The Little Book of Investing Like a Pro – Joshua Pearl
The Little Book of Investing Like a Pro – Joshua Pearl
His framework helps you invest like a Wall Street pro … Joshua Pearl doesn’t see stocks as lottery tickets or wiggles and jiggles on a chart. Instead, he views investing as owning a piece of a business. Over the course of his career, he’s worked hard to share his step-by-step strategy with the world. Pearl discusses his books and five-step investing process with host Charles Mizrahi.
- An Introduction to Joshua Pearl (00:00:00)
- Discovering Your Process (00:07:07)
- Finding Investment Opportunities (00:09:16)
- Developing a Framework (00:13:31)
- Identifying the Best Ideas (00:18:05)
- Analyzing CEOs and Leadership (00:21:13)
- Lithia Motors (00:32:09)
- Starting From Scratch (00:34:32)
Joshua Pearl has been in the investment business for nearly two decades. He started out as a credit investment banker but transitioned to long/short equity investing around 10 years ago.
Today, he’s the founder and chief investment officer of Hickory Lane — a long/short equity asset manager. In addition, Pearl has written two books (below) that have received glowing reviews in the investment community and beyond. These works exist to help retail investors take their financial futures into their own hands.
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JOSHUA PEARL: In order to learn the market — beyond reading my book and other books — you really have to be invested. You have to experience the highs and lows. You have to learn a process. You have to develop that temperament where — if a stock you like goes against you — you should actually buy more versus selling.
CHARLES MIZRAHI: My guest today is Joshua Pearl. Josh is the founder and chief investment officer of Hickory Lane, a long/short equity asset manager. He focuses on equity investments and special situations — utilizing a fundamentals-based approach.
CHARLES MIZRAHI: He’s also the coauthor of: The Little Book of Investing Like the Pros: Five Steps for Picking Stocks. His book has received glowing testimonials from the investing community. Howard Marks, co-chairman of Oaktree Capital, wrote that he had “never before seen a book that provides the same complete and thoughtful orientation to the process of investing.”
CHARLES MIZRAHI: Joshua’s approach teaches a simple framework and step-by-step manner on how to pick stocks. I recently sat down with Josh to discuss his five-step framework on how to invest like the pros on Wall Street.
CHARLES MIZRAHI: Josh Pearl, thanks so much for being on the show. I greatly appreciate it. I’ve been looking forward to this since we first spoke about a year ago — when your book came out.
JOSHUA PEARL: My pleasure. Thanks for having me.
CHARLES MIZRAHI: All right, Josh. Let’s get right to it. You came out with a book called: The Little Book of Investing Like the Pros: Five Steps for Picking Stocks. I liked it a lot when I read it. What gets me is that you have testimonials from the elite of Wall Street. Howard Marks wrote the foreword. You have Stanley Druckenmiller — the famed hedge fund guy who made zillions of dollars throughout the years; Nelson Peltz, CEO of Treuhand Fund Management; and Abby Joseph Cohen of Goldman Sachs. How’d you get these people to say that this book is the best thing since sliced bread?
JOSHUA PEARL: I appreciate that. It’s certainly a fun process interacting with these individuals. You can imagine that if they’re going to put that their name on a product that’s going to be out there forever, they’ve got to do their diligence on you. I went to individuals like Howard and Nelson because they were investors who I wanted to emulate and that I respected externally.
JOSHUA PEARL: My view was that the way they were thinking, acting, spending their time and investing was how I wanted to be as an investor. So, it meant a lot that I was able to get to these individuals. I had a connection. I worked with somebody who worked with them. I knew some of these individuals personally, and I certainly appreciated all of their help and support. I could talk about a few of the stories of how I got to them — or what the process was — if you like. Each one is a fun story. Each one is a great memory that I’ll tell my kids about at some point.
CHARLES MIZRAHI: It’s just great because you’re right. These guys would not put their names on something that was sub-par. Before we get into the book, your five-step approach and how retail investors could take it — and this is the approach that you’ve been using. I think the key is your background. You’ve been doing this for a while, right?
JOSHUA PEARL: I’ve been in the business for 18 years now. I started out as a credit investment banker, doing high-yield, leveraged loans and restructurings. Then, I became a long/short equity investor about 10 years ago.
