Transcript QAV S03E01 – Intro To QAV

QAV Reboot 301

Length:  1:03:11

 (00:04)

Intro: This is QAV a podcast for people who want to learn how to invest like a professional.

(00:13)

Cameron Reilly: Welcome everybody to the first episode of QAV Reboot 301, the reboot series. My name is Cameron Reilly; with me is my partner in crime, Tony Kynaston. How are you, Tony?

(00:31)

Tony Kynaston: I’m good. How are you?

(00:32)

Cameron Reilly: Good, thank you, mate. We’re recording this late March or March 23rd, 2020. We’re both currently in lockdown from coronavirus. And I want to explain for new listeners and for old listeners, the concept of the reboot. So, we’ve been doing this podcast now for about a year and change. And over that period of time, as we’ve been explaining Tony’s investment methodology and who Tony is, we’ll get to that in a minute, if you’re brand new, but Tony has an investing methodology that he’s been developing for over 25, 30 years. And what we do on this podcast is we explain how that works.

Now, when we started this podcast 13 months, 14 months ago, yeah, it was okay. I did my best to make it a good show. I’ve been doing podcasts for 15 years, so, I know how to make a podcast, but I was completely out of my depth when it came to Tony’s investing, financial data and terminology and the modeling, and all this kind of stuff. So, it took me a long time to get up to speed. I reckon at least six months before I felt a little bit comfortable with it. And consequently, those episodes, there’s a lot of me dog-paddling through this stuff, trying to keep my head above water.

And Tony wasn’t really used to, A, speaking on a microphone and, B, articulating this to anybody outside of himself at 3:00 AM over a scotch because he’s just done it himself for 30 years. Apart from his family, he’s never really had to explain it to anyone before. And as he’s been explaining it on the show over the last year and a bit, he’s got a lot better at it. In fact, he’s very good at it now he’s, Warren Buffett in training with his bon mots. So, we had dinner in Sydney last week before the lockdown with some of our QAV listeners in Sydney. And they suggested, Hey, why don’t you redo those episodes? Because I think you’ll do a better job of them now.

Now, that you’re a lot more fluent in how to talk about this stuff. And we thought what a great idea, much easier for new listeners to start with these reboot versions. Also, the checklist that we use it’s Tony’s IP, but I wanted to build my own. So, I got my head around it and it’s gone through lots of changes over the last 30 months as I’ve improved on the checklist and streamlined it, modified it. So, if you’re starting at 101, episode 101, you’re going to have to go through all the different checklist changes in a linear timeline. If you start with this one, you’ll be able to use the latest version, at least as of March 2020.

I don’t think it’s going to change a lot from here, but who knows? So, anyway, Tony, that’s my preamble out of the way we do want to always start with this. Disclaimer, this podcast is an information provider. We’re giving you information about how Tony invests and we will talk about stocks and we will talk about other investment vehicles, but we’re not recommending that you buy anything. We’re not recommending that you invest this way. We are not financial advisors. We haven’t taken into account your individual investment objectives or financial circumstances or needs.

Please don’t take anything you ever hear on this podcast or on our website or in our emails as financial advice. If you need financial advice, go see a financial advisor. What this podcast is about is explaining how one guy who’s a very successful professional investor, and has been doing it for decades, how he thinks how he invests to basically teach financial literacy one way of valuing a stock and deciding what it’s worth and what to pay for it. But don’t take it as financial advice is my bottom line here. I hope I’ve been very clear about that. Tony, do you want to add anything?

(04:34)

Tony Kynaston: No, that was a good summary.

(04:36)

Cameron Reilly: Well, the way that we started the original series, and I think we should start this one as well is to talk a little bit about you, Tony. I know it’s your least favorite subject to talk about. You’re quite a quiet fellow by the way, for new listeners Tony and I go back over 12 years, we’ve known each other a long time. We’ve become friends. We’ve worked on a number of projects together. We’ve written a book, we’ve made a film; we’ve traveled the world for fun. And so, we know each other very well. Now, during those 12 years, I didn’t really know much about how Tony made money.

I did assume for a while that he was some kind of a hitman for the mob, probably the Irish Mob, because he’s quite tall, pale, and has red hair. So, he didn’t look Italian and I think I asked you early on, what do you do, Tony? He said, Oh, I’m just an investor. Then I was like, okay. And that was it. I think it was over our first dinner at a Teppanyaki restaurant in Fortitude Valley, 11, 12 years ago. And that was basically it. I went all right. Well, obviously you don’t want to share, so, okay. I’ll just do all the talking then shall I.

(05:59)

Tony Kynaston: You do all the talking anyway.

(06:00)

Cameron Reilly: I know. That’s the joke there. And then about the beginning of 2019, I have twin sons who were 18 at the time they had their own podcast and they said, Tony is quite a wealthy guy, right? I said, yeah, I think so. And they said, well, we want to talk about money management and making money for our audience. Do you think Tony would come on and be a guest? And I said, yeah, I’m sure he’d be happy to. And you did that. And I listened to that episode. And in that episode, you actually explained your investing methodology at a very high level. And I was like, what you have a system for making money and you’ve never told it to me, you rat bastard.

(06:46)

Tony Kynaston: You’ve never had any money, anyway. You kept telling me that you had no money.

(06:49)

Cameron Reilly: Well, that’s true. I have no money, but if I had money, it would have been good to know how to invest it. And, so a couple of days later, I said to Tony, why don’t we do a podcast about this method that you have? And you’re like, really? Would anyone want to listen to that? And I was like, yeah, I think some people might like to know how to invest successfully. And that’s been the show. And of course, over this time it’s been relatively successful and a lot of people have expressed their appreciation to us. But to you mostly for taking your time freely at no charge over the last year to talk about the basics of wealth creation, through investing and the basic fundamentals of how to be a successful investor. So, that’s the Genesis of the shot, but Tony, why don’t we go back and tell us, well, before you became an investor, what was your career like?

