Tobias Carlisle Soldier of Fortune: QAV AU #923

QAV AU 923

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Cameron: Wel­come back to QAV. wel­com­ing back to the show our old friend Tobias Carlisle, who has a new book out, Sol­dier of For­tune: War­ren Buf­fett, Sun Tzu, and the Ancient Art of Risk-Tak­ing. And I’m just gonna start with this, and then I’m gonna throw to TK to ask some ques­tions.

But one of the blurbs, this is one of the blurbs. Check this out. “Sol­dier of For­tune is a bril­liant syn­the­sis decod­ing the genius of War­ren Buf­fett through ancient eyes. The book reveals that Buf­fet­t’s unpar­al­leled suc­cess comes not from fol­low­ing com­mon Wall Street max­ims, but rather from the pro­found, patient wis­dom of a war­rior philoso­pher.

This book is a rev­e­la­tion, an indis­pens­able guide to the time­less art of strate­gic risk-tak­ing. Jim O’Shaugh­nessy, author of What Works on Wall Street.” How the hell did you get Jim to write a blurb for your book? We’re huge fans of Jim.

Toby: blurbed a [00:01:00] few of my books. I, I, I, uh, have the good for­tune to, uh, know him and have known him for, uh. He blurbed, I think he blurbed “Quan­ti­ta­tive Val­ue,” which came out in 2012. But I, I found him on, when he came on Twit­ter ear­ly on, he had, you know, like 100 fol­low­ers, and I was, I was one of them. And I reached out to him, and I got to know him then, so I’ve stayed in good, I, I love Jim. He’s a good dude.

Tony Kynas­ton: Wow. Can

Cameron: We only dis­cov­ered his book.

Tony Kynas­ton: him on the show.

Toby: Yeah,

Cameron: Yeah. We’re

Tony Kynas­ton: his chap­ters.

Toby: I’m sure he’d do it.

Cameron: We only dis­cov­ered his book like four or five years ago, maybe less. And I, I think it was dur­ing COVID I read it and I was like, “Oh my God, this is just what we talk about to a T.” Like, he absolute­ly

Toby: The

Cameron: was way ahead. Yeah.

Toby: Yeah.

Cameron: Bril­liant.

Toby: I’ve re- I’ve got a few ver­sions of it. So the. You know, in the orig­i­nal ver­sion, he said that the best val­ue met­ric was price sales, and then in a lat­er edi­tion, he [00:02:00] said it’s EV/EBITDA, is where I get to too. there’s lots of rea­sons why price sales works well, and then he said not, not any one of them, use a com­bi­na­tion is I think what he final­ly fell to.

But that, that sound, like that’s pret­ty sen­si­ble advice, I think. There’s lots of rea­sons to use price sales. It’s not a bad met­ric. It’s just you can’t use any­thing in iso­la­tion, I think.

Cameron: Well, Tony, I’ll throw it to you because you’ve got a list of ques­tions that I don’t want you to miss out on. Why don’t you kick it off?

Tony Kynas­ton: So con­grat­u­la­tions on the book. It’s, it’s, I loved it. It’s fan­tas­tic. love read­ing books on War­ren Buf­fett and cor­po­rate strat­e­gy and strat­e­gy in gen­er­al, so well done. Um, I

Toby: you

Tony Kynas­ton: wan­na start uh, got. The book sort of focus­es on three of War­ren’s invest­ments, excuse me, and they were large for Berk­shire Hath­away and rea­son­ably con­tro­ver­sial in that they did­n’t sort of fit the nor­mal val­ue invest­ment mold, you know, cause I think when the [00:03:00] first one was prob­a­bly done peo­ple were more used to War­ren buy­ing Coke or Amex and hav­ing a you know big moat around a con­sumer com­pa­ny that would go on for­ev­er throw­ing off cash. But there were some dif­fer­ences to these trans­ac­tions. Um but all the all the three of them proved to be out­stand­ing hind­sight. So maybe you could just uh take us through what the three trans­ac­tions were first of all.

Toby: These were, I was look­ing for a way to illus­trate some of the ideas in the book, and I’ve writ­ten a lot about Buf­fett, so I did­n’t wan­na rehash all of the stuff that I had writ­ten pre­vi­ous­ly. Uh, though I think that you could use a lot of that to illus­trate those ideas. So I want­ed to find that I felt were mis­un­der­stood, cer­tain­ly trans­ac­tions that were mis­un­der­stood at the time that they were done. And I vivid­ly remem­ber all of these trans­ac­tions. I was a Buf­fett watch­er just in 1997, so I remem­ber this trans­ac­tion [00:04:00] com­ing through, and I remem­ber being per­plexed. Only, only per­plexed in the sense that I knew that this was an insur­ance deal, and I knew that Berk­shire was an insur­er. And so it did­n’t sur­prise me that he would do an insur­ance acqui­si­tion, but, uh, I did­n’t real­ly have the ana­lyt­i­cal expe­ri­ence at that time to under­stand the trans­ac­tion. Par­tic­u­lar­ly because there are a num­ber of fea­tures of it that cer­tain­ly seemed to go against the grain of what he had been preach­ing in his let­ters up to that point. You know, I’d just dis­cov­ered him, but I’d gone and read all the, the let­ters and, um, tried to orga­nize them. And I had the Lawrence Cun­ning­ham book where he’d sort of put them all into the­mat­i­cal­ly rather than chrono­log­i­cal­ly.

So I, I felt like I had a pret­ty good han­dle on what he was doing, and then he did this, Gen­er­al Re acqui­si­tion. So the fea­tures of the Gen­er­al Re acqui­si­tion that were a lit­tle bit unusu­al were, he did it in stock, and he’d been say­ing you nev­er do it in stock. always prefers to pay cash. [00:05:00] the oth­er thing that. It, it looked, it looked opti­cal­ly expen­sive as well. That was one of the oth­er things that, that folks were talk­ing about. And I think that they had antic­i­pat­ed that crit­i­cism some­what by talk­ing about the syn­er­gies that they were expect­ing from this acqui­si­tion. And you can go back and find Buf­fett pre-Gen Re talk­ing about syn­er­gies, like nev­er man­i­fest­ing every sin­gle firm.

Who­ev­er does an acqui­si­tion and slight­ly over­pays said, “Oh, it’s jus­ti­fied because there are gonna be syn­er­gies,” and they, they nev­er man­i­fest. And so here he was seem­ing to be con­tra, you know, going against what he had pre­vi­ous­ly said that he would do. When you, with hind­sight, the deal worked out real­ly well. and I sort of have been invest­ing for long enough now that I can sort of break it down and ana­lyze it prop­er­ly, which I could­n’t do at the time. But the things that real­ly stand out. The rea­son he did the trans­ac­tion, you have to [00:06:00] go back a lit­tle bit ear­li­er. He’d, he’d done this deal with Coke very famous­ly. With Coke, where sim­i­lar­ly it looked like he’d, he’d over­paid. He was pay­ing a lot for Coke. He’d nev­er real­ly paid up to that extent before. But it was a wild suc­cess. He put a third of the equi­ty of the, of Berk­shire into Coke, then it pret­ty quick­ly, it was like half the equi­ty of Coke, and then it tripled. And by nine, by the late 1990. He so did it like the late 1980s, ear­ly 1990s. By the end of the 1990s, was, um, trad­ing at like 60 times earn­ings. It was a giant part of Berk­shire’s equi­ty hold­ings. Berk­shire on top of that, Buf­fett had been undis­cov­ered, I think, up to that point, but he was well and tru­ly well known by late 1990s. And uh, Berk­shire itself was trad­ing at three times what was prob­a­bly already a pret­ty inflat­ed, val­u­a­tion that includ­ed Coke. [00:07:00] so he can’t sell it because that incurs this huge cap­i­tal gains tax. He’s also preached not sell­ing, hold­ing these things for the very long run. And he’s received a lot of crit­i­cism since then because Coke real­ly has­n’t done much in the 26 years since they did this trans­ac­tion. But I think that that’s because f, that crit­i­cism is, is a lit­tle bit unfair when you under­stand what hap­pened with the, with the Gen Re trans­ac­tion. And this was Christo­pher Bloom­stran sort of alert­ed me to this. But in essence, what he did by using scrip, by using stock, he was able to dilute down the Berk­shire hold­ers their big hold­ing in Coke, and he got prob­a­bly a pret­ty good deal.

He cer­tain­ly paid less for Gen Re than he was giv­ing up in, in the stock that he was to the Gen Re share­hold­ers. So the trans­ac­tion works like this. In a scrip for scrip trans­ac­tion, Berk­shire acquires Gen Re. The share­hold­ers of Gen Re become share­hold­ers in [00:08:00] Berk­shire, and the com­bined enti­ty ends up with a share of, the, the Berk­shire share­hold­ers remain, the Gen Re share­hold­ers become Berk­shire share­hold­ers, dilut­ed down a lit­tle bit.

