QAV 102 — How He Does It
Pub­li­ca­tion date: 2019-03-05
Source audio dura­tion: 1:13:09.695

Full machine-gen­er­at­ed tran­script using local whisper.cpp / large-v3-tur­bo. Time­stamps refer to the user-sup­plied MP3. Speak­er labels have not been assigned. The key health-scor­ing pas­sages were checked with a sep­a­rate focused tran­scrip­tion from the orig­i­nal audio. Oth­er word­ing, punc­tu­a­tion and prop­er names may con­tain tran­scrip­tion errors.

[00:00:00.180] The pro­duc­ers of this pod­cast would like to advise that you should not take any­thing we say on this pod­cast as being spe­cif­ic finan­cial advice for you, your loved ones, your neigh­bor, or your cat.

[00:00:10.080] We don’t know your par­tic­u­lar finan­cial sit­u­a­tion.

[00:00:13.440] So before you make any invest­ment deci­sions, please use your head and obtain finan­cial advice from a suit­ably qual­i­fied advi­sor.

[00:00:19.760] And now…

[00:00:30.000] Wel­come back to the QAV pod­cast.

[00:00:34.460] My name is Cameron Reil­ly.

[00:00:35.780] Tony will be join­ing me in a minute.

[00:00:37.000] I just thought I’d drop in and give you a lit­tle bit of a reminder about what we’re going to do in this episode.

[00:00:42.100] A bit of a pro­duc­er note, if you like.

[00:00:44.360] So the first episode, which you’ve hope­ful­ly already lis­tened to.

[00:00:47.580] If you haven’t, go back and lis­ten to that one before you lis­ten to this one.

[00:00:51.060] I know I’m not the boss of you, but that’s just my rec­om­men­da­tion.

[00:00:54.560] Because that’s where Tony tells his sto­ry, how he got to be where he is and his back­ground.

[00:01:01.480] So you know he’s just a nor­mal bloke who stud­ied the art of invest­ing and became very, very good at it.

[00:01:11.140] This one we’re going to get into the weeds a lit­tle bit.

[00:01:13.840] We’re going to start talk­ing about his method, his sys­tem for fig­ur­ing out which stocks are like­ly to out­per­form the mar­ket, out­per­form the oth­er stocks.

[00:01:26.120] And I’m going to try and do it at a very high lev­el in this episode.

[00:01:30.320] We’re going to run down a list of things that he looks at that’s acces­si­ble to every­body.

[00:01:35.980] You don’t need a degree in account­ing.

[00:01:38.880] You don’t need a degree in maths.

[00:01:41.020] It’s very, very sim­ple.

[00:01:42.060] In fact, as I’ve been going through and record­ing these shows and edit­ing these shows, I’ve been build­ing my own spread­sheet accord­ing to Tony’s guid­ance that he says on the pod­cast just to make sure I can do it.

[00:01:55.700] And trust me, if I can do it, you can do it.

[00:01:58.880] And we’ll prob­a­bly share that spread­sheet as well up on the web­site at some stage.

[00:02:04.120] A cou­ple of oth­er notes with this pod­cast.

[00:02:06.840] Some of it, Tony was record­ing in his bed­room while his apart­ment he’s just moved into in Syd­ney is still being ren­o­vat­ed and he was try­ing to hide from the builders.

[00:02:17.940] You might hear a lit­tle bit of con­struc­tion noise in the back­ground, but there’s also a bit of shuf­fling.

[00:02:21.480] That’s him on his bed.

[00:02:23.920] Then in some oth­er parts of the record­ing, it’s actu­al­ly high­er qual­i­ty because I got him to record his end so I don’t have to record it over Skype.

[00:02:32.300] But you’ll hear it’s bet­ter some­times.

[00:02:34.040] That’s just, it’ll all be good soon when he’s fin­ished get­ting the ren­o­va­tion done to his house.

[00:02:42.020] All right, and I’m just going to inter­rupt from time to time, sor­ry about that, to clar­i­fy some of the stuff that he’s say­ing or maybe reword it in a dif­fer­ent way or reit­er­ate it.

[00:02:52.640] Tony’s a very, very dry guy, very smart, very, very artic­u­late, but very dry.

[00:02:59.460] This is only his sec­ond pod­cast he’s ever done, so cut him some slack.

[00:03:03.520] And he’s sober.

[00:03:04.840] I tried to get him to drink a cou­ple of bot­tles of wine before he record­ed.

[00:03:08.040] He did­n’t think that was a good idea, con­sid­er­ing we record like mid­day.

[00:03:11.640] Any­way, so I’ll try and butt in every now and again, just to make sure you’re still awake, just to make sure you’re fol­low­ing along with the method­ol­o­gy and the sys­tem.

[00:03:22.460] And hope­ful­ly by the end of this, you’re going to have an idea about how you can do what Tony does.

[00:03:28.940] And then I’ll tell you what we’re going to do next at the end of this episode, I guess.

[00:03:33.400] So I’m going to start by get­ting Tony to tell you what hap­pened to him last week­end.

[00:03:38.880] Tell me about your week­end.

[00:03:40.540] So I have a race­horse breed­ing busi­ness and rac­ing with a friend of mine, and we had a horse run­ning in a group one in Mel­bourne at Caulfield on the week­end, so I flew down for the week­end.

[00:03:55.140] And unfor­tu­nate­ly, our horse ran last, but it was still a good week­end.

[00:04:00.860] I caught up with lots of friends and had a big night Sat­ur­day night in a cock­tail bar on Fitzroy Street in St. Kil­da.

[00:04:07.480] And it was so big that I left my lap­top in the lounge on the way home on the plane on Sun­day morn­ing.

[00:04:14.420] So I’ve got to have that peri­od up.

[00:04:16.740] So if we have any tech­ni­cal dif­fi­cul­ties, that’s the rea­son.

[00:04:19.200] I’m on a very old lap­top, which is just real­ly being held togeth­er lit­er­al­ly with sticky tape at the moment.

[00:04:27.860] I tried to have the bat­tery replaced on this lap­top a cou­ple of weeks ago.

[00:04:31.920] I went to the Genius Bar, and they said, sor­ry, we don’t keep bat­ter­ies that old.

[00:04:36.620] So I’ve got to keep the plug in, which is why I’ve got sticky tape around it.

[00:04:41.700] Oth­er­wise, it just shuts off straight away.

[00:04:44.340] So, okay, a cou­ple of imme­di­ate ques­tions.

[00:04:47.060] Peo­ple are prob­a­bly think­ing, hold on, this dude’s sup­posed to be rich.

[00:04:49.940] Why don’t you just buy a new lap­top?

[00:04:51.500] Yeah, I need to.

[00:04:52.880] Actu­al­ly, we could talk about this lat­er offline, but I want to get up some kind of, you know, in the cloud type sys­tem.

[00:04:58.120] So I’m not rely­ing on any one lap­top so I can have two or three at dif­fer­ent places and not wor­ry about leav­ing one behind, but stay up to date.

[00:05:05.520] Yeah.

[00:05:05.940] So maybe you could give me some advice.

[00:05:07.560] Yeah, I’m your man there.

[00:05:08.640] A mil­lion dol­lars an hour is what I charge, but I’ll, you know, I can help you, def­i­nite­ly.

[00:05:13.320] Yeah, good.

[00:05:15.300] Sec­ond ques­tion is, how long have you been breed­ing hors­es, race­hors­es?

[00:05:20.600] Yeah, what’s it, about sev­en years now, I think.

[00:05:23.300] Obvi­ous­ly, you haven’t found a sys­tem as good as your QAV sys­tem for breed­ing race­hors­es.

[00:05:29.040] No, it’s been a dead loss so far.

[00:05:31.180] The breed­ing side’s not too bad.

[00:05:34.480] That’s more of a busi­ness, so you can con­trol the cost a lot bet­ter and, you know, you can scale it up, scale it down.

[00:05:41.080] It’s not as reliant on one big win pay­ing for the rest, which the horse rac­ing game is.

[00:05:46.780] So the horse rac­ing game’s for fun.

[00:05:48.920] And this par­tic­u­lar horse, Furyk, is one that’s about a mil­lion bucks in prize mon­ey, so it kind of pays for the rest.

[00:05:54.460] Oh, okay.

[00:05:55.920] It’s basi­cal­ly tax lot.

[00:05:57.200] You’ve got to get one good one to pay for all the oth­er ones in horse rac­ing, yeah.

[00:06:01.300] It’s like invest­ing in start-ups, right?

[00:06:03.500] Yeah, exact­ly, yeah.

[00:06:04.420] Or doc­u­men­taries.

[00:06:06.440] Yeah.

[00:06:07.180] Or books.

[00:06:07.720] Or books.

[00:06:10.340] That’s a lit­tle bit of an in-joke.

[00:06:11.820] We won’t talk about that right now.

[00:06:13.140] That’s for a future episode.

[00:06:14.480] So, mate, what I was hop­ing to do with this episode is get into a lit­tle bit of the nuts and bolts of the QAV sys­tem.

[00:06:25.740] Remind peo­ple what QAV stands for?

[00:06:27.980] Qual­i­ty at val­ue.

[00:06:29.980] Right.

[00:06:30.820] That’s per­son­al­ly how I choose my wives.

[00:06:34.420] Now, I…

[00:06:35.420] On the val­ue side.

[00:06:38.460] Yeah.

[00:06:39.400] Yeah, absolute­ly.

[00:06:41.200] Qual­i­ty at val­ue.

[00:06:43.140] Yeah.

[00:06:45.540] Now, I’m going to get in trou­ble for that.

[00:06:48.600] I’ll edit that out lat­er.

[00:06:49.600] Just remind me.

[00:06:51.420] I just want­ed to start real­ly, real­ly basic, if we can.

[00:06:56.780] So, let me go back and ask a dumb ques­tion I should have asked at the very begin­ning.

[00:07:00.880] Now, this 19.5% that you talk about, is that the increase in the val­ue of the shares in your port­fo­lio,

[00:07:08.600] or is this to do with div­i­dends that your port­fo­lio is return­ing each year?

[00:07:14.340] No, it’s…

[00:07:15.060] If you think about my invest­ments as a com­pa­ny, it’s the increase in the mar­ket val­ue of the shares at the end of the year com­pared to the start of the year,

[00:07:24.960] plus any cash hold­ings I might have, plus any div­i­dends that come in, less my costs, less any tax I have to pay, and from time to time any inter­est on bor­row­ings I have to pay.

[00:07:37.240] Okay, so it’s the increase in the share price and the div­i­dends, essen­tial­ly.

[00:07:41.820] Yes, that’s right.

[00:07:42.440] Yep.

[00:07:42.700] It added togeth­er.

[00:07:43.680] Okay.

[00:07:44.140] Yeah.

[00:07:45.560] All right, so now I’m going to get Tony to start going through this check­list.

[00:07:49.100] And as I said, I’m going to try and keep it high lev­el.

[00:07:52.400] Just regard­ing the check­list, if it sounds pret­ty daunt­ing to you, remem­ber this.

[00:07:58.620] I guess the oth­er thing to say is that it’s a long check­list, but, you know, prob­a­bly 80% to 90% of com­pa­nies don’t get past the first hur­dle.

[00:08:07.940] So it does­n’t involve a whole heap of work.

[00:08:11.180] It’s only when you find a com­pa­ny that pass­es the ini­tial sort of tests that you do the full check­list on them.

