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IFB93: Investing in a Low Interest Rate Environment with Vitaliy Katsenelson

Dave:                                    00:00:36               All right folks, well welcome to Investing for Beginners podcast. Tonight we have a very, very special guest with us. One of my favorite writer, thinkers and investors. His name is Vitaly Katsenelson and he is the CEO of the IMA firm based out of Colorado and he has a fantastic blog. It is one of my favorites that really, really has helped me learn and grow so incredibly much. It’s called the Contrarian Edge. If you do not already subscribed to it, you need to, it’s fantastic. So without any further ado, I’m going to go ahead and get us started that you don’t want to hear me talk. We want to hear Vitaly talk. So Andrew, why don’t you go ahead and ask the first question and we can go ahead and chat a little bit.

Andrew:                              00:01:15               Yeah, thanks Vitaliy, for joining us. And, I’m also a big fan. I’m currently, it was actually good timing because I’m in the middle of reading your Sideways Markets book. Just so happened to be reading that when I reached out to see if you want to do an interview. We’re obviously a show that’s very focused on beginners and we like to talk about value investing and trying to buy stocks– buying low, selling high. So when you think, how do you think about value investing because that’s one of the things that you like to talk about. You’re a value investor, you’d like to think about investing. So do you approach the actual topic of value of investing differently? Do you see it as like a numbers game? Do you see it as maybe a mixture of both? How would you go about approaching the idea on the topic of value investing?

Vitaliy:                                  00:02:09               Well, first of all, Dave and Andrew, thank you very much for having me. I’m looking forward to this. All right. I think value investing is usually misunderstood. And let me explain why. Ben Graham wrote the Bible of value investing The Intelligent Investor and when most people read this book, they get would they get out of this? They get this recipe and the recipe is basically this: buy cheap stocks. And I think they get the wrong message out of this though. The recipe is part of the book. The bigger message of the book is really, it’s a value investment philosophy. It’s something I go through in my six commandments. But basically value investing is a philosophy where you say, and let me just go through a few of those six commandments. Stocks are not piece of paper their businesses.

Vitaliy:                                  00:03:04               You would analyze a stock the way you would analyze a business. Risk is not really the volatility of the stock market, but a permanent loss of capital. When the stock price declines and never comes back. Mr. Market is there to serve you and not the other way around. So this was the just three commandments out of six and implore your listeners, go to Investor.FM, where they can listen to all six commandments, which of the basic excerpt from a chapter of the book that I’m working on, that’s the point number one about investing. Value Investing is a philosophy and not just the recipe of buying kind of stocks to trade at 10 times earnings or less because if that’s all it was, then you can just have a computer do value investing and it’s not even good computer because all you have to do is count to 10, right.

Vitaliy:                                  00:04:04               If the PE is less then buy, so you don’t have to be that smart. And also the other part, it’s the kind of the Ben Graham’s recipe kind of, just by statistically cheap stocks is a very one dimensional because it only focuses on kind of on price. But you also have two other dimensions, which is basically quality and growth, right? Quality is a very important dimension because if you have a high quality company that basically that has a strong competitive advantage that basically guarantees you that the cash is in the future will be there, that’s very important. And Growth, there’s a lot of value in growth because Google is a lot more valuable today than it was 10 years ago because it’s earnings up, I don’t know, 5x or 10x since then. So there was a lot of value has been created by Google, you know, growing as an example. So if you focus just on statistical price and ignore the quality and growth you are really missing out on a lot.

Andrew:                              00:05:10               Yeah, that makes a lot of sense. So I guess when investors try to look at how a stock price kind of moves and how they’re trying to pick these sort of investments, do you see any really key kind of a big things that they can do know? Obviously you’re a fund manager. You, you spend all day looking at stocks, analyzing stocks as an investor, as somebody who is following Ben Graham. Also trying to kind of put your own twist on it and understanding that it’s more than just numbers. We’re also looking for growth. We’re looking for these businesses that can compound capital because that’s the ideal. We want businesses that will compound capital for us and so we don’t have to do as much work. Are there like big picture ideas of what we can do to kind of put all the odds in our favor, and give us the best chances for higher investor returns?

Vitaliy:                                  00:06:16               Well, I think you have to work very diligently on trying to be rational. Okay. And what I mean by this… the stock market does an incredible job to turn in any inspiring investor into trader. Because what happens, the stock prices, stocks you own a quarter, every millisecond… And so if you look at your stock portfolio changes the value, second by second. So we tried to do and what I think most investors should try to do is divorce themselves from the stock market. And basically first of all, figure out, what are their core competency? What businesses they understand. Also where’s not just IQ, which would be core competency, but also the, EQs the highest, so in other words, if you own a business and you feel that over time you become very emotional when something happens to the business, you probably should not own that business because you will not be able to be rational in the long run.

Vitaliy:                                  00:07:33               So when I look at a company, I ask myself first two questions, do I understand the business? It does that business align with my Eq where my EQ is the highest. If the answer is no to either one of them. I move on. To answer your question, first you start looking at the start looking for businesses, where you’re the most irrational volume of them and then just basically look for the market to come to you. So figure out if you want to pay $60 for that business and the price is 80, just do nothing and wait when you to the price gets to $60 and below and then you start buying. So that’s kind of the answer to your question. I’m not sure what that’s exactly what you’re looking for.

