Investing the Warren Buffett Way – Robert Hagstrom
Investing the Warren Buffett Way – Robert Hagstrom
Combine temperament with the right method and you have a winning formula for investing. No matter the market’s state, Robert Hagstrom remains steadfast in sharing Warren Buffett’s investing approach. The best-selling author discusses Buffett’s investment philosophy, value investing and the key elements of a Money Mind with host Charles Mizrahi.
- An Introduction to Robert Hagstrom (00:00:00)
- Finding Buffett (00:02:05)
- A Game-Changing Method (00:07:30)
- Before Buffett (00:09:15)
- The Warren Buffett Way (00:11:58)
- Price vs. Valuation (00:27:56)
- The Philosophy of Language (00:35:47)
- Intelligent Investing (00:39:51)
- The Ultimate Money Mind (00:44:50)
Over the past 30 years, Robert Hagstrom has conveyed Warren Buffett’s wisdom to the world. In 1994, Hagstrom kicked off his writing career with The Warren Buffett Way, a New York Times best-seller. It stood out as one of the first detailed accounts of the Oracle of Omaha. His latest book, Warren Buffett: Inside the Ultimate Money Mind, reveals the ultimate strategy for navigating today’s market.
Hagstrom also currently serves as a senior portfolio manager for EquityCompass and chairman of the investment management committee for Stifel Asset Management.
Before You Leave:
ROBERT HAGSTROM: “Would you like to invest like Warren Buffett?” and they say, “Absolutely.” They get started and then fall off the wagon. They fall off the wagon because they don’t have the temperament. This book helps them get the temperament, which allows them the psychological or emotional strength to apply the mechanics — the methods — that we already know work. It’s a perfect bookend to The Warren Buffett Way, and I’m extremely proud of it. Thank you.
CHARLES MIZRAHI: My guest today is Robert Hagstrom. In addition to being the chief investment officer at EquityCompass — with total assets of $4.2 billion — he’s also a prolific author. Robert is the author of nine investment books, which mainly focus on the investment strategy of Warren Buffett.
CHARLES MIZRAHI: The Warren Buffett Way is considered the definitive book on how Buffett analyzes stocks and makes investment decisions. It’s a New York Times bestseller. His latest book, Warren Buffett: Inside the Ultimate Money Mind, breaks new ground. Hagstrom provides the reader with a deep analysis of Buffett’s essential wisdom and insights.
CHARLES MIZRAHI: In short, the book helps readers understand the building blocks that go into making a Money Mind so one can begin to incorporate its principles in service to a life of value. I recently sat down with Robert to talk about how Buffett’s approach has influenced the way he manages money and how developing a Money Mind can give you a competitive advantage — not only in investing but in all aspects of life.
CHARLES MIZRAHI: Robert, thanks so much for coming on the show. I greatly, greatly appreciate it. I’m excited to speak to you today.
ROBERT HAGSTROM: Charles, it’s great to be with you. Thank you.
CHARLES MIZRAHI: What I find interesting about you, Robert, is you’re not only an author — you have nine books, and I don’t know how the heck you have the time to do that — but you’re also a portfolio manager. You’re the chief investment officer at Equity Compass, and you still have time to write new books.
CHARLES MIZRAHI: Your first book came out in 1994. That was…
ROBERT HAGSTROM: The Warren Buffet Way.
CHARLES MIZRAHI: That set the stage for a whole bunch of books that came out after. My first question is this: You sat down 27 years ago and started writing about Buffett. What new things did you bring to the table with that book, and why was it such a groundbreaker?
ROBERT HAGSTROM: That’s a great question, Charles. We spent 20 to 25 years going through all the methods — whether it was picking stocks, portfolio management, how it related to technology and things like that. That’s all we did. We looked at the mechanics and methods, and I thought we were pretty much done.
ROBERT HAGSTROM: Then, in 2017 at the Berkshire annual meeting, Warren introduced the concept of a Money Mind. The Money Mind was the secret sauce that made the methods work. It really hit a light bulb because I was only half correct in my analysis. I needed to spend some time thinking about and investigating the concept of the Money Mind. That was the genesis of my new book.
CHARLES MIZRAHI: You started in ’94 — 27 years ago. Why did you pick Buffett? How did you find that approach? What excited you about it? You’d been in the business a long while. I think you told me earlier that you were still using slide rules back in the day. You could have chosen anyone. How did you find Buffett? How did you get into money management? How did you start this whole odyssey?
ROBERT HAGSTROM: I fell into the money management business by accident. I was a political science major — undergraduate and graduate — and went to Washington D.C. in the 80s, thinking I could change the world and be like a Woodward-Bernstein.
ROBERT HAGSTROM: I got down there, and for about six months, I just hated it. I didn’t like it at all. I came back to Philadelphia. I did some writing in college for the local newspapers. I wanted to be a reporter. I thought, “OK, let me see if I can get a job as a columnist.” Nobody would hire me, but one local paper on the Main Line said, “Look, if you if you sell some advertising for our newspaper — quarter-page ads — maybe you can make enough money, and we’ll let you do a column.
ROBERT HAGSTROM: So, I walked up and down Route 30 to the Main Line, knocking on doors and selling quarter-page ads in the newspaper. I came across a company called Legg Mason Wood Walker: members of the New York Stock Exchange.
ROBERT HAGSTROM: I had no idea what it was. I walked in and said, “Can I see the manager?” They let me see the manager. I said, “Hi, I’m Robert Hagstrom. Would you be interested in buying a quarter-page ad in the newspaper?” They said, “No. Would you like to be a stockbroker?” That was how it started. I fell into it — backwards — and went to a training program at Legg Mason in the last week.
ROBERT HAGSTROM: I thought I made a terrible mistake, Charles. I had no idea about investing. I didn’t know economics, finance or accounting. On the night before our last class, they gave us a copy of the Berkshire Hathaway annual report, written by this guy named Warren Buffett. I’d never heard of him or Berkshire. But I read it that night in a hotel room, and the proverbial lightbulb went on. Everything began to make sense.
