The transcript from this week’s, MiB: Michael Mauboussin on Stocks, is below.
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RITHOLTZ: This week on the podcast I have an extra special guest, the returning champion Michael Mauboussin. He is on the buy-side. People think when I say that Michael is at Counterpoint Global at Morgan Stanley Investment Management, it’s not Morgan Stanley, the big sell-side broker-dealer. It’s a totally different division. They’re asset management division. We really spent a lot of time talking about the new edition of his book, “Expectations Investing.” What I love about Michael is how thoughtful he is, how interesting his approach to investing, thinking about markets, individual companies’ value, and basically, the approach he brings to research, to the investment community.
He’s been writing and publishing about markets for literally decades not just as many books, which I’ll include in my notes, but the research papers he puts out and shares with the public. They’re always interesting and thoughtful, and I frequently find myself looking at these, reading these and going, huh, cocking my head, I — I hadn’t thought about that. That’s a really interesting take on a — a very fundamental idea. And I’m — I’m glad I had the opportunity to — to give this a thought.
I found this to be a master class in valuation and how to think about what a company’s proper potential value is, what your expectation for investing in that company should be. It’s no surprise he’s been teaching at Columbia for, I don’t know, 20 years as an adjunct professor in the business school.
I’m going to stop babbling and say with no further ado, my conversation with Morgan Stanley’s Michael Mauboussin.
ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My very extra special guest this week is Michael Mauboussin. He is the head of Consilient Research at Counterpoint Global, which is part of Morgan Stanley’s Investment Management Group. It’s the buy-side part, not the sell-side part of Morgan Stanley. Previously, he was Head of Global Financial Strategies at Credit Suisse, and before that, Chief Investment Strategist at Legg Mason Capital Management, working with the famed investor Bill Miller during his incredible streak. He is also a Professor of Finance at Columbia Business School and Chairman of the Board of Trustees at the Santa Fe Institute.
Michael Mauboussin, welcome back to Bloomberg.
MAUBOUSSIN: Awesome to be with you, Barry, always a blast. And it’s so good to be with you in person, by the way.
RITHOLTZ: I know. You know, I don’t do this. I don’t throw my arms up when I’m doing it at home remote using a Comrex machine to jack into the Bloomberg machinery. It’s nice to be in the studio and — and look at you eye-to-eye. I have four hours’ worth of questions for you, so we’ll — we’ll — we’ll see if we can get through some of them.
But let’s start talking about your most recent book, which I — I hold in my hand, “Expectations Investing: Reading Stock Prices for Better Returns.” So, you first wrote this 20 years ago with — your co-author is Alfred Rappaport. What made you decide to revisit this and reissue this 20 something years later?
MAUBOUSSIN: Yeah. Well, I should first tell you a little bit about the background of the first book. And — and I was a — you know, I was a — someone who had no business experience coming on to Wall Street and read a copy of Al’s book “Creating Shareholder Value” in the late 1980s, and it was, for me, a professional epiphany. And I say that because it really — everything I’ve done professionally has come and ripped off of this, so it’s really standing on the shoulder of giants. And so, Al Rappaport has been an incredible mentor and collaborator for me.
So that book, by the way, was aimed at corporate executives about building value, and there were three lessons in there that I — that I always have taken with me. One is it’s about cash flows and not accounting numbers, you know. And it’s funny, Barry, that we seem to relearn this lesson from time to time.
RITHOLTZ: Over and over again, yeah.
MAUBOUSSIN: But we’ll probably get into it in some degree, but I think today we’re in a particularly interesting time in markets where, because of the way the accounting works and because of the way the economy is moving, you have to really follow the cash trail more than ever.
The second thing is he said, you know, to do intelligent valuation work, you have to understand both finance and strategy. And I think this is something else people feel very free-throwing multiples around, and so on and so forth without really doing the proper strategy analysis. And I think that was the second lesson.
And then the third thing — this is my buildup to your — an answer to your question. The third thing was the recent (inaudible) was called Stock Market Signals to Managers. And the argument was, hey, executive, if you want understand how to allocate capital judiciously or even set-up incentives, you need to understand what the market’s pricing into your stock. So that, obviously, has direct implications for investors and that ended up — you know, we ended up collaborating on the original version aimed at investors’ call expectations, especially now, I’m glad you’re sitting down because the original version came out September 10, 2001.
RITHOLTZ: Like literally 20 years ago.