JOSHUA PEARL: But even growing up — and I think this is probably the case for a lot of our listeners or anybody who wants to get involved in Wall Street — you’re looking at a scroll at the bottom of CNBC or Bloomberg and trying to figure out what that means. Or, your parents or grandparents are involved in investing and give you a stock certificate or buy you a mutual fund for your birthday, bar mitzvah or what have you. And that kind of starts the initial bug.
JOSHUA PEARL: I talk about this in the book. To be a pilot, you need a license. To be a doctor, you have to go through years of medical school and a residency. But anybody in the world can open up an E-Trade account and start buying stock. You can get hurt that way. So, my thought process — and my co-author’s thought process — was to put something out there that could help the average individual.
CHARLES MIZRAHI: Just a few weeks ago, at the [Berkshire Hathaway] shareholder meeting, Buffett and Munger were talking about young people investing and — I use the word in quotes — “gambling” through Robinhood. [They’re] buying and selling — thinking stock-picking is an easy game. What do you think is going to happen to these folks?
JOSHUA PEARL: There are positives and negatives. Obviously, the negatives are that there are individuals who see their friends making a lot of money on some of these meme stocks, and they’re fast followers. Ultimately, there’s a lot of volatility there. So, they might be buying high, and then the stock starts going down. And they say: “I just put in this month’s paycheck, and I’m losing money. I don’t want to lose any money.” And then they sell, but the stock goes back up.
JOSHUA PEARL: The only positive there is that in order to learn the market — beyond reading my book and other books — you really have to be invested. You have to experience the highs and lows. You have to learn a process. You have to develop that temperament where — if a stock you like goes against you — you should actually buy more versus selling.
JOSHUA PEARL: I think Robinhood certainly has gotten a lot of people involved in my network — and even just my wife’s friends or friends of mine who know what I do. They’re getting a lot more involved in the markets. Certainly, over a long period of time, the market has been an incredible wealth-creation engine for individuals. Exiting the original recession — the Great Depression — the markets compounded well over 10% per year. Any stock or index chart you look at, where you’re putting money in the market along the way, the market has tended to create value over time. As long as individuals get involved — and that can be a very good thing — without the proper knowledge base, they can get hurt. We wrote our book for that reason.
CHARLES MIZRAHI: We’re going to go through your process of picking stocks — the five steps — in a second. You take an approach like you’re an owner of a business. You don’t look at a business as a lottery ticket or wiggle and jiggle on a chart. You see it as a business and analyze it that way. Am I right?
JOSHUA PEARL: That’s correct. As opposed to just being some green or red font on a screen — or just some number —and I think a lot of other investors who are fundamental-focused think like this as well — is that you’re buying a share of a business. You become an equity owner of the business. So, if you seek to be a long-term-oriented investor, you have to have the skills to understand the business prospects, the fundamentals of the business and what that can look like over time.
CHARLES MIZRAHI: The thing that I’ve always seen throughout the years is that most investors call themselves investors, but they don’t have a process. They don’t have an approach. It’s like if they were restaurant owners. One day they’re selling sushi. The next day, they’re selling Frankfurters. The next day, they’re selling fish sandwiches. There’s no rhyme or reason.
JOSHUA PEARL: It does take years to develop a process. I think that for a lot of individuals, their processes can start with their daily observations — the so-called “Peter Lynch methodology.” What are they seeing in their personal and professional lives? How are their friends and family acting? How are they spending their time and their money? And that can be very informative for individuals who are just starting their investing process.
JOSHUA PEARL: Invest in what you know. Invest in what you see every day. If you see that you’re spending a lot more money on a certain website or some type of vehicle, maybe those are good investment opportunities. So, that’s always a very good place to start.
CHARLES MIZRAHI: I remember that a few years ago, at one of the annual meetings, Buffett lamented how he missed Google. He was asked to invest in it. And the thing that got me was he mentioned that Google was being used by Geico — the insurance company. And he said: “What a terrific business. Every time you click, there’s no incremental cost. You click, and they had to pay Google.” He said: “I’m just kicking myself that I missed investing in [Google].” It was right under his nose.
JOSHUA PEARL: I think what he says — and a lot of investors who are professionals have this experience — is that their biggest mistakes are the ones that they don’t do. It’s staring at them. They’ve done the work on it. It’s right in front of their faces. It just seems too good to be true or so simple.