(07:47)

Tony Kynaston: I had a career in retail for 20 years. So, I started off after university in the IT department at the Shell Company of Australia. And after a couple of years in IT, I felt like I wasn’t part of the action. So, I moved across into the retail side of Shell, which is the section that looks after service stations and distributors and does the actual business of selling petroleum products, and worked my way up from there into general management roles. I started off in the financial planning area.

So, I’ve got a good overview of how Shell operates in Australia. And then went out into the field in Queensland and looked after the Autocare franchises and all the service stations around Queensland, Northern Territory, and the car washes and then became the Central Queensland, territory manager. So, I looked after some big fuel distributorships and some service stations, I don’t want to say hooked after. I was basically the franchise or they were the franchisee. So, lots of discussions around how to price products, going after and winning big contracts, looking after health, safety, and environment.

(08:56)

Cameron Reilly: We don’t need to go into that much detail, Tony. You were a corporate executive at Coles and Shell. That’s basically all I was looking for.

(09:04)

Tony Kynaston: Oh, okay.

(09:05)

Cameron Reilly: You ran very large companies for 20 years. Okay.

(09:09)

Tony Kynaston: I did at Coles Myer and then Shell.

(09:12)

Cameron Reilly: And then when did your investing career start?

(09:16)

Tony Kynaston: I feel like this reboot should be called podcast attention. I mean, lockdown having to redo my work. I thought we’d slide that one through last year. It’s like being in The Breakfast Club without Molly Ringwald and Ally Sheedy.

(09:33)

Cameron Reilly: Who am I Judd Nelson or the teacher?

(09:37)

Tony Kynaston: The teacher.

(09:38)

Cameron Reilly: Ah, okay. Yeah.

(09:41)

Tony Kynaston: Anyway. So, what was the question? Sorry.

(09:44)

Cameron Reilly: How did your investing career start?

(09:47)

Tony Kynaston: Yeah, good question. So, when I was at Shell and it would have been, I’m guessing the mid-nineties, so, towards the end of my time there they came up with a way of giving us some extra remuneration by offering us a loan that had to be used for investment purposes. You couldn’t buy a house and live in it with this loan. It was to the amount of your annual salary. And it was offered at a low-interest rate. The kind of interest rate Shell was getting when they borrowed money, which was less than the market rate. And I thought that was a great idea.

And a couple of friends and I got together and we said, well, what are we going to do? How are we going to invest it, let’s take Shell up on this offer? And so we did, and we did a bit of investigation and we spoke to a guy who was a property developer about going into partnership with him. We went to some big-name stockbrokers and asked for their advice. And we thought both of those were a bit too pedestrian because we were gung-ho young masters of the universe at Shell. We wanted to invest in things that were going to double our money quickly. And we started doing all the wrong things because we were aggressive.

So we took tips from people from, stockbrokers, from our colleagues in the upstream side of the business who were involved in startup petroleum drilling companies, and the like. And basically after about a year, I lost half of my capital through mostly penny dreadful investments in the mining sector. And yeah, that was a bit of a wake-up call and I thought shit not only have I lost half my capital, but eventually I’ll have to pay it back. And so, I’ve got to find it from somewhere too. So, that was like a double whammy. And so I started to subscribe to whatever you say there, I could find on investing, read any book I could find on investing.

And one day I happened to be in an airport bookshop and I came across The Making Of An American Capitalist a book by a guy named Roger Lowenstein. And it was a book about Warren Buffett and it really resonated with me the whole idea of value investing, his story had a much more scientific feel to it than what I’d been used to so far in things I’d read or heard. And it also had a very good take on how to take the emotion out of it. And just make common sense and it seemed simple. And so, I started applying those principles and eventually got my money back and was able to pay Shell out in the loan when I left and moved across to Coles Myer and the investment bug bit. And I went from there.

(12:26)

Cameron Reilly: For people who don’t know who Warren Buffett is although I think most people probably do we’ll talk more about him in a minute. So, how long have you been a full-time professional investor now, Tony?

(12:38)

Tony Kynaston: Well, I retired when I was 43, so, about 14 years ago. And the caveat is that my wife has been working, so, we’d been able to live off her income and then invest all of our capital or time to let that grow.

(12:55)

Cameron Reilly: You decided to be a stay at home dad and just manage the investment portfolio.

(13:00)

Tony Kynaston: Jenny and I joke about her being P & L and me being balance sheet. So, she’s cash flow and I’m capital. And I had the benefit of raising my daughter, which was fantastic. We have a great relationship because of that.

(13:13)

Cameron Reilly: And it’s not because you’re some sort of a misogynist and you sent your wife out to work. We should point out that. Your wife, Jenny is a very successful, corporate executive and loved her work and didn’t want to retire. Could have retired, had the option but chose not to until recently.

(13:33)

Tony Kynaston: Well, she may retire although she’s talking about going back to work. She resigned from her current role recently. And that will be finishing up soon and she’s going to take six months off and consider her options.

(13:43)

Cameron Reilly: But you’ve basically been a professional investor now for several decades and full-time for the last 14, 15 years.

(13:51)

Tony Kynaston: Yeah. That’s right. Investing since about, I would say the mid-nineties, so 25 years.

(13:57)

Cameron Reilly: And the average return on your portfolio over that 25-year period.

(14:04)

Tony Kynaston: Nineteen and a half percent. And again, full disclosure. It’s probably going to drop now that the market’s tanking, but I think once we come out, the other side of it; we’ll be back up there again. When I say tank, it might drop to 18%, something like that, 17, but at the moment, as of the end of last year, 19 and a half percent.

(14:24)

Cameron Reilly: Now to put that into perspective. Because when you first told me that, I mean, it sounded good, but I didn’t really know how good it was over the last 50 or 60 years that Warren Buffett has been investing with Berkshire Hathaway. I think he claims that his average annual return is about 19.8%. Does that sound right, 19.7 or 19.8?

(14:47)

Tony Kynaston: It’s something around that definitely above 19.

(14:51)

Cameron Reilly: So, that means that there are some years when it’s going to be much higher than 19%, some years when it will be lower. Like this year, for example, when the market has tanked due to coronavirus. But on average, over 10, 20 years and beyond it averages out at nineteen and a half percent. So, for people who have been around investing for a while, they will know that all odds, the Australian stock exchange and it’s true of other stock exchanges, like in the US or any other country if you look at their average growth over decades, it tends to be somewhere around 9, 10, 11%, depending on which exchange you’re looking at.