ROBERT HAGSTROM: From that point forward, as I went into production, I was like a kid following a ballplayer. Anything he did, I did. Any company he bought, I bought. I got all the Berkshire Hathaway and FCC reports. In those days, you had to write a letter and send a check. I collected all the annual reports and magazine articles that followed him. In the early ’90s, there was the opportunity to write a book.
CHARLES MIZRAHI: What year was it when you went to Legg Mason?
ROBERT HAGSTROM: That was 1984.
CHARLES MIZRAHI: So, that was a time period where there was no Internet, and information was pretty scarce. I remember reading about Buffett from a newsletter called Outstanding Investor Digest (OID).
ROBERT HAGSTROM: Oh, yeah. Henry Emerson. Sure, I remember!
CHARLES MIZRAHI: That was the only place you could get anything about investors. He used to do all the clippings and presented. He only put them out when he had enough good information. It was really scarce.
CHARLES MIZRAHI: In ’84, Buffett was not a household name. Far from it. I think there were still only 1,000 or so people at the Berkshire annual meeting. And the stock was selling in the hundreds, which was considered way too much for most people. You said the light bulb went on. What was it — when you read the annual report — that got you to say, “Holy smokes. Investing makes sense”?
ROBERT HAGSTROM: When we went through the training program, Legg Mason was a classic value investing shop — Ben Graham-centric. We had these seasoned brokers that would come in and talk to us, and they would all use a value line investment survey.
ROBERT HAGSTROM: Remember the value line? It would go back 20-some odd years. It had row after row of financial data: price-to-book, price-to-earnings, earnings, cash flow and things like that. They would speak to me in all these financial accounting terms and tell me whether or not it was a good stock. It just didn’t connect.
ROBERT HAGSTROM: Then, when you read the Berkshire annual report, Warren didn’t talk about that at all. He talked about the companies he owned, the products or services that they sold and the management that was running them. He talked about profitability and what they did with the profits.
ROBERT HAGSTROM: All of the sudden, I was like, “Oh! This is what his investing is all about.” You are basically buying a company. You’ve got to understand the products and services. You’ve got to understand the competition. You’ve got to understand management.
ROBERT HAGSTROM: You put all that together with some sense of valuation and go forward.
ROBERT HAGSTROM: [I thought,] “OK, I get it. I can do this.” And that’s how I took off from there.
CHARLES MIZRAHI: I’m just digressing for just a second. Robert, you’ve been in this business a little longer than I have, and we both — more or less — follow the same path. We both started reading Buffett, and it just makes a lot of sense. What is it about stocks as pieces of a business? Why is that a game-changer in thinking?
ROBERT HAGSTROM: I think it’s a game-changer in thinking because for me — and others who have followed Warren over the years — it makes sense in world where you look at the ticker tape at the bottom of the television screen and [hear] all this noise about trying to predict the market, the economy going up or down and our interest rates … It’s really a mosh pit of a lot of nonsense that can make you very confused.
ROBERT HAGSTROM: It’s hard to find your way. It’s hard to find your path and get from point A to point B because of all those distractions. But when you reduce it down to owning a business, Warren used to say: “Just think about if your family owned 100% of that business, and its net worth or value was going to fund your children, grandchildren or great grandchildren. How would you think about it? What would be the most important thing to you?
ROBERT HAGSTROM: So, you begin to think about having cash. Right? Cash has got to come out of this thing. You’ve got to be able to sustain it over time. You have to have managers that don’t do stupid things with the money. When you line it up in that way, everything makes sense.
ROBERT HAGSTROM: That makes more sense than trying to figure out whether the market’s going up or down, whether or not to buy value or growth or whether to go big-cap or small-cap — all that stuff is a bunch of nonsense. You don’t have to do that to be successful. That’s what has resonated with me.
CHARLES MIZRAHI: Great stuff. So, from ’84 onwards, you work in business. You start as a broker — which most people don’t realize that brokers have very little knowledge. In most cases, they’re basically salesmen. That’s why they have the analysts come in. Some brokers know a little more than others, but brokers are paid for their productivity, not for their tremendous investing insights.
ROBERT HAGSTROM: Right. And you hit on the point of how I moved to my second career.
ROBERT HAGSTROM: I owned Berkshire Hathaway, Coke, The Washington Post and other kinds of businesses. My manager came in one day and said, “Robert, you’d actually double your production if you ever sold anything. But you just buy and hold.”
ROBERT HAGSTROM: That was before E.F. Hutton started the separately-managed accounts. And you could get a fee for it. That was long before that.
ROBERT HAGSTROM: The only way you could make a living as a broker was to buy and sell things.
ROBERT HAGSTROM: Everybody to the left and right of me was always buying and selling things — all day long. I was buying things. I got new accounts, and I would buy things. I got new accounts and I’d buy [more] things.
ROBERT HAGSTROM: But I rarely ever sold. My manager would say: “Look, you’re going to go broke if you don’t ever sell anything.” And I’d say: “Well, these companies are doing just fine. They do go up in price. The intrinsic value is growing. We’ll be fine.” Then, he’d say: “Yeah, but you’re not going to make a living.”
ROBERT HAGSTROM: That’s why I went to the buy side. I went to a local bank. I went to a small investment counseling firm and got a salary. But we were charging a fee on assets. So, our net worth, salaries and bonuses basically went up to the degree that our assets did. So, our interests were somewhat aligned.
ROBERT HAGSTROM: Then, in ’92, we got news. I was a CFA — chartered financial analyst. In ’92, they had new performance presentation standards. They said, “If you share in the decision-making process with your clients on what you’re buying or selling, that’s not a discretionary track record or performance.
ROBERT HAGSTROM: We acted like a trust company. We were a small shop — $100 million. If a client had a favorite stock, we’d put it in there. If the kids wanted something, we’d put that in there. You know, tax-loss selling — things of that nature.