JOSHUA PEARL: They pass for whatever reason, and then that stock goes up two-fold, three-fold or ten-fold. Or, on the positions that they own, they’ve got a price target that’s 100% upside. They reach it very quickly and sell. And then they don’t capture the next 100% upside.
CHARLES MIZRAHI: Right.
JOSHUA PEARL: So, it’s typically the stocks that you don’t do that end up hurting your performance the most.
CHARLES MIZRAHI: Right. OK, so let’s get into it. You have five steps that are simple to understand, but not so easy to implement. It really takes experience. It takes time. And like anything else, the more you do it, the better you get at it. So, let’s get to the first one. The first step you have is idea-generation. What is that?
JOSHUA PEARL: We outline the core buckets of opportunities for our readers — where professional investors tend to find interesting ideas. In our intro, we talk about what I just mentioned about daily observations. But in general, there are certain categories or buckets in which professional investors tend to traffic and find ideas. And those are opportunities that, over time, have created a lot of value.
JOSHUA PEARL: First, we’re looking for undervalued companies — ones that are trading in a particular multiple but should be at a higher multiple because of their business prospects. Then, we’re looking for companies that have an inflecting financial performance — which is a very strong financial performance. Or maybe, in general, our internal numbers are much higher than Wall Street is anticipating —
CHARLES MIZRAHI: Hang on a second. I’m an average guy. I work in another industry. I have no idea if an undervalued company would bite me in the ass. So, how am I supposed to figure out what an undervalued company is so that I can do this idea-generation thing?
JOSHUA PEARL: Well, not to plug my other book, but I wrote one called Investment Banking — which is a professional book. It’s in its third edition. It’s sold about 250,000 copies so far. We talk about how to do the valuation work.
JOSHUA PEARL: But in general, there are certain methodologies — comparable company analysis, precedent and transaction analysis and DCF analysis — that, even if you’re a doctor or lawyer who’s spending time in the markets, it makes sense to look at. Everyone knows about the PE multiple, price to free cash flow or enterprise value.
JOSHUA PEARL: Even in this mass market book, we do a tutorial on valuation. But I’ll use terms in the books — and we talk about this up front — so it probably makes sense to read a very rudimentary accounting book. There’s one called: How to Read a Financial Report by John Tracy. It’s another Wiley book. It’s very, very simple to pick up. Wiley owns the “For Dummies” brand — Reading Financial Reports for Dummies.
JOSHUA PEARL: Read through those. Get yourself familiar with the terminology before you become an investor. In essence, to simplify it, I think the company is going to be worth more because I think that it’s going to earn more over time, and the market is going to reward it with a higher multiple. So, [I’m] trying to figure that out.
JOSHUA PEARL: I’m looking at M&A opportunities — mergers and acquisitions. Company A is buying company B. They’ve announced synergies. I think that as a result, they’ll cut costs. They’ll grow faster.
JOSHUA PEARL: I’m looking at spinoff opportunities — opportunities where a company is spinning off or divesting a non-core asset that might be able to be worth more with a different capital structure or more investment.
JOSHUA PEARL: I’m looking at restructuring — as in turnarounds. Often, companies that have been through bankruptcy or have had hard times are very interesting opportunities.
JOSHUA PEARL: I’m looking at new IPOs, CEO changes or even other investors. What are some of the best investors in the world doing? I’m looking at investors with great track records.
JOSHUA PEARL: So, there are a lot of different approaches to finding ideas. And we outlined and simplified how to find them in the book.
CHARLES MIZRAHI: OK, so let me give you a simple idea. I know Google. I use it all day. I use it for search. I use it for clicks on ads. I know something about the company because I’m a customer. Now, I want to go ahead and buy the stock. What’s my first step?
JOSHUA PEARL: The first step is to get an account. There’s a lot of public information out there. Let’s say you don’t have access to a lot of the Wall Street research. You don’t have access to management. But every public company has FCC files — where they describe its business and prospects in detail. Managers take on the business— sometimes even guidance.
JOSHUA PEARL: You can go to the corporate website. You can look at all their different products. They’ve got pictures of all their products. You can go to their investor relations section, read their investor presentation and watch the analyst report. All this public information is out there, and there are so many different resources. Your podcast, blogs, etc. … Read what other people are saying about these businesses. That’s a very good place to start. Understand the company.