[00:08:19.800] But gen­er­al­ly, the the­o­ry is we’re try­ing to take out the bad stocks and the rest should beat the mar­ket.

[00:08:24.420] I mean, that’s the gen­er­al the­o­ry.

[00:08:25.420] If you think about the index of stocks in the ASX or in any sort of stock mar­ket uni­verse, they’re made up of good and bad stocks.

[00:08:33.380] What we’re try­ing to do here is pull out the bad ones, and we expect the good ones to per­form bet­ter than the aver­age, includ­ing the bad ones.

[00:08:40.180] So I hope that makes sense any­way.

[00:08:42.340] Yeah, so it makes sense to me.

[00:08:43.920] What Tony’s say­ing is the sys­tem that he’s got is to rel­a­tive­ly quick­ly weed out the com­pa­nies that he does­n’t expect to per­form very well, out of all of the com­pa­nies on the stock exchange.

[00:08:56.720] The ones that are left over are the ones that are prob­a­bly going to make it.

[00:09:00.340] It’s a bit like, I guess, test­ing a sci­en­tif­ic hypoth­e­sis through exper­i­men­ta­tion.

[00:09:05.920] You run the exper­i­ments.

[00:09:07.400] A whole bunch of the hypothe­ses will fail, and the one that does­n’t fail is prob­a­bly the one that’s right.

[00:09:17.060] And that’s what we’re going to do with Tony’s method­ol­o­gy.

[00:09:19.880] So the next ques­tion I ask Tony is, if he was start­ing right from the begin­ning again, let’s say he did­n’t have a port­fo­lio, but he knew every­thing that he’s learned over the last 30 years, and he had to start from scratch, what would he do?

[00:09:32.840] Because I fig­ure that’s most of it.

[00:09:34.460] Some of you might already have a port­fo­lio, and you’re want­i­ng to opti­mize it.

[00:09:37.680] Some of you, I’ve kind of been mak­ing this show with the view that my audi­ence and my 18-year-old sons, Hunter and Tay­lor, this is real­ly for them to get their finan­cial future sort­ed out, try­ing to get them to learn every­thing Tony learns so they can do what he’s done.

[00:09:54.380] So if he was them, what would he do first?

[00:09:59.020] Where would I start?

[00:10:00.400] Well, if I was start­ing from scratch, I’d be very quick­ly look­ing at what’s called the oper­at­ing cash line of the results.

[00:10:09.780] So every com­pa­ny that reports on the ASX in Aus­tralia has to report using a cer­tain for­mat, and it’s the same in all coun­tries.

[00:10:19.440] The US has a dif­fer­ent one, dif­fer­ent for­mat, but the same rules.

[00:10:24.380] And one of the things that they report on is what’s called a cash flow state­ment.

[00:10:29.300] And just as in life, in shares and com­pa­nies, cash is king.

[00:10:35.380] And the rea­son I say that is because it has been known to hap­pen, just like it does in the horse rac­ing game, that peo­ple can manip­u­late the fig­ures to make them­selves look good.

[00:10:48.560] So it’s very hard or it’s hard­er to manip­u­late the cash flow state­ment than it is com­pared to, say, manip­u­late your prof­it and loss state­ment, because there’s less account­ing trick­ery you can use.

[00:11:02.240] It’s pret­ty basic.

[00:11:03.480] The top line of the cash flow state­ment says, I had this much come in and receipts in the last six months, and I had to pay sup­plies this much.

[00:11:11.940] And that’s about it.

[00:11:13.000] You can put oth­er costs in there.

[00:11:14.680] Some­times some busi­ness­es will put their staffing costs, at least at the point of sale, if they’re a retail­er, for exam­ple.

[00:11:21.480] But it’s pret­ty basic.

[00:11:22.680] It’s only after that that you start get­ting into lots of finan­cial, not chi­canery or trick­ery, but arcane sort of rules about what goes where.

[00:11:35.000] And they can always be a lit­tle bit manip­u­lat­ed.

[00:11:37.460] I’m not say­ing it’s always for a bad rea­son.

[00:11:39.300] Some­times it’s just a, you know, it’s the call of the trea­sur­er or the CFO as to where it goes.

[00:11:45.960] But cer­tain­ly cash is king.

[00:11:47.720] So the first thing I look at is the oper­at­ing cash line.

[00:11:55.820] All right.

[00:11:56.480] Well, if you’ve got a pen and paper handy, write that down.

[00:11:59.520] Oper­at­ing cash flow.

[00:12:00.580] If you don’t, if you’re at the gym or at the car or walk­ing the dog, don’t wor­ry about it.

[00:12:05.060] We’re going to cov­er these details over and over and over again over the next how­ev­er many episodes.

[00:12:12.060] We’re going to take indi­vid­ual com­pa­nies and break down their num­bers and their finan­cials until we can all do it with our eyes closed.

[00:12:24.160] So the very first thing I’ll do is quite quick­ly, I’ll look up the cash.

[00:12:29.980] I’ll look up how much cash is being gen­er­at­ed per share, which is just divid­ing the oper­at­ing cash by the num­ber of shares on issue.

[00:12:37.160] Again, that’s in the report­ing pack that comes out for each com­pa­ny.

[00:12:40.780] And then I’ll do what’s what I call a price to cash flow.

[00:12:44.620] And I’m look­ing for a com­pa­ny with a price to cash flow of less than 10 times.

[00:12:51.620] So I guess I’m putting the val­ue side of things ahead of the qual­i­ty side of things at this stage.

[00:12:57.880] But it’s prob­a­bly the eas­i­est way to get into look­ing at a com­pa­ny.

[00:13:02.440] Okay, okay, wait, wait, wait, slow down a sec­ond there for me, champ.

[00:13:07.340] I’m already lost.

[00:13:08.900] So let me just go back a step and see if I’m fol­low­ing.

[00:13:12.620] Yeah.

[00:13:13.420] Oper­at­ing cash line, that’s telling us how much cash the busi­ness has gen­er­at­ed in the last…

[00:13:20.280] Com­ing in the front door, that’s right.

[00:13:21.260] …in the report­ing peri­od.

[00:13:22.500] So in the last six months.

[00:13:24.400] And then you look at…

[00:13:26.480] You take that total num­ber and you divide it by the num­ber of shares that have been issued.

[00:13:31.280] That’s right.

[00:13:31.760] And that gives you how much cash is being gen­er­at­ed per share.

[00:13:36.180] Why is that an impor­tant met­ric, the per share aspect?

[00:13:41.060] Because I want to com­pare it to the share price.

[00:13:44.140] So I want to get…

[00:13:45.500] So a lot of ana­lysts will focus on what’s called the P‑E ratio,

[00:13:50.840] so the price-to-earn­ings ratio.

[00:13:53.320] And one of the lines in the finan­cial report is the earn­ings per share.

[00:13:58.340] But that’s much low­er down in the account­ing prof­it and loss state­ment.

[00:14:02.840] That’s tak­ing into account all the oth­er costs in the busi­ness

[00:14:05.880] and any oth­er incomes from invest­ing or rais­ing mon­ey or rais­ing debt,

[00:14:11.340] all that kind of thing, and how much tax you’ve paid, all that kind of stuff.

[00:14:15.460] But I’m cre­at­ing my own met­ric,

[00:14:18.920] which is just the cash that comes in through the front door,

[00:14:21.740] less what­ev­er costs are asso­ci­at­ed with that cash.

[00:14:24.620] So the price-to-oper­at­ing cash ratio.

[00:14:27.980] So to get the…

[00:14:29.320] To be able to com­pare it to the share price,

[00:14:31.220] I’ve got to first cal­cu­late the oper­at­ing cash per share.

[00:14:34.860] And you said you’re look­ing for one that is less than 10 times the price-to-cash flow ratio.

[00:14:43.900] Yeah.

[00:14:44.320] Okay.

[00:14:44.820] So once you cal­cu­late that fig­ure,

[00:14:46.700] you take the oper­at­ing cash for the report­ing peri­od,

[00:14:49.180] you divide it by the num­ber of shares that are on issue,

[00:14:52.140] and then you’re look­ing for one that’s less than 10.

[00:14:57.080] Yes, that’s right.

[00:14:58.640] And hope­ful­ly less than six.

[00:15:00.300] I mean, six is the mag­ic num­ber,

[00:15:01.720] but I start with 10 because,

[00:15:03.600] oh, look, in invest­ing,

[00:15:06.280] you don’t want to be too black and white.

[00:15:07.860] So I’ll start with 10 and do some more dig­ging.

[00:15:11.840] But if it’s some­thing like a…

[00:15:13.340] If it’s six or less,

[00:15:14.260] that’s a real fine.

[00:15:16.260] That’s a good com­pa­ny to focus on

[00:15:19.920] because their shares are trad­ing at such a low price-to-cash ratio.

[00:15:23.500] So they have lots of val­ue in the share price.

[00:15:26.900] So that’s the first thing you focus on.

[00:15:29.840] And the rea­son why I focus on that…

[00:15:31.780] All right.

[00:15:32.160] Let me take a pro­duc­er moment here and just check in with you all.

[00:15:35.080] You doing okay?

[00:15:35.820] Is your brain melt­ing?

[00:15:36.960] I know mine was at this junc­ture,

[00:15:39.000] but I’ll tell you what I’ve done for you.

[00:15:40.800] So I’ve gone while I’m edit­ing this

[00:15:44.000] and start­ed to build a spread­sheet based on what Tony’s say­ing

[00:15:48.860] so I can bet­ter under­stand it.

[00:15:50.300] And I’ll throw that up in the show notes for this episode, episode two.

[00:15:53.260] You can go up to qavpodcast.com.au.

[00:15:56.240] Have a look at that.

[00:15:57.080] But basi­cal­ly what he said is this.

[00:15:58.480] You go to the annu­al report of the com­pa­ny that you are look­ing at.

[00:16:02.540] Look for the finan­cial sec­tion of the report.

[00:16:06.300] It’ll be down the back.

[00:16:07.360] There’s a lot of blath­er up the front

[00:16:09.440] about what a great bunch of guys and girls they are

[00:16:11.900] and how they’re going to change the world.

[00:16:13.480] And they’re sav­ing cats and dogs from trees on a dai­ly basis.

[00:16:17.940] And they love the envi­ron­ment.

[00:16:19.220] Can’t get enough of the envi­ron­ment.

[00:16:20.540] It’s great.

[00:16:21.300] They love it.

[00:16:22.800] By the way, I did use BHP as my test exam­ple.

[00:16:25.980] That’s why I’m say­ing that.

[00:16:27.400] Go down.

[00:16:27.800] You have a look at their net cash flow is what the line is.

[00:16:32.620] Net oper­at­ing cash flow for the peri­od.

[00:16:35.380] That’ll tell you how much cash that they’ve brought in dur­ing that peri­od,

[00:16:40.060] less the out­go­ing.

[00:16:42.380] So incom­ings ver­sus out­go­ings in cash flow, net oper­at­ing cash flow.

[00:16:46.140] Then you want to go down to the sec­tion that talks about share cap­i­tal

[00:16:51.460] under cap­i­tal struc­ture in this report.

[00:16:53.560] It’ll tell you what the clos­ing num­ber of shares was for the peri­od.

[00:16:58.160] So you can throw that up in your spread­sheet.

[00:16:59.980] So then you’ve got how much cash, the num­ber of shares, throw them into your spread­sheet

[00:17:05.580] and divide the total cash by the num­ber of shares.

[00:17:09.740] That will give you the cash per share.