ROBERT HAGSTROM: So, we couldn’t point to our track record as being 100% discretionary. I said to my partners: “Look, we’ve got to build a discretionary track record.” They said, “What do you want to do?” I said, “Let’s do this Buffett thing. It makes a lot of sense.”
ROBERT HAGSTROM: But they said, “Robert, I’m up to here with you and Warren Buffet. If you write a white paper — a marketing piece — on Warren Buffett and get enough people to sign onto it, that’ll be our discretionary track record.
ROBERT HAGSTROM: That white paper actually became the book proposal that led to The Warren Buffett Way. That’s how it worked.
CHARLES MIZRAHI: Excellent. Did you meet Buffett prior to writing the book?
ROBERT HAGSTROM: No.
CHARLES MIZRAHI: So, you basically wrote everything, and all your knowledge came from public information that anybody could have gotten at the time?
ROBERT HAGSTROM: Yeah. We went through all the annual reports.
ROBERT HAGSTROM: I remember I was about halfway through the book — and as you know, the Berkshire Hathaway annual reports are copyrighted. It was the only annual report that was copyrighted. I could go through and distill out the financial tenets, management tenets, business tenets and figure out valuation. But I had Warren speak throughout the book — through the quotes of the annual reports. I would say something, but I’d have Buffett affirm it or talk about it.
ROBERT HAGSTROM: My editor Miles Thompson — who’s a great guy, and we’re still friends today — said, “Do you have the copyright permission?”
ROBERT HAGSTROM: So, I sent a letter to [Buffett] in Omaha — Kiewit Plaza, where he is today — and said, “Dear Mr. Buffett, my name is Robert Hagstrom. You don’t know me, but I’m writing a book about you. May I have your permission to use your copyrighted material?”
ROBERT HAGSTROM: About a week or two went by, and a letter came from Kiewit Plaza. I opened up the letter and he had said, “Robert, thanks very much for your kind note. I can’t give you permission just yet.”
ROBERT HAGSTROM: In sales, “just yet” doesn’t mean no. It just means “What do we have to do to get this done?”
ROBERT HAGSTROM: The deal was this: He said, “Look, I have to see what you’re writing.” So, I had to send every chapter to him so he could look at it. He wanted some idea of how we were going to market the book. He didn’t want “The get-rich-quick schemes of Warren Buffett” or “How to make $1 billion at Warren Buffett.” He wanted to see what I did.
ROBERT HAGSTROM: I’d finish a chapter, put it in the mail and send it to Debbie Bosanek — who was probably 18 years old then and is still his secretary today. Then, she’d call me and say, “OK, Robert, chapter one is fine. Keep going. Chapter two is fine…”
ROBERT HAGSTROM: At the very end, we had his OK, and he finally set the copyright approval. We tied up the book, and it was published in the fall of 1994.
ROBERT HAGSTROM: Soon thereafter, we hit the New York Times bestseller list.
CHARLES MIZRAHI: I had a similar experience. We both used the same publisher — Wiley. I wrote my book Getting Starting in Value Investing, and I used some quotes. I waited to send the whole manuscript to Buffett.
CHARLES MIZRAHI: A few days later, I received an email from Debbie — from Buffett. It said, “Dear Mr. Mizrahi, I looked through the thing. Please feel free to use whatever quotes you used. I look forward to reading it. Warren Buffett.”
CHARLES MIZRAHI: I called her up and said, “Is that really him?” She said, “He writes all these things. I just type them out.” I went home that day and said, “Wow, that’s something.” That was back in 2006.
ROBERT HAGSTROM: When I sent him Warren Buffett: Inside the Ultimate Money Mind, Debbie sent me the email. It said: “Debbie Bosanek on behalf of Warren Buffett.” She typed it [like him] and said, “Dear, Robert…”
ROBERT HAGSTROM: He wrote several paragraphs about the book and said, “Good luck with the book. It’s fine. It’s great. Great stories.”
CHARLES MIZRAHI: That’s really interesting. We had similar experiences, but yours were much more in depth. What made The Warren Buffet Way a New York Times bestseller?
ROBERT HAGSTROM: You’ve got to remember the markets weren’t that great in the early ’90s. We came out of the recession in ’91. We were moving into a new administration. The Dow Jones wasn’t doing that great. So, there was some pent-up demand, and there had only been one book written about Warren at the time. You might remember a great writer named John Train who wrote The Money Masters.
ROBERT HAGSTROM: After he wrote The Money Masters, which included a chapter about Warren — along with Ben Graham, Bill Fisher and other greats — John Train wrote a very quick book called The Midas Touch. He made the mistake of writing the book without cluing in Warren. And Warren wasn’t too pleased about that. The book didn’t do very well. It didn’t catch.
ROBERT HAGSTROM: I’ll give you the quick three minutes on why I think my book became a New York Times bestseller.
ROBERT HAGSTROM: First of all, the market had an appetite for success, and nobody had really written it yet.
ROBERT HAGSTROM: Two … I’ll back up. So, I was at my parents farm in Nashville, Tennessee, where I grew up. I went to school at Villanova. I got a call on Thanksgiving weekend from my publisher, John Miles. He said, “Robert, the book has taken off. You’ve got to get back to New York as quickly as possible.” I said, “Come on, you’ve got to be kidding me. This doesn’t make any sense.”
ROBERT HAGSTROM: I hopped a flight on Sunday night to go to New York. I landed, and Miles took me down to Fifth Avenue. There used to be a big Barnes and Noble store on Fifth Avenue. It was late at night — 8:00 or 9:00 p.m. — and there was a cold, drizzly rain. We walked by the window, and there was this huge eight-foot picture of the book. And there was Warren and all his spectacular-ness.
ROBERT HAGSTROM: At the top, it said, “Foreword by Peter Lynch.” At the time, Peter Lynch was the guy. He was the greatest mutual fund manager. It so happened that John Rothchild, who was a friend of Miles Thompson, was the ghostwriter for Peter’s books.