JOSHUA PEARL: We talk about this in the book. What does a company do, and how does it make money? It’s kind of like Kindergarten Cop — if you remember that movie from the 90s. Who’s your daddy, and what does he do? It’s the same thing with a company. What does the company do? OK, I know what they do. Now, how does it make money? Is it a function of adding more subscribers, and they’re charging more for that subscriber every single year? There are really only two or three business drivers that form the nucleus of how a company generates money. As an investor, it’s your job to figure out where those business drivers are and whether or not you think they’re going up or down.
CHARLES MIZRAHI: Got it. OK, so let’s use Google, Facebook and Microsoft. I can understand those businesses. Those aren’t 10-foot hurdles. They’re pretty simple businesses to understand.
CHARLES MIZRAHI: Now, we go to step two. How do I figure out — as you have in the book — the best ideas? What am I looking for to figure out what the best ideas are? Should I invest in these 10 companies that I figured out? I know the business. I use the business. I wear Nike sneakers. I drive a Tesla. I use Google. So, there are things I could understand. Got it. Next step.
JOSHUA PEARL: So, that’s where you start with your process. That’s where the experience of investing comes in. Every investor should develop a framework. What we do in our book is set up a basic framework. We provide templates for our readers on how to process an idea.
JOSHUA PEARL The first thing is to think about the investment thesis — which is basically my reason for owning a stock. What’s good about the stock? What’s the business rationale for owning the stock? What do the business prospects look like? What’s the management team like? Who’s running this business day to day? That’s a very important part of the process.
CHARLES MIZRAHI: Let me jump in for a second. So, you and I are buying a coffee shop near a train station. Not Starbucks. We want a regular Joe’s coffee shop. We’re passive investors. We’d want to know all the things that any passive investor or silent partner would want to know about the coffee shop. Why does it have an advantage? What’s the management like? When is the best time for customers? What season of the year do they go? What profit margins are they working on? How are they going to increase sales?
CHARLES MIZRAHI: It’s all basic stuff. If you take away the word “stock,” “stock market” or “Google” and talk about your local coffee shop, we’d look at it the same way. Is that right?
JOSHUA PEARL: I think everybody will develop their own bells and whistles, bright lines and things they look for. Some are bottom-feeders. And some are growth investors.
JOSHUA PEARL: I like to equate it to purchasing a vehicle. When you purchase a vehicle, you’re looking for a certain thing. You’re doing all the different types of comparisons. Some individuals want to buy a used vehicle because there’s good value there. They’re going to drive it for a very long time. It’s OK if there’s 30,000 miles on it. Some individuals want to buy the best possible vehicle, and it has no miles on it. It’s the best brand name. And that may work for anybody.
JOSHUA PEARL: It’s the same thing with stock investing. Some investors want to buy a company when it’s doing poorly — when there’s a new management team, and it can change. Some investors want to buy a company that’s growing very fast, and they think that its growth might continue. So, there are all different types of investment philosophies. All we do in this book is provide a framework to start thinking about that.
JOSHUA PEARL: In our step two — identifying the best ideas — we lay out some templates and give some guidelines for how individuals can sift through all these companies. Once they’ve identified a couple of core candidates that they want to look at, they can start organizing their work.
CHARLES MIZRAHI: Right. I want to share with you one thing that I did with my newsletter — Alpha Investor. In March 2020, when the country shut down, I said: “Holy smokes. We’ve never seen anything like this. I have to only look at businesses that don’t rely on retail traffic or products being physically delivered and have recurring revenue streams.
CHARLES MIZRAHI: So, that led me to companies like Netflix. I don’t want to go through all of them, but companies unlike, for example, Starbucks — where people had to go out. Or movie theater chains. Or cruise lines. Those needed customers outside during a pandemic. I said: “I don’t know how long this thing is going to last.” So, in your framework, that would be something where I just narrowed it down in your verbiage, right?
JOSHUA PEARL: Oh, 100%. What becomes tough is that once those companies you’ve identified start to really work — and now those stocks are up 50%, 75% or 100% — is now the right time to buy? And some of the other companies that were being disrupted during that time period — the travel or retail companies — will start to improve their prospects over time. Does it make sense to start buying some of those?
JOSHUA PEARL: So, that’s a bit more complex and nuanced. We talk about a lot of that stuff in the book. But certainly, what you talked about is what I mentioned up front in terms of those daily observations. A year ago, the businesses that relied on human-to-human contact will probably not do very well.