[00:17:12.600] Then you just go to the ASX’s web­site, look up the last share price for the com­pa­ny.

[00:17:19.180] And then you can throw that into your spread­sheet.

[00:17:22.120] And then you divide the share price by the cash per share.

[00:17:28.340] And that will give you Tony’s num­ber that should be below 10, ide­al­ly below 6.

[00:17:36.120] And if you’re won­der­ing why it should be below those num­bers and how that’s rel­e­vant,

[00:17:40.840] we’re going to get to that lat­er on in the episode when we start run­ning down his check­list

[00:17:44.980] and adding up all of the scores that the busi­ness gets based on all of these indi­vid­ual met­rics.

[00:17:51.100] So don’t wor­ry about why it’s impor­tant so much.

[00:17:53.740] Now we’ll get to that in about 20 min­utes, half an hour.

[00:17:58.300] So that’s the first thing you focus on.

[00:18:01.460] And the rea­son why I focus on that, and it came about from a book I read,

[00:18:05.380] which I must have read it 10 years ago or so.

[00:18:11.680] I’m just try­ing to think of the name.

[00:18:13.060] It’s some­thing like Mar­ket Wiz­ards or Mar­ket Mas­ters of the Mar­ket, some­thing like that.

[00:18:20.960] But it was basi­cal­ly a book about half a dozen or so real­ly good investors

[00:18:27.200] who did­n’t have a large, did­n’t have a high pro­file in the pub­lic.

[00:18:30.520] And one of them was the guy who owned a com­pa­ny called Cap Cities, so Cap­i­tal Cities, which was a TV sta­tion

[00:18:36.220] that start­ed off as just one sta­tion in I think New York, upstate New York, and then even­tu­al­ly grew to be one of the big net­works.

[00:18:43.740] And War­ren Buf­fett even­tu­al­ly bought a large share­hold­ing in them, and he always nom­i­nates the CEO of Cap Cities as one of the best investors he ever saw.

[00:18:56.260] And one of the met­rics that he used, the CEO of Cap Cities, was to look at oper­at­ing cash flow and to pay less than six times.

[00:19:05.020] So it’s a rule of thumb.

[00:19:07.920] And like I said, you could pay more if there was a rea­son to pay more, but six is a good num­ber.

[00:19:13.800] So the first thing you look at is the val­ue side of things.

[00:19:18.280] And what you’ll find is that that nar­rows down the work­load to a small num­ber of shares.

[00:19:22.900] I mean, I think from mem­o­ry in Aus­tralia, there’s some­thing like two and a half thou­sand shares on the share mar­ket.

[00:19:27.980] They’re all report­ing in four weeks, so it’s a lot to go through.

[00:19:30.860] But if you can just focus on one thing, you can fil­ter out a lot quite quick­ly.

[00:19:36.300] So basi­cal­ly what Tony is say­ing here, the rea­son why this num­ber is impor­tant, this num­ber again is the price per share ver­sus the cash per share,

[00:19:47.060] is to get an idea of whether or not he thinks there is val­ue in the com­pa­ny as an invest­ment.

[00:19:55.220] It’s a basic met­ric that he applies, and it can very quick­ly fil­ter out a lot of com­pa­nies so he does­n’t need to spend any more time invest­ing in them.

[00:20:03.700] In order for a share to be worth his time and effort, that price per share divid­ed by the cash per share needs to be at least low­er than 10, ide­al­ly low­er than 6.

[00:20:16.760] That’s his basic indi­ca­tor of val­ue.

[00:20:19.520] If com­pa­nies don’t pass that met­ric, if they’re above 10, then he won’t even both­er look­ing at them, usu­al­ly any fur­ther, unless there’s some sort of extra­ne­ous cir­cum­stances.

[00:20:29.780] So that’s why this num­ber is impor­tant.

[00:20:31.940] So you cre­ate that num­ber, and you throw that into your spread­sheet.

[00:20:36.560] What’s next?

[00:20:38.140] What’s next?

[00:20:39.100] If it comes out good, I’ll then start to go through and look at the qual­i­ty side of things.

[00:20:42.680] So I have a shared val­u­a­tion spread­sheet, and what I’m work­ing towards with the val­u­a­tion side of things is a check­list where I can just give a lot of the met­rics that I fol­low or that I look for in a com­pa­ny.

[00:20:58.480] I’ll give them a score.

[00:21:00.360] Usu­al­ly it’s a score between minus 1 and 2.

[00:21:04.560] Most­ly it’s just bina­ry, 1 or 0, and then I’ll add them up and work out what their score is.

[00:21:11.780] And ide­al­ly, to get a score that becomes investable, you want that score to be up around 75%.

[00:21:19.200] That’s a bit more work, so I can take you through that sort of line by line, if that’s help­ful.

[00:21:25.060] Yeah.

[00:21:25.960] Yep, so I’m going to talk about a com­pa­ny.

[00:21:27.780] It report­ed a cou­ple of weeks ago.

[00:21:29.440] It’s a com­pa­ny I’ve had shares in for a long time, so it’s been a long-term hold­ing of mine.

[00:21:35.820] It’s been a qual­i­ty com­pa­ny for a very long time.

[00:21:38.600] It does fly under the radar.

[00:21:40.180] I would ven­ture to say if I did men­tion its name, most peo­ple prob­a­bly haven’t heard of it.

[00:21:45.000] So where I start to look at things is with the share price graph.

[00:21:49.340] And this is a very, very, again, a very sim­ple way of look­ing at shares.

[00:21:54.400] And it was some­one I lis­tened to on an ASX pod­cast a long time ago put it very suc­cinct­ly.

[00:22:01.320] If the share graph is going from the bot­tom left to the top right, it’s a buy.

[00:22:05.640] And if it’s going from the top left to the bot­tom right, it’s a sell.

[00:22:09.340] So the first thing we’re going to do is check what we call a sen­ti­ment on the share.

[00:22:15.960] And for this one that we’re talk­ing about, the sen­ti­men­t’s good.

[00:22:20.200] It’s mov­ing from the bot­tom left to the top right.

[00:22:23.020] Now, these things wig­gle around.

[00:22:25.360] It might go up and down.

[00:22:26.720] But over time, we’re look­ing for it to go up.

[00:22:29.400] And so the type of graph I’m look­ing at, and you can use Yahoo Finance or Google Finance or even the ASX to get this infor­ma­tion, is a five-year month­ly share price graph.

[00:22:41.820] So we’re look­ing for the trend.

[00:22:43.840] But again, keep­ing it sim­ple, this com­pa­ny we’re talk­ing about has a ris­ing share price.

[00:22:49.640] So that’s a tick.

[00:22:51.140] Sen­ti­ment in the mar­ket has been good about it.

[00:22:53.320] The next thing I’m look­ing at is price, and I’m look­ing to see some of the met­rics around price.

[00:22:59.000] So the first one is I’m look­ing for a rea­son­able yield.

[00:23:03.220] Now, some com­pa­nies don’t pay a div­i­dend, and that’s okay as long as they’re in growth mode and they’re rein­vest­ing the mon­ey into their own busi­ness and grow­ing.

[00:23:12.080] But most com­pa­nies will pay out some prof­its and pro­duce a yield.

[00:23:15.220] So a yield is the div­i­dend per share, tak­ing that num­ber and divid­ing it by the price.

[00:23:20.520] Okay, let’s take a pause there for a sec­ond.

[00:23:23.000] So what is a div­i­dend and how does it relate to yield?

[00:23:27.560] Well, think of a div­i­dend like this.

[00:23:28.960] So com­pa­nies make mon­ey, and what a lot of them do, pub­licly list­ed com­pa­nies, is they will give some of their prof­its out to their share­hold­ers.

[00:23:39.640] It’s prof­it share, basi­cal­ly.

[00:23:41.540] A cou­ple of times a year, usu­al­ly, they will pay their share­hold­ers a lit­tle bit of mon­ey for every share that they own.

[00:23:49.860] That’s called a div­i­dend.

[00:23:51.480] The word div­i­dend comes from the Latin div­i­den­dum.

[00:23:55.160] If you’ve lis­tened to any of my his­to­ry pod­casts, you know I love get­ting into the Latin roots of words, which means thing to be divid­ed.

[00:24:02.540] So a div­i­dend is a pay­ment that’s divid­ed by the num­ber of share­hold­ers, I guess.

[00:24:09.160] So just to recap on what Tony’s been talk­ing about, this yield busi­ness.

[00:24:14.340] So if you go into the finan­cials of the com­pa­ny’s annu­al report, you’ll be able to see what the div­i­dend per share is.

[00:24:21.900] They’ll prob­a­bly list that.

[00:24:23.780] And then you throw that into your spread­sheet, and then you just divide that div­i­dend per share by the price per share, which you’ve already got in your spread­sheet.

[00:24:33.160] That will give you the yield.

[00:24:35.660] And as Tony’s say­ing, what he thinks is impor­tant is the con­sis­ten­cy of the yield, that they’re reg­u­lar­ly pay­ing out rough­ly the same per­cent­age of their prof­its to their share­hold­ers each year.

[00:24:50.940] It’s not wild­ly fluc­tu­at­ing.

[00:24:52.720] Fluc­tu­at­ing is a sign of insta­bil­i­ty, of prob­lems, and that’s some­thing that we want to avoid when we’re try­ing to assess the com­pa­ny for qual­i­ty.

[00:25:03.060] Is it a qual­i­ty com­pa­ny?

[00:25:04.620] Is it being run well, et cetera?

[00:25:07.960] So the com­pa­ny I’m talk­ing about is pay­ing a yield of 3.4%.

[00:25:12.340] I’m look­ing for a con­sis­ten­cy of yield.

[00:25:15.280] So it does­n’t have to be high or low.

[00:25:17.560] It’ll be dif­fer­ent for dif­fer­ent com­pa­nies who are in dif­fer­ent stages of their eco­nom­ic growth.

[00:25:22.420] Often­times, a start­up won’t pay a div­i­dend.

[00:25:26.860] But a com­pa­ny that’s big and mature will pay a high­er yield.

[00:25:30.740] And it’s a bit of an incen­tive for investors.

[00:25:33.080] So if you’re a retiree, for exam­ple, you can get, like, say, a 5% yield from a blue chip com­pa­ny.

[00:25:39.420] It’s not a bad place to park your mon­ey and live off the div­i­dend yield.

[00:25:43.580] But what I’m look­ing for at this stage is a con­sis­ten­cy of yield.

[00:25:46.400] So over time, has the div­i­dends been paid?

[00:25:50.420] Because you don’t want to – if you find that they’ve been stopped or low­ered for a par­tic­u­lar rea­son, that’s a bit of a red flag.

[00:25:57.320] It means that they’ve had prob­lems with their prof­it and they’ve had to reduce or cut out the div­i­dend.

[00:26:04.400] And that’s usu­al­ly the last thing a com­pa­ny would want to do because, as I said, peo­ple have bought the shares for a con­sis­tent div­i­dend.

[00:26:11.660] And if it’s not there or if it changes, then the shares will be sold off.

[00:26:16.740] Not by every­one, but at least those peo­ple who are rely­ing on the div­i­dend for their income.

[00:26:21.020] So this com­pa­ny has a 3.4% yield.

[00:26:23.480] That’s not too bad.

[00:26:24.860] It’s trad­ing on a price-earn­ings ratio of 13.

[00:26:28.960] So the P‑E ratio is like that price-to-oper­at­ing cash ratio I spoke of before, but it’s at the bot­tom end of the prof­it and loss state­ment.