So the Gen Re share­hold­ers cer­tain­ly got the worse end of that deal. Berk­shire end­ed up with the bet­ter end of that deal. But the essence of the trans­ac­tion was that he dilut­ed down the stock hold­ing in Coke, he was then able to bring down the over­all val­u­a­tion of Berk­shire Hath­away. And Gen Re had a, the syn­er­gies were real in the sense that Gen Re, most of its expo­sure was inter­na­tion­al or, and it was look­ing, and it was a lit­tle bit con­strained by kind of quar­ter­ly earn­ings, so it fit well with, with Berk­shire’s insur­ance book. so that gave him all of this, and their book was most­ly bonds. So peo­ple who’ve fol­lowed Buf­fett will know that they tend to run with uh, insur­ance, uh, poli­cies writ­ten to equi­ty [00:09:00] hold­ing or, or to, to under­ly­ing secu­ri­ties, those poli­cies that they’ve writ­ten because they tend to run with equi­ty, which can, which is more volatile but can per­form a lit­tle bet­ter. Where­as Gen Re was run­ning sort of more, in a more tra­di­tion­al sense. They were using bonds to back their, poli­cies, and the bonds don’t per­form as well over the long run. But they do have this nice fea­ture that when the mar­ket goes down, not always, this is, this is not, this is like a lit­tle bit of a, a received wis­dom in the mar­kets that bonds tend to ral­ly when equi­ty mar­kets col­lapse, and that’s not true.

If you go back far enough, you can see that they, some­times they go to, some­times they move togeth­er, some­times they move dif­fer­ent­ly. You can’t rely on it. It’s only in cer­tain cir­cum­stances, and this was one of those because the equi­ty mar­ket was so over­val­ued. Bonds were yield­ing pret­ty good, pret­ty well at that point.

So the two thou­sand col­lapse actu­al­ly hap­pened, the bonds all ral­lied, which he was able to then sell down, and he was then able [00:10:00] to invest that long in real­ly cheap equi­ties at the begin­ning of the two thou­sand. That set them up for the sort of next decade plus, uh, for Berk­shire to real­ly out­per­form.

So I thought it was a trans­for­ma­tive deal. It was a lit­tle bit mis­un­der­stood at the time, and a good illus­tra­tion of being more defen­sive­ly mind­ed and the pow­er of being defen­sive­ly mind­ed and think­ing about what hap­pens next after the crash. Can you sur­vive the crash? What hap­pens after the crash? And I thought that was a pret­ty good illus­tra­tion of one of the things at Sun Tzu, which is that you defend first, and then you think about, you secure your­self, and then you think about doing all the oth­er things you’re gonna do.

Tony Kynas­ton: Yeah. I mean I think from from um your analy­sis what I took out of it was it was a mas­ter­stroke of strat­e­gy by War­ren doing what he did for for any num­ber of rea­sons. I mean he real­ized the mar­ket was over­val­ued in the late nineties. He real­ized he had a large equi­ty port­fo­lio. He real­ized Berk­shire Hath­away was trad­ing on a to book [00:11:00] ratio which was way above what it nor­mal­ly did, so you know, quite ratio­nal­ly he could have said I’m gonna sell, I’m going to sell my equi­ty port­fo­lio, I’m going to diver­si­fy or what­ev­er. But he had always said if I sell I pay tax­es and that’s a fric­tion on my earn­ings. So he did­n’t want to do that. What else could he do? Well he could take that over­val­ued Berk­shire scrip and he could use it to acquire Gen Re, even though he’s always said I don’t want to issue more scrip. Um I don’t want to pay for things with scrip, I want to pay for them with cash. But he did, he broke that rule to I think a bet­ter out­come, which was he then diver­si­fied into bonds, that was the oth­er inter­est­ing thing is he’s you know always preached that um diver­si­fi­ca­tion is diver­si­fi­ca­tion but in that case he did diver­si­fy away from bonds. And then of course he um. And and Gen Re I think from mem­o­ry was con­strained, it could only invest in triple A secu­ri­ties or some­thing like that to back up its insur­ance pol­i­cy, so it [00:12:00] had to own bonds. Uh so he got a low­er price for Gen Re with the scrip bid than he would have oth­er­wise got­ten per­haps. And then of course he inher­it­ed the the um port­fo­lio that Gen Re had and spent a lot of time unwind­ing those and coined the expres­sion that deriv­a­tives are weapons of mass finan­cial destruc­tion, which was anoth­er inter­est­ing insight into it. So yeah. But but you raised a point there which I think brings us

Toby: think

Tony Kynas­ton: ahead.

Toby: I was just gonna say, I think that he tipped his hand a lit­tle bit with that when he said that he dis­cov­ered the, the. He gave the rea­sons for why he had done it, that it was this sort of defen­sive move, and then he, after the fact, dis­cov­ered the, uh, the weapons of mass finan­cial destruc­tion. And he instruct­ed them to unwind them real­ly quick­ly, and I think they end­ed, it end­ed up cost­ing them $400 mil­lion, and it sort of

Tony Kynas­ton: Mmh­mm.

Toby: the

them that even in a be- even in a benign mar­ket, two par­ties to the same trans­ac­tion could both be car­ry­ing it in their books at a prof­it, which is, like, impos­si­ble because one [00:13:00] par­ty has. is down and one par­ty is up. And so unwind­ing it was quite dif­fi­cult. He said it cost them $400 mil­lion, and he start­ed warn­ing about that. But that was well before all of those prob­lems man­i­fest for the oth­er insur­ers in the great finan­cial cri­sis, glob­al finan­cial cri­sis.

Tony Kynas­ton: Exact­ly. And and that’s again I think a an exam­ple of what you’re say­ing um about the defen­sive nature of the Sun Tzu strat­e­gy. It’s uh it’s you know to to fin­ish first, first you have to fin­ish type approach to it. And I think there was a a book writ­ten a cou­ple of years ago which summed it up well which said that the art of win­ning is not los­ing. I think that was the title of it. It talked about you know if you’re a good ten­nis play­er you keep the ball in play. You don’t try and go for

Toby: Right.

Tony Kynas­ton: on every sort of stroke. So sim­i­lar sort of approach. But um and I think that was summed up in your book by the term via neg­a­ti­va, not sure how you pro­nounce that, but via neg­a­ti­va,

which which uh Char­lie talks about. So could you maybe [00:14:00] out­line that and how it fits into these um acqui­si­tions please.

Toby: Via neg­a­ti­va is an idea that, it means by way of the neg­a­tive. And y‑y, the idea is that you, you go f, might not know what the right thing to do is, but you might have a pret­ty good idea what the wrong thing to do is. so you elim­i­nate all of the things that are the wrong thing to do, and that might leave you with the solu­tion to the prob­lem. And that’s very much. it’s a Char­lie Munger idea. And he, he says, “Invert, always invert,” which he gets from Carl Jaco­bi. But the idea is that just do exact­ly that. You don’t, you have a list of things that you don’t do, and so you could think of this as a check­list. Lots of investors do it this way. I, I like to do it this way.

I like to exclude lots of things ini­tial­ly. takes a, takes the men­tal load down a lit­tle bit. You don’t waste time with things that you’re just nev­er gonna do. And so that might be, for m- for me, it’s avoid­ing sta­tis­ti­cal earn­ings manip­u­la­tion, sta­tis­ti­cal fraud, all these [00:15:00] sort of lit­tle things that have. it makes it very hard for you to fi, to, to be assured of the intrin­sic val­ue. So you just take away the donuts, take away the zeros, and invest in what remains and, that’s the, that’s the sort of sim­ple appli­ca­tion of it.

Tony Kynas­ton: Yeah Um I think uh in your book you quote Char­lie who says We try not to be stu­pid rather than try to be very intel­li­gent I think was a good sum­ma­tion of it as well Yeah And um I remem­ber hear­ing an inter­view with uh with Char­lie um not long before he passed uh where he talked about came to him with an exam­ple of an invest­ment he would always ask for the case where it did­n’t work where it failed Under what cir­cum­stance does it fail And he’d start there and then work back into whether it was a good invest­ment or not So the the their mind­set is real­ly around how do we avoid ruin um in what we do And you know that leads you to not tak­ing on too much debt for exam­ple um you know and

diver­si­fy­ing when you need to all that [00:16:00] kind of thing So that I thought that was very a very inter­est­ing mind­set You also talk about anoth­er con­cept called Wu Wei Um can you tell me about that and how it applies

Toby: Yeah, I think– let me, let me, let me talk about the next trans­ac­tion

Tony Kynas­ton: Mmh­mm

Toby: uh, Wu Wei into it. So the, the next one was the Burling­ton North­ern San­ta Fe, um, that hap­pened in 2009. I remem­ber it being announced. I remem­ber peo­ple being absolute­ly per­plexed because Buf­fett had been this advo­cate for cap­i­tal light com­pounders that grow and throw off cash flow they grow. And here he is buy­ing a rail­way, which is the exact oppo­site of that. It’s cap­i­tal inten­sive, sucks up an enor­mous amount of cap­i­tal. And for 100 years before he had done that deal, had just been where cap­i­tal goes to die. the, the f- the very first, uh, secu­ri­ty analy­sis is almost entire­ly about ana­lyz­ing rail­way bonds because there [00:17:00] had been this mania for rail­ways at one point where they were the tech stocks of the day that attract­ed a lot of cap­i­tal. They’d over­built uh, there was no there there at the end of all of that. And so the next 20 or so years after that were peo­ple buy­ing the bonds of bank­rupt rail­ways and get­ting con­trol of the equi­ty, through that method. And so, uh. And then they real­ly had­n’t done much for most of the peri­od after that they’re so cap­i­tal inten­sive. And so when Buf­fett bought it, it was, uh, it was tru­ly bizarre, uh, that he had, had bought this thing. But pret­ty quick­ly after that, in the few years after he had bought it, um, the, the price that he had paid up front was shown to be much, much low­er than he actu­al­ly had paid because it had a whole lot of excess cap­i­tal on its bal­ance sheet that he was able to pull out. And pret­ty quick­ly it was return­ing very sub­stan­tial div­i­dends. And [00:18:00] he li– I think he liked the fact, ’cause this was, this was dur­ing 2009, uh, inter­est rates were very low. For­ward returns looked like they were very low too, and this was a way for them to get a reg­u­lat­ed 10% the CapEx that they would require, which was very sub­stan­tial.