ROBERT HAGSTROM: Miles knew John and said, “John, do you think Peter will do a foreword?” John called Peter, and Peter called Warren. He said, “Hey, they’re asking me to do a foreword for this new book: The Warren Buffett Way. What do you think?” Warren said, “The kid is OK. Do what you want to do. It’s up to you.”
ROBERT HAGSTROM: So, we had Peter Lynch do the foreword. Off to the right was a quote from Forbes magazine. It said, “The greatest book of the 1990s. Buy it, and read it.” That quote came from Ken Fisher, who was a columnist at Forbes.
ROBERT HAGSTROM: What I had done in the book was elevate the contribution that his dad, Phil Fisher, made to Buffett’s thinking. I really spent a lot of time pointing out the quantifiable work of Ben Graham with the qualitative work of Phil Fisher. Ken was so touched by that, so he wrote a really great review in Forbes, and they lifted that quote out of it.
ROBERT HAGSTROM: We’re sitting there in the rain. I’m looking at this thing. We’re going on the New York Times bestseller list. It says, The Warren Buffett Way, with a huge picture of Warren. At the top, “Foreword by Peter Lynch.” To the right, it said: “Forbes: Best book of the 1990s.”
ROBERT HAGSTROM: If you looked at the very bottom of the window on the far right, it said, “By Robert Hagstrom,” which was about two inches tall.
ROBERT HAGSTROM: The planets aligned very nicely. Warren could have said, “No, you can’t have the copyright.” Peter Lynch might not have done the foreword. Forbes might not have given us the quote. The market might have been going up by 20% per year. I was very lucky. It was very timely.
CHARLES MIZRAHI: Rather be lucky than smart. That’s phenomenal. What was in this book that was so amazing that you had all these great forewords, comments and reviews? The public was very receptive to it. What groundbreaking information did you share with readers?
ROBERT HAGSTROM: Well, there was nothing groundbreaking in The Warren Buffett Way. And even when I went to the annual meeting in ’98 — when we came out with The Warren Buffett Portfolio: Mastering the Power of the Focus Investment Strategy … The Warren Buffett Way was only about stocks. I didn’t really talk about portfolio management.
ROBERT HAGSTROM: The second book was The Warren Buffett Portfolio, which talked about focused, concentrated low-turnover portfolios.
ROBERT HAGSTROM: Each year, Charlie Munger used to tell people about the books he liked. Miles was sitting in the audience with me and they were asking [Munger], “What books do you like?”
ROBERT HAGSTROM: Charlie said, “Well, Hagstrom wrote The Warren Buffett Way. I didn’t think was that good of a book.” Of course, all the blood drained out of my face. I thought my career was over.
ROBERT HAGSTROM: But he really liked The Warren Buffett Portfolio because it was more of a groundbreaking book on the first book ever written about concentrated investing.
ROBERT HAGSTROM: Charlie was actually right. If you think about it, The Warren Buffett Way was not original. There was nothing new. I simply organized the material by going through the annual reports, and Warren would talk about management for 10 years. He would talk about what a good business was for 10 years. He’d talk about important financials for 10 years. He also talked about valuation when he introduced John Burr Williams.
ROBERT HAGSTROM: I took all his quotes over 10 or 15 years and aligned them with the companies he bought. They all lined up perfectly. What I think The Warren Buffett Way did was masterfully organize the material. It didn’t illuminate anything new. I just organized it in such a way that people could understand what was going on.
CHARLES MIZRAHI: For someone who never read The Warren Buffett Way or Berkshire Hathaway shareholder letter, you mentioned four things. What were those four things? Why were they important, and how did you look at them?
ROBERT HAGSTROM: Earlier, we talked about [owning] stocks as ownership in businesses. He distilled three important characteristics of a business. What did the business do? So, we went through what we called the business tenets. Was it understandable? Did it have products and services that were needed? Did it have a long-term, sustainable future? Things like that. And then, management.
ROBERT HAGSTROM: Before that, [it was] the financials. He talked about cash earnings or owner earnings. If you’re a businessman, you [have] owner earnings.
ROBERT HAGSTROM: He talked about return on equity, profit margins and things like that. So, those were the financial tenets. He talked about management. Management had to be trustworthy and honest. Did they rationally allocate the capital? Did they reinvest it in the business when they got high returns on capital? Did they give you dividends and buy back stock? Or, did they do foolish things like buying unrelated companies?
ROBERT HAGSTROM: We had all the tenets outlined. The valuation work was the dividend discount model — outlined by John Burr Williams. We took The Washington Post, Capital Cities and Coca-Cola and broke those companies down based upon the tenets that Warren outlined in the annual report.
ROBERT HAGSTROM: But [one], it was organized in a way where we could walk you through Coca-Cola and why it was such a good business. Two, why were the financials so great? Three, why was management so smart?
ROBERT HAGSTROM: Then, we did the valuation work on the dividend discount model to show you that Warren actually bought it pretty cheap. We did The Washington Post. We did Capital Cities. We did Coca-Cola. We went into American Express. We did all his major purchases, and they all lined up beautifully. So, it was a roadmap for analyzing a company like Warren.
CHARLES MIZRAHI: You’ve been doing this for a long while. Why do you think this doesn’t resonate with 90% of stock traders and investors? Why is this so alien yet so simple?
ROBERT HAGSTROM: What a wonderful question, Charles.
ROBERT HAGSTROM: I’m going to give you my bubbly answer, but it’s a great question. I think it lies at the root why there are so few Warren Buffett imitators. It really isn’t that hard. We have the methodology — the mechanics — down. We understand how to swing the bat.
ROBERT HAGSTROM: I think it rests at the onset that you have to do a little more work than just being a stock trader. People can pontificate about the market all day long. Everybody has an opinion. It doesn’t take a lot of work to form an opinion.
ROBERT HAGSTROM: Everybody has an opinion. Moderators have opinions — financial columnists, tipsters, your best friends next door whomever. Opinions are easy to form.