Andrew:                              00:08:16               Yeah. Yeah. Hundred percent. I mean, I think if investors can find, like you use, you mentioned this EQ thing, if they have, it’s not just picking the right stock because you could pick the right stock and if the price goes down and you sell out before there’s a nice swing back up and the recovery that you’re obviously not going to receive those returns. So you know there’s like the one side where you need to pick the right stocks and on the other side you need to make sure that you have the, for the two to be able to weather any sort of storm and kind of let the business grow and compound regardless of where the stock market goes and whether it does. And so I like how you said, make sure you are divorced to the stock market because that’s like, I think for value investing to work, that that needs to be at the first and foremost thing. And if you’re not, if you’re not getting that equation, then you’re not getting the whole thing.

Vitaliy:                                  00:09:16               Let me summarize why EQ is important and I’m going to go with Mike Tyson. Everybody has a plan until they get punched in the mouth. Okay. So everybody has a great, has a plan when they buy a stock and then things happen, which happens all the time. This is where you eat. EQ becomes very, very important

Andrew:                              00:09:34               I guess on the topic of when things go wrong. Lately we, we’ve had, uh, a market that’s been difficult for value investors. I think, uh, there’s, there’s a lot of articles that have been coming out where people are saying value investing is dead and we have, I particularly see a lot of things that say the price to book value is dead and here’s the reasons why. So you have an environment where it’s been difficult for particularly value investors who buy on low price to sales, price to book and maybe even price to earnings. Do you think, I guess there’s a lot of the ways we could go with this, but, do you think that the price to book is like a completely out of date metric where we shouldn’t even look at it anymore?

Andrew:                              00:10:30               And then secondly, do you think, do you see this sort of cycle of value investing where it’s been underperforming, to the point where, is it just one of those things where growth is just under performing and it’s just a natural cycle? Or is this indicative of something that’s maybe longer term? Because it seems like, to me it’s been quite a while, like 10 years of depending on, I guess who you’re talking to, but maybe 10 years of underperforming growth seems quite excessive and like maybe that’s something that’s not a cycle and maybe is indicative of something, something that’s developed in the market that, we need to think about.

Vitaliy:                                  00:11:17               Andrew, I really liked how you broke up this question into two questions because they’re two very different questions. Okay. One is basically looking at value investing as a kind of Ben Graham kind of way saying, okay, you said the price to book is dead or price earnings is dead. And then kind of talking about, well invest in from a value investing is a philosophy. So let’s look at it this way. Okay. So I never looked at value investing, price to book to me was always was only applicable when you look up the strength of stocks, like when you look at banks, price to book actually is a meaningful number because banks have to mark the assets to a value once a quarter or so you will need, so when you look at the book value, actually, you know, it’s a meaningful number.

Vitaliy:                                  00:12:15               I’m not sure what, like if you look at Microsoft’s price to book is meaningless because, Microsoft’s assets are not on the balance sheet. In a traditional form there, they don’t show up on the balance sheet, and if you look at Coke, same thing. If you look at that Facebook, it’s same thing. When you had a manufacturing economy, measures like price to book made a lot more sense in today’s economy, that was just the nature. The accounting metric as a book value just is, becomes less and less relevant. If you can guesstimate what the value of the companies then, and you call it book, then price to book actually matters.

Vitaliy:                                  00:13:07               My point is the kind of traditional measures can, the price to book to me, it was only applicable to when it comes to financial companies, maybe insurance companies, but that’s about it. When it comes to value investing in general, if you think about the environment we’ve been in over the last 10 years, interest rates basically declined from, I don’t know, five or 6% or 7% to almost zero in some countries they actually negative. And when that happens, if you will, if you, if I employ you to look at stocks as you would look at bonds for a second, if you own a 30 year bond and I’ll say five year bond, what would happen to the price of those bonds when interest rates decline? While the price of the 30 year bond would go up a lot and the price of the five year bond would go up a lot less.

Vitaliy:                                  00:14:01               Okay. So I would…

Andrew:                              00:14:04               can you, can you explain to us really quick why as far as, because we have some sort of

Vitaliy:                                  00:14:10               Absolutely. So there’s a, there’s a method, it’s a method. It’s first of all, it’s mathematical relationship. But think about this, the most of the value of the 30 year bond, like a big portion of the value of 30 year bond lies in the interest payments that people in your day that the whole of the band would receive over long period of time if you discount. So the, when interest rates decline, you start discounting those future payments at a lower rate and therefore they become more valuable today. And therefore the volume, the value of, the price of the bond would go up. That doesn’t make sense.