[00:26:38.120] So it’s the prof­it for the com­pa­ny con­vert­ed into earn­ings per share and then divid­ed by the price of the com­pa­ny.

[00:26:46.940] So this com­pa­ny is 13.

[00:26:48.580] The mar­ket aver­age in Aus­tralia is about 16.

[00:26:52.740] So this is slight­ly below aver­age, which is a good sign.

[00:26:56.140] It’s a good sign for the lead­ers to think this might be like a val­ue share pur­chase, which it is.

[00:27:05.640] That’s kind of, again, the very sim­ple, quick first look at it.

[00:27:10.000] So, for exam­ple, I’m look­ing at the price of the com­pa­ny we’re talk­ing about.

[00:27:14.680] In the very next row of the spread­sheet I’m using, there’s anoth­er com­pa­ny which has been known for its high growth, and that’s trad­ing on a P‑E of 50.

[00:27:24.220] And that’s a com­pa­ny that has been known for its high growth pro­file.

[00:27:28.880] And that’s typ­i­cal­ly what hap­pens is that the P‑E is high for growth com­pa­nies, and it comes down low­er back towards the mar­ket aver­age for low growth com­pa­nies.

[00:27:36.980] But there is a sweet spot.

[00:27:38.200] There are some com­pa­nies who still have rea­son­able growth and trade below the mar­ket aver­age, and they’re the ones we’re try­ing to find.

[00:27:45.760] So that’s to give you con­text, high growth com­pa­ny at 50, this com­pa­ny at 13, mar­ket aver­age at 16.

[00:27:54.220] So the next thing Tony says he looks at when he’s got the P‑E ratio is the his­to­ry of the P‑E ratio for that par­tic­u­lar stock over the last cou­ple of years.

[00:28:03.960] You can get that on Yahoo Finance or any one of those sort of sites.

[00:28:07.880] And he’s look­ing to see if the P‑E ratio is going up or if it’s going down, because if it’s actu­al­ly been going down, that means that it may hold more val­ue as an invest­ment.

[00:28:20.700] If it’s at the top of its P‑E trend over the last few years, there’s prob­a­bly less val­ue in it as an invest­ment as there is if it’s at the low point or if it’s com­ing down from its high point in terms of P‑E.

[00:28:35.360] The next thing I guess I want to talk about is I start to get into the qual­i­ty side of things, and I use a cou­ple of sub­scrip­tion ser­vices.

[00:28:44.320] Both of them that I use are soft­ware providers, and they have their own ways of grad­ing com­pa­nies in terms of the qual­i­ty of the bal­ance sheet and the P&L, the prof­it and loss.

[00:28:57.800] And so I have a quick scan of those two ser­vices.

[00:29:01.180] This com­pa­ny is com­ing out on the good side, not great, but not bad.

[00:29:06.380] We’re not get­ting into which sub­scrip­tion ser­vices he uses at this stage, because that’s a whole oth­er con­ver­sa­tion that I want to wait for a lat­er episode.

[00:29:14.940] I think we can talk about the mer­its of this one ver­sus that one.

[00:29:18.320] So don’t wor­ry about that for now.

[00:29:20.040] Just know that he uses a num­ber of these tools, and you’ll get more infor­ma­tion in future episodes.

[00:29:27.580] I’ll then look at the bal­ance sheet in terms of the total equi­ty.

[00:29:34.260] And so what total equi­ty is?

[00:29:36.580] Assets minus lia­bil­i­ties, and it gives you the equi­ty in the com­pa­ny.

[00:29:40.800] So I’m focus­ing on net equi­ty, and the thing I’m focus­ing on, has it con­sis­tent­ly gone up?

[00:29:45.560] And the rea­son I do that is because basi­cal­ly that would mean the com­pa­ny has been pret­ty steady in terms of not rais­ing more cap­i­tal or not rais­ing more debt.

[00:29:57.360] So it’s been able to let the prof­its flow to the bot­tom line and sit there until they’re acquired.

[00:30:03.420] So it’s a good thing to see com­pa­nies hav­ing their equi­ty increase con­sis­tent­ly over time.

[00:30:11.780] Now, you can find total equi­ty or net equi­ty in the annu­al report of the com­pa­ny.

[00:30:17.220] It’ll be in the finan­cial state­ments there some­where.

[00:30:19.800] Tony does point out that some­times com­pa­nies may make acqui­si­tions or things like that, which can cause the trend of their equi­ty to sub­stan­tial­ly go up or down.

[00:30:31.360] So if you see some­thing like that, it’s worth drilling into, see if there’s any good caus­es, good rea­sons for that.

[00:30:37.420] But gen­er­al­ly speak­ing, he’s look­ing for a pos­i­tive upward trend with their net equi­ty over time.

[00:30:44.080] The next thing I’m look­ing at is what’s some­times called the price to book, or it’s basi­cal­ly the price to net equi­ty.

[00:30:53.980] So I’m going to do a cal­cu­la­tion to express the equi­ty again on a per share basis.

[00:30:59.480] So just take the net equi­ty from the com­pa­ny report and divide it by total shares to get to equi­ty per share.

[00:31:05.680] And I’m going to com­pare that to the price.

[00:31:08.340] In this case, the com­pa­ny I’m look­ing at, the price or the equi­ty per share is much low­er than the share price.

[00:31:17.880] So it’s not a great price to book mul­ti­ple.

[00:31:20.120] So it does­n’t get a great score on that basis.

[00:31:22.580] But again, that’s not nec­es­sar­i­ly a bad thing.

[00:31:24.740] Some com­pa­nies trade around their, what’s called their book val­ue or their equi­ty val­ue, and some com­pa­nies com­mand a pre­mi­um.

[00:31:31.860] Gen­er­al­ly, a qual­i­ty com­pa­ny com­mands a pre­mi­um.

[00:31:34.560] But it’s also nice to buy equi­ty at cents in the dol­lar, too, which can hap­pen from time to time.

[00:31:40.900] So I had to lis­ten to this sec­tion a few times before I felt like I under­stood what he’s say­ing.

[00:31:46.840] But I think we’ve got to keep in mind here that we’re not look­ing at buy­ing stocks in com­pa­nies that are doing well.

[00:31:55.820] We’re look­ing at buy­ing stocks in com­pa­nies that are doing well but are under­val­ued in the stock mar­ket.

[00:32:03.800] Their share price does­n’t accu­rate­ly reflect the fact that they are doing well.

[00:32:09.560] So some com­pa­nies will be doing well and their share price will reflect that.

[00:32:15.040] That does­n’t mean nec­es­sar­i­ly, as Tony’s say­ing, that they’re a bad invest­ment, but they’re prob­a­bly not going to give you that 19.5% aver­age annu­al return that he’s look­ing for.

[00:32:25.800] So, again, when he says that this com­pa­ny that he’s look­ing at when he’s doing his analy­sis is trad­ing at its sort of book val­ue, that prob­a­bly means that the mar­ket has kind of real­ized that this com­pa­ny is doing well, which is great, but prob­a­bly means it’s not a val­ue invest­ment, if that makes sense.

[00:32:47.640] There’s not as much upside in it as there might be if it was trad­ing at a price low­er than its book val­ue.

[00:32:55.860] Hope­ful­ly that makes some sense.

[00:32:57.260] Makes sense to me any­way.

[00:32:59.500] I’m next look­ing at what’s called the earn­ings per share, which we spoke about before.

[00:33:06.140] And one of the things that a lot of com­pa­nies will do because they’re often pres­sured by stock­bro­kers or fund man­agers is to give an earn­ings guid­ance.

[00:33:17.320] So they’ll either tell you what they think their earn­ings per share might be next year or the fund man­agers will work it out for them­selves.

[00:33:23.700] And you can either get this from the com­pa­ny reports or sources like Yahoo Finance or Google Finance will have what’s called a con­sen­sus esti­mate.

[00:33:35.240] So they’ll poll stock­bro­kers and fund man­agers and tell you what they think the earn­ings per share will be on aver­age next year from their poll.

[00:33:44.300] So I’m look­ing for growth.

[00:33:45.780] I’m look­ing for the earn­ings per share to be going up.

[00:33:48.760] Okay.

[00:33:49.020] I think that was pret­ty self-explana­to­ry.

[00:33:51.080] Now, the next thing Tony’s going to talk about is what he calls a hur­dle rate.

[00:33:55.300] And it took me a lit­tle while to get my head around this.

[00:33:57.920] Let me see if I can give you the quick brain dump.

[00:34:02.360] When Tony’s try­ing to fig­ure out whether or not a com­pa­ny is going to be a good invest­ment for him with the kind of per­for­mance that he wants from an invest­ment,

[00:34:14.520] this 19.5% on aver­age per annum return.

[00:34:19.020] One of the ways he does that is by using this thing called a hur­dle rate.

[00:34:23.280] A hur­dle rate is basi­cal­ly an arbi­trary fig­ure that you use.

[00:34:27.700] It’s basi­cal­ly the return that you want to get on your invest­ment.

[00:34:31.500] Now, you may not want to get a 19.5% return.

[00:34:35.580] You may want to just get a 6% or 7% return.

[00:34:39.080] You might want to get a 10% annu­al return.

[00:34:42.080] But Tony wants a 19.5%.

[00:34:44.400] So he says he uses a cou­ple of dif­fer­ent hur­dle rates that will be used lat­er on in the spread­sheet in your check­list.

[00:34:52.200] But to cut a long sto­ry short, it’s just the kind of invest­ment that you want to get out of your port­fo­lio.

[00:34:59.400] And then you’ll be able to mea­sure that against some oth­er met­rics along the way.

[00:35:03.500] So just in your spread­sheet, if you’re play­ing along at home, type hur­dle rate and then put beside it the kind of annu­al return you want to get.

[00:35:13.040] It can be based on oth­er things.

[00:35:15.740] So it might be, for exam­ple, if you’ve bor­rowed mon­ey to invest in the share mar­ket, you want to at least get a return which is going to pay for the cost of ser­vic­ing the loan.

[00:35:25.460] So, you know, that’s prob­a­bly a hur­dle rate of 5% or 6%.

[00:35:27.980] It’s real­ly up to you what you use as your hur­dle rate.

[00:35:31.760] Some peo­ple just pick 10% because I think that’s a good num­ber and that’s what they’re try­ing to achieve in the mar­ket.

[00:35:36.840] Now, Tony is talk­ing here about bor­row­ing mon­ey.

[00:35:39.380] I know because he’s told me one of the things that he did at var­i­ous stages was pay down the mort­gage on his house, use the equi­ty he then had in his house to bor­row more mon­ey against that as an asset,

[00:35:56.040] and then invest that mon­ey into the stock mar­ket because he knew he could bor­row the mon­ey at, I don’t know, 5% or 6%, return 19.5%.

[00:36:04.740] It’s a good deal, right?

[00:36:06.780] But if you’re going to be doing that, you need to make sure you’re at least get­ting enough of a return to be able to ser­vice the cost of the mort­gage.

[00:36:14.560] He also said in this sec­tion that with this hur­dle rate of 19.5% that he has per­son­al­ly, not many com­pa­nies are going to meet that kind of return.

[00:36:24.480] So it’s anoth­er fil­ter­ing mech­a­nism to fil­ter out the stocks that aren’t going to be a good invest­ment for him.

[00:36:31.100] One thing I haven’t spo­ken about yet, but I should, is what’s called return on equi­ty.