ROBERT HAGSTROM: If you’re going to be a business analyst and follow The Warren Buffett Way, you actually have to read things. You have to read an annual report. You have to do some work. It’s more laborious.
ROBERT HAGSTROM: I don’t want to demean, but most people are just too lazy to do the work and be business owners. It’s easy to pontificate and have opinions about stocks. If you go down that path, it’s easy but you won’t make a lot of money.
ROBERT HAGSTROM: If you go down The Warren Buffett Way path, it’s a little more laborious. It’s a little more time-consuming. You actually have to read something. But the profitability is much higher.
ROBERT HAGSTROM: It’s thinking fast versus thinking slow or system one versus system two thinking. System one is very easy. It’s about having an opinion. So, what?
ROBERT HAGSTROM: With system two, you have to think — and there aren’t a lot of people that want to do system two thinking. The Warren Buffett Way is definitely system two thinking.
CHARLES MIZRAHI: The confluence of great events happens. The book takes off. Just for our listeners: Peter Lynch, manager of the Magellan Fund, created a 29% annualized compounded rate for around 13 years. Astounding.
CHARLES MIZRAHI: Ken Fisher’s father was Phil Fisher, who played a significant influence on Buffett’s thinking in terms of looking at businesses and getting what he called scuttlebutt — asking around about them — where Graham said to only look at the numbers.
CHARLES MIZRAHI: So, Buffett is changing. The thought process is now evolving. You hit every one of those people who followed and influenced him directly. You hit it in the book. Phenomenal. The public seems to love it. It was a New York Times bestseller.
CHARLES MIZRAHI: I read your book in ’99, and it made all the sense in the world to me. I’ve been following Buffett since ’86. Like you, I mailed away. I used to get the annual reports, the FCC 10Ks and all that. The public loved it. But if you had to guess, how many of them read it, said it made sense but didn’t follow it?
ROBERT HAGSTROM: [It was] probably 90%.
ROBERT HAGSTROM: We kind of go into it in the new book. But to back up, remember: Buffett doesn’t own a lot of stocks. And he doesn’t buy and sell.
ROBERT HAGSTROM: So, it’s a concentrated, low-turnover portfolio. Today, academia calls it high active share. How different does your portfolio look relative to the market? And low turnover.
ROBERT HAGSTROM: That’s the pathway to generating excess returns. If you’re a stock picker — and you can understand valuation — you want to own fewer stocks and hold them longer to benefit from the compounding of intrinsic value.
ROBERT HAGSTROM: You don’t want to trade. OK, so that’s right. But here’s the problem: A concentrated low-turnover portfolio, which is called high active share, underperforms the market about half the time on a month-to-month, quarter-to-quarter, and year-to-year basis. You’re going to be right half the time. You’re going to be wrong half the time.
ROBERT HAGSTROM: That begs the question: If you’re right half the time and wrong half the time, how do you make money? It’s not a frequency argument. It’s magnitude. It’s not how many times you’re right plus how many times you’re wrong. It’s how much money you make when you’re right — less how much money you give back when you’re wrong.
ROBERT HAGSTROM: Using a valuation methodology when you’re wrong … As you know, the market gyrates all the time. You’ve been at this game as long as I have. The market has an opinion about things at different times of the week, month and year. It moves from different sectors — different companies — and it’s all over the place. When the light shines on your portfolio, you look like a hero. When it moves off, you look like an idiot.
ROBERT HAGSTROM: People tend to equate valuation with price. That’s wrong. Price is not valuation. If the price is going up, people think it’s worth more. If the price is going down, they think it’s worth less. So, people are stuck on changes in pricing.
ROBERT HAGSTROM: If you play that game, you’re going to lose money. You’re already out of the game.
ROBERT HAGSTROM: If you make bets on prices going up and down and try to anticipate that change, you’re out of the game. You can’t make money.
ROBERT HAGSTROM: But, if you recognize that what you own has value — and price will vacillate up and down relative to that value — you won’t be concerned about changes in prices. [That’s] as long as you understand economics.
ROBERT HAGSTROM: But go back. Are you a system two thinker? Are you thinking about your stock as a business and doing the work of a business owner? [Are you] looking at stock prices secondarily? There are a lot of people who have different opinions. We write this in the new book.
ROBERT HAGSTROM: People tend to think that if a stock price goes up or down, it’s because someone agrees or disagrees with their point of view. Well, there are a lot of opinions about stocks! There are speculators. There’s high-frequency trading. There are all kinds of arbitrage going on out there. There are tons of different ways in which people make bets on the stock market that have nothing to do with valuation.
ROBERT HAGSTROM: Whether you think you’re right or wrong, you don’t recognize that there are lots of reasons why the prices go up and down. Once you bring that into your mindset, you’ll begin to say: “Prices don’t really matter to me in the short run.” There are a lot of games being played simultaneously. Once you begin to realize that, then you’ll say: “OK. I don’t care that this stock is up or down 10%” — whatever the case may be.
ROBERT HAGSTROM: If you just look at your economic returns, prices won’t bother you that much. That’s hard for people to do. It’s hard for people because they don’t do enough work to be business owners. And they’re not confident enough in their business evaluations, so they think they could be wrong because the prices are going down. It all coalesces together.
ROBERT HAGSTROM: So, The Warren Buffett Way was system two thinking about stocks.
ROBERT HAGSTROM: Warren Buffett: Inside The Ultimate Money Mind — the new book — is about the temperament of a person who plays the game in the stock market as a business owner.
ROBERT HAGSTROM: What does self-reliance have to do with it? We go into stoicism — Ben Graham. You don’t care about the market. You have a stoic indifference to changes in stock prices. We go into the history of rationalism — how to think rationally about investing. We go into pragmatism.
ROBERT HAGSTROM: Most importantly — I’ll just key off of this and turn it back to you. You mentioned the evolution of Warren Buffett. We have a whole chapter — chapter three — called: The Evolution of Value Investing.
ROBERT HAGSTROM: We pointed out that it started with Ben Graham. Then, it morphed to Phil Fisher, and got you Coca-Cola.