MAUBOUSSIN: The day before the greatest …
RITHOLTZ: 9/11.
MAUBOUSSIN: … the greatest National Treasury and, by the way, much less significantly in the midst of a three bear — three-year bear market, right?
RITHOLTZ: Right.
MAUBOUSSIN: So — and, by the way, you know, many of the ideas and books stood up over time, but I have been teaching from this — these principles for a long time. And so, you know, and part of it was COVID-induced, but I was — you know, I’m in constant conversation with — with Al and I said to him, “You know, there’s enough that’s going on in the world that I think we — it’s time for us to take another swing at this, which is bring in what is new, freshen up our case studies, and like let’s focus on what works still and what still is good, but let’s bring it in and make it more contemporary. So just thought it was — and — and — and — and — and in teaching it, what lessons have I learned on how to communicate some of the ideas effectively, what matters and what don’t.
So, we ended up only getting rid of one chapter, replacing one chapter all together, but there’s so much about it. So, the bones are basically the same, but there’s so much about it that’s brand new in terms of the case studies, and — and again reflecting how the world has changed in the last 20 years.
RITHOLTZ: And for people who may not be familiar with Alfred Rappaport, he’s a professor — professor at Kellogg, and — and he has done a ton of work on how to create long-term value and overcome short-termism amongst investors and corporate managers. Tell us a little bit about his background.
MAUBOUSSIN: Well, that — yeah, I mean, I’d say — I mean, look I think that he is going to — he — he — he is one of the great sort of academics in this whole area in the last half century. His Ph.D. is in accounting, by the way, I should mention.
RITHOLTZ: Oh, really?
MAUBOUSSIN: But he has made very important contributions in accounting and finance and, as I mentioned, was one of the great synthesizers of bringing together strategy in finance. He, by the way, did a lot of the executive programs to Kellogg and had a — literally a world-famous program called Merger Week. And if you were anybody in the mergers and acquisitions world, in the corporate world in the 80s and 90s, you — the mecca was to go to Kellogg to do Merger Week and learn about this. And so, yeah, I mean, he — he’s just a tremendous — tremendous resource.
Now he’s in — he’s in his late 80s now. He, by the way, could not be better. I mean, I talk to him almost every single day and — and sharpen and, you know, just intellectually so curious, a very avid reader, I mean, so really going — still going really, really strong. But — and it’s, by the way, total delight — it’s always a total delight working with him, in part, for — for — for the joint learning that goes on, but also to have someone to be a reality check …
RITHOLTZ: Right.
MAUBOUSSIN: … when you’re sort of going off a little bit and — and need a little course correction. He’s the old professor that sort of brings you back into line, which is powerful.
RITHOLTZ: That — that’s great. Everybody needs a Jiminy Cricket on their shoulder to make sure they’re not — you know, they’re not going off to never-never land.
So, there are a bunch of quotes from the book I want to get into, but I have to start with one that that’s so macro and all-encompassing. It really talks to the theme of the book, which is when investors talk about expectations, they’re usually talking about the wrong expectations. Explain.
MAUBOUSSIN: Well, I think that it’s interesting that when people talk about what a stock is worth, and you should — you should correct me if you hear something differently. It’s almost always some multiple of some sort of earnings metric …
RITHOLTZ: Right.
MAUBOUSSIN: … of some sort.
RITHOLTZ: P.E. to say the very least and then a million variations.
MAUBOUSSIN: Right, P.E. or …
RITHOLTZ: Price-to-sales ratio.
MAUBOUSSIN: … EV/EBITDA or something like that, right? And so, the basic argument is that multiples are shorthand for what is a broader valuation process. And multiples embed in them lots of assumptions about how the world works, including assumptions about returns on capital, and growth, and so forth. And then as we’ll talk about in probably more detail, measures like earnings or even EBITDA themselves can be very unreliable measures or metrics of value creation.
So — so when they say, oh, at — at X multiple, the — it looks like low expectations or it’s “cheap” in quotation marks or it’s “expensive” in quotation marks. They — they really don’t know exactly. They haven’t unpacked exactly what the story is. Whereas I think we’d all agree, at least in theory, that the value of a business is the present value of the cash flows. The argument I always like to make is let’s — let’s lay the — lay — lay bare on the table what those assumptions are, what the underlying economic assumptions are and then debate them, right? We may not agree or come down to the same place on these things, but at least we know what we’re dealing with versus these — these — these — using — putting together a multiple — these two things that are neither which, on — on their own, are very helpful.