[00:36:35.440] And that’s one of the key met­rics we’re look­ing at in terms of the qual­i­ty of the com­pa­ny.

[00:36:41.120] So this par­tic­u­lar com­pa­ny has a return on equi­ty of 22%, which is quite high.

[00:36:47.440] And that means that for the equi­ty that’s sit­ting in the com­pa­ny, the earn­ings it’s mak­ing is return­ing the com­pa­ny 22%.

[00:36:55.820] All right.

[00:36:56.540] I might just want to stop and break down this one a lit­tle bit.

[00:36:59.020] This one reminds me of the old Bible sto­ry of the para­ble of the tal­ents.

[00:37:04.840] You have to for­give me, but I’ve spent the last few years mak­ing a doc­u­men­tary on ear­ly Chris­tian­i­ty called Mar­ket­ing the Mes­si­ah.

[00:37:11.760] Look it up.

[00:37:12.460] It might be out by the time you hear this.

[00:37:14.380] Tony has been involved too.

[00:37:16.020] He’s one of the pro­duc­ers of the film.

[00:37:17.980] Any­who, you know, the old Bible sto­ry, para­ble of the tal­ents, even if you’re not a Chris­t­ian, you know, there’s this king and he gave his three sons mon­ey and one of them went and bought Coke and snort­ed it off a hook­er’s tits.

[00:37:32.720] And anoth­er one bought a Fer­rari.

[00:37:34.820] And the third one, I think this is how it goes in the Bible.

[00:37:37.240] The third one invest­ed it in Apple in 1983 and made a lot of mon­ey out of it.

[00:37:43.340] So basi­cal­ly, this return on equi­ty that Tony’s talk­ing about is how well is the com­pa­ny doing with the mon­ey that it’s got as a met­ric?

[00:37:52.100] Is it tak­ing a buck and turn­ing it into two bucks every year?

[00:37:56.420] Or is it turn­ing it into 10 bucks every year?

[00:37:58.780] Or is it turn­ing it into minus three bucks every year?

[00:38:01.740] So this is obvi­ous­ly a very big deter­min­ing fac­tor in whether or not it’s a qual­i­ty busi­ness.

[00:38:08.580] Is it a very well-run busi­ness, I guess?

[00:38:12.360] And the way you cal­cu­late this per­cent­age if you’re at home is you basi­cal­ly take its earn­ings, its net income, which again is in the finan­cials, and you just divide it by its net equi­ty, the net equi­ty fig­ure we got ear­li­er on from the finan­cials.

[00:38:28.000] So net earn­ings divid­ed by net equi­ty, and that will give you a per­cent­age.

[00:38:33.800] What we’re going to do then is com­pare the return on equi­ty to the share price, the price that we have to pay for it to make sure that our return on the price we pay is high enough.

[00:38:46.520] Okay, so Tony gave you an exam­ple here for why this fig­ure is impor­tant, and it was a lit­tle bit con­vo­lut­ed, so let me give you my ver­sion of it.

[00:38:52.980] Let’s say I’ve got a nice crisp $100 bill in my hand, and I tell you that you can buy it for $100.

[00:39:00.640] Is that a good invest­ment for you?

[00:39:02.520] Not real­ly.

[00:39:03.380] You’re break­ing even.

[00:39:04.460] If I say you could buy it for $10, that’s a good invest­ment.

[00:39:09.640] You’re buy­ing a $100 bill for $10.

[00:39:11.420] You’re mak­ing a 10 times return on your invest­ment.

[00:39:14.060] If I say you can buy it for $80, okay, you’re mak­ing a return on your invest­ment, but it’s not as high.

[00:39:20.880] So what he’s doing here is tak­ing this return on equi­ty fig­ure, com­par­ing it to the share price, and that tells him how much mon­ey he needs to spend on a share to get a cer­tain amount of return on equi­ty.

[00:39:33.880] Basi­cal­ly, it’s an indi­ca­tor of, am I spend­ing $85 to buy a $100 bill here, or am I spend­ing $10 to buy a $100 bill?

[00:39:43.760] Hope that makes more sense.

[00:39:44.960] I then put togeth­er a check­list, and again, this is some­thing I start­ed doing after I read a book, and the book was called The Check­list Man­i­festo by a guy called Atul Gawande, and I prob­a­bly pro­nounced his name incor­rect­ly.

[00:40:00.500] But the gist of the book was he was a sur­geon, and he was appalled at the mis­takes that were being made in oper­at­ing the­atres, you know, peo­ple hav­ing surgery on the wrong arm or the wrong leg or the wrong side of the body or what­ev­er.

[00:40:16.180] And he either was a pilot or had some­thing to do with pilots, and he said, well, before a pilot takes off, he goes through or she goes through a very detailed check­list.

[00:40:25.700] And so he devel­oped a process, which is still used in hos­pi­tals now, of going through a check­list of mak­ing sure you’ve got the right patient, mak­ing sure it’s the right leg you’re oper­at­ing on, all that kind of stuff.

[00:40:38.560] And so he sug­gests that you use this kind of process in all dif­fer­ent types of endeav­ours, and so I’ve start­ed using it in my share invest­ing, just to make sure you take every­thing into account.

[00:40:52.700] And it is a ben­e­fit to write things down and then give them a score, and you can see, you can com­pare one oppor­tu­ni­ty to anoth­er and rank them, which is anoth­er ben­e­fit of doing this process.

[00:41:04.040] So my check­list is a sum­ma­ry of all the things we’ve gone through, but I’ll just read them out now, I guess, for com­plete­ness.

[00:41:12.660] So the first thing I check for is the finan­cial health.

[00:41:17.240] Has it met the finan­cial health stan­dards in my sub­scrip­tion ser­vices?

[00:41:21.080] Yeah, I don’t think you want to lis­ten to all this.

[00:41:24.740] We will go through all of his check­list in detail as we go into the series a lit­tle bit more and we start tak­ing indi­vid­ual com­pa­nies and break­ing them down live on air.

[00:41:37.120] As David Lee Roth would say, live in front of your naked steam­ing eyes.

[00:41:41.780] That’s the plan for the con­tin­u­a­tion of the series.

[00:41:45.620] We’ll take stock by stock and do a com­plete analy­sis of them and work out whether or not they meet Tony’s cri­te­ria.

[00:41:54.020] So let’s leave the check­list stuff for now.

[00:41:57.880] We’ll get back to that at a lat­er point.

[00:42:00.180] Real­ly, all I want­ed to get across in this episode is to give you an idea of the sort of things that Tony does.

[00:42:09.000] The fact that he knows what he’s doing.

[00:42:11.820] I mean, come on.

[00:42:13.120] I mean, this is the most seri­ous sound­ing guy I’ve heard in years.

[00:42:15.460] He sounds like an accoun­tant.

[00:42:17.640] He’s very seri­ous.

[00:42:19.220] He’s thought it through.

[00:42:20.940] He’s got a process.

[00:42:21.980] It’s worked very well for him over 20, 25, 30 years.

[00:42:27.240] And he’s going to teach it to me and I’m going to teach it to you over the course of the series.

[00:42:31.840] So, yeah, we’ll leave the check­list, I think, for a future episode.

[00:42:36.980] He’s just going over the same stuff and talk­ing about mak­ing sure at the end of this that he’s checked every­thing.

[00:42:44.640] After I do all these things, and for most of these things, it’s a one or a zero, but for some of them, I’ll actu­al­ly give them two points.

[00:42:50.980] All right.

[00:42:51.600] Let me see if I can sum­ma­rize the scor­ing of the check­list for you.

[00:42:54.980] So, he goes down the check­list.

[00:42:57.020] Every item on the check­list, the com­pa­ny gets either a pos­i­tive score or a zero, usu­al­ly.

[00:43:02.620] Some­times neg­a­tive, some­times as high as two.

[00:43:05.120] But basi­cal­ly, pos­i­tive or a zero score.

[00:43:07.320] Then at the end, he cal­cu­lates how many items got a pos­i­tive score, how many items got a zero or neg­a­tive score,

[00:43:15.240] and divides the num­ber of pos­i­tive scores by the num­ber of zero scores, and that gives him a per­cent­age.

[00:43:22.480] And then he says he only wants to invest in stocks that score 75% or above.

[00:43:29.560] Ide­al­ly, we want to invest in stocks that score 75% or above.

[00:43:34.440] Now, that’s, again, a rule of thumb.

[00:43:36.000] And that’s basi­cal­ly the blend of qual­i­ty and val­ue that comes out after that check­list is done.

[00:43:42.000] All right.

[00:43:42.600] So, that’s the high-lev­el overview of how he deter­mines whether or not a com­pa­ny is qual­i­ty at val­ue, QAV.

[00:43:51.720] We then talked a lit­tle bit about if he decides to invest in a par­tic­u­lar stock,

[00:43:56.860] how he deter­mines what allo­ca­tion of his port­fo­lio he’s going to put in that.

[00:44:02.200] But I don’t think we need to go into that right now.

[00:44:03.820] It’s some­thing we can do lat­er on.

[00:44:05.620] He was talk­ing about liq­uid­i­ty and exit strate­gies and all of that kind of stuff.

[00:44:09.980] But, again, we’ll tack­le that in a future episode.

[00:44:13.960] One ques­tion I did have for Tony at this stage, though, was that his analy­sis seemed pret­ty aca­d­e­m­ic and dry.

[00:44:19.380] He’s focus­ing on num­bers, not real­ly look­ing at what prod­ucts the com­pa­ny has, who the peo­ple are, the vision, R&D,

[00:44:29.620] all of that kind of excit­ing stuff that I would have expect­ed would have formed part of his analy­sis.

[00:44:35.020] And so, I got him to talk to that a lit­tle bit.

[00:44:37.800] Yeah, look, that’s a good ques­tion.

[00:44:39.020] And, in fact, the very next note I have talks to that.

[00:44:43.040] I do focus on the num­bers.

[00:44:44.820] I think that’s part­ly because I now know the Aus­tralian share mar­ket so well.

[00:44:48.480] I’ve got a fair­ly good idea of the com­pa­nies and the peo­ple who are play­ers.

[00:44:52.620] And over time, this method does tend to bring the same sorts of stocks to the top all the time.

[00:44:58.660] And I say I know them well.

[00:45:00.300] But the next step is, once I’ve worked out that I want to buy a share and how much to buy of it and what to pay for it,

[00:45:07.000] I will go and do a bit of research on the com­pa­ny.

[00:45:10.680] More to check that there’s noth­ing unto­ward going on that I haven’t fac­tored into my con­sid­er­a­tions.

[00:45:16.860] So, I’ll go and do a Google search or a Yahoo Finance search and just see what the news is on this com­pa­ny.

[00:45:23.840] And a cou­ple of times I’ve been caught out because it may be under a takeover, for exam­ple.

[00:45:28.180] So, unless you want to trade a takeover play, which arguably can be prof­itable,

[00:45:33.960] it’s not going to be a long-term hold for you.

[00:45:36.080] So, that might affect my deci­sion to buy or not.

[00:45:42.180] I will often­times go to the annu­al report and just make sure there has­n’t been any sort of qual­i­fied audit report giv­en by the audi­tors.

[00:45:52.100] So, as long as the audi­tors are giv­en a tick of qual­i­ty, that’s a good sign.

[00:45:57.300] Very rarely hap­pens that they don’t, but I’ve been caught out with that in the past as well.

[00:46:01.940] And I’ll just do a quick search on any­thing about the com­pa­ny that might be in the news.

