’s not this huge, labor-intensive, time suck, literally email, call, try to get this thing paid. They’re going to make it as fast as basically swiping credit card. Well, that’s a marriage of trucking. In this case, it was truckload, not LTL. But I had an understanding of the dynamics of the trucking market. I knew banking. So, here’s where they came together. That’s probably a more unique example. But I think just in general, you’re just out there, you’re looking around, companies come on your radar, you find a couple of chicken butts. [Jake laughs]
As you were talking, Jake, I’ve got this watchlist, and I’m looking for all these really good companies. I find it very instructive to look at bad businesses too, and you’re inevitably going to come across very poor businesses. When I was a commercial lender for a number of years and some of the businesses, we would look at were just horrible. You could see the economics were just so terrible and so tough. So, I think there’s almost this risk that you spend your time looking at all these really great companies. You almost get spoiled or something. But I think it’s very instructive to look at bad businesses too. So, hopefully, that answers the main question there with maybe a couple extra tidbits thrown in.
Jake: I would say probably shrinking your circle of competence limits type one errors, like sins of commission, and then doing work to expand it then limits your type two errors, which are the sins of omission.
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How to Spot Bad Businesses
Tobias: Yeah, good one. “What are some of the indicia of businesses that aren’t great? What do you see in the really tough businesses?” “Let’s invert,” as Munger says.
Adam: [chuckles] Sure. Well, again, you think of a business like an Old Dominion or even some of these other companies, these beer companies that have a ton of capital investment– Anheuser-Busch or AB InBev now is at the top of the market in terms of returns, margins, capital turnover. Heineken’s number two. You work your way down to a Sam Adams, Boston Beer company, which I own. Anything below that, it just gets super tough to generate any of the economics.
So, capital intensity can help you as long as you have some other things, customer demand, economies of scale. But it’s this catch 2022 where if you fall below it, you’re basically going to fall flat in your face. So, it’s those companies that have high capital intensity where you have to reinvest a lot of money.
I think that a lot of times, it’s management. I just find, and this gets back to this chicken sexing thing, it’s like those are all those little things that you just can’t put down on a spreadsheet. Just these comments that a manager might make or how they approach something, or just you pick up on it over time. It’s individual. I keep a log a journal of what I’m thinking on every investment decision, including holds or no decisions. But you just mentally create this pattern recognition. I think it just comes from the reps.
For watchlist investing, I just went through the Russell microcap rebalance. So, however, many companies were in there line by line and just said, “Okay, here are the ones coming in. Here are the ones coming out.” I find that exercise to be really helpful every year. Some years, I do it on the Russell 2000.
Value Line is another great example. Just go through and you just get this feel of like, “All right, clearly, this business has been tough for a long time. It’s not generating returns.” And then, again, you bring in the management aspect of it, it’s like, “All right, well, management says that they’re going to do this or they’re going to do that.” It’s like if you just go back and study the history of the business, “They’ve said this a hundred times. This time is probably not different.” It really comes down many times to just the quality of the industry. Some industries are just really darn tough.
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How to Analyze Banks For Investment
Tobias: As a commercial end, did you do much bank analyzing? Are you able to comment on do you have an approach to analyzing banks, or what are you looking for when you’re analyzing banks?
Adam: Again, management. The one biggest thing I probably learned operating inside of a bank for 10 years is management estimates. [chuckles] By the time something goes wrong in a bank, it’s far too late for an investor. It’s almost a paradox too where it’s interesting, because as a bank, you’re constantly under some audit or exam.
FDIC is coming in, state division of banks, your internal auditors, the external auditors that you hire every year. You’re just constantly under audit, and yet banks blow up and do all these stupid things. So, it really highlights the lesson of you have to rely on yourself to make these judgments and think through. But if there’s a bank with a great track record, they change management tomorrow, that track record goes completely out the door.
So, I say, I look at banks and I do look at banks. I currently own two banks, Triumph that I mentioned and this other bank called Hingham Institution for Savings, which I think is one of the best run banks in the country. Going through some difficult time now with the yield curve inverting or continuing to invert going on, gosh, two years now.
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Jake: Yeah. Toby, where are we at on that? Can we get an update on the yield curve inversion? What is this recession you promised?
[laughter]Tobias: I think what’s clear is that there’s no real recession until after the inversion normalizes, once you go back to normal. It’s probably seeing the recession coming that causes the central bank to normalize. It’s an artificial thing that the Fed is engineering the inversion in an effort to slow down the economy. I’ve seen there’s an unusually large amount of fiscal spending, there’s an unusually large amount of stimulus around at the moment, which might be interfering with that signal a little bit.
There’s a post on Twitter today. I only read the thread, I haven’t read the post, but they’re describing it as activist treasury issuance. That was saying that where the Fed had stepped into the bounds of the treasury’s realm by controlling interest rates and doing some of the things that they’ve been doing, treasury can do the same thing. The effect of what treasury has been doing is what 1% reduction in rates over the last few years At some point, they have to reverse that. When they do reverse that, it’ll be like a 2% drag. I think, on the economy or 2% drag on rates. I hesitate to raise it, because I’ve been so bearish for so long. I just don’t know. I just don’t know is the answer.