JOSHUA PEARL: What was interesting about Amazon was that its moat was certainly fortified during the pandemic because so much of its competition — the mom-and-pop competition — unfortunately, wasn’t deemed essential. You think about a toy store that’s been in a family’s generation for years. They sell toys. Now, they can’t sell toys anymore during the pandemic. So, where do you go to buy toys? You go to Amazon.
CHARLES MIZRAHI: Hardware, shoe and clothing stores — I looked at that and said: “My gosh, through this pandemic, the government created a monopoly that’s even stronger and is going to get stronger.”
JOSHUA PEARL: Exactly. This weekend, I was speaking to somebody who started investing during the pandemic for the first time, and they bought Peloton because they’d bought a Peloton for their home. I bought a Peloton. Other people are doing the same thing, I’m going to go buy the stock. So, for the average individual, those types of operations can create a lot of value for them in a portfolio.
CHARLES MIZRAHI: There’s one shortcut that I want to talk about because I think you’re one of the few who do this. You view stock investing as owning a piece of a business. So, we’re all on there. And a lot of people do the same thing.
CHARLES MIZRAHI But as a passive investor — meaning we’re just giving our money to someone and we’re sitting back — you do a lot of research on the CEO — the person running the ship. You do a lot of research on that person because you could have a great business, but if a knucklehead is running it, it’ll quickly go into the ground.
CHARLES MIZRAHI: So, walk me through what you look for with a CEO — something that’s public information. You’re not stalking the guy or going through his garbage. [Tell me about] the stuff that anyone could figure out about a CEO — which makes or breaks the business.
JOSHUA PEARL: The first thing is that you want to make sure they’re incentivized — or have money at stake. You think about a CEO who owns $1 million of stock — that sounds like a lot of money to the average individual. But if that company goes bankrupt, the CEO loses a million dollars and gets another job.
JOSHUA PEARL: Today, most of the CEOs in our portfolio have an excess of $25 million, $50 million or even billions of dollars of stock. The CEO of Lithia Motors, for example, has $75 million of stock in one of our top positions. The CEO of Shift4 Payment (NYSE: FOUR) is 38 years old and founded this business 21 years ago. He has $3 billion of stock. So, if his company goes bankrupt, he’s going to $3 billion. I think he’s going to try to do what he can to create value.
JOSHUA PEARL: The next thing you do is look at track record. You want to see what this individual has previously done in terms of creating value for shareholders — either in the stock price or what they’ve done to numbers point to point. Have they been increasing value by driving margins, revenue growth, earnings growth etc.? We spent a lot of time talking to peers and former staff members. We wanted to understand what these individuals were like personally and professionally.
CHARLES MIZRAHI: One second. I can’t do that. I can do the first two. I can’t call up the guy’s brother-in-law and ask him what he’s doing.
JOSHUA PEARL: I can’t either.
CHARLES MIZRAHI: OK, so I can’t do that. Tell me what I can do. You did mention the track record — if the guy worked at another company, or he’s been there for 20 years. Let me see their earnings, revenue and what the stock price did over 20 years. That’s empirical evidence. There’s no fudging. The numbers speak for themselves.
JOSHUA PEARL: Right.
CHARLES MIZRAHI: That’s pretty simple. What else can I do?
JOSHUA PEARL: Sure. So, my team and I like to watch YouTube videos on these individuals.
CHARLES MIZRAHI: Nice.
JOSHUA PEARL: We want to know if they’re well-spoken. Are they a good communicator? It’s important because they have to be able to communicate not only to their investors, but also internally. You think about a leader as an effective communicator. All they have to do is convince the level of management below [to implement] their strategy and let that next five, six or 12 individuals communicate and execute it throughout the entire organization. That’s a great communicator.
CHARLES MIZRAHI: Let’s use John Malone, for example. [He’s] the cable cowboy. I don’t think anyone on Earth knows as much about the cable industry as this man. Most people would agree with that. Do you agree with that?
JOSHUA PEARL: Sure. We’re invested in a couple of his entities. He owned Charter Communications, which is backed by Tom Rutledge — a great CEO. Also, [he’s] on the back cover of my investing book.
CHARLES MIZRAHI: Right. OK. Let’s walk through a very simple example. So, John Malone has started cable companies and created enormous shareholder value over the past 40-odd years. To put this in average terms: He’s the Warren Buffett of cable. Or, Warren Buffett is the John Malone of stock investing. That’s how good this guy is. You watch a video of John Malone — and there are tons of interviews. The guy is 80 years old or so, right?