Andrew:                              00:14:47               Yeah. So if interest rates are higher than you could, if you had the money, you could have reinvested it and bought a bond that we get you higher interest and then side, it’s the other way. So then that’s why. Yeah,

Vitaliy:                                  00:15:03               Yeah. But no, but that’s true for both with five year bond. The 30 year bond the point is this, if I get you, let’s, just make it even simpler than that. Let’s see. I’m going to give you, um, hundred dollars 30 years from now or I give you $100 five years from now. Yes. If a small adjusted, if interest is go from 7% to 5%, the impact on that, that ton of dollars that you’re young going to give you three years from now is gonna be much greater. Right? Because that impact is magnified by time. Okay. So and that, and that’s, that is the key. So the longer the, longer duration of the bond, the longer the maturity, the greater impact change in interest rates has an price like, that’s the axiom of you can say been invest in but actually almost value in any asset.

Vitaliy:                                  00:15:58               Okay. So the reason it’s important that because the same applies to stocks. If you, and I hate to use this kind of, this divisions, but we have to, and I guess in this case, so when you have growth stocks versus value stocks, growth stocks means basically companies that earnings are growing at a very fast pace and they usually trade at higher price to earnings because, a larger portion of their earnings lies in the future. Just like a great portion of the cash flows for long term bonds lies in the future as well. So therefore, when interest rates decline, the value of growth companies goes up a lot more than the value of value companies who are traded lower price to earnings and happened to have a lower growth rates. And so therefore, in the last 10 years, when interest rates declined from normal rates to abnormal rates, the value investing has not done as well as, as kind of growth investing at some point when rates decline. I’m so when rates start declining and stagger, start going up that’s gonna revert. That would be one of the reasons for the reversion to happen, I guess.

Andrew:                              00:17:22               Yeah. Actually that makes a lot of sense. Does it feel like we’re kind of the laid as far as, okay, so I ask this because alright I’m in the middle of your sideways market book, you had predicted in the book we had just come from like a 18 year bull and then when you wrote the book, it seemed like we were in a sideways market. And then since I guess since 2015, the market’s kind of gone straight up. And we’re still not at the next 18 year mark, since the last bull. But you know, in previous, so I’ll let you introduce what I’m talking about so people might be confused of what I’m talking about. But you know, maybe in previous bull markets that have been followed by sideways markets, we’ve had interest rates that I guess when down and then up and kind of looked more normal. Whereas recently we’ve had these very, it seems like a very extended long period of interest rates being artificially low and it’s never, it seemed to me like it never, interest rates never climbed back where they should have for like a real recovery. So do you think that has an effect on what we’re talking about and on this sideways market that hasn’t happened yet?

Vitaliy:                                  00:18:54               Let me try to summarize the 80 pages of my book and the three minutes or less so I can answer your question. Let me simplify this way. If you own stocks in the long run that you get compensated by price going up and dividends, well, hopefully going up, but basically changing prices and dividends, okay, begin to put dividends aside for a second and look at this stock price. Why does price go up really methodically for two reasons? Because earnings are growing or declining or price to earnings is going to up or down. So let’s assume that earnings will be growing. If you look over the last hundred plus years, earnings could roll in about five or 6% a year. Not every year, but on average they’ve gone five or 6% a year. So let’s keep that as a constant.

Vitaliy:                                  00:19:45               So let’s ignore that for a second. But then if you look at price to earnings, price to earnings basically is the pendulum that creates a lot of noise in the, you know, but, and that’s what causes market cycles from 66 to 82 price to earnings. When you had a lost sideways markets, price charts went from high to average to below average. And that’s why the stock market has got nowhere. Even though earnings have grown, I don’t know, five or six to 7% a year during that time. The reason it’s important is this. If you basically make an assumption and that’s an assumption itself, that earnings will continue to grow, then what’s really going to determine what the stocks are going to do in over an extended period of time, let’s say 10, 15, 20 years.

Vitaliy:                                  00:20:33               It’s really priced earnings. And when the price to earnings is high, at the end of the bull market, usually it’s like a pendulum. It really swings from one extreme to another and that, when I wrote the book price to earnings was very high and I forget the numbers now, but this in 1999, I think the price to earnings of the was a, I forgot to say 30 times earnings for something. So historically when it, you’ve put swan from 30 times earnings to eight or 10, that that’s, that decline would basically cause any growth from earnings to be wiped out. And that’s, so that’s, and when, when that happens you have sideways markets. So when I was writing the book, I was basically saying, you know, variations of high, which the war and, the price to earnings, likely what it’s going to do, what it did in the past is going to go from high to average to below average.

Vitaliy:                                  00:21:26               Except what I was worried about is that the interest rates went from normal level to negative interest rates in many countries. And that has kind of, I don’t think it’s changed the sideways markets then omics is kind of positive? And, so since then, people were kind of forced into buying stocks because if the, if like you basically, if you had the saver who used to own corporate bonds, government bonds, and that’s how the basic that that was their income, now the forced into buying cokes and Kimberly Clark’s and Kraft Heinz because they’re looking at those talks to get dividends, and you know, they’re buying them from dividends and that kind of, and that’s changed the, and that’s kind of interrupted my kind of sideways markets. This is for a while.But I would still write the same book if I was, if I was sitting today, like if I assume that I did not know what interest in the industry it’s been, you know, we’ll go to zero and negative in many countries. I was to read the same book today. I think the overall framework of the book is too accurate.