Again, some years it will be higher. Some years will be low, but on average, it’s about 10%. Let’s say just for a quick heuristic. And you’re basically doubling that your objective is to basically double the index.

(15:48)

Tony Kynaston: Correct. Yes. Double the market on the premise that if we can filter out the bad stock some of the rest must do better than the index. So again, not rocket science. And that might be a simple statement or sounds like a simple statement, but it’s hard to put into practice because the filter is the key. But yeah, if you think about it, if you take out the rotten apples, the rest should be edible.

(16:09)

Cameron Reilly: And we’ll talk about how you do that as we go along. My own brief bio, my name’s Cameron Reilly. I had a career in sort of tech in the nineties. I worked at one of Australia’s first ISPs in the mid-nineties. Then I got a job at Microsoft in the late nineties I was at Microsoft for seven years, sort of one of the.com guys, first early sort of internet people that Microsoft hired I’d travel around the country and talk to CIOs about what the internet was and what HTML was and how Microsoft was going to make the internet so much better. I left that in 2004 and started Australia’s very first ever podcast.

Believe it or not, it was called G’day World. And then in early 2005, I started the world’s first podcast network cunningly called The Podcast Network and built that up for a few years and was making money out of advertising until the GFC hit in 2008. And we lost all of our advertising overnight. And I went and cried in a corner for a couple of years and did some marketing jobs came back into podcasting in 2013. And today I make my living out of producing podcasts, mostly on ancient history. If you want to check those out, go to thepodcastnetwork.com and despite working in the stock market when I was 18 just after the 87 crash for a while and working for a private investment firm a little bit after that.

I have had a number of failed startups, been divorced several times. I’m the world’s worst money manager completely broke, even though I’m nearly 50, lost it all in divorces and startup failures. So, the premise for the show basically is Tony who is very good with money is teaching me a complete idiot how to stop being a complete idiot and you, the audience get to listen as he does that. Now, Tony let’s talk a little bit about value investing your style of investing, you mentioned Warren Buffett before. Can you give us a quick background on value investing and why you think it is the best form of investing?

(18:27)

Tony Kynaston: Yeah, sure. I mean, I think if you take it back to first principles, all investing is value investing. We’re all trying to buy something now, which we think is undervalued and will be worth more in the future. But there are different ways of doing that. And then there are people who focus on growth. So, they’re looking for companies which they think will grow quickly and they buy those. There are people who think that the best way to invest is by the quality and they don’t really care about the price. As long as the company is a high-quality company and they’ll buy those.

And there are people who kind of do a bit of both and they’re called momentum investors. So, they follow the trends in the stock market, but a value investor is looking for things that sell for less than what’s called the intrinsic value. And that’s the kind of rub, you got to work out what the intrinsic value is. And you’ve got to find the undiscovered companies, so, to speak that are trading below what they really should trade for. And that’s what value investing is.

(19:29)

Cameron Reilly: So, how does Warren Buffett fit into this, Tony?

(19:32)

Tony Kynaston: Well, he’s probably the most famous value investor there are others, but he’s been around for a long time. The guy is, I think about 87 or 88 years old now, maybe even 89, I’m not sure he has a partner called Charlie Munger, who’s even older and they’d been doing it since the fifties and sixties. Buffett learned at Columbia University at the feet of a guy called Ben Graham and Ben Graham along with his colleague Dodd I forgot Dodd’s first name, but anyway wrote a book called, Oh shit, what’s it called? Guess my memory’s going; we’ve been talking for too long.

Securities Analysis, sorry about that they wrote a book on how to analyze securities and that led to the concept of intrinsic value and to some of the concepts that Buffett has continued to teach, like the fact that price is what you pay and value is what you get. And in the short term, the market is a voting machine, but in the long-term, it’s a weighing machine.

(20:36)

Cameron Reilly: What does that mean? Can you explain that?

(20:39)

Tony Kynaston: Yeah. So, a stock market is a market, it’s people coming together to buy and sell products. And in this case, the product is a company. And so, it’s subject to all the kinds of psychology and whims of human nature that we encounter every day. And that’s why in the short-term, it’s a voting machine. So, shares and their prices will move according to how people vote with their feet in the short-term. So, at the moment, the shares are going down quickly because people are selling up and getting out of the market. So, the votes at the moment are the votes are in, and the market’s crashing.

People are, going to cash, but in the long-term, a share price of a company should represent what its intrinsic value is. And we’ll have to talk in detail about what that means, but basically, the weighing machine comes into play in the long-term. So if, for example, BHP is a good company, even though it’s being sold off now, eventually the share price will trackback to what it should be to reflect the accurate value of BHP.

(21:45)

Cameron Reilly: I remember I’ve got a quote from Buffett somewhere here. Let me just find it. If a business does well, the stock usually follows. So, he’s trying to basically in my understanding of value investing at a very simple level. Is it’s looking for well-performing companies, good quality companies that are well-managed have a good business, good prospects for the future, they’re making cash, and it looks like they’re going to continue to perform well for the future. Because generally speaking, the shares of those companies will do well. And then, B, the second component of it is buying stocks in those companies, when you can buy them at a reasonable price, you work out what you think the value of that stock is on any given day. And then you try and buy it at a discount to that. And that’s basically it.

(22:43)

Tony Kynaston: Yeah, that’s right. There’s a lot of things to unpack in those simple statements, but that’s essentially what I do is try and marry some kind of measurement or rating of what the quality of a company is with a rating or analysis of how discounted the share price is to what I think it’s worth. And just more on Buffett, I mean, the guy’s been investing for a long time. So, he has gone through a couple of iterations of that whole process. Early on in his career, he was focusing on more of the value side of things and pay less attention to quality. Then he teamed up with Charlie Munger and Munger convinced him to pay more attention to the quality side of things.