JOSHUA PEARL: Yeah, I think he’s close to 80 now.
CHARLES MIZRAHI: I listen every time he’s on a podcast or CNBC. And I just want to speak to what you’re saying. He is so clear and to-the-point that when you finish listening, you know where the business is heading and what area it’s going to — cable, streaming or anything to that effect. And you can just imagine all of the little John Malones that he’s created to develop this network of companies. That’s getting a message out in one breath to a whole bunch of companies.
JOSHUA PEARL: Yeah, he’s quite amazing, and I’ve had the opportunity to meet him a couple of times. I’ve had the opportunity to sit next to him in his boardroom at an investor meeting. He’s an incredible individual. There are so many YouTube videos about him. Just hearing him speak — the way he thinks about the philosophy of investing and creating value. What he’s done with Charter two years after Tom Rutledge joined as CEO — in terms of M&A and driving broadband penetration. It’s just amazing.
JOSHUA PEARL: If you or your audience have the opportunity to read Cable Cowboy … It’s an incredible narrative of his journey with creating the modern cable ecosystem — which has spawned the entire internet. Every single company you were talking about before — whether it’s Google, Microsoft, Amazon or Netflix — rides on the broadband backbone. He was responsible for implementing it.
CHARLES MIZRAHI: He implemented the plumbing of the internet in the 90s, right? Without him, you wouldn’t be able to watch Netflix.
JOSHUA PEARL: Exactly.
CHARLES MIZRAHI: Or, [you wouldn’t be able to] work at home. I just want to go back to something really easy now. So, I’m listening to this and saying: “This guy, Josh, is a smart guy. He writes books. He manages money. I’m never going to be this guy, and I’m not going to compete against him. But I can figure out a company like Microsoft. I can look at Satya Nadella’s videos. He’s all over YouTube. I can see what he says at presentations or keynotes…”
CHARLES MIZRAHI: Or even Tim Cook of Apple. It doesn’t take a genius to figure out that this guy is brilliant. In fact, Buffett mentioned in the annual shareholder meeting that Tim Cook was probably one of the greatest businessmen he’d ever seen. And he’s known a lot of great businessmen.
CHARLES MIZRAHI: So, if I just follow what Jeff Bezos, Tim Cook and Malone are doing, and understand the flaws, then I won’t lose money over time. I’m going to do pretty well.
JOSHUA PEARL: Exactly. Invest behind high-quality management teams — which are incentivized to create value and are running great businesses that are on the right side of secular or structural change.
JOSHUA PEARL: You talked about Apple, for example. Are there going to be more individuals in the world who are going to be using smartphones going forward? Absolutely. There are so many individuals who don’t have access to the internet or a smartphone right now but will over time.
JOSHUA PEARL: You think about its product. Individuals can compare their products. Maybe their friend has a Samsung, and they’ve got an Apple phone. They can compare the products. If you take it back to the Charter example with broadband, there are more devices going into the home. It seems like every single day — you click on your modem, and you can actually see all the devices in your home that are connected.
JOSHUA PEARL: Are there likely to be more devices connected at home going forward? A lot more. Every device is becoming internet-enabled. That means you need more capacity, bandwidth and broadband speed. So, when you can get on the right side of strong secular growth — with a product that’s in demand — then you can layer on a strong management team and board.
JOSHUA PEARL: If you look at the board of Charter, for example, you’ve got so many individuals who are incentivized — like Malone, Greg Maffei, Eric Zinterhofer, Tom Rutledge, Mauricio Ramos and the Newhouse family.
JOSHUA PEARL: The average individual — outside of Malone, the Newhouse family and Tom Rutledge — has $4.5 million invested in Charter. That’s a lot of money. So, you have a whole team that’s centered on creating value. As long as you have a great business, you’re on the right side of secular change and you have a great management team, you should do well over time.
CHARLES MIZRAHI: It’s much easier to avoid stupidity than seek brilliance. So, I always try for these one-foot hurdles. And what I’ve found over time — and I got that from your book as well — is that if you start with one great company — let’s use McDonald’s, for example. It has more than 30,000 [locations] throughout the world. It’s a franchise business — meaning the company is collecting royalties each and every month. It owns the real estate. It’s in the real estate business.