RITHOLTZ: So — so let me take a swing at this and you tell me if I’m on the money or — or off. So, when we look at earnings, a lot of different things go into making earnings high or low, cheap or expensive. And if you’re just looking at that net number, you’re blind to all the moving parts that might be temporary one-offs or potentially reflect fast future growth. Just looking at the number itself relative to price doesn’t give you a complete picture. Is that a fair assessment?
MAUBOUSSIN: Well, that — that — that for sure is true, and then there’s another component of it that’s probably even more compelling, which is growing earnings is not synonymous with growing value. So, saying it differently, if you invest in your business and you’re earning exactly your cost of capital, growth doesn’t make any — doesn’t add any value whatsoever. And so, — so — so — so earnings growth can be good, it can be bad, it can be indifferent, and so you just don’t know that. So same as differently, company A and company B same earnings growth rates, but very different value creation prospects.
You can’t tell — you know, the multiples are going to be different and they should be different, but the earning — the earning number in and of itself doesn’t tell you the answer.
RITHOLTZ: And — and then the other question that comes out of this that I thought was really fascinating, what sort of expectations should investors have from reading stock prices? And how can the ordinary investor read stock prices?
MAUBOUSSIN: Yeah. So, this — I mean, this gets to the heart of it. And, you know, Barry, I was trying to do a little — even — and — and — and working on this book, I was trying to get a little bit of the psychology of this because it seems fascinating to me that people love to think that they can figure out the value, and then they’re going to compare the value to the price, right? So, the they’re — they feel like their job is to figure out what some of the (inaudible) …
RITHOLTZ: Identify intrinsic value …
MAUBOUSSIN: Yeah.
RITHOLTZ: … buy at a discount, sell at premium.
MAUBOUSSIN: Right. And what this — the — the — the premise of this book is obviously just to reverse the whole process and just say like there’s only one thing we know for sure, and that’s the stock price, right? You — and again, you may not — may like it or not like it doesn’t matter, it is something we know for sure.
RITHOLTZ: It’s an objective number versus what’s essentially …
MAUBOUSSIN: Correct.
RITHOLTZ: … an opinion.
MAUBOUSSIN: So, then we say we’re going to reverse engineer what has to happen for that thing to make sense and then try to judge whether that is — is sensible.
Now, to me, the most powerful and vivid metaphor is the handicappers. So, you go off to the horse races to figure out — and — and presumably you like to make money. There are two things that are really important, right? One is the odds on the tote board, which is telling you which horse or horses are likely to win. The second is how fast the horse is going to run, right? And so, it’s the combination of these two things that it’s important, but often starting with a tote board is a very sensible thing as you say, “All right. Well, you know, is this a favor or is this a long shot?” Whatever — whatever it is. So, this is basically saying let’s do these things backwards.
And — and, by the way, there’s a — there’s a fascinating guy who’d you, by the way, you should get him on some time — he’s really interesting — a guy named of Steven Crist (ph). Do you know Steven Crist?
RITHOLTZ: Make – make an introduction. No, I don’t.
MAUBOUSSIN: Do you know Steven Crist?
RITHOLTZ: No, I do not.
MAUBOUSSIN: Anyway, he’s a – he’s an interesting guy, and he – and he’s written a lot. By the way, he wrote a chapter in a book called – it’s called “Crist on Value.” It’s a 13-page chapter, which is one of the best chapters about investing I’ve ever read …
RITHOLTZ: Really?
MAUBOUSSIN: … even though it’s about handicapping. And Crist sort of talks about, you know, it’s — it’s about this mispricing between odds and — and — and — and performance and so forth.
But one of the — one of the lines in there he loves — he says that I love, he says, you know, “Everybody thinks that they’re doing this thing, but very few people actually do.” And I think that’s the same thing for — for investing. So when — when you explain “Expectations Investing,” the basic principle, people go, yeah, boy, it’s kind of what I’m doing, and isn’t it? And — and — and the answer is no, not really what you’re doing, right?
So — so there are really three steps in the process, which we’ll probably get to. But one is to say what has to happen for today’s stock price to make sense, right? So that’s just basically where is the bar set. And then step two is introducing, you know, sort of more highfalutin strategic and financial analysis to determine whether a company is going to outperform that expectations, underperform or gee, it’s going to be I have no strong opinion one way or another. And then step three is to make buy, sell and hold decisions as a consequence.