And he went from trying to buy things at deep discounts to paying a fair price for a quality company. And now he’s probably more focused on the quality side of things. How can I preserve my capital going forward?

(23:37)

Cameron Reilly: Because now he’s spending hundreds of billions of dollars to buy large chunks or entire chunks of business, he’s not just trading on the market as you or I would.

(23:49)

Tony Kynaston: Correct.

(23:49)

Cameron Reilly: It’s a different kind of game.

(23:52)

Tony Kynaston: Most of these investments are outside the share market now, even though it’s still a big part of Berkshire Hathaway, which is his company. I think maybe about three-quarters is actually, or the market capitalization is tied up in direct investments in companies.

(24:06)

Cameron Reilly: And one of the things I’ve learned since we’ve been doing this show is that value investing this style is Buffett or Benjamin Graham’s style of investing. It goes through cycles in terms of its popularity in the market. Last year we were at the tail end, as it turned out of a fairly long bull market, a booming market, and people weren’t interested in value investing, generally speaking, they thought it was boring. They thought it was out of fashion. This time it’s different.

They would say to us, and they wanted to put all their money in tech stocks, high growth stocks that would never get through your checklist because quite often they’re either losing money or their PA ratios are too high and a variety of other things. And their future is uncertain, but their share price is going up, up, up. And so people jump on board and they think value investing is boring, of course, then the market crashes. And typically if I understand my history value investing will become a little bit more valued by the market in the next five years. But then the market will get back to a cycle again, where it’ll hit another boom time and people will be like, ah, value investing is stupid.

It’s dead, it’s over. But what I’ve learned from you over the last year is that, yeah, some people make money during boom times by jumping on bandwagons, but then they tend to lose money more than they make money. It’s very difficult to find anyone who isn’t a value investor who has produced consistent roughly 20% returns year in, year out, over decades, outside of value investors.

(26:01)

Tony Kynaston: Yeah. I’d agree with that. There probably are exceptions, and obviously, the venture capitalists in Silicon Valley may have had similar results from investing in tech stocks or better results from investing in tech stocks. But mostly the successful long-term investors are value investors.

(26:18)

Cameron Reilly: I’m talking about regular people, investors.

(26:21)

Tony Kynaston: Yeah, no, that’s right regular people investors. And just to unpack that a bit, I mean, we saw it happening last year. This is what happens. Maybe it’s an indicator of the top of a bull market. If you look at when value funds start going down within about two or three years, the market crashes, and what happens is it’s because of people especially new to the share market. And oftentimes, in this case, it was millennials are going out saying 20%. I brought a mate who bought into Afterpay at five bucks and he’s made 250% year on year going forward, blah, blah, blah.

And I could name any of the other tech stocks in, what they call the wax in Australia or the Fang companies in the US and it’s true, but look at them most of them are crashing not all of them, but most of them are crashing and oftentimes crashing worse than the rest of the market. And we’re at the early stages of a share market correction at the moment, in my opinion. And they’re going to be starved for capital going forward and start to eat up all their cash. And that’s when you hang on for the white knuckle ride and it’s the millennials, or I shouldn’t pick on any particular class of people. It’s the people who have followed that trend and thought that 20% year on year, wasn’t good enough who are probably locked into those stocks. And they may recover, but a lot will go broke.

(27:46)

Cameron Reilly: And we should point out that the stock market, like every other market, but probably even more so trades on the fact that there are whole generations of new investors coming in every few years who are greedy and impatient and want to make quick returns. There are a lot of old-timers out there that smell new meat and take advantage of that. And it’s the old dogs like you, the old fuddy-duddies, like Alan Cola, called you, whether or not he actually did. I can’t remember, but as far as I’m concerned, he did, he at least intimated it. If he didn’t use those words, when he was on our show, just stick to basic time-worn, tested principles that have worked for Warren Buffett and Charlie Munger for 60 years.

(28:42)

Tony Kynaston: And they’re still around and they’re still going and they’re in their eighties and nineties and they’re incredibly wealthy. And they sleep well at night. I think one of the things you may have noticed about me, even though there’s a lot of worrying in the world at the moment is I’m not overly worried about the share market.

(29:01)

Cameron Reilly: No, because you’ve got rules and principles that you follow, and it has worked for you in previous recessions and downturns. And you see no reason why it won’t work this time. And by the way, they’re also similar rules that other value investors, like Warren Buffett and Charlie Munger use. And so, you’re confident that you’ve got a plan and you stick to the plan. And that’s what most of us don’t have when we get into investing is we don’t have a plan. We do what you did in the early stages. Well, screw it up. And then after that, run around and try and read stuff and piece it all together. And there’s a lot of contradictory stuff out there, whereas you’ve dedicated decades of your life to figuring it out and distilling it down to something that dummies like me can understand.

(29:49)

Tony Kynaston: Exactly, right. Keep it simple, that’s important too.

(29:53)

Cameron Reilly: That was a good opportunity for you to jump in there and say, you’re not a dummy, Cam. Don’t put yourself down like that, but that moment’s gone.

(30:01)

Tony Kynaston: You need to DM on Skype when I get lines like that. No, well, you’re not done.

(30:08)

Cameron Reilly: Follow the script, Tony. It says right there in the script, no, Cameron, you’re not a dummy and you’re very handsome and well endowed. Just read, go to all this effort and you just don’t do your job.

(30:21)

Tony Kynaston: Back to detention, I go.

(30:24)

Cameron Reilly: All right. So, let’s talk about the investment ladder, Tony, what is the investment ladder?

(30:31)

Tony Kynaston: Yeah. So, let me step back from value investing and say that a lot of people don’t get into investing or direct investing themselves because they lead busy lives, and they have a career as a doctor or a nurse or a teacher or an architect or whatever. And having to spend time managing their finances, is just really not possible because they’re so busy. People may from time to time dabble in it and come in and out. But sticking to it full-time over a long period of time does require a bit of a time. And I have to say that I’d be spending maybe an hour or so a day, sometimes more in periods like we’re in now and there are lots happening or if companies are reporting but it can be done for kind of an hour or two a day.