Andrew:                              00:22:42               Yeah. 100% reversion to the mean and evaluations and price to earnings going up and down. Yeah. Like you said, that’s how, that’s what drives stock prices. Uh, D I guess. Do you think if we’re starting to see interest rates slowly climb? I guess if it got to a point where, I don’t know if it feels more like normal interest rates, if we saw that, from here, maybe let’s say the next two, three years, how do you think that would affect the value cycle that we’ve been seeing and just the market in general?

Vitaliy:                                  00:23:17               You know, I tried to sit down and write about this many, many times and every single time I could not finish the article because I think I’m, I’m really concerned about what would happen to all economy if you had higher interest rates. Because I feel that, um, like if you look at the economy, I feel like the economy, what’s like, if you think about over the last 10 years, the economy has grown. Like [inaudible] said, semi normal rates. Not necessarily great wade, but semi normal rate while our debt has skyrocketed. And, if something works one way, it must work the other way too. So, in other words, if interest rates go higher today, corporations are a lot more indebted than before. Governments are a lot more in debt than before. Consumers are much better health, which is good and that we’re being consistent as a much better health.

Vitaliy:                                  00:24:15               That’s good. But if you bought a car, and you got 4% financing and suddenly you’re going to buy a car and they finance and six or 7%, which is like we’d be normal, like in the 1990s, that would be a normal number. Then suddenly the car becomes 20, 30% more expensive and you say, well, maybe I should not be buying 45 [inaudible] car. And she did buy $35,000 car and that has a huge impact and profitability of car makers. So this is just a, as an example, now think about this, you know, what would higher interest rates due to prices of housing you have, how house prices their track and, and also think about what high interest rates would do to you as government was. That has basically doubled over the last 10 years. But interest payments are still the same as a dollar amount and saint level the word 10 years ago.

Vitaliy:                                  00:25:14               So I am really concerned what would high interest rates would do to the health of the economy. So right now I just sound paranoid and then maybe, maybe you shouldn’t be. Maybe it should be paranoid about this, I’ll look over the last 10 years. The more vigilant you are and the more kind of the more you knew about the economy, kind of how can we move works the less money you made. So you kind of like of lasting years ignorance was bliss, you know, the less you knew, didn’t know the money and rates. Yeah. I’m not sure, but this is kind of what I think about high interest rates. It really worries me. When I say this, people say, well then, you know, then we can’t afford it because we can’t afford higher interest rates.

Vitaliy:                                  00:26:12               Therefore, the Federal Reserve would not allow how it starts to happen on which my answer is that assumed that central banks can actually control interest rates in the long run. Like the central banks may have a much greater control of short term interest rates, but then of the day the markets will set launch them interest rates, they can try to find out the central banks will try to fight it by then end of the day, if you think inflation is going to be high, you are not gonna be buying lunch on bonds. You know, it was just, people would just make rational decisions and say, I don’t want to buy bonds and if I think in general inflation’s going be six and therefore, you know, so I think at the end of the day, you know, the kind of the greed or self interest will actually, that’s what it will be set in the interest rates for La London rates.

Andrew:                                  00:27:07               I guess on that cheery note, how would you position or how are you positioning your portfolio then? Are you just sticking the head in the sand or are you picking stocks differently?

Vitaliy: We’ve been incredibly conservative and incredibly defensive and we’ve been emphasizing quality and for us quality basically, I’m generalizing, means companies has a good grid business. It’s a great balance sheet and great management and great balance sheet becomes even more important than the context of the discussion that you and I just had. And Another factor is if, you know, and also we are very concerned about valuations, so when we are analyzing companies, we are looking at an absolute basis, not on a relative basis.

Vitaliy:                                  00:28:11               And let me explain it to your listeners. What it means when you look at a company. I say, what does the company worth? And let’s say hypothetically, it’s worth 2 billion, on a semi normal interest rate environment, it should be trading at 15 times earnings, just for illustration purposes. Okay. If it’s a fair value is 15 times earnings. I went to buy it, I don’t know, let’s say 10 times earnings. Okay. Hypothetically. Okay. That’s absolute valuation analysis. Okay. Relatively analysis would be, you don’t look at what you basically say where’s the company’s price joining cause has been historically and you say, okay, well or you look at the competitors and say, well competitors used to trade at 26 times earnings or maybe still traded 26 times earnings and this company is trading today at 18 to 20.

Vitaliy:                                  00:29:02               So based to it’s past or it’s relative, sending to competitors, it’s cheap. We don’t do that because beaten, you know, depending on valuation of last five years and we not necessarily what’s, you know, what the relation is, we’re going to see when the next five years. So we look at what the companies are really on absolute basis. That’s a, that’s a, that’s not the point. And third point, if I can find enough companies that meet my quality criteria and quit my in and basically in meet my valuation criteria, we’re going to have cash and a today our counts have a lot of cash. Our new accounts today would be maybe only 20, 35, 40% invested. And so they would kind of have 60, 65% invested in six months treasuries. Yeah. So that’s how we positioned today in our accounts.