So it sort of com­mit­ted them to these enor­mous cap­i­tal expen­di­tures inside Burling­ton North­ern that gave them a reg­u­lat­ed return on it, which was pret­ty sub­stan­tial. And in addi­tion to that, no one’s build­ing new rail­ways, no one’s over­build­ing what they have. then I thought that there was this geo­graph­ic dis­tri­b­u­tion that the US was sort of shift­ing from pri­mar­i­ly a rela­tion­ship through the East Coast with Europe to rela­tion­ship with Asia via the West Coast, and that was where Burling­ton North­ern had, had its foot­print. And so it gave them this, total­ly dif­fer­ent, geo­graph­i­cal dis­tri­b­u­tion. Plus it had these pret­ty impres­sive tax, uh, tax [00:19:00] qual­i­ties that meant that they could write off a lot more tax than they would oth­er­wise write off. So on a, a cash in, cash out basis and on a return on invest­ment basis, it was, it was a, it was a great deal for Berk­shire, even though ini­tial­ly it did­n’t seem that way or opti­cal­ly it did­n’t seem that way. So I use it as, it– I use it as pri­mar­i­ly this, this idea of coup d’œil, which is, they say that the great gen­er­als have the coup d’œil, and Napoleon had the coup d’œil that you show up to. it means a stroke of the eye. And so w- uh, old Napoleon, he famous­ly would show up at bat­tle­grounds where one of his gen­er­als was doing some­thing, and he would see some­thing that the gen­er­al had­n’t seen, and it might be the, uh, the ene­my was all pushed up against the, lake with water behind them, and so could­n’t move, and they were all, uh, they were, they were, they were stopped.

They weren’t doing any­thing. They were in a truce or some­thing like that. And he would sort of imme­di­ate­ly say, “You need to attack them right now,” because he had under­stood that they had this advan­tage that would– that could slip [00:20:00] away pret­ty quick­ly if they were allowed to get away. Buf­fet­t’s the same.

He’s– He under­stands the tax, he under­stands the reg­u­la­to­ry envi­ron­ment, under­stands the geo­graph­ic loca­tion, and he under­stands that he can get this reg­u­lat­ed return on this invest­ment. And even though rail­ways have been a ter­ri­ble invest­ment for so long, he sees all of these things, so he can just ignore the fact that rail­ways have been a bad invest­ment, and he can see that he can get this quite sub­stan­tial return if they move quick­ly and, and buy Burling­ton North­ern, which they end up doing. And since then, it’s been a, been a stun­ning suc­cess, and I track the sort of pay­ments out of it in the book, which, um, have been extra­or­di­nary. Like, it seems to be the Buf­fett idea is that you make the invest­ment and then the cap­i­tal comes back. So even though it’s cap­i­tal inten­sive, it’s had this great ROI for,

Tony Kynas­ton: You fo you focused on the

Toby: I,

Tony Kynas­ton: okay we’ll come back to it But before you do um you focused on uh the tax It’s almost like a car­ry trade I guess um that [00:21:00] Burling­ton had for Buf­fett that he picked up on can you just explain that Cause I I found it a bit hard to fol­low in the book I don’t know if it’s a it’s a um a unique to US account­ing stan­dards but I can’t think of an exam­ple of it in Aus­tralia that uh match­es it

Toby: Yeah, some­times in the States they have these, um, they allow you to write down 100% of an invest­ment in the year that you make the invest­ment. And so your tax in that year is reduced by the size of your invest­ment. So an exam­ple for, uh, indi­vid­u­als in the States is if you buy a work­ing– you buy a car that weighs more than 6,000 pounds, which is deemed to be like a truck or kind of work­ing truck, you can depre­ci­ate 100% of it in the year that you buy it. it hap­pens that like there’s a lot of lux­u­ry kind of SUVs that qual­i­fy because they’re very heavy, and so you can buy your­self a lux­u­ry SUV and write 100% of it off in the year that you buy it, and it comes off your tax. Just accel­er­at­ed [00:22:00] depre­ci­a­tion

Tony Kynas­ton: Right And how did that accel­er­at­ed depre­ci­a­tion ben­e­fit Berk­shire in this case

Toby: Well, they’re, they’re able to write down. It– You, you’re able to make an invest­ment and write down more of it ini­tial­ly the first year or so of, of mak­ing the invest­ment, which just gives you more tax cov­er. So your, your earn­ings are reduced to the extent that you write down cap­i­tal gains tax in a, in a, in any giv­en year

Tony Kynas­ton: the the I mean the hypo­thet­i­cal­ly they could invest in Burling­ton and pay no tax It’s all going back to Burling­ton real­ly

Toby: I‑internally in Burling­ton, they can, they can do that. I, I don’t think it would get. I don’t think they would ever get to the point where they were pay­ing no tax, but you can reduce– You can make of dol­lars of invest­ment in rail­way bridges and, and so on, and write them down. I for­get the exact detail of, of it because I, uh, I wrote the book a lit­tle while ago now, but that the– You can, you can accel­er­ate the depre­ci­a­tion, which is not uncom­mon for cer­tain in cer­tain indus­tries, you’re allowed to accel­er­ate your depre– [00:23:00] So oil and gas has a sim­i­lar kind of idea.

Tony Kynas­ton: Yep

Toby: think that they’ve intro­duced some­thing for some of the hyper­scalers as well, where we’re able to write down what you have. And so you make a bil­lion dol­lars of invest­ment this year that has a use­ful life that might be five, 10, 15, 20 years, but you write it all down this year, and so it gives you some tax cov­er to the extent that you’ve writ­ten it down

Tony Kynas­ton: Yeah right Because I I did won­der whether fact Berk­shire may have under­in­vest­ed in Burling­ton because they could they could hypo­thet­i­cal­ly invest a lot get a tax ben­e­fit from it and I guess get a bet­ter offer­ing for their cus­tomers and be more com­pet­i­tive have bet­ter mar­gins longer term and and gain some kind of advan­tage which would allow them to scale the busi­ness quick­er than if they could­n’t get that tax advan­tage

Toby: I think that there’s some lim­it to how much scal­ing they can do because there’s not a lot of y- you know, it’s hard to build more rail­way, but you can cer­tain­ly fix the bridges,

Tony Kynas­ton: Yeah

Toby: it’s, you know, [00:24:00] in pris­tine con­di­tion

Tony Kynas­ton: Right But you you did use that exam­ple to talk about Wu Wei so I’ll come back to that maybe explain what that is and how it applies to the Burling­ton acqui­si­tion

Toby: Wu Wei is this idea that, um, it’s– it– there’s lots of dif­fer­ent inter­pre­ta­tions of, of what it means. It’s kind of a nice term. I like the idea. I think it’s good for val­ue investors who are nat­u­ral­ly con­trar­i­ans. Some­times if you look at a busi­ness, the busi­ness, has these great tail­winds that, mean that it’s prob­a­bly worth more than you would pay for some­thing that h‑has a head­wind or has a per­ma­nent head­wind.

And so the idea is that, like, that you, you allow some­thing to go on win­ning. Wu Wei is this sort of qual­i­ty that means that it’s just going to. it’s, it’s effort­less suc­cess or they, they sort of use it in a, in a, in a social set­ting. It’s like [00:25:00] sprez­zatu­ra or– which is this Ital­ian word for, you know, just like ease of con­ver­sa­tion, ease of dress­ing, like just, just being loose and, um, flex­i­ble in social sit­u­a­tions or in an invest­ment sense, it would be sort of being a lit­tle bit more flex­i­ble about the way that you con­sid­er an idea and look­ing at ways that it can, can win over time.

I think it is a lit­tle– it’s a lit­tle bit woo, you know, the, the Wu Wei, I think is a lit­tle bit woo, and I’m, I’m not a par­tic­u­lar­ly woo guy, but I’ll– I do like the idea of, um, just hav­ing that like men­tal flex­i­bil­i­ty in cer­tain sit­u­a­tions, just being a lit­tle bit loos­er. And I think that, I think that that w– is what allowed him to sort of break away from this idea that were where mon­ey goes to die, and that this was a sit­u­a­tion where it sort of met all of his oth­er cri­te­ria, did throw off cash.