[00:46:09.500] But oth­er than that, I mean, I read the Fin Review every day, like I said before,

[00:46:13.440] and I sub­scribe to quite a few, both sub­scrip­tion ser­vices in terms of the fig­ures, but also in terms of mar­ket news.

[00:46:23.440] So, you do tend to keep abreast of what’s going on with these com­pa­nies and you’re quite famil­iar with them.

[00:46:28.880] But, yeah, the very last thing I do is, like I said, a quick Google News search and maybe look at the annu­al report to make sure that there’s noth­ing unto­ward I haven’t caught up with late­ly.

[00:46:36.640] Well, we’re almost done with this episode.

[00:46:39.180] Before we go, I want­ed Tony to talk a lit­tle bit about War­ren Buf­fet­t’s annu­al newslet­ter.

[00:46:45.960] Again, you may recall from last week’s episode, War­ren Buf­fett, one of the most suc­cess­ful investors in the world.

[00:46:52.340] He’s in his late 80s, mul­ti-mul­ti-bil­lion­aire in the Unit­ed States.

[00:46:58.320] Tony’s a big fan of his.

[00:46:59.620] I know he spent a cou­ple of hun­dred thou­sand dol­lars buy­ing a sin­gle share of Berk­shire Hath­away, Buf­fet­t’s com­pa­ny, a cou­ple of years ago,

[00:47:07.080] just so he could go to one annu­al gen­er­al meet­ing and hear Buf­fett speak live.

[00:47:13.620] And so, I was talk­ing to Tony a lit­tle bit about my teenage boys and how I’ve been talk­ing with them recent­ly about start­ing invest­ment port­fo­lios,

[00:47:25.220] learn­ing these strate­gies that I’m learn­ing from Tony so they can get start­ed when they’re 18.

[00:47:31.340] And then we got into a dis­cus­sion about War­ren Buf­fett.

[00:47:34.140] Yeah, well, I mean, that’s a great mind­set for them to be in.

[00:47:37.420] And I think, I can’t remem­ber the exact fig­ures, but Buf­fett did that cal­cu­la­tion in the lat­est annu­al let­ter to share­hold­ers

[00:47:44.960] where he talked about the first share he ever bought when he was 12, I think.

[00:47:48.840] And I think he’d saved that from his paper route and paid about $100 for it, which was a fair bit back then.

[00:47:55.220] And he had sold it along the way, but he said, if I’d tak­en that $100 and put it into an index fund,

[00:48:02.460] it would be now worth, I for­get how many mil­lions of dol­lars or tens of mil­lions of dol­lars, you know,

[00:48:07.240] $14 mil­lion or $50 mil­lion or some­thing.

[00:48:09.720] It was a real­ly large num­ber over the 60-odd years, 70 years since then,

[00:48:15.380] which just points out the pow­er of com­pound­ing.

[00:48:18.440] Wow, $100.

[00:48:21.360] Yeah.

[00:48:22.140] Over what­ev­er peri­od of time that is.

[00:48:24.560] Yeah, 65 years or some­thing turns into tens of mil­lions.

[00:48:28.220] So that’s the, I mean, that’s the mes­sage for your boys.

[00:48:31.240] And for any­one lis­ten­ing to this pod­cast, it’s, you’re not going to become a mil­lion­aire overnight,

[00:48:35.500] but you will if you do it long enough.

[00:48:37.680] And look, even if you don’t want to go through the method­ol­o­gy I go through, put it in an index fund.

[00:48:43.240] Put it in a low-cost list­ed invest­ment com­pa­ny, which does­n’t charge much in fees,

[00:48:48.840] which grinds out year in, year out the mar­ket aver­age.

[00:48:52.140] And over a long enough peri­od of time, you’re going to do real­ly, real­ly well.

[00:48:55.480] Yeah, that’s, as you know, one of my oth­er mates down in Mel­bourne, Steve Samati­no.

[00:49:01.280] I did some pod­casts with him about his invest­ment strat­e­gy, which is basi­cal­ly that,

[00:49:06.620] which he start­ed doing when he was in his ear­ly 20s.

[00:49:09.580] And that’s pret­ty much all he did.

[00:49:10.900] We call it the Samati­no method.

[00:49:13.200] And yeah, he’s done very well out of that.

[00:49:15.980] Was able to retire from his cor­po­rate job in his 30s, I think,

[00:49:19.640] as a result of doing that from his ear­ly 20s onwards.

[00:49:22.240] Well, maybe we could catch up with him at some stage as an inter­view on this pod­cast

[00:49:26.420] and just find out where he’s at with that.

[00:49:27.980] Yeah, absolute­ly intend to have Steve on as a guest, along with oth­er guests.

[00:49:32.980] In fact, Torsten Hoff­man, the pro­duc­er of our film, as you may know,

[00:49:37.320] has just done his sec­ond doc­u­men­tary on cryp­tocur­ren­cy.

[00:49:40.360] He said he wants to be our first guest to talk about cryp­tocur­ren­cy as an invest­ment strat­e­gy.

[00:49:45.300] All right, well, it’s not my try­ing.

[00:49:46.460] I don’t know much about that at all, but I haven’t looked into it very far.

[00:49:49.680] And when I have, I haven’t been excit­ed by it.

[00:49:52.320] So that’ll be inter­est­ing.

[00:49:54.700] Yeah, I thought it’s some­thing we should at least talk about,

[00:49:57.500] because peo­ple will be won­der­ing, should I invest in cryp­tocur­ren­cy?

[00:50:00.980] Yeah, it’s inter­est­ing.

[00:50:01.940] It’s fun­ny.

[00:50:02.480] When I have dis­cus­sions with younger peo­ple about this kind of stuff,

[00:50:05.780] that’s often­times the very first ques­tion that comes up.

[00:50:08.840] Should I be buy­ing Bit­coin?

[00:50:11.060] Yeah.

[00:50:11.680] Yeah.

[00:50:12.760] Well, I’ll be inter­est­ed to get your thoughts on that in a future episode.

[00:50:16.600] Yeah.

[00:50:16.880] I always say no, but yeah, sure.

[00:50:19.460] Yeah.

[00:50:20.860] I remem­ber when you were around here with din­ner with the boys and it came up

[00:50:24.520] and you just kind of laughed.

[00:50:25.540] Oh, cryp­to.

[00:50:27.500] Bit­coin.

[00:50:29.140] So any­way.

[00:50:30.360] Yeah.

[00:50:30.820] It’s a pump­ing down.

[00:50:31.500] In all fair­ness, you had a cou­ple of bot­tles of wine and half a bot­tle of scotch in you

[00:50:35.340] at that point.

[00:50:36.020] So I think we’ll get your views on it in a slight­ly more sober state.

[00:50:42.820] Buf­fet­t’s let­ter.

[00:50:43.860] Let’s talk about that.

[00:50:45.900] Yeah.

[00:50:46.100] So I’m always very excit­ed every year around this time.

[00:50:50.080] It’s Christ­mas in March for me when Buf­fett writes his annu­al let­ter to share­hold­ers.

[00:50:54.580] So he’s required by law to put out an annu­al report, which is very, very dry.

[00:51:00.280] It’s such a big com­pa­ny.

[00:51:01.160] Now there’s like 100 pages of num­bers in it.

[00:51:04.540] But he writes a let­ter.

[00:51:06.020] It’s only fair­ly short.

[00:51:07.260] That’s prob­a­bly a dozen pages.

[00:51:08.700] But it goes through his feel­ings on the mar­ket, his feel­ings on account­ing stan­dards, his feel­ings

[00:51:14.960] on the econ­o­my, and what’s hap­pen­ing in Berk­shire Hath­away.

[00:51:18.660] And it’s just always such a refresh­ing read.

[00:51:22.140] It’s very, very share­hold­er friend­ly and full of sort of, you know, home­spun charm, which

[00:51:30.900] is just delight­ful.

[00:51:32.540] I know I get excit­ed by it.

[00:51:34.280] And when you were talk­ing before about peo­ple lis­ten­ing to this pod­cast, doing their exer­cise

[00:51:38.520] or going for walks or what­ev­er, who may not be get­ting excit­ed, I’m hop­ing there’s a cou­ple

[00:51:42.980] of peo­ple out there who are just doing cart­wheels to get access to this infor­ma­tion, because

[00:51:46.700] I find it excit­ing.

[00:51:48.400] And I’m sure, you know, peo­ple like your boys who are seri­ous about their finan­cial future

[00:51:53.040] are find­ing it excit­ing too.

[00:51:55.280] But any­way, Buf­fet­t’s let­ter.

[00:51:58.900] On the first page of this share­hold­er’s let­ter every year, and you can get it on the Berk­shire

[00:52:03.780] Hath­away web­site for free.

[00:52:06.540] It’s a very sim­ple web­site.

[00:52:08.120] Is this the 2018 let­ter you’re look­ing at?

[00:52:09.660] It is, yeah.

[00:52:10.860] Yeah, I’ve got that in front of me.

[00:52:12.220] Yeah, just Google Buf­fett annu­al let­ter, you’ll find it very eas­i­ly.

[00:52:17.420] And so the very first page has the annu­al returns for Berk­shire Hath­away over its life,

[00:52:22.900] which is, I don’t know how many years, a long time.

[00:52:26.380] 40 years, maybe.

[00:52:27.840] And it gets com­pared to the index in the US, S&P 500, I think they use.

[00:52:37.140] And the most recent com­pound­ing growth of Berk­shire Hath­away runs at 20.5%.

[00:52:43.600] So maybe I should have saved myself all this time and trou­ble and bought a Berk­shire Hath­away

[00:52:47.580] share when I retired and would have com­pound­ed it to 20.5%, not the 19.5% I’ve been get­ting.

[00:52:54.960] But you do have to deal with cur­ren­cy fluc­tu­a­tions being an Aus­tralian investor and US report­ing,

[00:53:02.380] which is a pain in the butt too.

[00:53:04.840] So just quick­ly on that, there’s a cou­ple of columns in that col­umn.

[00:53:11.200] In the past, Buf­fett has called out the fact that he would like share­hold­ers to focus on the change in book val­ue

[00:53:17.980] rather than the change in share price.

[00:53:22.380] He’s changed that in this newslet­ter because he’s wor­ried that the account­ing stan­dards in the US

[00:53:26.720] don’t pro­vide an accu­rate reflec­tion of book val­ue.

[00:53:31.000] And with­out bor­ing lis­ten­ers, it goes to mark­ing to mar­ket the val­ue of shares.

[00:53:37.700] So if they’ve had, he has a very large port­fo­lio of share invest­ments in com­pa­nies like Coca-Cola,

[00:53:43.600] Amer­i­can Express, Wells Far­go Bank, et cetera, et cetera.

[00:53:47.020] If they go up or down quar­ter by quar­ter, he has to take that through the P&L now,

[00:53:52.040] and that can change the val­u­a­tion of the book val­ue for Berk­shire Hath­away.

[00:53:58.040] That was­n’t always the case, so he’s call­ing it out as being some­thing he does­n’t like,

[00:54:02.380] and he’s going back to just look­ing at the change in the share price.

[00:54:06.800] Get­ting that out the way, though, prob­a­bly the biggest thing to hit Berk­shire Hath­away recent­ly

[00:54:11.920] was to do with a write-down by one of their biggest share­hold­ings,

[00:54:17.540] a com­pa­ny called Kraft Heinz, which we all know and I’m sure we use the prod­ucts of,

[00:54:22.820] so Heinz toma­to sauces or may­on­naise or Kraft may­on­naise.