Adam: What is the treasury doing that’s manipulating the rates? Issuance?
Tobias: The way that they’re conducting the issuance, yeah. I don’t fully understand. As I said, I just read the thread and I hadn’t read the article yet.
Adam: Yeah, I’d love to read that. So, it’s one of these things that’s so important. Even–
Tobias: It’s Nouriel Roubini along with somebody else, just so you.
Adam: Oh, okay.
Tobias: It’s like a full context.
Adam:… a note. It’s interesting. This may be a personal bias or personal observation, but it just seems– I found this when I was in banking too. It’s like the next recession is like hanging on this cloud around you. And then when it actually happens, it’s like, “Okay, well, geez, that’s normal.” Generally, we’re back to business in six months or something, or nine months. It’s not as bad when you’re actually going through it. I feel like the anticipation of a recession is worse than the actual recession itself.
Jake: Yeah. What’s that Mark Twain quote about, “I’ve had many worries in life, some of which actually came true,” or [Tobias laughs] something like that.
Adam: Yeah. But again, for value investors, it’s great. Let other people panic. Let other people make the mistakes.
Tobias: Well, that’s my view too. It’s basically, it’s an opportunity. When everything’s going well and everybody’s bulled up, everybody’s too optimistic and the prices that they’re paying are too high, so there’s really not much to do for the most part. But you get that systemic crash, and all of a sudden, you get a lot of opportunities.
Jake: For like a week?
Tobias: Well, that was the last one. Yeah, it didn’t last for long, did it? [Adam laughs] The funny thing is that, I was tweeting out, “Hey, Berkshire’s at a big discount to book.” The last time it was that discount this wide, it was pretty good return. And then everybody’s like, “Oh, well, the book’s down a lot,” which is true, but also misses the point that you don’t get those opportunities very often.
Adam: Yeah. In Berkshire, you get this big swing because of the investment portfolio. But I tend to normalize that just to– Generally, it’s Apple. It has some heavyweight.
Jake: Yeah. How much haircut are you giving it right now with Apple being such a big part of it?
Adam: I have so little self-shameless plug here. For subscribers, I have a live valuation sheet for Berkshire that I update every quarter. I think I give it a haircut. I think I normalize it to 20 times earnings.
Jake: Okay. That’s going to be a pretty good chunk off Apple then, that probably cuts a third off or so.
Adam: Yeah. As of last quarter, it was a 21% haircut, $160 billion. Again, it’s my bias, but that’s what I’ve done. But that helps with some of those fluctuations.
Jake: Yeah, [crosstalk] balance some of the–
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How Greg, Ted, and Todd Will Shape Berkshire Hathaway’s Investment Future
Tobias: I got a few questions about Ted, and Todd, and Greg running the investment book. Do you have any views there, what happens?
Adam: I do like that Greg will have the ultimate authority for the portfolio. I think that’s logical, rational. I think that makes sense. Again, I think it’ll largely continue as is. They may have more explicit portfolio duties. I think they each manage, whatever it is, $15 billion or something today. I haven’t heard an updated figure on that in a while. Maybe they get some more cash to invest.
I think another underappreciated thing about Todd and Ted is that they are also fielding acquisition candidates. In addition to a little side note, I think it would better for Berkshire if Todd was not running Geico. I don’t know, I just feel like having a full-time job at Geico, and Todd says he can do it on the weekends or nights or whatever, I’d rather have him in the investors seat. But those guys, regardless, they’re seeing stocks come across their desk, they’re seeing deals come across their desk.
So, I think Greg and Todd and Ted, where I’d like to see, and I hope what would happen is them getting together on a regular basis and just talking about business markets. Forget about the stock market, but what’s going on in the stock market, should we allocate capital there, or what’s available in the business market? Those guys will be evaluating those opportunities too.
I think one of the big questions is, what kind of leash will Greg get in terms of acquisitions? Can he commit on a phone call to a $10 billion acquisition like Buffett, can today with no questions asked? Maybe over time. But I think with Todd and Ted, the background vetting all of that, I wouldn’t say a rubber stamp from the board, but it’s going to be much more likely that the board says, “Yeah, go ahead.” So, I suspect if Greg is as good as he seems to be, he is going to maximize the value of Todd and Ted and find out what those guys like to do, where they like to operate and put them to work.
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Tobias: Hey, Adam, we’re coming up on time. If folks want to follow along with what you’re doing or get in contact, what do they do?
Adam: Sure. I’ve been trying to stay off social media a little bit more these days, but I am on Twitter, @BRK_Student. And then watchlist investing, I have a Substack that I write. So, you can check me out there. I’ve got some free posts that I put out there.
Tobias: Good one. And Jake, if folks want to shrink the feedback gap in investing so they get that 10,000 chicken butts quicker, what’s the way to do that?
Jake: Yeah, I think the Journalytic can definitely help with that. Just to be able to see what you thought at a given time point and not be able to lie to yourself is a huge win already. So, I would recommend that type of service currently free. So, get in there and get started.
Tobias: Good stuff. Thanks, everybody. We’ll be back next week. Same bat times, same bat channel. See you then.
Adam: Thanks, guys.
Tobias: Oh, hold on.
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