It was going to be this sort of not cap­i­tal-like com­pounder, but it was– it sort of behaves that way [00:26:00] because they can invest, uh, with the cap­i­tal gains tax, accel­er­at­ed depre­ci­a­tion. They get all these sort of ben­e­fits out of it, plus the dura­bil­i­ty, plus the, uh, the dis­tri­b­u­tion. All of these things togeth­er, sort of sum up to some­thing that is a lit­tle bit more than the sum of its parts

Tony Kynas­ton: I

Cameron: Sor­ry, I just have to, the, I, I just have to jump in with the kung fu anal­o­gy of wu wei, Tony. It’s just too much to give up. Bruce Lee, big fan of wu wei. Any­one who’s ever read any of Bruce Lee’s stuff on kung fu, you pour water into a cup, it becomes the cup. That’s You pour water into a bot­tle, it becomes the bot­tle.

You put it in a teapot, it becomes the teapot. Now, water can flow or it can crash. Be water, my friend. I do Wing Chun kung fu, uh, Tobias, and we talk about action through no action all the time, you know? Using your oppo­nen­t’s ener­gy against them, using their force against them. [00:27:00] You know, mov­ing with the force.

Don’t fight the force. Flow around the force. Yeah.

Toby: Yeah. It’s, it’s, it’s a real, it’s a, it’s a cen­tral idea in mar­tial arts, right? And I mean mar­tial arts like Sun Tzu is, is, is the, the head of phi­los­o­phy of mar­tial arts, and then you find out it’s repeat­ed, that idea of be like water, like that comes from Sun Tzu. He talks about, he talks about that repeat­ed­ly through­out the, through­out the text, and then you find it in oth­er things like The Book of Five Rings, and you find it in Bruce Lee’s say­ings, and it’s, it’s often taught, this idea that you use the ener­gy of your oppo­nent or use the ener­gy of the thing, or to aug­ment your own.

Don’t fight it, sort of move with it

Cameron: The famous line from Napoleon is, “Nev­er inter­rupt your ene­my when he’s mak­ing a mis­take,” right?

Toby: That’s a good one

Cameron: Yeah.

Tony Kynas­ton: Yeah I

Cameron: Yeah, no, it’s a good one. It’s,

Tony Kynas­ton: water Yep that’s that’s

Cameron: be water

Tony Kynas­ton: it It’s the water flow­ing around the rock idea not try­ing to move the [00:28:00] rock not try­ing to crush the rock around the rock It’s the way of

Cameron: Yeah.

Tony Kynas­ton: I

Cameron: Yeah

Tony Kynas­ton: good friend in Cana­da whose nick­name is Wu cause he just goes with the flow and uh you know if you’re g gen­er­al­ly calm yep always always smil­ing and hap­py does­n’t mat­ter what’s going on with the flow Yeah

Cameron: うん。うん。

Tony Kynas­ton: you’ve tak­en that out of the trans­ac­tions be and I think that’s a legit­i­mate take out from these trans­ac­tions often­times with these con­tro­ver­sial trans­ac­tions with um Berk­shire Hath­away it’s almost like War­ren said one thing for decades and then he’s just turned on a dime and done some­thing dif­fer­ent cause it suits him Yeah He’s flex­i­ble Exact­ly

Toby: flex­i­bil­i­ty, like that’s, that is, that is part of it. You have to be men­tal­ly flex­i­ble, and I think it’s, it– there’s lots of dif­fer­ent inter­pre­ta­tions of it, but men­tal flex­i­bil­i­ty and also like look­ing at the thing. Some of these busi­ness­es have that tail– just have that nat­ur­al tail­wind to them.

Some man­agers have that nat­ur­al tail­wind, and I think if you can [00:29:00] rec­og­nize it uh, you know, not fight it too much. Like fight­ing it might be insist­ing on too low a price before you do it, going with it might be just you can afford to pay up, and I think he did that with Coke. Um, cer­tain­ly sort of paid up for it a lit­tle bit. North­ern just being men­tal­ly flex­i­ble, and I think it also applies with the, uh, the Japan­ese con­glom­er­ates that I’m sure we’re gonna talk about short­ly.

Tony Kynas­ton: are yeah

Cameron: we do that, you.

Tony Kynas­ton: sor­ry go ahead

Cameron: Sor­ry, before we do that, can we talk about Apple? You start the book talk­ing about Apple, which you call the great­est trade of all time, and obvi­ous­ly that’s been one that I think for a lot of, uh, Buf­fett fol­low­ers, they scratched their head when he bought into Apple after say­ing for decades that he did­n’t under­stand tech­nol­o­gy stocks.

Why is it the great­est trade of all time, in your opin­ion?

Toby: Well, I also say that it’s a lit­tle bit in the eye of the behold­er. It’s like mod­ern art. You sort of– It speaks to you or it does­n’t. And I think that. But I, I, I have, I have– I think I have pret­ty good, pret­ty good rea­son­ing. The– [00:30:00] When I say this, peo­ple often say, “Well, what about the, uh, Naspers doing the Ten­cent deal?”

Like, that’s the one that every­body comes back to because they put in twen­ty mil­lion and it’s tens of bil­lions of dol­lars and it’s. They’ve had to split it out from Naspers and it’s like total­ly mis­shapen the South African stock mar­ket. And then I say, “Well, this was the great­est trade ever because Buf­fett was a known quan­ti­ty at the time.

Apple was the most famous com­pa­ny in the world. Might’ve been the biggest com­pa­ny in the world at the time. could’ve done the deal. Any­body could’ve put that trade on. a few peo­ple did, even though we ha- we had, fun­ni­ly enough, we’ve writ­ten about it a few times in Quan­ti­ta­tive Val­ue and oth­er, in oth­er books since as– ’cause it was the, the, the cheap­est thing in the, in the screen at the time.

It sort of– It used to have this, it does­n’t do this so much any­more, but it used to have this, uh, cycle where every time they issued a new iPhone, it’d run up and do real­ly well, and then in the inter­ven­ing peri­od, it’d sort of fall back. So [00:31:00] in 2013, it got cheap and then it had a good run. 2016, got cheap and then had a good run.

And same thing was hap­pen­ing in sort of the 2019, 2020. But I think it’s moved away from that a lit­tle bit. It does­n’t have that behav­ior so much any­more. I say he put in an enor­mous amount of mon­ey, I think it was forty bil­lion dol­lars or some­thing, in pret­ty short order. If you think about the enti­ties that can do trans­ac­tions on that scale, there aren’t very many of them.

But I’m sure that, you know, maybe, uh, who’s the Japan­ese guy, uh, who. He’s the Japan­ese gun­slinger. He w- he had a, he did a great– had a great run in 2000 and almost blew up, like went back nine­ty-nine per­cent, and then he’s had a great one more recent­ly. Name’s just escap­ing me. He runs NTT Doco­mo.

Cameron: Oh yeah

Toby: Uh, Masa son

Cameron: Oh, Masa son. Yeah, right.

Toby: What’s this?

Cameron: it’s n-

Toby: Any­way, Masa. Masa– There aren’t very– Like, maybe big pri­vate [00:32:00] equi­ty firms could have done that. Masa could have done that. aren’t very many folks who could have dropped a forty bil­lion, but, like, they– I’m sure that they would all have loved to have had this insight and put the forty bil­lion to work. Because pret­ty quick­ly, he’s three X’d, five X’d on an enor­mous sum of mon­ey, and then he’s sold that down enor­mous­ly, and it’s giv­en him a big part of that three hun­dred and sev­en­ty bil­lion dol­lar war chest that they have now for a rainy day, if we ever see anoth­er rainy day, uh, for his– for Greg Abel, G- for Greg Abel to run.

And he sold it down very sig­nif­i­cant­ly. It’s still one of their biggest hold­ings, but it’s not nowhere near as big as it could have been if they just in it and hold it. So I thought for all those rea­sons, he was a known quan­ti­ty. It was a very big invest­ment. It paid off very, very quick­ly, and it was a break from what he had done in the past.

It just, again, it demon­strat­ed that men­tal flex­i­bil­i­ty and, and it worked real­ly well. And I’ve just thought in, in terms of the sheer scale of the return on the size of the invest­ment, that dis­tin­guished [00:33:00] it from the Naspers invest­ment, which was a small­er invest­ment, and per­haps they got lucky. Like, if you, if you had to think about all of the made around the world on every stock mar­ket, and you had to go to the South African one and a Chi­nese, you know, to find some­thing that was, like, equiv­a­lent, then I think it sort of illus­trates the point that Buf­fet­t’s was a great invest­ment.