CHARLES MIZRAHI: And the way I got that idea was by reading a book called Grinding it Out — about Ray Kroc — in 2004 or 2005. I said: “Wow. This business is amazing. And as time went on, I learned about other fast food businesses. By the way, this was all free stuff on the internet. I was just going from the investor relations of McDonald’s to Chipotle and Burger King before Ackman.
CHARLES MIZRAHI: All that information was out there. And once you learned about one industry you could look at another. And I’ve also found another thing that speaks to your point. Once you find a good manager or CEO, they usually run in clusters. A good CEO will have great board members. Each board member might run another company, and he might be on that one. So, it’s not so hard. Am I getting this right?
JOSHUA PEARL: You’re 100% right. You look at those individuals who are very easy to identify as a strong management team. And even the level below them is strong as well. They tend to be great mentors. And No. 2, No. 3 and No. 4 are strong as well. They’re being mentored by that individual.
JOSHUA PEARL: Now, the key — and where you can make a lot of money — is finding those CEOs early on — which is difficult to do. We’ve done that with Shift4. Or, there are those CEOs who kind of fly below the radar. You think about Lithia — which is among our top positions. It’s a car dealer.
CHARLES MIZRAHI: What’s the symbol of that?
JOSHUA PEARL: The ticker is LAD. It’s run by an individual named Bryan Deboer. He’s a third-generation manager of this business. And sometimes you see some variability and transition from the original founder to the next son or daughter and so forth. But in this case, Bryan has really accelerated the growth of this business through a very unique organic growth and M&A process.
JOSHUA PEARL: If you look at the past 10 years, this car dealer — which has less than 2% market share of U.S. auto sales, ranks No. 6 on 10-year earnings per share growth and No. 4 on 10-year-total shareholder return of the Fortune 500. So, he’s basically No. 4 of Fortune 500 CEOs in terms of producing returns for shareholders.
CHARLES MIZRAHI: So, for example, this is like LeBron James playing for a bush league team that doesn’t get much press. He’s out there doing amazingly well, and not many people hear about him.
JOSHUA PEARL: I definitely wouldn’t call it bush league because these guys have been compounding earnings at 25% per year over the last 10 years.
CHARLES MIZRAHI: Yeah, but how many people have heard of this company?
JOSHUA PEARL: Exactly. Not many. But they will soon because the company launched a new platform called Driveway.com — which is an omnichannel platform that’s kind of similar to Carvana. I think everybody knows what the large cap tech companies are — and those have been tremendous investments over the past couple of decades. You can’t go wrong investing in those.
JOSHUA PEARL: But there are obviously a lot of others out there. And for those who are enterprising or read our book, they can dip in their toes over time and try to find very good ideas. There are so many ways to make money in this market — or other markets — and there are so many different opportunities out there.
CHARLES MIZRAHI: So, if you were starting from scratch, what would be the one thing that you would look for in a business? You didn’t know accounting. Basically, you had money and wanted to partner into a business. What would be the No. 1 thing you’d look for?
JOSHUA PEARL: The No. 1 thing would be understanding the business.
CHARLES MIZRAHI: What does that mean?
JOSHUA PEARL: You have to really know what you’re investing in.
CHARLES MIZRAHI: Explain.
JOSHUA PEARL: I talk about it in chapter three in terms of underwriting business due diligence. What does the company do? Can I understand and explain to myself in a couple of sentences what this company actually does?
CHARLES MIZRAHI: Give me an example of your No. 1 holding: LAD. Tell me what the company does in one sentence.
JOSHUA PEARL: The company is a provider of new and used car vehicles. It sells new and used vehicles. The company finances those vehicles and provides insurance for them. And it also does parts and services.
CHARLES MIZRAHI: It’s basically a car dealer in new and used cars. Good. OK, that’s pretty simple. Got that. Why is that such a growth industry?
JOSHUA PEARL: It’s a growth industry — and the way we found this out is quite informative for your audience in terms of what you’re seeing in the real world. And this is where individual investors have an advantage over professionals. Because the professionals generally sit in offices. Most of the time, they’re reading research or are bogged down by numbers. Maybe they don’t have the day-to-day observations that somebody in the real world has.
JOSHUA PEARL: We use a lot of long-term data sources, and maybe this is getting a little bit too far down the rabbit hole. But what we saw that really excited us about auto dealers — and Lithia in particular — during COVID were some fact patterns that we thought were quite informative for these businesses.