But most people who are busy raising families, they have other lives, they don’t want to do that. So, let me just sort of outline what I call the investment step ladder that might take you from being busy with your own career up a few rungs to being able to be more in control of your own finances. And I have to say that if you stay on the bottom rung, that’s fine too. If it works for you, that’s great. There are four rungs to the ladder. The first rung is, please if you have any sort of money invested at all anywhere, make sure you’re limiting your fees. I went through my father’s finances when he was very late in life and he was a very proud man who didn’t like to ask for advice.

And when I did, I was just completely blown away by how much he was paying in fees for really getting no benefit. And the first thing I’d say to people is to check what you’re paying and what you’re getting. And so, how do you do that? Well, you compare it to the lowest cost operator in the market. And that is a low-cost index fund. In the Australian market, for me, that means companies like Australian Foundation Investment. So, their code on the stock market is AFI. They’re what’s called a listed investment company. So, it’s basically a managed fund that you can invest in, which is listed. So, when you go to invest in it you buy shares in the company rather than giving them your money and they invest it on your behalf. Why do I like that company? Well, what they call the management investment, or the management expense ratio is about 0.25 of 1%.

And that management expense ratio is equivalent to the fees that the fund manager would charge you to manage your money. So, that company gets basically the stock market average return because they have big baskets of stocks it’s been around for over a hundred years. And so, they just continually buy and sell and rebalance their holdings to resemble what the stock market looks like. And so, you get the average returns. And as you said before, Cam the average in the stock market is about 10% year on year. So, that’s not Sherry. I mean, if you think about the companies that are out there on the stock market, I’d hazard a guess and say, half to three quarters, aren’t making that kind of return in their own businesses.

So, to be able to go out there and get 10% with the cost of it being a quarter of 1% is pretty good. And so, if your investments aren’t getting that, please consider seeking financial advice and moving across into at least owning shares in something like Australian Foundation Investment. I don’t like giving financial advice, but that’s my recommendation to investigate. Go and get your own financial advice and compare it. Now, I know some industry super funds offer a similar kind of low fee service but again, look at all their fees. If you need to talk to them about their fees, you might find you’re paying more than you think or seek financial advice.

So, that’s, that’s step number one, please limit your fees and please at least get the average return on the share market. Step number two though is okay if you’re at step number one and you’re feeling like you’re pretty happy, stay there, but if you want to get better at rising up the ladder, then maybe you want to put together your own index fund. Because if you think about the way the index is structured, really the top 20 stocks by market cap are most of the index. I think it’s over 70% of the value of the stock market by market capitalization is contained in the top 20 stocks on the ASX.

So, it’s actually not hard for you yourself to go out and buy an equivalent of your own index fund go and buy shares in the top 20 stocks and buy them in a ratio, which is equivalent to their market cap. So, you’re buying more of CSL and BHP and maybe less of Woodside or Woolworths, or whoever’s on the bottom of that list at the moment, but you can reasonably and easily put together your own index fund, and that’s just going to cost you the sheer brokerage of doing that. And that will just cost you once when you trade. So, that’s potentially even the cheaper option for you.

And then maybe once every six months when the companies report their latest earnings or 12 months, depending on how you feel look up what the market caps are and look up who’s in that top 20, and maybe take out the one that’s fallen out and add one that’s changed, that’s coming to the top 20. And so, you can, you can quite cheaply keep your own index fund going, again giving you the average return over the years for a very low cost. So, that’s step two. And step three is what you might say to yourself after you’ve done that for a while. Well, hang on, not all these top 20 companies are giving me the returns I want, I’m getting the average return of them so, what’s different here. And I certainly went through that process.

And what I found was that the best return in the top 20 stocks, and I now do it for the top 10 stocks, because it’s a little bit easier than doing it for 20 is to say, if I can work out what I think each of these companies will be worth next year. And I looked for the biggest discount between what I think the value of that company is and what its current share price is. And I buy that company then shouldn’t, I just get the return of it, closing the gap, which is often above 10%. And the answer is yes, more times than not, you do that. And your return over time is going to be higher than the 10% average because you’re trying to pick the winner in that top 20 or top 10 portfolios that you’re holding.

And once you get good at doing that, and you start to understand how to value companies then logic will lead you to the next question of, well, why just learn myself of the top 10 or 20 companies on the share market surely, there are companies out there which aren’t in the top 10 or 20, which are growing much faster or presenting better value to us than that top 20 list of companies. And that’s the case. And that’s where we are with our QAV investing framework.

(37:55)

Cameron Reilly: Nicely done. So, this is around your level of risk that you’re ready to take your level of sophistication or education that you currently have, or are willing to develop in terms of becoming an investor, the amount of effort that you’re able to put in or willing to put in. So, the first one is the easiest, lowest effort, the lowest risk for the best possible return. And then increasingly gets a little bit more sophisticated, a little bit more risk but for better returns.

(38:29)

Tony Kynaston: Yes. Or lower costs.

(38:31)

Cameron Reilly: Or lower costs. Yep. Well, that’s better returns too, right? Because.

(38:35)

Tony Kynaston: Oh, it is you’re right. Yes, good point.

(38:37)

Cameron Reilly: The cost comes off the returns. All right, Tony. Well, I guess that leads us to level four then QAV which involves the checklist. And so, maybe we start talking about the concept of the checklist. Probably won’t have time in this episode to get too deep into how it works in detail. We’ll leave that for the next episode, but maybe we can talk about what it is and how it works, and why you developed it. And I just want to say to people if you’re listening to this and you’re one of our QAV club subscribers, you can go to our website and download the checklist, the Excel spreadsheet, the latest version of it, just go to the portfolio and checklist tab. You’ll find links there for QAV subscribers. You’ll be able to get a copy of that for everyone else, if you’re just tuning in and then getting a feel for it we’ll try and explain it verbally bit by bit.

(39:35)

Tony Kynaston: Yeah. So, why I checklist? Well, I started using a checklist to guide my investing about seven or eight years ago. So, I haven’t always used it. But it came about when I read a book called the checklist manifesto about a doctor who said, I’m a surgeon and I’m in a hospital and we have too many patients who die from basic mistakes or who relapse and come back in with other problems because of mistakes we caused during surgery. And so, he cast around and said, well, is there a better way of doing surgical procedures where we make fewer mistakes?