Tony Kynas­ton: yeah no just uh I guess talk­ing about invest­ments and what we were talk­ing about before about oppor­tunis­tic invest­ments the link I think to the Japan­ese invest­ment is is the quote you men­tioned uh from Buf­fett that he talks about not hav­ing a mas­ter strat­e­gy or a cor­po­rate plan­ning depart­ment and that acqui­si­tions can seem hap­haz­ard So why do you think that’s an advan­tage for a com­pa­ny like Berk­shire

Toby: You could, you could com­pare it to. So Masa sort of is a tech­nol­o­gy invest­ment, investor. So Masa is sort of con­strained a lit­tle bit. Masa could­n’t go out and do Burling­ton North­ern. That would just– peo­ple would say he’s lost his mind. That’s not a tech­nol­o­gy. He could­n’t do [00:34:00] Gen Re. Masa might have been able to do the Japan­ese con­glom­er­ates, but I don’t think so. Masa’s sort of con­strained to tech. There are lots of oth­er investors out there who are. They’re well known in their niche. They’re not real­ly allowed to step out­side their niche. By sort of say­ing at the out­set, “We, we got, we got no plan. We, we.” You know, so what, what I think about the con­glom­er­ates like Con­stel­la­tion Soft­ware, they, they are– they may now step out­side their niche, but they’ve his­tor­i­cal­ly been ver­ti­cal VMS, ver­ti­cal mar­ket soft­ware. you think about some of the con­glom­er­ates like Rop­ers or Dana­her or those kind of. They’re allowed to do trans­ac­tions in their niche, but they’re not allowed to step out­side that. Berk­shire has always said, “We’ll do what­ev­er comes along that makes sense if it’s cheap enough.” And so they’ve giv­en them­selves that cov­er, that flex­i­bil­i­ty to do what­ev­er they want. There’s no mas­ter plan. They’re not try­ing to build out the ener­gy depart­ment nec­es­sar­i­ly. If some­thing comes along, they would do it, but there’s no urgent need to, to take, you know, the, the clean­est dirty [00:35:00] shirt in any giv­en indus­try, which is some­thing that a lot of investors who are. I have friends who are health­care investors or they’re con­strained to.

And so they’re try­ing to find the best thing, but the indus­try– if the indus­try is over­val­ued, then, um, uh, that’s sort of, that’s sort of bad luck. You have to do, you have to do the best deal that you can. So I, I, I think that it just gave him that. That men­tal flex­i­bil­i­ty is a big part of it. And I think that Sun Tzu says some­thing sim­i­lar where he’s, “Don’t, try and force it.”

Again, this is like that Wu Wei idea. You’re look­ing for. They’re often try­ing to find the, the soft point or the weak point. So you test a lit­tle bit, you look at what’s cheap, you look at what’s mov­ing away, mov­ing down, and then that might be the place where, uh, that, that is the most inter­est­ing. So I, I did­n’t, I did­n’t use that nec­es­sar­i­ly for the Japan­ese, the Sogo Shoshas, but Sogo Shoshas, but we can, we can talk about that one

Tony Kynas­ton: I think um before I leave the quote on the cor­po­rate plan­ning depart­ment the oth­er side of that coin is [00:36:00] that they don’t have the expense of a cor­po­rate depart­ment plan­ning their strate­gies They don’t have all these peo­ple run­ning around who have to jus­ti­fy their exis­tence by buy­ing some­thing that prob­a­bly would­n’t buy Cause these trans­ac­tions the big ones we’ve been talk­ing about they come along once a decade on aver­age for Berk­shire They’re not out in the mar­ket every day know try­ing to find some­thing So I think that’s a big advan­tage for them as well and that brings us to the Japan­ese con­glom­er­ate which is kind of this decade’s big trans­ac­tion And it also is again a head scratch­er for Berk­shire fol­low­ers because Buf­fet­t’s always said I’m gonna back Team USA I’m gonna back the US econ­o­my And then sud­den­ly he’s a major investor in Japan again is anoth­er bit of woowah I guess But um but it’s also an about­face from what he’s always said

Toby: I think he had done He’s done Iskar, which is, which is Israeli. I think he might have done it per­son­al­ly. He’d done some Kore­an. I think maybe that was his per­son­al cap­i­tal. I don’t know if he put Berk­shire into it, but he, he had gone and got the Kore­an [00:37:00] ver­sion of what­ev­er the, you know, the just the guide, and you go, go through A to Z, and he’d just gone through A to Z and found a few net nets and bought them for him­self.

I think, I think Buf­fett has about a bil­lion dol­lars out­side of Berk­shire that he’s just run his own cap­i­tal and run it up to that sort of scale. That’s, that’s what I have heard. That’s what I under­stand. But the– I real­ly like the Japan­ese deal. Again, any­body could have put this–

Tony Kynas­ton: Mmh­mm

Toby: could have put one part of this trans­ac­tion on. But the thing that makes it so was the car­ry part of the, the trans­ac­tion. So the Japan­ese have these trad­ing con­glom­er­ates that were set up dur­ing the Mei­ji era. And because Japan is a small island and it’s resource-con­strained, they got these con­glom­er­ates which were sup­posed to go out to the world and find nat­ur­al resources and bring them back to Japan. And the way that they’ve devel­oped over the years is that they have become ver­ti­cal­ly inte­grat­ed. So they go and find the, the resource in the first instance, and [00:38:00] then they, process the resource, and then they build it into these high­er order goods until they’re, they’re mak­ing tech­nol­o­gy at the oth­er end, and they’re sell­ing cars and, and so on. And so there are five of these, uh, trad­ing hous­es that sort of do this thing, and they, they are dom­i­nant in Japan. If you go to Japan and you wan­na do busi­ness in Japan, it’s high­ly like­ly that you’re, you’re doing busi­ness with these guys. And I was in Japan last year and I met with, with one of them. I, I think it might have been Marubeni. a pri­vate equi­ty group that does, that does of every size from the small­est to the biggest, and they, they have the Marubeni kind of stamp on every­thing that they do. They have this process. Peop– It’s, it’s a com­mon way for folks to leave leave uni­ver­si­ty, start an appren­tice­ship, and sort of grow inside these orga­ni­za­tions. So finds them trad­ing very cheap­ly. They’re like sin­gle-dig­it PEs. all pret­ty good div­i­dend pay­ers. Uh, like might have been, [00:39:00] div­i­dend yields of sort of sev­en to nine per­cent, which is, which is very fat. At the same time, they– you can bor­row in Japan­ese yen at vir­tu­al­ly noth­ing because the Japan­ese yen has been so crushed for so long, or the BOJ has inter­vened in that mar­ket for so long.

So they– You can– You could– I think any­body could get, uh, debt for sort of like half a point, half a per­cent, to a few per­cent. And so if you put these trans­ac­tions on, and that’s what, that’s what Berk­shire did. Berk­shire actu­al­ly had some zero per­cent notes that they were able to issue. So they paid no inter­est at all on these notes, then they invest­ed that into these five con­glom­er­ates.

So they’re rea­son­ably safe because there’s– each one is a con­glom­er­ate already. They’ve got very diver­si­fied income streams, high­ly like­ly to keep on earn­ing the way that they had. High­ly diver­si­fied income streams glob­al­ly across indus­tries. Like they’ve, they, they l- they’re big mach- they’re big sort of enter­pris­es that are [00:40:00] very sta­ble and, and throw off cash pret­ty, pret­ty well. so he’s get­ting car­ried in these posi­tions where the div­i­dends com­ing back in the order of six or sev­en hun­dred mil­lion dol­lars a year, and their cost to finance this was, was vir­tu­al­ly noth­ing. So he was imme­di­ate­ly car­ried on this posi­tion. So it’s anoth­er sort of Buf­fett deal where the cash goes in and it’s almost imme­di­ate­ly cash flow pos­i­tive back to Berk­shire.

And so I just thought it was a, a great trans­ac­tion that, as you say, had sort of been– was a lit­tle per­plex­ing to folks because they expect­ed him to be pri­mar­i­ly a US investor, and he had said that he under­stood the US, he under­stood the reg­u­la­to­ry en- envi­ron­ment, under­stood the, the cul­tur­al envi­ron­ment, and here he was mak­ing a big depar­ture.

And so I thought it was anoth­er like i- illus­tra­tion of how men­tal­ly flex­i­ble he was.

Tony Kynas­ton: Yeah it’s inter­est­ing I mean it’s anoth­er exam­ple of what what I think is one of the secret sources of Berk­shire Hath­away It’s it’s being able to find sources of fund­ing with­out doing a cap­i­tal raise or with­out tak­ing [00:41:00] on debt as you say the car­ry trade has from a you know again from hind­sight was a nobrain­er in the way of get­ting mon­ey back into Berk­shire for the invest­ment But um you know I guess oth­er peo­ple have done it but no one on the scale that he has So he’s always good at find­ing these oth­er ways of get­ting cap­i­tal that he can then rede­ploy

Toby: I also used it as an illus­tra­tion of, um, there’s this idea in Sun Tzu that, um, you, you do the right thing, you get a rep­u­ta­tion for doing the right thing, you do it for the right rea­sons. And then when you go to invest in these Japan­ese com­pa­nies and he bought up to sort of the lim­it that he was allowed to take as an out­side share­hold­er. then he goes to meet with them and his rep­u­ta­tion is ster­ling, and so they, they wel­come him with open arms because they know that he deals fair­ly. know the terms on which he deals, and so they increase their share­hold­ing lim­its to allow him to buy more. then that turns into oth­er syn­er­gies where there, there’s going to be ways for Berk­shire to work with them sort of behind the scenes rather than [00:42:00] just being an equi­ty share­hold­er

Tony Kynas­ton: Ques­tion

Cameron: And he did these deals, if I. Sor­ry, if I remem­ber cor­rect­ly, he start­ed doing these deals dur­ing COVID, right? When the share prices had bot­tomed out, inter­est rates were next to noth­ing. He was able to just, you know, swoop in, bor­row a lot of mon­ey at, like, 0.5 or 1% inter­est rates and Yeah just swoop in. Like, it was per­fect tim­ing

Toby: Again, I think that lots of peo­ple around the world could have done these deals, and it’s just– it was still sort of shock­ing when he did it on the scale that he had done it, just sort of showed what a great investor he was, what a sort of whole world­view he has

Cameron: And, you know, for years before that every­one had quot­ed War­ren as, you know, you know, “You make mon­ey when there’s blood in the streets,” or what­ev­er it is he had said. And he was lit­er­al­ly doing it dur­ing COVID, lit­er­al­ly what he’d been preach­ing for decades. And again, but, [00:43:00] uh, only War­ren, not only War­ren, but he’s one of the few peo­ple who’s pre­pared to go and buy, uh, dur­ing peri­ods like that.