JOSHUA PEARL: One, we saw Apple mobility trends — which measure leisure travel, and these are individuals who are requesting a location on Apple’s map — approaching pre-COVID levels by May.
JOSHUA PEARL: What that was telling us was that despite the fact that nobody could fly — or people weren’t flying to their leisure destinations — they were still driving. So, that was interesting. We thought that boded very well for parts and services businesses — more wear and tear on vehicles. And who owns parts and services vehicles? Well, dealers do.
JOSHUA PEARL: We were also serving data coming out of China — which we thought preceded the U.S. because it started getting COVID a few months earlier — that showed that about two-thirds of new-car buyers were first-time car buyers. And to us, that represented the seeds of deurbanization or suburbanization — where individuals, professionals and families move out of the cities to suburbs. And what’s the first thing you do when you get a house and move out of the city? You get a broadband connection. And then you buy a car.
JOSHUA PEARL: At the same time, the automotive manufacturers had shut down production largely — and you’re seeing a lot of that now with the chip shortage. We thought that boded very well for used car prices. Lithia is primarily a used car dealer. So, we thought all those themes boded very well for car dealers.
JOSHUA PEARL: And how we got to Lithia was we looked at its track record. We looked at all the CEOs in the auto dealer space. Lithia had been compounding earnings at 25% per year and growing revenue at 19% per year.
JOSHUA PEARL: Its nearest competitor, Asbury, had also been growing earnings at 22% percent per year. So, three basis points lower, but revenue was only at 9% per year. And so that little data point — that revenue to EPS differential was telling us that these individuals at Lithia are not trying to squeeze as much margin out of their customers. That’s a very unique methodology. At that point, we started doing a lot of work on it.
CHARLES MIZRAHI: Let me ask you — I couldn’t do any of this. I don’t have data points. I have none of that. How am I going to compete with you?
JOSHUA PEARL: Well, the good thing about Lithia — and very good management teams — is that they lay this all out in their investor presentation. They actually put their track records in their investor presentations.
CHARLES MIZRAHI: Where do I get the investor presentations?
JOSHUA PEARL: All you do is you go to Lithia Motors’ website, or just Google search: “Lithia Motors investor relations,” and you’ll get to their investor presentation.
CHARLES MIZRAHI: So, most people have no idea that companies put investor presentations — which are decks or simple, easy-to-read slides — on their websites that they give to Wall Street guys like you.
JOSHUA PEARL: For that reason, we wrote this book. I’ll tell you, when I went from being an investment banker to an investor — I had already written a book about how to be an investment banker. I thought I knew how to be an investor. Until you’re doing it day-to-day, you don’t really learn those skills.
JOSHUA PEARL: So, the best way to do it is to read books about it. We found that while there were so many great books out there … Obviously, Howard Marks has written a couple of very good books. The Most Important Thing is an amazing book. Seth Klarman wrote a book — Margin of Safety. It’s a great book. Joel Greenblatt has written a bunch of books. He obviously launched the Little Book series with The Little Book That Beats the Market. Those books are amazing.
JOSHUA PEARL: It’s difficult to pick up those books and be able to invest the next day. So, we basically took it to a level below those books and really outlined how to do this stuff from scratch. Where do you go for these resources? What is an investor presentation? All of this is in the book, and we felt that because individuals don’t know about this stuff, we needed to provide the resource for them.
CHARLES MIZRAHI: All right, man. Great. Josh, thanks so much. The name of the book is: The Little Book of Investing Like the Pros: Five Steps for Picking Stocks by Josh Pearl and Joshua Rosenbaum. Josh, I wish you continued success. I want to revisit this maybe a year from now. Let’s see how Lithia does and shift forward. I think they’re really great developing stories.
CHARLES MIZRAHI: And I think you’ve done the investment community — especially the first-time investors — a big service by coming out with — I wouldn’t say this is an elementary book. I think you need a little skill. It wasn’t something like a book for dummies because you go a little deep. But I think the value of this book is that most people will avoid the stupid mistakes. I think that’s key.
JOSHUA PEARL: I really appreciate the praise. Thank you so much for having me on the show. I look forward to discussing again.
JOSHUA PEARL: Great. Thanks so much, Josh.
JOSHUA PEARL: Take care, Charles.
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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