[00:54:29.380] Very, very big con­sumer goods com­pa­ny.

[00:54:32.040] And the inter­est­ing thing about this is that War­ren Buf­fett has always talked about

[00:54:37.080] look­ing for com­pa­nies that have a moat around them.

[00:54:40.900] And what he means by that is that they have such good­will that they’ve built up

[00:54:45.060] or they spend so much on mar­ket­ing or they have some kind of nat­ur­al or his­toric advan­tage

[00:54:50.500] that it’s very hard for some­one to start up and to take on that com­pa­ny and beat them.

[00:54:59.060] What I think has hap­pened and has been inter­est­ing in the last sort of five to ten years

[00:55:03.940] is that’s been hap­pen­ing in the mar­ket.

[00:55:05.360] There’s been plen­ty of, you know, Kraft brew­ers, for exam­ple,

[00:55:08.520] tak­ing mar­ket share off the big play­ers.

[00:55:11.160] And now it’s start­ing to hap­pen in the super­mar­ket space with com­pa­nies like Whole Foods.

[00:55:17.500] So small­er niche play­ers, they might be cater­ing to organ­ic seg­ments of the mar­ket

[00:55:23.260] or they might be cater­ing to, you know, local tastes or veg­ans or what­ev­er.

[00:55:28.420] They are now start­ing to assail these moats around big com­pa­nies like Proc­ter & Gam­ble and Kraft Heinz.

[00:55:35.200] Cou­pled with that, Buf­fett also helped a com­pa­ny called 3G,

[00:55:38.060] which is a Brazil­ian pri­vate equi­ty com­pa­ny buy-in to Kraft Heinz.

[00:55:45.620] And they’ve done the clas­sic PE price equi­ty type strat­e­gy of try­ing to rip as much cost out of the com­pa­ny as they can

[00:55:54.140] and poten­tial­ly, I guess, in the future with the view to sell­ing it at a high­er price

[00:55:59.400] because the cost reduc­tions have increased the prof­it.

[00:56:04.700] The only prob­lem with that strat­e­gy with this com­pa­ny is that to main­tain that moat,

[00:56:11.080] Kraft Heinz spends a heck of a lot on mar­ket­ing

[00:56:13.160] and some of the cost cut­ting has­n’t affect­ed that mar­ket­ing

[00:56:17.220] and it’s made it eas­i­er for the star­tups to take some mar­ket share off it.

[00:56:22.460] So I thought this was just a very inter­est­ing update on Buf­fet­t’s think­ing on the moats.

[00:56:28.520] He’s still say­ing he’s a big believ­er in them.

[00:56:30.640] But a lot of ana­lysts in the last week have chal­lenged that view and said,

[00:56:33.620] look, it may have been the case in the 50s and the 60s in Amer­i­ca,

[00:56:37.280] but are any of the moats safe now with dis­rup­tors going on?

[00:56:42.100] Hav­ing said that, you know, it’s a 25% write-down on one share in the Buf­fett port­fo­lio,

[00:56:46.380] so it’s not going to break the back of Berk­shire Hath­away.

[00:56:49.180] But, yeah, just an inter­est­ing and time­ly debate on whether the moats still hold.

[00:56:59.440] He com­ment­ed on the mar­ket in say­ing that he has so much cash,

[00:57:04.180] I think he’s sit­ting on some­thing like $130 bil­lion worth of cash

[00:57:07.220] or cash equiv­a­lents, like bonds, for exam­ple, that he can’t deploy.

[00:57:12.220] He’s strug­gling to find big com­pa­nies that he wants to buy out­right

[00:57:16.220] that meet his val­ue cri­te­ria.

[00:57:19.180] So what he’s say­ing is that he’ll prob­a­bly have to keep putting mon­ey into the share mar­ket

[00:57:23.440] and instead of buy­ing one big ele­phant and own­ing it 100%, which is his pref­er­ence,

[00:57:28.400] he’ll con­tin­ue to buy stakes of, say, 10% in Apple and Amex, Coca-Cola, etc.

[00:57:35.720] So I guess a bit of a fore­cast for the econ­o­my in that he’s say­ing things are fair­ly ful­ly val­ued.

[00:57:49.700] He’s strug­gling to find deals.

[00:57:53.660] Inter­est­ing, inter­est­ing quote, he often crit­i­cis­es Wall Street for using met­rics like adjust­ed EBITDA,

[00:58:01.760] so that’s earn­ings before income, tax and depre­ci­a­tion.

[00:58:05.540] And this is often a com­mon met­ric used by a com­pa­ny that’s not mak­ing much mon­ey.

[00:58:09.340] So they’ll say, don’t look at our prof­it and loss line because we’re grow­ing in the future.

[00:58:13.840] Look at our EBITDA line.

[00:58:15.200] Look at our earn­ings before we have to pay inter­est or tax or depre­ci­a­tion.

[00:58:19.840] And he’s always been a big crit­ic of that.

[00:58:23.860] And the exam­ple he uses in the annu­al let­ter deals with stock-based com­pen­sa­tion.

[00:58:29.740] So this is where CEOs or boards grant CEOs part of their salary in shares,

[00:58:37.380] and then they hide the cost of that share issue as an abnor­mal below the line.

[00:58:42.920] And they say, well, our nor­mal prof­it or our nor­malised prof­it is this,

[00:58:46.680] and they don’t call out what it costs them to issue shares to them­selves.

[00:58:50.020] And he’s call­ing it out as a prob­lem.

[00:58:51.600] And he quotes Abra­ham Lin­coln, who said,

[00:58:54.580] if you call a dog’s tail a leg, how many legs does it have?

[00:58:58.720] And the answer is four, because call­ing a tail a leg does­n’t make it so.

[00:59:03.620] And basi­cal­ly what he’s say­ing is the same thing applies to these CEOs

[00:59:06.700] who are play­ing fun­ny bug­gers with the account­ing stan­dards.

[00:59:11.420] So always a good quote from Buf­fett on the malfea­sance of Wall Street in there.

[00:59:18.840] One of the points I want­ed to raise, and he rais­es it,

[00:59:21.660] one of the secret sources and per­haps the secret source to Berk­shire Hath­away

[00:59:25.300] is what’s called the insur­ance flow.

[00:59:27.700] So Berk­shire Hath­away over the years has become a large insur­ance com­pa­ny,

[00:59:31.760] and I think it’s prob­a­bly now the largest in what they call prop­er­ty and casu­al­ty,

[00:59:36.100] so like gen­er­al insur­ance.

[00:59:38.840] But any­way, basi­cal­ly Berk­shire Hath­away has fund­ed its acqui­si­tions

[00:59:43.620] out of what’s called the insur­ance float.

[00:59:45.480] So what that is, is if I own an insur­ance com­pa­ny and we charge pre­mi­ums,

[00:59:52.060] we get to keep that mon­ey that’s raised by the pre­mi­ums until we have to pay it out on a claim.

[00:59:57.620] And of course, not all the claims get paid out.

[01:00:00.760] And a lot of those insur­ances that are tak­en out don’t get paid out too well into the future,

[01:00:06.680] like life insur­ance or work­ers’ com­pen­sa­tion type insur­ances.

[01:00:12.680] So he can get use of those pre­mi­ums for a life­time basi­cal­ly or a gen­er­a­tion before he has to wor­ry about pay­ing them out.

[01:00:20.320] And that’s called the insur­ance float.

[01:00:22.500] So it’s the use of the pre­mi­ums over time, and it’s also often called the under­writ­ing prof­it.

[01:00:29.320] So if the pre­mi­ums exceed the claims, that’s called the under­writ­ing prof­it.

[01:00:34.560] And those two things have enabled Berk­shire Hath­away to always remain rel­a­tive­ly debt-free.

[01:00:40.640] Some­times they bor­row, but they’ve got so much cash com­ing in from those insur­ance busi­ness­es

[01:00:45.060] that they’re strug­gling to deploy it these days.

[01:00:48.420] And that’s been the secret sauce for Buf­fett.

[01:00:51.180] I call it the mon­ey fly­wheel.

[01:00:52.640] So it’s throw­ing off so much cash.

[01:00:55.940] It’s not avail­able to you and I to do.

[01:01:00.180] But it also, I think, has to be tak­en into account when peo­ple just point to Buf­fet­t’s invest­ing abil­i­ty.

[01:01:05.880] He also set up a real­ly good busi­ness, which throws off so much cash.

[01:01:12.560] I said before, yeah, so just the point I said before about he’s strug­gling to find large acqui­si­tions

[01:01:20.580] and will keep buy­ing shares while he’s search­ing.

[01:01:23.320] But he says this is not a mar­ket call.

[01:01:26.420] And the quote in the newslet­ter is,

[01:01:28.000] Char­lie and I have no idea how stocks will behave next week or next year.

[01:01:34.260] That sort of pre­dic­tion has nev­er been part of our activ­i­ty.

[01:01:38.460] And, you know, I think that’s a real­ly good thing to say and call out.

[01:01:43.440] And it’s also, I think, per­ti­nent to our stock mar­ket invest­ing in that, you know, I do pay a large atten­tion to the fig­ures and the facts of what’s in front of us.

[01:01:55.040] And I pay less atten­tion to where I think the mar­ket will be cur­rent­ly or in the future because you just, no one can pre­dict the future and you’re always con­stant­ly sur­prised by it.

[01:02:04.200] So it’s just, it’s real­ly a hope­less thing to try and do and an even more hope­less thing to try and base your invest­ment deci­sions on.

[01:02:11.560] So I love the annu­al let­ter from Berk­shire Hath­away because it just keeps rein­forc­ing all these ideas in your mind as an investor.

[01:02:18.580] Let’s pause for a sec­ond and talk about what you just said there.

[01:02:22.260] So we did talk, I think, in last week’s episode about buy or maybe the first episode about, you know, the old wis­dom of buy­ing low and sell­ing high.

[01:02:36.600] And I think the way most peo­ple, when they’re start­ing out and invest­ing in the share mar­ket, trans­late that is buy­ing when the mar­ket is low and sell­ing when the mar­ket is high.

[01:02:47.100] And there’s obvi­ous­ly usu­al­ly a lot of talk about where the mar­ket’s at and whether or not there’s going to be a cor­rec­tion in the mar­ket and when should you buy, when should you sell.

[01:02:57.240] But you’re say­ing you don’t pay a great deal of atten­tion to where the mar­ket’s at in terms of its nat­ur­al cycles of ups and downs?

[01:03:06.600] No, I find it comes through in the num­bers that I’m see­ing.

[01:03:10.100] So when the mar­ket’s high, I find less stocks that meet my val­ue cri­te­ria.

[01:03:15.180] So kind of nat­u­ral­ly you don’t invest in a peak­ish mar­ket.

[01:03:19.940] And when the mar­ket’s low, you know, you find lots of stocks to invest in.

[01:03:23.960] So if I take some exam­ples, com­ing up into the dot-com bust around the year 2000, val­ue investors real­ly strug­gled to find stocks to buy.

[01:03:34.620] And if you found one or two, again, they were your cig­ar butts that, you know, were cheap for a rea­son rather than being a qual­i­ty com­pa­ny at good val­ue.

[01:03:46.360] Con­verse­ly, com­ing out of the GFC in about 2009, I lit­er­al­ly was just awash with com­pa­nies that I could invest in.

[01:03:55.220] It was actu­al­ly almost hard to invest because I kept, you know, the behav­ioral part of your brain’s going, do you real­ly want to buy in this mar­ket that’s still going down?