And he looked at the airline industry and he was amazed that airlines operate with a very, very, very low crash ratio or incident ratio compared to the number of planes in the air. And he said, well, how does that happen in the airline industry, but not in the hospitals. We’re both industries run by smart people. And what he found was that pilots will go through a checklist especially before they take off. And they’ll make sure that all the functions in the plane, are serviceable and working, and they’ll go through the whole process line by line. They won’t skip any lines. If there’s a problem, they’ll stop.

And they’ll sort the problem out before they take off. And he thought that’s a great idea. I can apply it to a hospital environment. So, as the patient comes in at the start of the process, the doctors and the nurses go through a whole checklist of procedures to make sure that we’re doing the right surgery, that the patient is who we thought they were and blah, blah, blah that everything in there in the operating room is, as it should be, all the instruments are sterilized, et cetera, et cetera.

And he found that by applying a checklist to surgery in his hospital, the relapse rates and the patient care went up. And so, I thought that’s a great idea. How do I apply it to what I do? And so, I started to systematize what I did and up until that point, I had a lot of heuristics and I would apply them at different times, given the situations, again, always going back to Buffett and Munger and Graham to guide me. But over time, you kind of distill things that you’ll look at. And I decided to put those down into a checklist, which itself has evolved over time as well. And I’ve emphasized some things and lessened the emphasis on others, added some things, taking them out. And that’s where we are. It’s a process that guides me in investing.

(42:06)

Cameron Reilly: And I want to just let people know that from my perspective, the most exciting aspect of the checklist is it only uses numbers. So, the way that the checklist allows us to evaluate any particular stock and determine whether or not it deserves a buy rating or not, it’s all about looking at publicly available numbers. I don’t need to be an expert on the travel industry or the medical goods industry or the whatever industry Afterpay is the lay-by industry, the fake lay-by industry, the fake credit industry, or the mining industry, or the telecoms industry. I don’t need to be an expert in these things because Tony’s figured out a way to get the numbers, to tell that story. And we can get those numbers from a variety of different sources.

We’ll talk about the data services in a minute, but it enables us to use the numbers and the different scores and ratings. That other services give that particular stock to get an overview of its current financial and management health and the predicted future financial and by the performance aspects of the business from people who are experts, analysts, who do study these industries, study these businesses, and hopefully have a good idea of what’s going on. It enables us to gather a summary of a number of different kinds of data and put it into a little framework and spits out a score at the end. It’s a brilliant piece of condensation.

I always say it’s Tony’s equals MC squared. He looked at all of this complex stuff and he condensed it down to 20 questions and a star at the end. So, not wanting to blow too much smoke up your ass, Tony, but I think you deserve a Nobel Prize for it. I’m putting you for that I’ve submitted you to be the Pope and to get a Nobel Prize next year for this. And the other good thing about it is as you always say, Look, it’s a guideline, it’s not a rule. Or as I’ve been saying, it’s a tool, not a religion. The checklist. Yeah. It guides us. And there are times when you or anyone using it can decide, they’re going to make exceptions to a rule it’s to help us invest, but it’s not a religion.

You’re not going to spend eternity in hellfire and damnation. If you modify it, change it however you want. But I would check with Tony before you change it. It’s just up to me. There may be good reasons why he’s got it the way it is.

(44:57)

Tony Kynaston: Well, I think that’s a good point though. I do see the checklist as being an evolutionary process. It’s not set-in cement. I’m hoping that some of our listeners might come back in time and say, look, I’ve got better returns than you. I did this and that. And we can compare notes overall through all our listeners and come up with a better checklist. I might change it going forward myself. That’s how it evolved to where it is now. Yeah. But yeah, I mean, you’re right. Towards the end of my career, probably the second half of my career, I got heavily involved in data. Back when it was sort of very early on before big data was a thing before Moneyball was written, all that kind of stuff. So, I worked in loyalty programs. I was a database marketing expert who ran a direct marketing company or sorry, drip marketing retailer.

So, I had a lot to do with data. So, that kind of looking for the story and the numbers really appealed to me when it came to investing and it also kind of backs up one of the things that Buffett said. He said he thinks it’s been a real advantage for him living in Omaha and not Wall Street because he’s not swayed by what people say he’s swayed by the numbers. And based on discussions we’ve had recently; CEOs are often chief belief officers or chief preaching officers. They’re out there to convince people that their companies are great and going to last forever and keep growing. But we have to kind of switch off that noise and look at the facts underneath.

(46:24)

Cameron Reilly: Well, one of the difficult things, obviously for people with investing is it’s very emotional in good times and in bad times for different reasons and human beings are driven by emotions. And it seems to me that a lot of the mistakes that people make with investing certainly this is my case in the few dabbles that I’ve had over the decades before meeting you, were based on emotion. Well, I like this guy, and this is a friend of mine’s company, or I like this story, or I like this product, or I don’t want to miss out. Everything’s going up. I should get on. I don’t want to be the one idiot who missed out on this thing, or, oh my God, everything’s falling off a cliff. I better sell everything immediately. Or it’s going to go down zero and I’m going to lose everything.

And the thing about the checklist is it gives us relatively simple. Once you get your head around it, and there’s a learning curve there, I think it took me six to 12 months to feel comfortable with it. But it’s a set of guidelines, a set of rules that takes the emotion out of it. The score is either positive or it’s negative, that’s it. Doesn’t matter what’s going on. Doesn’t matter if it’s a bull market or a bear market, doesn’t matter if the sky is falling or the roads are paved with gold. There is a score, and the score is a score, doesn’t matter what’s going on. All I need to do is pull the numbers, look at the score. And that tells me what I need to know.