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RITHOLTZ: So, in the book you — we’re going to talk about earnings now, but I have to bring up the broad changes you identify in the market, and — and we’re going to circle back to these, but I want to reference these relative to earnings: the shift from active to passive, the rise of intangibles, the move from public investing to private investing, and then the major changes in accounting rules. All four of those things have changed since the first version of this book. How significant are they to how earnings are accounted for and valued by investors?
MAUBOUSSIN: So, I mean, maybe we can parse these a little bit because I think the active to passive thing would affect — you know, if it affects anything would be things like are markets, more or less, efficient and things like that. So, I — I — I don’t know that that’s a big thing …
RITHOLTZ: Right.
MAUBOUSSIN: … for what we’re talking about in terms of earnings. And the other one is public to private and, you know, even since we wrote this book that I think there are third fewer public companies than there were 20 years ago …
RITHOLTZ: But on that point, keep in mind, someone — there’s been some studies done and a huge swath of those were penny stocks that got kicked off the Nasdaq and onto the pink sheets …
MAUBOUSSIN: That’s correct.
RITHOLTZ: … and — and nobody really cares about them.
MAUBOUSSIN: Yeah, that’s — that is absolutely correct. And so — but the nature of these companies change …
RITHOLTZ: Sure.
MAUBOUSSIN: … (inaudible) the market caps, and so forth. But again, that — I’m not sure that’s a big story for earning.
I think the one that — I mean, accounting changes, but I think the really big one is this rise of intangibles that you pointed out. And just to give — well, first of all, let’s go back a little bit even further in history. Back in the 1970s, tangible investments, so tangible, physical things …
RITHOLTZ: Think factories.
MAUBOUSSIN: … big factories and (inaudible) …
RITHOLTZ: (Inaudible).
MAUBOUSSIN: … machines …
RITHOLTZ: Right.
MAUBOUSSIN: … drills, all that, right? Those were twice the level of intangible investments, and intangible, by definition, nonphysical. So, think now branding or …
RITHOLTZ: Patents, copyrights, software.
MAUBOUSSIN: … yeah, software code, all this kind of – OK, right. So, two to one, tangible to intangible.
At the time we wrote the book, so-called 2001, 20 years ago, they were – the first version of the book, they were at parity. And our — our estimate is, for 2021, that intangibles will be more than two times tangible. So, in the last 20 years alone, they – you could sort of say they started the race basically neck and neck, and now it’s much, much more intangible. So why — why is that important, like why do we care about that?
That’s important because tangible assets, the way the accounts record them, is they’re capitalized on the balance sheet, right? It’s a — it’s property, plant and equipment, which we then depreciate over time. So, it does show up in the income statement, but primarily in the form of depreciation.
By contrast, intangible investments are fully expensed. Now the most famous of these is research and development, and we’ve known that. And since the 1970s, the FASB decided that — that R&D should be expensed. And there’s debate about — there’s been debate about that for a very long time. But now, R&D is only a quarter of total intangible investment, so there’s lots of other stuff that’s going on that’s all expense. So, what does that mean all things being equal? The answer is earnings are a lot lower than they would otherwise be.
I always like to point out that, you know, great companies like Wal-Mart, great companies like Home Depot, for the first 10 or 15 years they are public, had negative free cash flow, right, which their investments were bigger than their earnings, so they had positive earnings. Was that a problem? No, it’s fantastic, right, because their investments had very high returns on — on capital.
And so, — and, by the way, Walmart, for example, its first 15 years, tripled the performance at the stock market, right? It crushed it. And when you do the — that’s a substantial compounding advantage, right? But the problem is now, we’re — we’re — we’re conflating investments and expenses on the income statement, and we don’t see that we can’t unpack those things.
RITHOLTZ: And just to — just to jump in. Places like Wal-Mart and — and Home Depot, and those — they’re buying land, they’re putting up new stores, they’re expanding, so that sort of tangibles does show up on the balance sheet.
MAUBOUSSIN: That’s right, that’s the whole point. So, they’re — they’re — and, by the way, even Wal-Mart — Wal-Mart, for sure, was an early user of technology, right? If you read Sam Walton’s book, which by — everybody should. It’s fantastic. I reread that memoir just last year. It’s just awesome.