[01:04:07.020] And the more ana­lyt­i­cal side of the brain’s going, this is fan­tas­tic, back the car up and load up, let’s go.

[01:04:15.940] And luck­i­ly I did the sec­ond one and I think almost every­thing I bought in 2009 tripled in val­ue very quick­ly.

[01:04:22.900] So you’ve got to have that dis­ci­pline of not pay­ing atten­tion to what the noise is about the mar­ket or try­ing to form a view of is the mar­ket high or low or is it going to go high­er or low­er?

[01:04:33.420] But to look at the num­bers of the stock ship that are in front of you and are they good buys?

[01:04:38.440] And so the oth­er thing too, the oth­er thing too is that if you’re doing it as I am, as you’re always tak­ing the six month­ly reports and going through the num­bers and mak­ing your deci­sions to buy or sell,

[01:04:50.200] you’re actu­al­ly doing what’s called dol­lar cost aver­ag­ing.

[01:04:53.320] So you’re buy­ing at every stage in the mar­ket and over time, you’re not going to have all your mon­ey in the high or the low, but you’re going to get the aver­age, which is not too bad.

[01:05:04.580] I want­ed to ask you about some­thing that I read over the week, some mar­ket watch, an opin­ion piece writ­ten by some guy called Howard Gold.

[01:05:16.540] It’s enti­tled, Investors Should No Longer Bet on War­ren Buf­fett.

[01:05:21.560] And he was talk­ing about his Buf­fet­t’s share­hold­er newslet­ter that went out and says,

[01:05:27.380] one thing jumped out at me in his annu­al let­ter, his acknowl­edge­ment that his best stock pick­ers had­n’t beat­en the mar­ket

[01:05:33.740] and his tac­it admis­sion that investors could­n’t expect Berk­shire Hath­away to do so in the future either.

[01:05:42.380] Blah, blah, blah.

[01:05:43.600] Invest­ment man­agers from Berk­shire said,

[01:05:46.300] Over­all, they are a tiny bit behind the S&P, each by just almost the same mar­gin over the same time, Buf­fett said.

[01:05:54.660] They have done bet­ter than I have.

[01:05:58.020] Humil­i­ty aside, that’s quite an admis­sion.

[01:05:59.860] War­ren Buf­fett, the great­est investor in his­to­ry, is say­ing that nei­ther he nor his best hand­picked stock pick­ing tal­ent

[01:06:05.320] has achieved the essen­tial goal of active mon­ey man­age­ment, beat­ing a bor­ing old index fund.

[01:06:10.760] Any Schlemiel can buy in his or her 401k.

[01:06:16.000] What would be your thoughts on that?

[01:06:18.400] Yeah, I think it’s a valid crit­i­cism, but I don’t think it’s a valid crit­i­cism of the future of Berk­shire Hath­away.

[01:06:24.800] There will always be peri­ods from time to time when active man­agers will under­per­form the mar­ket.

[01:06:30.860] That in itself might be a bit of a hint that the mar­ket’s get­ting a bit peak­ish,

[01:06:36.520] because what’s prob­a­bly hap­pen­ing is that Berk­shire Hath­away…

[01:06:39.800] Well, first of all, I should explain that War­ren Buf­fett does­n’t do all the invest­ing in Berk­shire Hath­away any­more.

[01:06:44.560] As part of the suc­ces­sion plan, which basi­cal­ly sees Buf­fett going, you know, shuf­fling off his mor­tal coil,

[01:06:51.300] he’s hired a cou­ple of peo­ple that he trusts to imple­ment his style of invest­ing for the future,

[01:06:58.880] so that when Munger and Buf­fett aren’t around any­more, basi­cal­ly four peo­ple run Berk­shire Hath­away.

[01:07:04.980] There’s two guys doing the invest­ing, and there’s two guys, one look­ing after the insur­ance busi­ness­es

[01:07:10.480] and one look­ing after the rest, the oper­at­ing busi­ness­es.

[01:07:13.720] And so he’s start­ed to give the fund man­agers more and more funds to invest.

[01:07:21.080] If they’re using the Buf­fett style, which I think they prob­a­bly are, and they’re under­per­form­ing the mar­ket,

[01:07:26.160] it’s prob­a­bly a sign that the inter­net-type stocks that have high PEs have had a good run,

[01:07:33.800] which is often a sign that the mar­ket’s get­ting a bit peaky.

[01:07:37.420] If they’ve under­per­formed by only a small amount, I would­n’t be too wor­ried about the mar­ket get­ting peaky,

[01:07:41.740] but that’s prob­a­bly one of the rea­sons for it.

[01:07:43.260] If you look at that front page of the newslet­ter for the last 40-odd years or what­ev­er it’s been,

[01:07:47.920] they’ve basi­cal­ly dou­bled the mar­ket.

[01:07:51.080] They do call out every year that as they get big­ger and big­ger, that’s hard­er to do

[01:07:55.200] because, as I’ve said before in this pod­cast, you have to focus on larg­er mar­ket cap stocks,

[01:08:01.280] and they’re not going to per­form as well as the small stocks,

[01:08:03.960] which have small­er oppor­tu­ni­ties to buy, and when you start to have peo­ple buy­ing them,

[01:08:10.400] that forces the share price up just through the sheer small vol­ume that’s on offer.

[01:08:15.820] So there’s that.

[01:08:16.840] But also, too, the last point I make is that I think in almost every newslet­ter I’ve read,

[01:08:21.080] Buf­fett always comes out and says,

[01:08:22.660] I’m not pre­dict­ing I’m going to do as well in the future as I did in the past.

[01:08:26.420] It’s his way of set­ting low­er expec­ta­tions, which he then beats in the future.

[01:08:34.740] I just want­ed to point out, when you said he’s imple­ment­ing a suc­ces­sion plan,

[01:08:38.640] that Buf­fett is cur­rent­ly 88 and Char­lie Munger, his part­ner, is 95.

[01:08:43.500] That’s right.

[01:08:43.880] And as he points out in the newslet­ter, I’m the young one.

[01:08:50.300] No, exact­ly.

[01:08:52.040] Yeah, they’re old guys.

[01:08:53.980] They’ve been doing it a long time.

[01:08:56.240] So if I under­stand your point is, look, one year’s per­for­mance is real­ly mean­ing­less.

[01:09:03.260] It’s their per­for­mance over time that real­ly counts by stick­ing to their strat­e­gy.

[01:09:07.520] Yes, yes.

[01:09:09.220] And they’ve got a long track record of doing well.

[01:09:12.940] And I think also, too, these days with Berk­shire Hath­away, as War­ren Buf­fett says,

[01:09:16.540] he’s look­ing for the big ele­phant invest­ments now.

[01:09:18.700] If he does hap­pen to find a com­pa­ny he can buy for $100 bil­lion,

[01:09:23.180] that’s much more like­ly to have an impact on Berk­shire Hath­away’s share price

[01:09:27.080] than these fund man­agers going out and buy­ing anoth­er 10% of Apple.

[01:09:31.520] Yeah.

[01:09:32.100] Yeah.

[01:09:34.720] And I think, I can’t remem­ber the exact met­rics,

[01:09:36.920] but if you look at the share, the newslet­ter to share­hold­ers,

[01:09:41.800] he points out that these two biggest com­pa­nies, I think, were up like 25% in earn­ings year on year.

[01:09:49.640] So, you know, he still knows how to invest.

[01:09:52.600] Trust me.

[01:09:53.500] All right, Tony.

[01:09:54.120] Well, lis­ten, I think that’s prob­a­bly all we’ve got time for this week.

[01:09:56.440] I think maybe next week we’ll actu­al­ly start to drill down on a par­tic­u­lar com­pa­ny

[01:10:01.700] and a lot of these check­list things might start to make more sense

[01:10:07.480] as we actu­al­ly apply it to a real com­pa­ny.

[01:10:10.940] And we do that over and over and over until we do our 10,000 hours and we get good at it.

[01:10:17.700] By we, I mean the rest of us that aren’t you.

[01:10:20.680] You’ve already done your 10,000 hours and then some.

[01:10:23.080] One of the thoughts I had prep­ping for this show is that I’m guess­ing that peo­ple who are going to be inter­est­ed in this show

[01:10:29.940] are prob­a­bly start­ing out along their own invest­ment path, much like your boys,

[01:10:35.180] or maybe even like you might if you have a bit of spare cash.

[01:10:38.960] And it might be worth­while try­ing to put togeth­er a small cap port­fo­lio for them.

[01:10:46.120] So, you know, pick the shares that I might not nec­es­sar­i­ly buy because they’re too small,

[01:10:51.320] but some­one with $5,000 to invest might, or $1,000 to invest might have no prob­lems with the liq­uid­i­ty of that share.

[01:10:59.540] And I think we’ll get some good returns from that port­fo­lio.

[01:11:02.400] Okay, great.

[01:11:03.320] I mean, so we can build that and keep track of it each week and see how it’s track­ing

[01:11:07.620] and give peo­ple some­thing they can fol­low along with.

[01:11:10.340] That’s a great idea.

[01:11:10.940] I mean, mind you, like, even at, I talked about the kids, but even at my age, like, I’m not quite 50.

[01:11:19.020] But even if I was able to start a fund now at my age, by the time I’m 70, I’m still going to be work­ing the way I’m going.

[01:11:27.840] So it’d be nice to build some­thing that could ease my retire­ment from 70 onwards.

[01:11:32.360] Absolute­ly.

[01:11:32.980] I mean, the old say­ing of the eco­log­i­cal activist was the best time to plant a tree was 40 years ago.

[01:11:38.880] The sec­ond best time to plant a tree is today.

[01:11:41.020] Right.

[01:11:41.500] Yeah.

[01:11:41.880] Yeah.

[01:11:42.540] Yeah.

[01:11:42.860] All right.

[01:11:43.260] Well, let’s do it next week.

[01:11:45.840] We’ll start plant­i­ng some trees.

[01:11:47.180] Yeah, good.

[01:11:48.080] Thanks, bud­dy.

[01:11:48.680] All right.

[01:11:48.960] Thanks, Cam.

[01:11:52.200] Well, I hope you sur­vived episode two.

[01:11:54.880] It was a long one, an hour and 10.

[01:11:58.200] Lis­ten, just as a reminder, this, you should not make any invest­ment deci­sions based on this pod­cast alone.

[01:12:06.420] Go out and get some pro­fes­sion­al invest­ment advice before you spend your mon­ey.

[01:12:12.120] And, of course, you can sub­scribe to our newslet­ter.

[01:12:15.760] Go up to our web­site, qavpodcast.com.au.

[01:12:19.740] We’ve got a week­ly newslet­ter that will be com­ing out soon, just with some thoughts from Tony about the mar­ket.

[01:12:26.380] And you can sub­scribe, if you’re lis­ten­ing to this on the web­site, you can go up to iTunes or Spo­ti­fy or any pod­cast app where you get your pod­casts and to sub­scribe to our week­ly updates, week­ly episodes.

[01:12:40.340] My name’s Cameron Riley.

[01:12:41.460] You can find me on Face­book.

[01:12:42.960] You can prob­a­bly find Tony on Face­book if you want to join and chat to us offline about stuff.

[01:12:49.180] And we’ll be back next time.

[01:12:50.640] Thanks for lis­ten­ing.

[01:12:51.260] Thanks for lis­ten­ing.

[01:12:56.380] We’ll see you next time.