And it just enables me to go, okay, well, as long as you believe in the checklist and you believe in the framework and we believe in you and I have it on good authority from your wife, that you’re actually not the Messiah. You’re just a very naughty boy. But I think that’s the problem for brand new people listening to this is unlike me. I mean, they don’t know either of us. I’ve known you for over a decade and I’ve been to several of your houses in different parts of the world at different times. I know your wife very well. I know your daughter very well. I think I know you pretty well either, you’re the world’s greatest con man playing a really, really long con on me. Or you’re the real deal. And I tend to think you’re the real deal.

(48:48)

Tony Kynaston: If I was a good con man wouldn’t I try and con someone with some money.

(48:50)

Cameron Reilly: Well, yeah, you’ve just been funding my projects, not getting money out of my projects. So, you’re a long-term bad con man.

(48:59)

Tony Kynaston: Maybe you’re the con man.

(49:06)

Cameron Reilly: Yeah. Well, you wouldn’t be the first person to say that. And so, for people listening to this for the first time, look, you don’t know me, you don’t know Tony. And you’re like, why should I listen to this guy? Well, listen, we’ve got a lot of people who’ve been listening to this show now for over a year, you can listen to them and read their testimonials. And some of them have been on the show. We’ve had them on as guests and a lot of them are very successful people in their own right. And they can back it up as well. So, we understand that. Why the hell should I trust you guys?

But the point is, once you do trust Tony, and then you trust the checklist, it removes that emotion and panic and fear from the scenario. But he may not be there today, but keep listening, listen to enough episodes and you’ll get a sense for yourself, I guess, as to whether or not you think Tony is full of shit, or he actually knows what he’s talking about. The other thing.

(49:59)

Tony Kynaston: Sorry, And I’m going to be the anti-CEO here. Don’t trust us. That’s why we’re running a portfolio ourselves on the checklist and on our website. When we get enough runs on the board, look at that, Hey, if you want to follow us and follow along, do it on paper for a while. And then just when you get comfortable and can trust us based on our results then yeah. Go for it.

(50:24)

Cameron Reilly: Yeah. And if you’re a skeptical person, that’s fine. Be skeptical as long as you want. We’re not in any hurry. And look, you’re going to look at our portfolio right now, which we started on the 2nd of September, the public portfolio. Of course, it right now in March of 2020 is way underwater like everything else is, but we’re not as far underwater as The ASX is as the index is. And of course, that’s, our job is to beat the index. So, when things are going up, we want to go up being better than the index. When things are going down, we want to go down less than the index.

And so far, that’s what we’ve been doing up until January or early February. We were performing much better than the index going up. Now, we’ve dropped less than the index, but yes, this isn’t magic. If the world is in a global market correction, we’re going to get swept up in that. But because we’re in the middle of a correction, stocks are getting very, very cheap. And right now, we’re planning what we’re going to be doing when the inevitable turnaround comes, and the market starts to pick back up again because we should talk a little bit about that. The advantages or why a correction is actually a positive thing from an investment perspective.

(51:49)

Tony Kynaston: Yeah, it is. I mean, people say buy a share and hold it for life. And that will definitely work for people. And I’m not going to argue against that, but I can get better returns than that because our process tells us to go to cash at some stages. And if we’re in cash, when the market is dropping, then we’re going to outperform the market albeit, we still might be negative. But the benefit of that is when the market turns around, we have a lot to deploy and we get a bigger bang for our buck than the market would give us if we were just passively invested the whole time,

(52:23)

Cameron Reilly: Warren Buffett’s got a saying, be fearful when others are greedy and greedy when others are fearful. And at times like this, and while the market bottoms out most, particularly of those new investors that we talked about before, who don’t have a plan don’t have a system will be fearful still, even if the market starts to pick back up again, because they’ll be worried that it’s, what’s known as a dead cat bounce, but you’ve got a system for knowing when it’s relatively safe to buy back in. And so, we’ll get in when the market is still relatively low and ride it all the way back up again.

(52:59)

Tony Kynaston: Yeah. And with a bigger ability to invest than if we had stayed in the market the whole time.

(53:06)

Cameron Reilly: One other thing I want to cover before we get off the introduction to the checklist stuff is the coffee shop analogy. When you started using that it made a big difference to me and helped me get my head around it. So, basically, you helped me understand that buying stock in a business is exactly the same as if I was going to buy a small business, like a local coffee shop. Do you want to sort of walk through the coffee shop analogy a bit?

(53:31)

Tony Kynaston: Yeah, sure. So, I think one of the problems with the financial services industry is that if people make it more complex, they know they can charge bigger fees to demystify it for you. So, I think that’s a real problem with our, but the concepts overall are fairly simple, and the trick is to reduce a complex set of reports down to something which we can readily understand. And probably the easiest business to understand is a simple shop down the road. So, as I was talking to you now and looking out the window of the coffee shop. So, I use the coffee shop analysis and we all know how they run as a business.

So, I have to either buy or rent some space. I have to buy a cappuccino machine. I have to fit it out with furniture, tables, and chairs. And I have some stock I need to buy coffee beans, maybe some muffins, et cetera. And I have customers who come in and buy things off me. So, it’s a fairly simple transactional business. But we can hopefully reduce even the biggest complex businesses down to those same sorts of thought processes. I’ve got things I sell; I’ve got the cost to do that. And I’ve got to decide whether I want to buy that coffee shop or that big business based on the metrics of the available data.

(54:51)

Cameron Reilly: Yeah. And it really helps me take things that are potentially fairly abstract. We talk about PE ratios and price to cash ratios and earnings per share and future earnings per share and all these sorts of things. But when I think of them in terms of a coffee shop, and I guess that’s the other, thing that isn’t necessarily obvious or self-evident to people that are new to this, is that when Warren Buffett or Charlie Munger or Tony Kynaston is buying a stock in a company, you are actually literally thinking of yourselves as getting into business with a company you’re looking at it, not as an abstract figure or a dot on a graph.

You’re going well, is this business making money and how is it performing and what do I think that’s worth? So, when we bring that back to the coffee shop analogy, it’s like saying, okay, well, I’m looking at buying this coffee shop. They say the price is a hundred thousand dollars. Well, what’s it got in terms of its assets? How much money does it make? How long will it take for the business to return enough profit to neutralize my purchase price of the business? What do I think the chances are that it’s going to continue, or that its revenue is going to grow over the next few years? How long do I think the business is going to grow for?