You know, they were early users of technology, so they were early intangible users. So, well, but you’re exactly right, the vast majority of their investments were physical. You can — you can kick it, and so on and so forth, whereas other — other companies, that is not the case. So yes, so that, to me, is a — that’s a watershed change, and that’s why earnings.
Again, if you’re focusing on cash flow, these things become much less important because we’re getting to the ultimate rude answer. But if you’re simply using multiples or some sort of shorthand, you’re going to dismiss this very significant development.
RITHOLTZ: So — so people love to point out how expensive the stock market is and how pricey, that we used to call them FANG, but now with Facebook, I don’t know what that look anymore. But if we look at the top 10 or 20 technology companies or — or the top 25 percent of the S&P 500 by market cap, those appear to be pricey, but these are all companies that have massive investments in intangibles. So, it’s Google, it’s Apple, it’s Netflix, it’s Microsoft, it’s Facebook. Go down the list. It’s Nvidia.
All these companies are – they own software, they own patents, they own processes. Does this imply that these pricey technology companies — I left out Tesla from the list — are — these so-called pricey tech companies that have so much sunk into intangibles, are these perhaps less pricey than the average stock analyst believes?
MAUBOUSSIN: If you’re using traditional multiples, you get a very different picture. And, you know, we recently wrote a report called — it’s called Classifying for Clarity where we talked about — argue — we argue that certain things should be restated in the statement of cash flows. And we use our case study, Amazon.com, right, so one of these companies. And Amazon backed our calculation or our estimate. Is it Amazon’s intangible investments in 2020 were $44 billion?
RITHOLTZ: Astonishing.
MAUBOUSSIN: And you — their — if you amortize, if you’ll be able to schedule and amortize it, it still comes out to $19 billion of net profit increase. Now, Amazon’s profits last year were about $20 billion. So — so just if you accept this adjustment …
RITHOLTZ: Double the profit.
MAUBOUSSIN: Right? Now, if — you know, you — we could quibble about the details of it …
RITHOLTZ: Right.
MAUBOUSSIN: … and so on and so forth, but basically, that is it. You know, that’s exactly right. And the EBITDA numbers don’t quite double, but they close to double. And so, now the flipside of all that, that’s, you know, the earnings are better, but let’s also recognize the investments are a lot higher than what is reported to. And so, I always say the job of an investor is to understand the magnitude of investment and the return on investments to understand future profits.
And so, for a company like Amazon, they’re earning a lot more than people at least what they would seem to report, but they’re also investing a lot more. And so, you know, there’s still lots of judgment as to whether those investments will pay off, and so on so forth, but you’re exactly right. It’s a very distorted picture, you know, without commentary.
So, this is the whole thing about, you know, the market used to trade at this multiple …
RITHOLTZ: Right.
MAUBOUSSIN: … you know, it’s just the underlying nature of our markets, our businesses, our enterprises are so different today that I think that those sort of comparison seemed to be very simplistic and then just throw in the whole interest rate thing as another curve ball to complicate …
RITHOLTZ: Right, how do you calculate cost of capital so cheap. Does that artificially — does that artificially enhance earnings or are companies taking advantage of that? It’s — it’s not a one-off, oh, look, capital is cheap, therefore, earnings are higher. It’s our — money is free, our company is opportunistically taking advantage of that window when it presents itself.
MAUBOUSSIN: Right, I don’t know if that — is that a comment or a question?
RITHOLTZ: I don’t know. By — by the way, on a — on a related note to the intangibles, it just popped into my head. Joe Davis, who’s the Chief Economist at Vanguard, did a research paper, I don’t know, a year or two ago discussing the rise of intangibles as a predictor of which regions around the world, which countries around the world are prime for growth. When you start to see patents, and software processes, and copyrights expand in a given nation, you should expect their GDP and their stock market to subsequently respond to that usually in a positive correlation.
MAUBOUSSIN: I mean, I love to see that. It makes sense — it makes complete sense to me, and again, it’s just another indication of how things have changed, right? Whereas we may have said a generation or two before, if those factories are popping up and those good blue-collar jobs, right now you’re saying …
RITHOLTZ: Right.
MAUBOUSSIN: … something different and sort of a leading indicator of future wealth creation.
RITHOLTZ: That’s right. If you have a bunch of coders showing up in a particular area, that might mean something positive for — for the economy and for that stock market. So — so let’s bring this back to trying to figure out value, what do earnings actually tell us about a company’s value?