Andrew:                              00:29:58               Do you think the average investors should try to, cause you know, I think Ben Graham with his book, the intelligent investor, he tried to make it simple for, for layman like me and Dave, where we have just like a framework we can use and it’s very simplified and we don’t know anything about economics. And I mean, it’s more just trying to buy companies and, and let them compound capital and we, and we tried to hold it for the long term. Do you think the average investors should think about a cash position as well? Maybe take that circle of competence to find it. And then also if you can’t find enough stocks to fit that criteria to have them hold cash or do you think they should be indexing or should they do something completely different? What your thoughts on that?

Vitaliy:                                  00:30:51               I’m very conflicted on this question and let me give you where I’m coming from. So on one side, I think individual investors have an advantage to some degree versus people like me because, or not necessarily like me, but like against professionals. Because professionals have to serve the clients. And a lot of times you have clients who may have a different time horizons then you as investor should have. So, and a lot of times you like, I’ll give an example. In 1999, if you were looking for the interest of your clients, you probably would be extremely conservative and you would be by, and you own at the time value stocks, right? Stocks to trade it eight to 10 times earnings and happened to be high quality companies that were cheap and you will not own that comes okay.

Vitaliy:                                  00:31:47               But as a professional, you had a career risk because that comes, we’re going up in value stocks weren’t. And so a lot of value investing firms went out of business because the clients took them, took the money and invested into a hot Dotcoms. So as a professional investor, you always have a career risk. And so the, the way he’s structured, it affirmed that we have very little career risk because the only accept clients who basically share our philosophy. Okay, so to some degree as an individual investor, you only answering to yourself so you don’t have that issue. So that’s an advantage. At the same time, I find that a lot of people should not be managing their own money because for the same reason doctors should not be treating their own kids.

Vitaliy:                                  00:32:38               When my son was born, which was 17 plus years ago, I discovered the pediatricians actually don’t treat the kids. And I asked why. And the doctor explained that to be a good doctor, you basically have to be extremely dispassionate and rational and a very thorough. When you deal with somebody else’s kids, you can be rational. And you can look at probabilities, you can look at all the different diseases child could possibly have, et cetera. You can’t be rational when it comes to your kids. Your emotions can take over and therefore that will turn it from a good doctor to bad doctor. This is why you have somebody else to treat your kids. I find the same could be true, not for everybody, but for a lot of people because greed and fear get amplified when it comes to your own money.

Vitaliy:                                  00:33:31               So to be a good investor, you have to be incredibly dispassionate to some degree and incredibly process driven. So we tried to look at what we do here as the kind of analytics factory. Um, and so if you can do this. So they said, here’s the caveat, if you can do this with your money, if you can be dispassionate, and if you feel that greed and fear and not a big factors for you, then you should be managing your own money. If you find that’s not the case, maybe you shouldn’t. What you do is that if you hire a professional, invest in index funds, you know, that’s, that’s up to you. But I think the, when, um, and then let me go a step further. A lot of times I give speeches to students at universities and they ask me, what’s the best way to learn about investing?

Vitaliy:                                  00:34:20               And my answer is this, and I think I kind of stole it from Charlie Munger. I would say take as much money as you can afford to lose and look at it as your tuition money and just start analyzing companies as if you were going to present them to somebody else. Like do a full research. Not just say I like Intel because everybody likes and tell him buy it, do a research and like goal for the whole firm from like if you were working for money management forum and you had to present why you buy an Intel. So do this kind of analysis and just for few stocks and buy them. And it’s very important to actually, not to use paper money, but it was actual money. And the reason for that is because, I’m going to quote Charlie Munger, who said learn about investing through a paper portfolio is like learning about sex from a romantic novels.

Vitaliy:                                  00:35:24               The thing is because investing is a lot more,than just analysis. It’s a psychological game and the only reason you can trigger that psychology is when you actually come meet you on capital to a stock when you actually own it. And you experienced the pain of stock price decline etc. So I would really recommend, yeah, just take as much money as you can afford to lose and look at as tuition and buy a few companies and they don’t look at it as a diversified portfolio because at this point you’re not trying to build a diversified portfolio. You just trying to build a skill of analysis and then portfolio management is secondary to that.

Andrew:                           00:36:10               That’s, that’s one of the best breakdowns I’ve heard on the topic. It’s a very controversial topic for sure.

Vitaliy:                           00:36:17               Well thank you.

Andrew:                           00:36:29               I know you had some questions, Dave, I apologize. I’ve been hogging the mic.

Dave: Yeah, I got a couple of things I want to throw at you Vitaliy. So since you started investing, have your thoughts on investing, evolved? Have they kind of changed from when you first really started to embrace this idea and to where you are today?

Vitaliy:                                  00:36:53               Yeah, so I think I kind of want to start in invest in, I was a lot more kind of a one dimensional kind of Ben Ben Graham recipe investor two. I started to pay attention to a lot more qualitative factors, not just quantitative factors. So when you buy companies day, I spend a lot more time thinking about management and when you buy companies, we, today we tried to buy companies where management owns a lot of shares because if they on like if you have companies where money yell, but a CEO owns 20% of the company, every time he makes an equalization for every dollar of money companies spans 20 cents of it is his. So therefore

Vitaliy:                                  00:37:36               he cares a lot more. But that acquisition working out then I would, because for me it’s a three or five or 7% position for him, I’d say 95% of his net worth. Over time I evolved into being kind of more quantitative to become a lot more qualitative. So I appreciate the kind of, the little innuendos and it kind of the qualitative factors alot more. And I’m also, so the invest in kind of went from being a more of a science to a lot more of an art form and a kind of an, I try to it. And over the last couple of years has it been working in my new book, which may take me five or 10 years to write. Then, I become a lot more, like it’s taken me a lot more into the, how do you become even more multidimensional than that.