When every­one else is run­ning for the hills, he’s swoop­ing in and doing deals

Toby: Yeah. I think to be fair, he did ini­tial­ly, uh, balk a lit­tle bit and sold out of all of the air­lines, which they, they had that lit­tle bas­ket of air­lines, and they prob­a­bly got the lo- hit the low on punch­ing out of those. But I, I don’t know. I think maybe they were con­cerned that there was, that, that it was gonna be some­thing more per­haps than it was.

That, know, if it’s like a, it’s like a 1916 Span­ish flu, then that’s not good for the equi­ty mar­kets. But as it turns out, it was­n’t that bad, and so they were pre­pared for that kind of out­come, par­tic­u­lar­ly because they’re insur­ers. They might have been, uh, they might have need­ed some cap­i­tal there.

But, uh, pret­ty quick­ly after that, I think that they announced the Japan­ese deals and that they were, you know, amaz­ing deals as they always are

Cameron: Hmm.

Tony Kynas­ton: I remem­ber read­ing about these Japan­ese con­glom­er­ates I’m gonna show my age here after the 1987 [00:44:00] uh bub­ble burst in the stock mar­ket and there was uh a cou­ple of write­ups I read about how I think there was a sim­i­lar sort of struc­ture in some Ger­man com­pa­nies but cer­tain­ly the Japan­ese ones were con­glom­er­ates But they’re dif­fer­ent to con­glom­er­ates as you and I know them They also had a lot of crossh­old­ings and so when the mar­ket crash hap­pened they sup­port­ed each oth­er and there was no large sell­down in their stocks and they rode out the mar­ket troughs pret­ty eas­i­ly and they sur­vived So that’s that was an inter­est­ing I think take on those two But ques­tion for you is um in the last sort of five years the Japan­ese stock mar­ket’s kind of wak­ing up to more West­ern ideas of being more share­hold­er­friend­ly unwind­ing crossshare­hold­ings Did Buf­fett know that was com­ing or did he or did he help agi­tate for change or was it just sim­ply hap­pen­ing any­way

Toby: Yeah, I think that they had been, uh, you know, they– s- the Japan­ese stock mar­ket topped out in 1992 or some­thing like that, and it’s fall­en pret­ty con­sis­tent­ly since then and might [00:45:00] have been close to the all-time lows in the late ear­ly 2020s. And I think that they had real­ized that they need­ed to do some­thing to attract inter­na­tion­al cap­i­tal again.

So uh, Shin­zo Abe had begun these reforms and the Tokyo Stock Exchange was sort of active­ly try­ing to find some way to cause them to become more share­hold­er-friend­ly. We met with the Tokyo Stock Exchange when we were there about this time last year, a lit­tle bit ear­li­er than this last year. And, you know, they have lots of, uh, they have lots of reforms that they’re try­ing to imple­ment, includ­ing this one that most folks know about, which is that you have to get your price to book. You know, you have to get your price to book over one. Oth­er­wise, they pub­lish this list of

Tony Kynas­ton: Yes

Toby: at a dis­count to book.

Tony Kynas­ton: That’s right

Toby: sort of try­ing to get them to get rid of the, the cross-share­hold­ings because, [00:46:00] uh, it sort of pre­vents them from being tak­en over.

It insu­lates the, the man­age­ment team from sort of exter­nal forces. When we went there, uh, when I first got there and we sort of met with some of the pri­vate equi­ty firms and the activists and includ­ing Muraka­mi, like they were telling us the ratios that they were pay­ing for these com­pa­nies, and I was ready to write it all down here and move to Japan and start doing this ’cause it was like, I thought it was like the US in the 1980s and it was gonna be. And I think that to some extent that has hap­pened. But we pret­ty quick­ly cooled down when we actu­al­ly met with some of these com­pa­nies. When you talk to them, you sort of under­stand how dif­fi­cult it is cul­tur­al­ly to shift them because their ratio­nale for the cross-share­hold­ings and also they all have, you know, they might. Uh, these num­bers are wrong, but you know, they have huge cash hold­ings that are just dis­pro­por­tion­ate to the size of the mar­ket cap­i­tal­iza­tion. And so once you back out the cash, you’re pay­ing vir­tu­al­ly noth­ing and then they’re, they’re pret­ty well earn­ing. [00:47:00] But they have this view that they won’t be good part­ners to their, or to their cus­tomers rather, and their sup­pli­ers, if they don’t have that big cash buffer that they could go out of busi­ness ’cause they could have a bad year or decade or some­thing like that, and that might send them out of busi­ness. And so they were very unwill­ing to con­sid­er pay­ing that cash out to share­hold­ers. And in their sort of con­stel­la- you know, like a Porter’s five forces or if you think about the, stake­hold­ers in a Japan­ese firm, like it’s cus­tomers and sup­pli­ers and employ­ees reg­u­la­tor and share­hold­er, and share­hold­er was right at the bot­tom and last, and they had their oblig­a­tions to all the oth­er ones super­seded those.

So it was gonna be a very dif­fi­cult lift, a real dif­fi­cult process to get them to shift. I think that you look at the, you know, the thing that they had had, they had no infla­tion for so [00:48:00] long that it was real­ly dif­fi­cult to put up prices and it was con­sid­ered, you know, it was like, uh, it was social­ly unac­cept­able to put up prices. So over the, the last, even the last 12 months, maybe slight­ly longer than that, the, um, infla­tion has now start­ed to pick up in Japan pret­ty sig­nif­i­cant­ly, and it’s meant that they’ve seen this quite sig­nif­i­cant rise in the yields on, uh, Japan­ese bonds, Japan­ese gov­ern­ment debt. Infla­tion is sort of there.

The yields are com­ing up. That means that, uh, the, the fire may have been lit and they may have to start rais­ing prices and, and mov­ing and doing things. So Japan, uh, prob­a­bly that, that dif­fi­cul­ty in shift­ing it means that it’s going to take a decade or two decades to sort of resolve the issue, but they’re prob­a­bly mov­ing in that direc­tion now.

And it’s one of the great world’s great economies. They’ve got incred­i­ble, um, tech­nol­o­gy. So I think it’s, it’s prob­a­bly gonna be a good place to invest for, [00:49:00] for the next few decades. Hav­ing said that, you know, folks had the same view about a decade ago, and a lot of peo­ple went and bought Japan­ese net nets, and so I think they worked out okay, but they did­n’t sort of work out any­where to the extent that peo­ple thought they were going to.

But, you know, this time’s dif­fer­ent.

Tony Kynas­ton: Yeah. Um inter­est­ing, inter­est­ing change in Japan. I think, don’t they have a con­cept now with a VIP club for shares trad­ing above book val­ue, where you get access to a spe­cial dis­count and things like that, you get ben­e­fits from from doing the right thing.

Toby: Yeah, they were try­ing to shame for not going through with these things. And, uh, and we would say, you know, because they, they gave them like a two-year grace peri­od to get them­selves sort­ed out, and we would say, “What hap­pens if, you know, they don’t do that?” And they’d say, “Oh, they’ll be shamed.”

I’m like, “Oh, well then, and then what?”

Tony Kynas­ton: Mmh­mm

Cameron: Have to com­mit harakiri.

Toby: There’s, that’s it. There’s no enforce­ment mech­a­nism. It’s just

Cameron: I apol­o­gize to my ances­tors. We talked about that about a year ago, [00:50:00] Tony, on the US show when we talked about Orix Cor­po­ra­tion. I remem­ber us talk­ing about all these deals. By the way, Orix is up about 90% since we talked about it in June last year, so it’s been all right. Yeah.

Tony Kynas­ton: Tobias

Cameron: did well

Tony Kynas­ton: um I’m gonna wrap up my dis­cus­sion around the book. It’s a won­der­ful book and I rec­om­mend it to any­one who likes read­ing about Buf­fett like I do. But I had some ques­tions about just gen­er­al­ly invest­ing in the US because in the last year Cam and I have been doing a val­ue invest­ing US show and there’s a cou­ple of con­cepts which we’ve puz­zled over and you might be able to help us out. Um the first one is ADR. So a lot of the val­ue we’re see­ing in the US mar­ket comes from over­seas com­pa­nies who have an ADR in the US. Is there a rea­son why as a class they might trade below what say a local com­peti­tor might trade at in the US?