MAUBOUSSIN: Well, I mean, earnings are just part of the equation, right? And so, we argue verily on the book that earnings tell you very little. In fact, the appendix to Chapter 1 shows again that earnings, by themselves, do not even tell you about value or value creation. So, the — what we focus on is a very standard finance way to think about this, which is free cash flow. And free cash flow is the pool available — a pool of capital available to all capital providers.
You know, Barry, besides doing all the stuff you do, you’re a business owner, so you know exactly how this — you have money coming in and money going out, and you sort of know how — you have to think about this kind of stuff.
RITHOLTZ: We just roll our cash in to, you know, Shebu Emu (sic) and — and …
MAUBOUSSIN: Exactly.
RITHOLTZ: … — and Dogecoins …
MAUBOUSSIN: That’s …
RITHOLTZ: … and we just let it roll, so we’re — that’s our approach. It’s been — it’s been speculative, but it’s been working out.
MAUBOUSSIN: But it’s been working out great, exactly.
RITHOLTZ: Right. Let’s do a deep value analysis on that one.
MAUBOUSSIN: And so, yeah, so the — so free cash flow is basically net operating profit after taxes, which is a rough measure of earnings, right? It’s a little bit more formal, but rough measure of earnings.
RITHOLTZ: Net operating profit …
MAUBOUSSIN: Profit after taxes.
RITHOLTZ: … after taxes.
MAUBOUSSIN: And — and the key to that — and — and the acronym is NOPAT. The key to NOPAT is that it’s the unlevered cash earnings of a business. So unlevered means there’s no reckoning for financial leverage at this point, and it’s cash earnings, right? So, you’re taking up all the cash accounts away. And that’s a beautiful number to know. And then investment is all the investments of the company needs to make, including working capital changes, and CapEx, and so on and so forth.
So — so free cash flow sort of the bottom line number. And, by the way, even when we — we make adjustments to intangibles, what we’re doing is essentially making earnings higher — NOPAT higher. We’re making investments higher. Free cash flow is sort of the bottom line that doesn’t change, and that’s the number we try to keep our eye on.
So, remember your high school basketball coach said keep your eye on the hips, right, because everything is going to fall off the hips …
RITHOLTZ: Right.
MAUBOUSSIN: … that is the hips of finance, right, which is free cash flow. That’s the number you want to keep your eye on.
RITHOLTZ: So, Howard Marks is fond of discussing second level thinking. And so, what I’m hearing from you is that just looking at earnings or P.E. multiples is first level thinking, and second level thinking is putting this into the broader context of earnings relative to free cash flow, relative to intangibles and growth. Is that like a wild overstatement or …
MAUBOUSSIN: No, not at all. I mean, I think that the answer is — the — the — the way I might say this differently is that free cash flow is the ultimate thing that we care about. All the other stuff you just mentioned in terms of earnings and multiples, those are all proxies that try to get to the same thing, so they’re short of shorthand, right?
And, by the way, I mean, you’ve had — you’ve had the great Danny Kahneman with you, right? What’s good about shorthands, what’s good about heuristics is they save you time, right? So that’s why they’re useful, that’s why we use them.
Wwhat’s limiting about heuristics or shorthand is they have biases, right? And so, the key is not to – the key is not to never use them, the key is to understand where their lie. And I think that’s where people get a little bit – can be a little bit lazy around the edges and just sort of say like it’s — those things always traded at 20 times this, and so it should be 20 times this. That’s not really — you — you want to go back to the core — the core ideas.
RITHOLTZ: So — so here’s the pushback that I think we would get from a Robinhood trader today who is looking in their portfolio over the past couple of years. They would say something like, hey, this sophisticated analysis is interesting, but I haven’t been using second level thinking. I’ve been picking the fastest horse the past couple of years without looking at the odds, without looking at anything else, and that’s been working out. And I joke about Dogecoins and things like that.
But if you bought the fastest SPAC, the fastest tech — E.V. company, the fastest crypto coin, it didn’t matter. Momentum seems to be driving those fast horses the highest. How do you respond to that sort of — of pushback?
MAUBOUSSIN: Well, there — there are sort of two levels of comments. One is I think it’s important — I’m going to sound like an old — an old fogey here, but I think it’s important to make a distinction between speculating and investing.
RITHOLTZ: Okay.