Dave:                           00:38:32               yeah, that makes a lot of sense. So a little like what Warren Buffett has gone through with the influence from Charlie monger, I guess.

Vitaliy:                                  00:38:39               That’s exactly right. No, that’s exactly the analogy I would make. Charlie Manga. And I think I wrote about this at some point, Charlie monger turned the Warren Buffett from kind of Ben Graham, kind of threats, kind of cooking recipe, buy stocks at six 10 zero or an excel 0.8 times book value to a multidimensional master. Absolutely. Yes. Let me take it a step further. So the Ben Graham, and again, I don’t want to diminish been ground because the philosophy, the valueless to philosophy that he introduced in the intelligent investor is it foundation that everything we do, so this is, I’m not trying to diminish what she’s contribution quite the opposite.

I’m just saying if the only thing you get out of intelligent investor, that’s kind of one dimensional recipe, you’re shortchanging yourself. But my point is this, Ben Graham would never buy Coke in the 80’s because it didn’t ever look statistically cheap, but Coke had an incredible brand and that the time it’s, you know, it’s still had a very high return on capital, which still has. But more importantly, it also had a huge growth runway. And therefore, if you look at Coke’s earnings 10 years out, the stock actually was very cheap when he bought it. They just, it was not cheap on the earnings that cold cad in next year, this year and next year, last year. So that’s, you know, that’s the kind of the evolution of a Warren Buffett.

Dave:                           00:40:04               yeah. That’s a great analogy. You mentioned your book, So let’s talk a little bit about that. I know we’re, we’re talking in five, 10 years for, from an actually being able to read it, but, you shared with your readers, kind of a snippet of the first chapter about the six commandments. And I know that’s on your podcast, that’s just been released as well. So could you talk a little bit about like the idea of where you came up with this idea of the six commandments of value investing?

Vitaliy:                                  00:40:33               Yes. So the, it came actually, originally I came out as a speech. I gave a speech and then guru focus conference and a conference organizer asking me to kind of talk about our approach. And the whole purpose about the speech was okay, this is the six commandments. And like I was speaking to other value investors, so nothing there. It was supposed to be shocking, it’s like me trying to, you know, explain alphabet to English majors, you know, so there was nothing shocking about the six commandments. Everybody in the room knew what they were, but I think my goal there was ok so we all know they are, but how do you actually embed them into in our investment process? And that was kind of the whole point. So it’s not just here’s the six commandments and them explain what they are, but more importantly, how do you integrate them into your investment process?

Vitaliy:                                  00:41:24               The name of the book I’m working on is called The Intellectual Investor and the intellectual investor is the next evolution of The Intelligent Investor. So the name of the chapter that I shared on the podcast and actually on my blog as well. I think you can download it. It’s called the six commandments of value investing, I could have called it also the intelligent investor because I just, took Ben Graham’s philosophy and just put up my own words. . So it’s, um, so that’s how it came up as a chapter. And so that’s introductory chapter to the book because, and everything else builds on top of that. And that’s kind of, this tour it to this book I’m working on is it, to me it’s fascinating because none of the story itself, but what I’m trying to do there is this, I don’t know where I read this, but there was a story of this mother comes to Dalai Lama

and, uh, the mother says, well, can you please talk to my son?

Vitaliy:                                  00:42:39               He eats too much sugar. That Lai Lama look at the mother, look for the song and says, you know what, why didn’t you come back in a month? So in a month later, my that comes back, obviously your San Dalai Lama look for the sign and says, stop eating sugar. So the mothers be ruled there. She was like, I was here a month ago. You could’ve said the same thing. The alarm off has your obstacle, right? But first I had to stop eating sugar myself. So the, the key is, so what I’m trying to do in this book, I am trying to become the intellectual and messenger. So this is really, I’m just writing really for myself. This is why there’s no publishing deadline because I am trying to stop it and sugar, you know, and I am trying to, by writing this book, I’m trying to kind of embed intellectual investing into myself. And so this is why to me, I get up every morning at that and off four or five o’clock and write for two hours. This is my kind of evolution into from an intelligent investor to in, in, into intellectual investor and it’ll take a long time and it’s probably a journey that never ends.

Dave:                           00:43:52               Oh, that’s, interesting. I like the way you’re approaching that too is it’s more about forming your own ideas and how you’re going to in essence change yourself and educate yourself just like you would if you were trying to change your diet or change an exercise routine or stuff like that. I think that’s really fascinating.

Vitaliy:                                  00:44:10               Yes, absolutely.

Speaker 2:                           00:44:12               All right. So I guess Kinda continue down that path. And so I know you talk about margin and safety is one of your commandments. So what, what does that to you and does it differ by a company? Does it differ by assets? I mean, how does that, when you look at a margin of safety, what does that mean to you?