Toby: Yeah, it’s not, again, it’s cul­tur­al. It’s not

no [00:51:00] tax rea­son that it would do that. And there’s, I can give you a, a fun­ny sto­ry about the ADRs. So Amer­i­cans can invest in the ADRs of these Kore­an chip mak­ers. Um, but they have sort of resist­ed doing it because they’re ADRs. And so there’s an ETF run by some friends of mine, Round­hill, called DRAM, D‑R-A‑M.

It’s the fastest-grow­ing ETF launch in his­to­ry. They’ve raised some­thing like. Last time I checked, it was thir­teen point eight bil­lion dol­lars, and that was a few ago, so the num­ber could eas­i­ly be over that now because every time I check, it’s so much high­er. The under­ly­ing stocks have done real­ly well too because they’re real­ly AI

Tony Kynas­ton: Mmh­mm

Toby: kind of names.

But the big inno­va­tion that that ETF had, were invest­ing through the Kore­an ETF because it gave them access to these two chip mak­ers. And DRAM just showed up and said, “We’ll give you a.” [00:52:00] You know, DRAM is the mem­o­ry. “We’ll give you access to these two Kore­an names, pret­ty con­cen­trat­ed, and some oth­er chip mak­ers.”

And the, the, mon­ey has flood­ed in because you can now invest through an ETF into these Kore­an names when they, pre­vi­ous­ly, you could have done that through an ADR, but the aver­sion to ADRs seems to be so great that they want­ed to do it through a ded­i­cat­ed ETF and now it’s, it’s been a great suc­cess for those guys.

Tony Kynas­ton: Yeah I find that strange. Is it, is it a bit of Peter Lynch that peo­ple wan­na be able to walk up the street and see what they’re buy­ing? Or is there like an extra com­mis­sion in there cause it’s an ADR? You know it just seems real­ly strange to me.

Toby: I don’t think so. It might be a for­eign exchange, it’s pos­si­ble that it’s hard to invest through some bro­ker­age accounts. If you have an Inter­ac­tive Bro­kers account, I think it’s pret­ty easy. I think most bro­ker­age accounts allow you to do it

Tony Kynas­ton: Yeah

Toby: sim­ply. It might be that. I, I just think it’s a, I just think it’s an aver­sion to, to doing any­thing.

It, they look, it just looks a lit­tle bit weird in your bro­ker­age account, and [00:53:00] I think that that’s been the main rea­son they haven’t done it.

Tony Kynas­ton: Well maybe Berk­shire Hath­away will scoop them all up because they tend to try to dis­count to sim­i­lar sim­i­lar list­ings in the US. Yeah.

Yeah.

And the oth­er ques­tion I’ve got for you is that, um, you know we focus on oper­at­ing cash flow when we’re look­ing at invest­ments. Um, oper­at­ing cash flow is my pre­ferred met­ric rather than price to earn­ings because of the abil­i­ty to manip­u­late earn­ings. But um, we’re com­ing across com­pa­nies that seem to be putting invest­ing cash flows in the oper­at­ing cash flows. We had a prop­er­ty devel­op­ment com­pa­ny we looked at and when they flipped a trans­ac­tion the income went through the oper­at­ing cash flow state­ment. Have you noticed any dif­fer­ence between US account­ing stan­dards and Aus­tralian ones that would cause that? Or know any oth­er rea­son you can think of why it would hap­pen?

Toby: Well, I, I grew up in the IFRS sys­tem, and I did account­ing at, at [00:54:00] uni­ver­si­ty and, and learned IFRS when I did that. I think it was just being imple­ment­ed at that time. Uh, IFRS has a, has a local imple­men­ta­tion all around the world. So Cana­di­an IFRS is slight­ly dif­fer­ent to

Tony Kynas­ton: Mmh­mm

Toby: but pret­ty, pret­ty sim­i­lar. When I moved to the States, I had to get my head around that, and I, there are some sub­tle dif­fer­ences between the two, but they’re real­ly not that sig­nif­i­cant. They’re, they’re pret­ty sim­i­lar. What you’re talk­ing about might be a spe­cif­ic thing to REITs, like a, but I don’t know why a sale of a build­ing, is that what it was?

Tony Kynas­ton: No. So this com­pa­ny in par­tic­u­lar and we’ve seen oth­er exam­ples but this guy was a prop­er­ty devel­op­er. They go and buy, they go and have a buy, land bank and then they devel­op it. They put a syn­di­cate togeth­er, um, and use the last land bank sale to fund the next one. But that sale was going through oper­at­ing cash flow rather than being an invest­ment cash flow entry.

Toby: Maybe that’s their busi­ness and so they have to do it that way. I don’t know. Off the top of my head, I don’t know. I don’t invest in REITs, so I don’t see, [00:55:00] don’t real­ly have to think about that prob­lem.

Tony Kynas­ton: Yeah. Okay. All right. I think that’s my list.

Cameron: Yeah, the suit

Tony Kynas­ton: ques­tions

Cameron: Oh, not, well, not a ques­tion as such. Just a cou­ple of quotes from the book that we’ve sort of touched. We, you were talk­ing before about, um, not doing any­thing stu­pid. It was in chap­ter five, you men­tioned that Buf­fet­t’s fun­da­men­tal goal is sur­vival, and this real­ly res­onat­ed with me. Um, a cou­ple of quotes that you got that I just thought were worth read­ing out.

“Buf­fett explained his view on the risk of ruin in these terms. ‘Even in 1965, per­haps we could have judged there to be a 99% prob­a­bil­i­ty that the high­er lever­age would lead to noth­ing but good. Cor­re­spond­ing­ly, we might have seen only a 1% chance that some shock fac­tor, exter­nal or inter­nal, would cause a con­ven­tion­al debt ratio to pro­duce a result falling some­where between tem­po­rary anguish and default.

We would­n’t have liked those 99 to one odds and nev­er will. [00:56:00] A small chance of dis­tress or dis­grace can­not, in our view, be off­set by a large chance of extreme returns.’ ” Then lat­er on in the chap­ter you say, it’s got a quote for him, I think at a Uni­ver­si­ty of Flori­da School of Busi­ness in the late ’90s.

“If you risk some­thing that is impor­tant to you for some­thing that is unim­por­tant to you, it just does not make any sense. I don’t care whether the odds are 100 to one that you suc­ceed or 1,000 to one that you suc­ceed. If you hand me a gun with a mil­lion cham­bers in it, and there’s one bul­let in the cham­ber, and you said, ‘Put it up to your tem­ple.

How much do you want to be paid to pull it once?’ I’m not gonna pull it. You can name any sum you want, but it does­n’t do any­thing for me on the upside, and I think the down­side is fair­ly clear. I’m not inter­est­ed in that kind of game.” And, you know, I think about that a lot, uh, whether it’s, you know, uh, uh, Bit­coin, peo­ple say­ing, “Yeah, buy Bit­coin,” or it’s Mag Sev­en stocks and all this [00:57:00] kind of stuff.

And it’s just this, this idea that I’ve learned from Tony over the last six or sev­en years we’ve been doing this show. It’s about just the phi­los­o­phy of invest­ing, risk ver­sus reward, not get­ting sucked into doing stu­pid shit. Um, you know, fol­low­ing a the­sis that is ratio­nal and log­i­cal and is rel­a­tive­ly risk averse, and just fol­low­ing it day in, day out, ignor­ing the hype, ignor­ing the noise.

And with that, uh, can you get me into the SpaceX IPO? Because, uh, I’m super excit­ed about Elon get­ting us all to Mars.

Toby: Yeah. I, I, I think that’s, that’s, it’s a real shift that you have to make in your mind, and not, maybe not every­body’s built that way. Not every­body. I, I sort of think the more expe­ri­ence you get, the more you, the more times you get burned with some­thing that does­n’t work, the less will­ing you are to do it.

And [00:58:00] so you get used to, like, look­ing at the down­side first and see­ing why, of these. You can have a look at the, the US stock mar­ket right now. Like, just ignor­ing even the SpaceX IPO, the, the Gold­man Sachs tracks this index called Prof­it­less Tech, which is exact­ly what it sounds like. In ’21 it ran up to these all-time highs, and then they all col­lapsed, as you’d imag­ine, through ’22, ’23, ’24.

But they’ve all run back up again to all-time highs. They’re almost where they were in 2021, prob­a­bly get there before the whole thing’s said and done. I don’t real­ly wan­na play that game. I, I think that you could pick out some of these names, and they will prob­a­bly be pret­ty good return­ers over the long term, but I don’t know which ones they are, and I think that there’s plen­ty of chances that there’s a lot of land­mines in there.

And I, I think that the more you do it, the more you get burned by the down­side. When I start­ed, I [00:59:00] start­ed invest­ing in 2000, walked into that reces­sion, depres­sion. For­tu­nate­ly, val­ue did real­ly well through there, so I got entire­ly the wrong mes­sage about how you just be a val­ue investor and nev­er wor­ry about draw­downs in your life. 2007, eight, nine came along, val­ue got smoked along with every­thing else then. Um, so that taught me a les­son that even val­ue gets smoked in most draw­downs. So I, I just, I don’t wan­na, don’t wan­na do things that don’t, so I try to avoid stocks that have shit­ty busi­ness mod­els, too much debt, crazy peo­ple run­ning them. Unproven busi­ness mod­els, there’s a lot of that around now. You look through the Rus­sell 2000, the top names in the Rus­sell 2000, they’re all things that they’ve got no rev­enue. They’ve got, they’re sci­ence exper­i­ments. They’ve got an idea to do some­thing. They will per­form real­ly well ’cause the idea is real­ly com­pelling.