MAUBOUSSIN: And, by the way, and — and this is without any sort of moral judgment, so this is just, you know, I just want to make this demarcation without judgment, right? A speculator is someone who buys something in the hope that it goes up. An investor is someone who buys a partial stake in the business, right? It’s a very different mindset. And so, if the market shut — shut down for three — three years or whatever, you wouldn’t care because you own part of a business, right?
So, this is almost again, Barry — Barry is the investor versus, Barry as the proprietor of a business, right. You think about the value of the business.
RITHOLTZ: Right.
MAUBOUSSIN: It’s a very different — as you know, it’s a very different mindset.
Now when I peer out of the world today, I — I guess I would actually think that — I sort of think of the world in sort of three different buckets. The first bucket is sort of the normal bucket where I think that notwithstanding we have some, obviously, little bit of zany stuff. Most of the stuff out there is pretty — is pretty solid, right, like pretty normal.
And then the second bucket might be, you know, where I put things like the meme stocks and so forth. These would be sort of the momentum and, you know, in — in our language, we call these sort of diversity breakdowns, people correlate their behaviors in certain ways. And, by the way, there’s — there’s some language in the book that helps talk about these things like reflexivity and so forth. You know, so this would be the GameStops of the world and AMCs, and so forth.
And, by the way, many of these companies have actually done very sensible things, which is they’ve — they’ve sold …
RITHOLTZ: Raised capital.
MAUBOUSSIN: … they’ve sold — raised capital which, by the way, increases the intrinsic value of the per share owners for ongoing holders.
And then the third area is cryptos, decentralized finance, part of what I think is going on with the electric — electric vehicle market and so forth. And there’s a very — there, I think, what we’re seeing is a very, very old and very well-known pattern, which is, as new industries develop, the very common pattern is you see a huge upswing in the number of participants and really experiments. So, it’s lots of new entrants, lots of money flows in, lots of people trying out weird and wacky stuff.
By the way, it wasn’t that long ago, Barry, you remember this in the dot com …
RITHOLTZ: Sure.
MAUBOUSSIN: … you know, same kind of thing, right? And, you know, people go, “This is all crazy and wasteful. Why?” OK, what happens is then eventually the market sorts this out, almost think of it as a Darwinian process. And then you have the — you come down the backend, so there’s a lot of exit through companies going bankrupt or consolidation, and so on and so forth. The market determines what is legitimate, what is not, and lots of things go to zero, but at the end of it, what — what distills out is something new and something important. So, until — and this is sort of standard setting as well, so I think that’s a good example.
What’s going on with crypto? I mean, to me, that whole complex is something that’s very real. It’s going to be — it’s going to be with us. Much of what’s going on out there is not going to survive, but there will be things that survive and will be making important contributions to our economy, yeah, but …
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MAUBOUSSIN: Say something.
RITHOLTZ: Well, I was going to — I just wanted to put into context because you — you bias the audience, like calling yourself an (inaudible) and referencing the dot Commission. But if you look at the history of bubbles and — and I don’t mean that in a negative way. In fact, Dan Gross had a great book, “Pop!: Why Bubbles are Great for the Economy.”
You can look at telegraphs, and railroads …
MAUBOUSSIN: OK.
RITHOLTZ: … and automobiles, and televisions, and computers, and fiber optic, and go through every one of these technological innovations, and they all follow that exact path.
MAUBOUSSIN: That’s right.
RITHOLTZ: There’s this Cambrian explosion of …
MAUBOUSSIN: That’s right.
RITHOLTZ: … experimentation, lots of companies, most of which don’t survive …
MAUBOUSSIN: That’s right.
RITHOLTZ: … but the ones that come out of it are — are game changers, really move the needle.
MAUBOUSSIN: Right. And we — and — and the point being, we don’t know a priority, which ones are going to succeed or fail, right? It gets sorted out. It’s a sort of a big messy sorting out process. So — so I think that’s a little bit — that’s a big part of what’s going on.
So, if things like — I mean, electric vehicles, this is — this is like the canonical example of how this works …
RITHOLTZ: Right.
MAUBOUSSIN: … right? And — and, you know, the main academic on this, I know Dan’s book is actually a really good book and an interesting one but, you know, sort of the canonical — the — the — the main — the main academic on this is a guy named Steven Klepper who is a professor at Carnegie Mellon. And Klepper has wrote very seriously about this and document it, as you pointed out, all these — these basic. So, it’s the flow of — of talent, it’s the flow of money, it’s the flow of entrepreneurs to try to solve problems with some new tools at their disposal not knowing in advance what’s going to work.