What if I invest a hundred thousand dollars in it now how long is it not only going to take to pay me back that price? And what is the risk associated with the length of time that I have to wait?

Is it one year? Is it five years? Is it ten years? Obviously the longer it takes for it to return my initial purchase price, the more risk is involved because anything could happen. A Coronavirus could hit, and everything could go to shit. Or how long do I think it’s going to return profits over and above that. And therefore, makes me multiple times my investment, these are easy enough concepts for me to understand when it comes to a little coffee shop. And so, what we will do as we go through explaining the checklist is to try and explain each of the data points and the scoring of those data points as if it was a little coffee shop. And it just really helps me get my head around the data points and why they’re important and what they stand for.

(57:18)

Tony Kynaston: And I think that I could be wrong, but I think the penny dropped with you when we started to talk about how long it will take me to get my money back if I buy that coffee shop at this price.

(27:28)

Cameron Reilly: Yeah, absolutely.

(57:28)

Tony Kynaston: That brought in the whole discussion about risk. The longer it takes, the more risk there is, and therefore I should try and get it paid back quicker. And that sort of, I think was a bit of an eye-opener in terms of why we’re focusing on value in our investments.

(57:42)

Cameron Reilly: Yeah, absolutely. No, it is. A light bulb went off when you first put it in that terminology. And I really started to understand more about what was going on. Thinking of these things, is this really a business that, if you look at the difference between, I don’t know, a gold miner, let’s say in an Afterpay, if you were Warren Buffett and you had a billion dollars and they said, Hey, you want to come in and be a partner in the business as it is right now, would I really want to get in, would I want to throw a billion dollars in this would I really want to become partners with these guys looking at the business at that level?

Do I really believe in the prospects of this company and that it’s going to be profitable, long-term, et cetera, et cetera? And as I was explaining to one of my 19-year-old boys yesterday, when he was talking about whether or not he should have bought into Bitcoin last week, one of the other things you’ve helped me understand is the difference between investing and gambling. Do you want to explain how you would define those two?

(58:42)

Tony Kynaston: Yeah, well, we are buying pieces of companies, so, the companies can be analyzed. We can work out what we want to pay for those companies, what we think those companies are worth. And we can go along for the ride with management, if we invest in them, that’s investing. If we have no way of valuing something, if we have no understanding of it, if we have no knowledge of the industry it operates on, or what drives the price up and down, then we’re gambling. That’s the basic difference. And generally, I mean, if you look at the BRW rich list or IFR rich list whatever it is now, there aren’t any, maybe except for David Walsh in Tasmania, there aren’t any billionaires on that list who are gamblers or who got their money through gambling.

There are plenty of billionaires on that list who got it through investing either directly in companies or on the share market or in real estate. So, if you can’t articulate the operation or the company, you’re buying a piece of, and whether or not it’s a good price that you’re paying for it, then it’s speculation. It’s gambling.

(59:49)

Cameron Reilly: Yeah. I mean, it’s luck. I mean, if your only rationale is, I think it’s going to go up, or I think it’s going to go down, there’s no science behind that, there’s no intelligence behind that. It’s a guess which comes down to luck, which is gambling.

(01:00:06)

Tony Kynaston: Yeah. And sometimes you’ll get it right. And a lot of times you’ll get it wrong. Yeah, that’s exactly what it is. It’s speculation. What you’re trying to do in those cases is buy something and then sell it to the greater fool. So, part of that saying is acknowledging the fact that you’re a fool in the first place. And then the other one is hoping that there’s going to be a greater fool down the track who will buy it off you for a higher price. Sometimes you’re the greater fool.

(01:00:30)

Cameron Reilly: And the problem with luck is we know from coin toss experiments, that it’s basically 50/50. So, luck is not a long, I used to say this when I was a marketing consultant, running marketing strategies for clients, luck is not a long-term strategy for success. Let’s put some science behind what you’re doing and why, just throwing on the wall and hoping some of it sticks is not a really great strategy.

(01:00:56)

Tony Kynaston: Buffett has a good eye for what we’re talking about, he says, if you’re sitting at a poker table playing poker and you look around the table and you can’t tell who the Patsy is, you’re the Patsy

(01:01:08)

Cameron Reilly: And his other one is a rising tide, may carry ships. But it’s only when the tide goes out that you get to see who’s been swimming naked. I like that one too.

(01:01:15)

Tony Kynaston: Yeah. This is what we’re doing at the moment, the rising tide stopped in about January.

(01:01:20)

Cameron Reilly: Yeah. All right. Well, listen, let’s leave episode one of the reboots there, I think Tony in our next episode, will start to get into the detail of the checklist. We’ll explain it step by step. We’ll explain the different places you can get data from. And we’ll take people through the checklist process. And again, as I said earlier if you want to download these. I should explain this too. We have free episodes each week. And we have premium episodes this week. The free episodes are for people who are just checking it out, or maybe want to learn a little bit more about investing, but they’re not really hardcore serious.

They’re not ready to dedicate serious energy to become successful investors. For the people that want to be serious investors for the hardcore people. That’s what our premium series is for. If you’re a premium subscriber, you get the checklist and there are extra newsletters and videos and episodes, extra episodes, longer episodes. So, you can get a two-week free trial to become a QAV Club Member. Just go to our website, qavpodcast.com.au. QAV, by the way, if you haven’t worked out yet stands for quality and value, we’re looking at both quality and value when we’re working out whether or not we should buy a stock.

So, you go to qavpodcast.com.au look for a 14-day free trial thing. You can download everything, listen to all the premium episodes, see all the videos everything’s there for 14-days, and you can decide whether or not you want to keep going with it or not after that. So, with that, just one more reminder, don’t take anything you heard on this as financial advice. We are not financial advisors. This is for educational purposes only, and good luck out there. Stay safe, wash your hands, and we’ll be back next week with part two of the review.

(01:03:11)

Tony Kynaston: Or as I call it podcast attention. Alright, thanks, Cam. That was great.

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