ROBERT HAGSTROM: Stage three value investing, which Warren has finally gotten a toehold into, is the valuation of network economics. How do you think about technology?
ROBERT HAGSTROM: Apple was Warren’s move into it. It bridged the second level of evolution in value investing with the third.
ROBERT HAGSTROM: It’s both a great consumer product company and a technological network economics business. We walk everybody through it.
ROBERT HAGSTROM: Here’s the point: valuation migrates. It evolves. It changes. Buffett is the only person that I know that … Well, that’s not true. Bill Miller also did it at Legg Mason Capital Management.
ROBERT HAGSTROM: He got to stage one value investing. Ben Graham got to stage two value investing with Phil Fisher, Coca-Cola and all that. Then, Buffett made it to stage three, where he bought network economic businesses.
ROBERT HAGSTROM: It’s very rare for someone to make that evolutionary change. Bill Miller has done it successfully. Warren Buffett has done it successfully.
ROBERT HAGSTROM: If you’re going to be a great value investor today, you have to evolve.
CHARLES MIZRAHI: Right. I think you’re spot on.
CHARLES MIZRAHI: Just to review, Ben Graham looked at the numbers of a business and said, “This is the book value of a business. The stock is selling for less than the book value of the business.” Therefore, it was a buy. That was right after the Depression.
CHARLES MIZRAHI: You can’t find many businesses today that sell below book value. And book value doesn’t mean much anymore because most of a company’s assets are its intellectual property. Coca-Cola is a brand name, for example. The company is worth X, but just that name is worth everything. It’s an evaluation. It’s not a steel mill.
CHARLES MIZRAHI: You mentioned step two. Stage two thinking was not only about looking at the numbers but also asking around about the suppliers, wholesalers and customers — getting that scuttlebutt. You asked people in the parking lot about the cars they drove and got information that way.
CHARLES MIZRAHI: Stage three — which you just mentioned with Bill Miller and Buffett … Bill Miller is a value investor. Let me define what value investing is. It’s basically getting more than you pay. It’s so silly. People are frozen in time.
CHARLES MIZRAHI: Bill Miller bought Amazon. If you looked at Amazon back in the day, when he bought it, there were no earnings to speak of. I don’t think were any earnings. Bezos was throwing money back into the business. I think he also bought Google at the IPO.
ROBERT HAGSTROM: We did.
CHARLES MIZRAHI: Right. Any stage one value investor would have said there are no earnings, book value, this or that. I think that’s a key point you brought up. Now we’re at stage three — where the valuation is based on nontraditional ways of looking at things. We’re trying to figure out X for the future and seeing what’s there today.
CHARLES MIZRAHI: For example: eBay or Apple — these are networks that are there, and you’re tied into them. They are going to make money over time because it’s so hard for competitors to get in.
ROBERT HAGSTROM: Charles, you’re 100% spot-on. You couldn’t have said it better.
ROBERT HAGSTROM: I worked with Bill Miller for 15 years. I acknowledged him in the book. I acknowledged Warren Buffett, and I acknowledged Charlie Munger. But I said there was no one person more important to me — that moved me from the theoretical, which was The Warren Buffett Way, to the practical, which is actually investing in it — than Bill Miller.
ROBERT HAGSTROM: I ran his growth fund while he ran the famous Legg Mason Value Trust. It outperformed the S&P 500 for 15 years in a row — starting in 1991. He had already moved to stage two value investing and owned a lot of consumer products.
ROBERT HAGSTROM: He was one of the very first value investors that moved into stage three. His first big bet was Dell, which started out looking like a value stock but became a phenomenal growth stock. He made 8,000% at 45x earnings. So, he had that. He had AOL. It was 50x his original investment.
ROBERT HAGSTROM: We owned Amazon. When we bought Amazon on the IPO, I was with him. We bought Amazon not because it looked like a Barnes and Noble or Walmart. Amazon was Dell. Amazon was a direct distributor of books — just like Dell was a direct distributor of personal computers.
ROBERT HAGSTROM: They all had the same recipe or business model. It was negative working capital. They didn’t have to put money into their businesses because they could run their businesses off the accounts receivable of the consumers who bought computers or the books over the Internet or phone. They had your credit card that night. They didn’t have to pay the supplier for 30 to 60 days. So, they ran it off the balance sheet instead of the income statement.
ROBERT HAGSTROM: When we hit the home run on Amazon, we had to suffer through 2000. It was mess. The people had the descriptions wrong.
ROBERT HAGSTROM: In the book, we talked about the philosophical challenges. Ludwig Wittgenstein, a great Austrian philosopher, spoke about the philosophy of language. The words you choose form a description that ultimately becomes your explanation.
ROBERT HAGSTROM: If you have the wrong description, you have the wrong explanation. Everybody thought that Amazon was Barnes and Noble. They said: “You should sell Amazon and buy Barnes and Noble.” Well, that didn’t work out well.
ROBERT HAGSTROM: Then, they said: “It’s Walmart. So, you should do a pair trade, sell Amazon and go buy Walmart.” That didn’t work out well.
ROBERT HAGSTROM: When we sat down and looked at it, Bill said, “It’s neither one of them. It’s Dell.” When we understood that, we knew we were home free. Since I wrote it in the book — from the time of its IPO up through 2018 — it was up like 2,750%. The market was up 200%. And everybody had been saying all along: “It always loses money.”
ROBERT HAGSTROM: It doesn’t lose money! I think it barely loses any money in the early years. And we talk about that in the book. If you take the operating cash flow — revenue and expenses that come in — you get a decision. You can either report it as EPS and pay the tax, or you can put it back in the business. It earns well over a 100% return on invested capital — rolling at 20% per year. If you’re a business owner, what should you do with the cash?
ROBERT HAGSTROM: Put it right back in the business, right? Don’t drop it to the bottom line on EPS.
CHARLES MIZRAHI: Let me explain that for those who are not in business. You’re basically saying that if you have a lemonade stand, and you take the earnings of that business, you have choices of what you want to do with them.