Vitaliy:                                  00:44:29               Our margin of safety basically is a function of companies quality. The higher the the quality of the company, the less margin of safety I need. Right. Because margin of safety is there to basically to give you two things is: to protect you from the future looking different than you think it would originally. And also it’s there to be the source of the return. To some degree margin of safety is an admission to your humility that you try to be humble saying, I don’t have a perfect crystal ball. My crystal ball needs to be not as clear when it on high quality companies then, when I own a lower quality companies. So that’s one factor. Another factor is if I want, so assuming it’s a high quality company, I was so assuming the quality is figured out.

Vitaliy:                                  00:45:37               The second factor would be growth. If I want a company that, uh, where I can reasonably say it has a higher, the higher the growth of the company, the less margin of safety I need because there will be value in growth, not just in margin of safety. If you’re reading my little book of sideways markets, I will have to write this book again. I would make a modification because I evolved since I wrote the book. We made a change at our, at my firm is that quality became absolute for us. In other words, in the past I would say, okay, this may be a lower quality company and therefore many of the much greater margin of safety. Okay. Today when I see a lower quality company, we just walk away.

Vitaliy:                                  00:46:26               So quality became a filter for us. If we look at a company, if the quality falls below a certain level, we just stop. We know nothing else matters. I don’t really care how much a company valuation is. We just walk away. And I think the reason for that, because I think the economic environment that began to encounter in the future is going to be a lot more, I’m looking for a kind of very drastic word, a lot less forgiving to low quality companies. This would take too much time to explain it on the podcast, but we basically embed quality of growth in our analysis. When analyzing a companies. Again I’m shamelessly to going to promote my podcast. Okay. But I do spend a good amount of time in the six commandments write up, but I do go through that there and just will be so much easier if somebody read that. So just go to investor.fm, listen to the podcast.

Dave:                           00:47:38               You can also, you can also download it. I’ll add onto your shameless plug. You can also download on any of your favorite podcasting apps, The Intellectual Investor Podcast, and you can download it and get all the latest updates on that as well. So that works out slick. That’s fine. Thank you. All right. Why don’t we wrap it up and talk about your other love besides you’re investing in your family, music. I know you’re a huge music fan and I love that aspect of your writing. And I love that you share that with people and it’s a great way to introduce people to you know, the not business side of you. So I wanted to ask you a question a little bit and we talked about that a little bit. So I’ll let you kinda take off on that. So what are your thoughts of Chopin?

Vitaliy:                                  00:48:26               Okay I love classical music and it’s one of my passions. When people subscribe to my articles, there were assuming investment article and at the bottom I usually share a classical music piece and mentioned something about the composer. And by the way, if you go to, and I’m shameless, even though I’m not selling anything. Iif you go to my favorite, classical.com, my favorite classical that come literally every single music reference, I will put it in my email is there. What fascinated me is the kind of the end of the in the 17 hundreds, early 18 hundreds in Austria.

Vitaliy:                                  00:49:23               What happened in Austria? Uh, basically, Beethoven who was German composer spent the last 30 or 40 years of his life living in Vienna, which was the kind of the neck of classical, you know, romantic, classical music at the time. There was no greater at the time composer then at the time. He was like if you took Beyonce and Michael Jackson combined. With Homan was greater than that at the time. So anyway, so [inaudible] was basically the tsar of classical music at the time. If you blocks from him, lived this composer, a Franz Schubert and Franz Schubert, the story of friendship with fascinates me because Franz Schubert always look, you know, never looked at himself as a great composer and the only reason for that because it home and was so close to him because bait hoe everybody liked bitcoin and Franz Schubert, uh, was, you know, all always somewhat depressed.

Vitaliy:                                  00:50:35               And he absolutely, but he loves to love writing classical music. And I think he died when he was 31 and a hero, like five or 6,000 classical music pieces, during his very short lifetime. Um, and he was depressed. He was also, got syphilis in his early twenties, which at the time was incredibly debilitating disease. So this is the person who loves me or writing music, but at the same time is indifferent to instruments. He just loves music, you know, writing music but doesn’t really care about piano, violin. He just writes music for them and, and does not publish much music because again, there is Beethoven next door who is incredible. So it’s the, the interesting part is this today when we talk about Schubert’s symphony in Beethoven symphonies, don’t compare them. We both, we think that they are terrific, you know, Showbiz symphony as it will be fine symphonies that terrific.

Vitaliy:                                  00:51:33               Schubert did not publish most of his symphonies because he did not think that were good enough. So I thought there was a, there was an incredible lesson. They’re buried there. Um, so, but that’s, that’s, that’s one story. There is also another composer, Franz Liszt, who was that I was actually Hungarian and Franz Liszt even though today we think of him as a composer at the time, during his life, he was actually famous for being an incredible pianist. He basically transformed piano to the modern instruments we know today. And the reason it’s important because he lived, in the, he became famous already after Beethoven’s death, et Cetera. And he was, if you’d take Michael Jackson and Frank Sinatra, he was more popular than those two at the time. He would travel around Europe and give two or three performances a day, you know. And because he played so much and practices so much, he became absolutely incredible in, he turned his performance as it became shoals people in yard. He was the first performer who actually had fans who would, who would basically be one, would basically throw themselves at him and you know, this kind of stuff.