It’s a great idea. Like, one of these guys is gonna build nuclear reac­tors in the States. Great idea. I think the, the US needs nuclear reac­tors, but they don’t have one yet, and it’s hard to build a nuclear reac­tor, so prob­a­bly [01:00:00] let that one go through to the keep­er.

Tony Kynas­ton: What’s your

Cameron: we,

Tony Kynas­ton: at the

Cameron: yeah, that was gonna be my ques­tion. Yeah.

Tony Kynas­ton: like it’s AI the mar­ket and then Main Street is is tank­ing. Uh does that wor­ry you at all? What, what’s your feel­ing and prog­nos­ti­ca­tion for that sit­u­a­tion?

Toby: Yeah. So, so does it wor­ry me? I mean, it’s irri­tat­ing in the short term. I don’t like under­per­form­ing, and I’ve been doing that a lot recent­ly. So I’ve been doing that a lot since I launched the funds, but I’ve been doing it par­tic­u­lar­ly recent­ly. But I think that the for­ward returns for small val­ue are excep­tion­al­ly good right now. There’s this K‑shaped mar­ket you– that every­body talks about, and I post­ed this chart today on Twit­ter, where it shows that basi­cal­ly every indus­try except for tech thinks that it’s going through a pret­ty sub­stan­tial draw­down. Like every­thing’s down thir­ty or forty per­cent except for tech, which is, which is off to the races and sort of cov­er­ing over, uh, the gaps in the mar­ket. For every­body [01:01:00] else, it’s a, it’s a, it’s a pret­ty sig­nif­i­cant, um, bear mar­ket. That sit­u­a­tion just does­n’t per­sist for long. It’s, it’s either tech catch­ing down or every­thing else catch­ing back up again. I think that the for­ward returns in the. I, I– The way I think about for­ward returns is just the, the amount of mon­ey that they’re sort of mak­ing col­lec­tive­ly, what they’re– the rate that they’re rein­vest­ing at, what the returns are like­ly from those rein­vest­ments, then you add that to what flows out. So there’s no mul­ti­ple required for pret­ty good for­ward returns here. That’s the way I like to, to, to think about it. So when you get those sit­u­a­tions, that means get some mul­ti­ple re-rat­ing along­side that. But even if you don’t count on it, you’re just look­ing at the, the– with­out mul­ti­ple re-rat­ing, I think the returns are real­ly good. I think that that’s not true for the index because it’s– a lot of these names occu­py a big part of the index, and they are priced for per­fec­tion. They’re not throw­ing off a lot of free cash flow because there’s so much rein­vest­ment going into the AI [01:02:00] CapEx. It’s a strange mar­ket, and real­ly, when the mon­ey runs towards those, the big end of town, it does get sucked out of all the small and micro. And there’s some great busi­ness­es in there that are just gonna ch-chug away for years and years and years. But they’re not excit­ing, and there’s no sort of over­whelm­ing nar­ra­tive that you can say to some­body, “Hey, I’ve got this– I’ve got these great lit­tle busi­ness­es.” But it’s not– Like I can’t say it’s AI, which is much sex­i­er. There’s no way to sort of pitch it to any­body. You just say, “Well, it’s small cap val­ue.” Like, “How much do you want?” ‘Cause it’s, it’s there. You can fill your boots.

Cameron: Hmm. The, the stock that we did, uh, this week on our US show was, uh, an Alaskan bank, North­rim Ban­Corp, NRIM. It’s just, you know, it’s rel­a­tive­ly small, 500 mil­lion mar­ket cap. It’s been around for 35 years. It’s throw­ing off cash. The price to oper­at­ing cash flow is 3.6 and we’re [01:03:00] like, you know, no AI with­in sight.

It’s just, you know, cheap as chips, throw­ing off mon­ey. Mar­ket does­n’t give a shit. You know, it’s, uh, there for the tak­ing. It’s crazy. When you say you under­per­form, remind me what you bench­mark your­self against?

Toby: I mean, I would look at the– I would look at every­thing. I’m look­ing at the index, the SPY, but, I real­ly bank– With ZIG, which is my mid-cap, large-cap, I bench­mark against the– it’s, it’s more like SP600, SP400, which are mid and small index­es.

Cameron: Right.

Toby: And for deep, uh, it’s Rus­sell, Rus­sell 2000 are the real index­es.

Those are the uni­vers­es that it’s being drawn from. So those are prob­a­bly index­es. Yeah, it’s a, it’s a fun­ny mar­ket. There’s a, there’s a lot of very good qual­i­ty, um, busi­ness­es that just don’t have any sex appeal what­so­ev­er. And so, you know, for­ward returns are like CAGRs as far as the eye can see, but 15% in a mar­ket that [01:04:00] like you, you can get a dou­ble pret­ty easy.

Like no, no one, no one, no one’s a buy­er at that lev­el.

Cameron: We are.

Tony Kynas­ton: Yeah it’s

Toby: Me too.

Tony Kynas­ton: Like it’s. There are, there are dif­fer­ent def­i­n­i­tions of val­ue I know but we’ve been out­per­form­ing the mar­ket with the, we call it the dum­my port­fo­lio that we put togeth­er of the stocks we talk about and, and know um into a, into a spread­sheet port­fo­lio. So it’s inter­est­ing that um, uh, there’s dif­fer­ent ver­sions of val­ue and some out­per­form and some don’t. And I know Cam trolls the Red­dit, uh, sub­red­dits on um invest­ing and peo­ple com­plain about, you know, that’s not work­ing but it’s been work­ing for us so it’s just sur­pris­ing.

Cameron: Hmm.

Tony Kynas­ton: But speak­ing of dif­fer­ent ver­sions of val­ue, you, I, I came across your writ­ings when you put out the Acquir­er’s Mul­ti­ple many years ago. How is that going now? Do you still track that and have a port­fo­lio, uh, that, uh, invests like that?

Toby: Yeah. So the– I, I don’t do it. The, the way that I actu­al­ly invest is [01:05:00] not Acquir­er’s Mul­ti­ple. I do dif­fer­ent– They do dif­fer from the web­site, the acquir­ers­mul­ti­ple. Um, it has been– I think that’s a great intro to sort of sta­tis­ti­cal val­ue, and if you buy a bas­ket of those names, I think that over time they do pret­ty well, and you, you’re gonna be hold­ing your nose when you do it.

They’re all heavy indus­try min­ers, ener­gy, those kind of names that have their day in the sun. I pre­fer a lit­tle bit more qual­i­ty in the busi­ness. I do think that. So for exam­ple, you could look at Cliff Asness’s paper called “Qual­i­ty Minus Junk,” and that came out in about two thou­sand and six­teen. And his def­i­n­i­tion of qual­i­ty is three­fold, but basi­cal­ly it’s the extent of prof­itabil­i­ty, the safe­ty of the bal­ance sheet, and then some oth­er fac­tors that might not appeal to val­ue guys, but they’re– he looks at the beta of the stock and so on, which, you know, you can prob­a­bly ignore those, ignore those things.

But [01:06:00] the idea is that look­ing for a risk-adjust­ed return. You’re look­ing for. A- and, and the qual­i­ty– I should say that the qual­i­ty is like, is like a fac­tor that per­formed very well, um, ignor­ing the val­ue of the, of the qual­i­ty port­fo­lio. But you do bet­ter if you hand­i­cap it, and so you– when qual­i­ty gets real­ly cheap or when there’s indi­vid­ual names in a port­fo­lio, you can buy them for a val­ue price.

I think that that sort of over­lap the– might not be the best return­ing strat­e­gy, but I think it’s the safest, and it’s the one that appeals to me intel­lec­tu­al­ly that. And qual­i­ty is not growth, although that is a com­po­nent of it. There’s a small com­po­nent of growth in there. Qual­i­ty is its own sort of thing. Um, and so I like qual­i­ty and val­ue. I like that inter­sec­tion. It’s sort of where I try to play.

Tony Kynas­ton: That’s what we call our port­fo­lio or our ser­vice, Qual­i­ty At Val­ue, exact­ly how I look at it too.

Toby: We

Tony Kynas­ton: Yep. Well, thank you.

Cameron: All right. [01:07:00] Bet­ter let you go, Tobias.

Tony Kynas­ton: Always good to

Cameron: Thanks, again for com­ing on and chat­ting and shar­ing your wis­dom with us. So the book, it give the book anoth­er plug, Sol­dier of For­tune, Tobias Carlisle. Oh, there you go. Tony’s got his hold­ing up too.

Toby: Sale ver­sion.

Cameron: Uh, mine’s a Kin­dle ver­sion. It’s hard­er to hold up. Uh, thanks, mate.

Hap­py hunt­ing out there. Stay well.

Toby: Like­wise. Thanks, gents. I

for hav­ing me. Thanks, Cameron. Thanks,

Tony Kynas­ton: Bye.

Toby: you next.

Tony Kynas­ton: Yeah.

Cameron: Seba.