CHARLES MIZRAHI: You can take them out, put them in your bank account, go on a nice cruise — when cruises are available one day — or buy yourself a new house or a mink coat for your wife. Or, you can take that money and reinvest in more lemons so you can open up more lemonade stands. You’re making a lot on that business.
CHARLES MIZRAHI: That was what Amazon was doing. It was taking that money and rolling it into more business because that money kept making money — and it was much better in the hands of Bezos than it would have been if it was paid out as earnings or dividends.
ROBERT HAGSTROM: What a terrific analogy. I couldn’t have said it better. So, what do you want Jeff Bezos to do? I just want him to keep growing the business. So, keep it all. Everybody looks at it and says it has no earnings. Well, that’s a heck of a lot of earnings.
ROBERT HAGSTROM: But he didn’t drop it to the bottom line. He put it back in the business because it was growing at a double-digit rate, earning 100% return on capital.
ROBERT HAGSTROM: That’s exactly what you want to do. If you think about it as a business owner, you’ll say: “It makes perfect sense to me.”
CHARLES MIZRAHI: I’m sorry to interject. If he ever sends the money back to you, the first question to ask would be: Did the business have a tipping point? If he’s able to generate such a high return running the business, what am I going to do with it? We’re making 4% in the bank. I want him to have that money.
ROBERT HAGSTROM: If he sends it back to me — bucket loads — we’d have a great price earnings multiple, and everybody would be happy. I’m thinking that he has run out of opportunity to reinvest the money. As a business owner, I’d say, “The market thinks: ‘Now it’s an attractive investment because it has a low multiple because it’s reporting all the EPS.'” Very solid insight, Charles.
ROBERT HAGSTROM: But I don’t want him to report EPS. I want him to keep putting it back into the company so he compounds intrinsic value.
ROBERT HAGSTROM: That’s the essence of Berkshire Hathaway. Berkshire Hathaway is a compounding intrinsic value business. It owns compounding businesses. That’s what it does.
ROBERT HAGSTROM: When you have a business mindset, the world makes a lot of sense. But it doesn’t make sense in a market zone that looks at stock prices, short-term losses, short-term performance, EPS and low multiples. That’s not a game you’re going to win.
CHARLES MIZRAHI: You’ve mentioned that once you call something a name, you kind of anchor to it.
ROBERT HAGSTROM: Yeah.
CHARLES MIZRAHI: It’s really not value investing. I don’t consider it value investing. I consider it rational or intelligent investing, because as Munger said, “All investing is value investing.” You never want to buy something for more than it’s worth and sell it — hopefully — at a higher price because that doesn’t always work.
CHARLES MIZRAHI: It’s the same when you buy a house. You want to buy the house as low as possible compared to the market price. If the house is going for $1 million on the street and you buy for $600,000, you have a fantastic deal.
CHARLES MIZRAHI: I think that’s the problem. I think it’s one of the problems when it comes to — and I use air quotes here — “value investing.” People get anchored to that. They think back to 1930 and Ben Graham — looking at old, dying companies being sold for scraps, where their scraps are worth more. They don’t do stage two thinking. They just move on and pick the company that doesn’t have earnings or money — just a great story.
ROBERT HAGSTROM: Yeah. And you hit on two very important parts. Graham did cigar-butt investing. He liked to buy things so cheap that he didn’t think they could go down anymore.
ROBERT HAGSTROM: But the problem was — as Warren found out over time — it worked well in his partnership days, from ’56 to ’69.
ROBERT HAGSTROM: Buying and holding cigar-butt companies … You can’t make money. You are long-term owning the economics of a poor business.
ROBERT HAGSTROM: That’s what moved him to buy See’s Candies — and ultimately Coca-Cola — in stage two value investing.
ROBERT HAGSTROM: Your point about all value investing being intelligent investing resonates with me. If I hear one more value investor tell me: “As soon as value investing comes back, I’m going to start to make money again.” It is an open admission that you don’t understand value investing. As Bill Miller points out, there’s a lot of value in high-multiple stocks.
ROBERT HAGSTROM: Warren Buffett would tell you: It’s not high PE or low PE. It’s cash returns on invested capital and the sustainability of that. If you tell me that you’re going to be successful as soon as value investing comes back, it’s an open admission that you have a very narrow view of what value investing is.
ROBERT HAGSTROM: If you think it’s just low-multiple stocks waiting to come back … For the last 10 years, as you rightly pointed out, they have done awfully. The economics of intangible investing — brand value, software and the new network economic businesses of level three, which don’t show up in price earnings multiples — are worth a lot more than the low-multiple, brick-and-mortar businesses that the classic value stocks are waiting to come back.
ROBERT HAGSTROM: Your listeners will say, “Well, value is working out pretty well.” And we are getting a rotation in the market as we reflate back from the recession. Value has been oversold, and growth has extended. But you’ve got to figure out when to trade it, right? You don’t want the buy-and-hold value forever. Once it’s fairly priced, you’re left with the mediocre economics of that business.
ROBERT HAGSTROM: So, we have a little rotation in the market. I’ve been through them before. You have too. We’ll get through it. But at the end of the day, it’s the economics of your business that will determine your long-term net worth — unless you’re a trader. You’ve got to figure it out. You’re either a trader or investor.
ROBERT HAGSTROM: People today, as we pointed out, are still trading stocks — not investing in stocks.
CHARLES MIZRAHI: Yeah. I always tell my readers that the stock price follows the underlying worth of the business — not the other way around.
ROBERT HAGSTROM: Absolutely.
CHARLES MIZRAHI: That’s why I always love buying businesses that are solid — with solid financials. If you’re right on management, the industry and the business, even if you’re wrong about the stock price, you won’t get hurt over the long term.
ROBERT HAGSTROM: As long as you don’t overpay. Exactly.
CHARLES MIZRAHI: Even if you do overpay, you’re not going to be left with zero. There’s some intrinsic value if you don’t do something silly and pay 20 times the amount. The point is: If you miss, you’re not going to miss big.