Vitaliy:                                  00:52:58               we are talking about, we are talking about classical music here. This is, you know,

Vitaliy:                           00:53:02               and I apologize, my phone was ringing

Vitaliy:                                  00:53:07               His passion is not just music, but it’s piano. And he basically pushes piano to limits that it’s never been pushed before. You have this kind of show man, composer slash performer on the other extreme. So on one extreme you have a kind of very, a delicate and very introverted and are depressed Franz Schubert. And then you have France list. And then in the middle you have a Frederick Chapin who is, just the same age as France list and our lives in at least Poland and moves to France where Frantz Liszt is incredible, incredible popular. On the one side, if you listen to Chopin’s music, it’s extremely melodic and extremely, um, melancholic like Schubert’s music.

Vitaliy:                                  00:54:09               But, but at the same time, he is right next to France list who is this great show, he performer. And so the, now if you leave, if you listen to the other part of Chopin’s music, it’s extremely technical and extremely dynamic. And that’s kind of the, so when I listen to Chopin’s music, I hear both Shubert and Liszt. To me it’s really fascinates me how you have composers, how one group group of composers impacts the other. And, uh, that’s really fascinates me about classical music.

Dave:                           00:54:55               Yeah, me too. I love the, I love the stories of that and how, and how they were such different personalities and how they, like you said, Chopin absorbed and looked at as influences and kind of absorb both of them into his own music. And I know when I was in school that there was, I was a classical guitar player and the other other musicians, a lot of the people that play piano, I was the world’s worst pianist by the way. When they would talk about the different composers that they liked. And you know, there was the camp of the Liszt camp with the, you know, the huge technical virtuosity and then the Chopin people that he had much more melodic system in his music. And I mean, they’re both fantastic, but you know, it’s kind of comparing Jimi Hendrix to Stevie Ray Vaughn. It’s like, same slice of the same apple. It was always fascinating to listen to those. So I loved hearing your conversation about the stories and kind of how they evolve from all that and know that’s a big passion of yours. I’m wanting to share that with our listeners.

Vitaliy:                                  00:55:56               Well, it’s my pleasure. I to me, so when I write, I always listen to classical music and what it does and I’ll conclude this was a little story. So this is an that, so when my son was born, so this is to southern one, and they said the Internet is in its infancy. We read about the mater of the fact and the most of the fact that basically says, if your son, if your child is exposed to classical music or Beethoven music, even better, then there’s a chance your child will become a genius. So being a parent who wanted, you know, when it all the best for his, you know, child or fidget child, I actually asked my wife, my wife was literally wearing a belt. They had a sticker when she was pregnant, when she was pregnant, that had a speakers built into it.

Vitaliy:                                  00:56:44               And, and, and this was before iPods. Right? So she, and if she was carrying a little CD player attached to it, so, but here’s the interesting part. This was early in the internet so therefore I couldn’t really read the original study. So I actually saw my, and also when my son was growing up, we’d listen to lots of water. Here’s the punchline of the study. I think when they did, when they actually did the study, the creator of the study loved Mozart, and that’s why they use Mosart to conduct the study. But what the found is actually they could have been living listening to ACDC or keys for that, that art really did that better.

Vitaliy:                                  00:57:28               What they found is this, you have a left brain and right brain. And when you listen to music, the music basically forces left and right brain to work together. While you listen to music, you are becoming it actually doesn’t use creativity while you listen to music. In reality, it’s kind of wears out very quickly. Um, so, uh, so listen to me, uh, so listen to music a while, a while a ride is actually hopefully helps my creativity. Plus, I enjoy it, but I also very, you know, but I could be listened to it, you know, it doesn’t have to be Chapin or list if, if he, if ACDC or KISS, whatever, that my references run out very quickly, if that helps you creativity, just be it. So it doesn’t really matter what your listen.

Dave:                           00:58:21               Wow, that’s a, that’s, that’s a great story. That’s very interesting. Truth be told, I kinda did the same thing with my daughter, but I didn’t do Mozart. I did, Stevie, Ray Vaughn and Jimmy Hendrix, but hey, you know, each year own. That’s right. So time will tell whether she turns out to be a guitar player or not. We’ll see.

All right folks, we’ll, that is going to wrap up our conversation with Vitaly for tonight and I have to say that that was absolutely fantastic. That was so much fun and he is so brilliant and he has such a great way of explaining all of his ideas and his thoughts and for the two or three of you out there that do not already subscribe to his many outlets for explaining his thoughts and ideas about value investing at ContrarianEdge.com, I urge you to look them up, invest in, invest in them, download them, it’s all free resources, so this is free free money for you and he has a wealth of knowledge that he can share with you. And it’s not just about investing, it’s also about life. And he’s a brilliant man. He’s very well thought and I really, really enjoy his stuff. I can’t emphasize enough how much I really enjoy his writing. So without any further ado, I’m going to go ahead and cite us off. You guys go out, have a great, great week. Invest with a margin of safety, emphasis on the safety, and we’ll talk to y’all next week.

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