CHARLES MIZRAHI: But if you buy a business that has great management, is in a great industry but is severely in debt … It’s drawing on credit lines. It doesn’t have any cash. Your margin of safety is so thin that you’ll be praying for a miracle. And every day you’re just happy to be in business.
CHARLES MIZRAHI: I don’t care what price you paid for that. It’s much easier to jump over a one-foot hurdle by buying a business that’s financially sound. That’s what I tell my readers all the time. Buy financially-sound businesses, and pay a fair price. Odds are, you’re not going to get smashed. If it’s the other way around, it’s going to be black or red. You might win. You might lose. But odds are, you’re not going to walk out a consistent winner by any stretch of the imagination.
ROBERT HAGSTROM: Brilliantly said. I couldn’t have said it better, Charles.
CHARLES MIZRAHI: So, sum up your new book. I just saw it on Amazon, and it has phenomenal reviews so far.
CHARLES MIZRAHI: You had a lot of smart people write great testimonials for you. I know you can’t buy those because they’re not giving up their names for a couple dollars or a mention in your book. Tell me why I should run out and get this book after reading everything about Buffett and learning about investing. Why do I need this book?
ROBERT HAGSTROM: Well, the biggest difference between The Warren Buffett Way and the new book is that The Warren Buffett Way is a method book. This is a thinking book. We want method books to tell us how to do something.
ROBERT HAGSTROM: But there’s a temperament you have to have in order to be successful with a method book. This is about temperament. It’s about the philosophy that Warren grew up with, which he learned from his dad. His dad — who he loved and meant the world to him — taught him about self-reliance from Emerson, stoicism from Ben Graham, rationality from Charlie Munger and pragmatism. We go through all that. We go through the evolution of value investing and how to think about changes over time.
ROBERT HAGSTROM: Importantly, we go in contrast to standard money management today — active money management defined by modern portfolio theory. What are its weaknesses? Why doesn’t it work long-term relative to what Warren does?
ROBERT HAGSTROM: Chapter six, which is my favorite chapter, is about a sportsman, a teacher and an artist.
ROBERT HAGSTROM: It talks about investing from an athletic standpoint. How do you compete? How do you compete well? What is the difference between process and outcome? [I talk about] the role that teaching plays. Those who teach about investing get smarter. Warren has been teaching about investing since 1955.
ROBERT HAGSTROM: Teaching makes you smarter. And [Buffett] has been a devoted teacher. People that follow Warren love his teachings. Then, lastly, an artist.
ROBERT HAGSTROM: He thinks about Berkshire Hathaway as the Sistine Chapel. He goes in and paints the Sistine Chapel every day. If you think about Berkshire Hathaway, Warren is the artist. He has a brush that has pigment — which is his capital — and he paints every day. He’s done some wonderful things.
ROBERT HAGSTROM: So, it’s really a philosophical temperament. But it’s absolutely essential that you combine that with the methods in order to be successful in the Berkshire approach to investing.
ROBERT HAGSTROM: I’m so proud of this book. But I’m just a dunce, Charles. It took me so long to figure out that I underweighted temperament and overweighed mechanics. If I was smarter about it 10 or 15 years ago, I would have said, “Yeah, we’ve got the mechanics, but we’ve got to get this temperament part right.”
ROBERT HAGSTROM: I was slow to figure it out, but when Warren mentioned it three years ago, in 2017, I said, “He’s exactly right.”
ROBERT HAGSTROM: I’ll leave you with this. If I said, “Would you like to invest like Warren Buffett?” they’d say “Absolutely.” They get started and then fall off the wagon. They fall off the wagon because they don’t have the temperament. This book helps them get the temperament, which allows them the psychological or emotional strength to apply the mechanics — the methods — that we already know work. It’s a perfect bookend to The Warren Buffett Way, and I’m extremely proud of it. Thank you.
CHARLES MIZRAHI: Outstanding. Temperament is the key. I think you said that if there’s one trait that distinguishes a good investor from a bad one it’s temperament. When prices go against you and your work is right, you don’t panic and sell into down-markets. And you don’t get giddy in up-markets.
CHARLES MIZRAHI: When I had an intern at my money management firm, I knew right off the bat how good that intern would be. When I asked for their brokerage statement, I’d ask, “Can I see it during a down period of time?” And if I saw hyper activity or selling, there was just no way that person was ever going to change.
CHARLES MIZRAHI: If you can look and keep an even keel when prices are down and get excited about it because you’re able to buy bargains … When prices are up, but you say, “It’s time to take some chips off the table,” you’ll do well.
CHARLES MIZRAHI: Other than that, you’re pushing a boulder up a hill.
CHARLES MIZRAHI: Robert, I want to thank you and wish you continued success. You have an outstanding book. What people don’t realize is that you also have a day job. You’re also managing money, and that is a full-time job — especially the way you do it. You read 10Ks and annual reports. You speak with management. But you’ve had time to write this, and you do a tremendous service to the investment community. Someone who is just starting out can take your book right off the shelf. What has taken you 27 years to figure out … Here it is. I think it’s a cheap price for a book on Amazon.
ROBERT HAGSTROM: Charles, thank you for the invitation. This is my first interview for the book, and I couldn’t have picked a better person to have it with. It’s been terrific.
ROBERT HAGSTROM: You asked all the right questions. It was a wonderful conversation. This hour went by in a blink. I had so much fun. Thank you.
CHARLES MIZRAHI: Absolutely. I feel the same. Robert, thanks so much for being on the show. I greatly appreciate it.
CHARLES MIZRAHI: Thanks for listening to this episode of The Charles Mizrahi Show. If you’re a new listener, welcome! If you’ve been listening for a while, we’re glad to have you back. Either way, we’d love to know what you think of the show. Please leave a review if you listen on Apple Podcasts. Reviews make it easier for others to find the show. You can also see the video of the interview on The Charles Mizrahi Show channel on YouTube.
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