By the way, I mean, I — this is now will nerd out for just one second. I — first time I ever wrote about this, it wasn’t actually action in the context of neural development of children. And it turns out that like the number of neurons in your brain actually don’t change that much through your life, what changes radically is the number of synaptic connections between the …
RITHOLTZ: Right.
MAUBOUSSIN: … the neurons. And so, from the time you’re born to the time you’re about two or three years old, there’s this huge upswing in synaptic connections. So, a three-year-old, if you’ve ever met them, you know, they’re not super-efficient machines, but they’re — they’re really open to the world, so learning languages, lot — they’re very curious about the world, and so on and so forth, but they’re inefficient.
And so, what happens then is this — it’s called the Hebbian process. You — you use it or lose it. If the connection works, you use it, and if it doesn’t, it gets pruned away. And you have this massive reduction number in a synaptic connections. So, scientists were interested in this certainly, so they documented this whole process. They’re like, well, this is kind of weird though, right, because the brain is a very costly mechanism. You know, it’s 20 percent of your energy usage, and this big thing on top of your head, and then you’re vulnerable and so on and so forth.
And it turns out that they sort of simulated this, and it turns out this idea of trying things out and then winnowing is one of the best ways to learn about an environment. Isn’t that cool? Right? So, in a sense, what we’re doing is these are — these — these Cambrian explosions you described are methods — financial, and technological, and entrepreneurial methods to learn about the world and figure out what works.
RITHOLTZ: So — so two comments on your nerding out, which I’m — I’m totally loving. First, if you haven’t seen American Utopia, David Byrne’s play, it actually starts out with that exact discussion of the — the — the childhood, the infant brain making all these synaptic connections, and then just letting atrophy that, which doesn’t work. And so, what you’re left with is a very efficient set of things that the brain knows actually are successful connections.
But second, there’s a fascinating book, which you and I may have spoken about previously called “Last Ape Standing.” And it talks about how homo sapiens came very close to not surviving the last Ice Age because of how energy-intensive the brain is and what works really well in most environments doesn’t work in a — in a resource poor environment. And the Ice Age turned out to be a very research poor. So, the — the book kind of says, hey, we were not — we were down to about 10,000 homo sapiens a couple more years of — of bad climate and, you know, this might be a …
MAUBOUSSIN: Whites out.
RITHOLTZ: Right, this might be a Neanderthal world, not — not a human world, which is kind of — kind of interesting. So, we could — we could walk out about a bunch of other stuff, but I want to bring it back to — to earnings in value.
One of things in the book you talk about is investors believe price earnings multiple determine value, but you argue that sort of backwards, price earnings multiples are a function of value. Am I — am I getting that, right?
MAUBOUSSIN: Yeah, I mean, you are if you think about it. I mean, the formulation is that E times P.E. equals P, right?
RITHOLTZ: Right.
MAUBOUSSIN: And so, what you’re saying is in order to forecast price, you need to know the price of that, which is the numerator of the P.E., right? So, in a sense, there’s a little bit of a circular argument.
RITHOLTZ: Right.
MAUBOUSSIN: So, I mean, I don’t want to dwell too much on that, like we had beaten up a little — enough on multiples, but the point being again, multiples are a — are not valuation, they’re shorthand for the evaluation process. And with that shorthand are all the good things about saving time and with that shorthand are all the bad things about limitations, and biases, and blind spots. And so, if you do not — if you are not aware of those limitations and blind spots, you’re going to be, I think, ill-served by using simplistic measures.
RITHOLTZ: Quite interesting. Let’s talk a little bit about modeling, and you use a number of examples in the book, companies like Shopify and Domino’s couldn’t be more different, but they each presents a challenge to traditional analysts’ ability to understand the business and forecast using old approaches.
Both companies have been incredible performers. People don’t realize, Domino’s is one of the best performers of the past 20 years, if not the best. It depends on where everything closes by the time people hear this, but right? Domino is top five, maybe even the highest performer in the past 20 years, is that right?
MAUBOUSSIN: I actually don’t know that, but yeah, that sounds right. It’s a great — it’s an amazing business, yeah.
RITHOLTZ: So — so let’s talk about how do you model these in a way that gives you a better insight into their future prospects, and what’s the difference between expectations investing and the traditional way analysts have been modeling these companies?
MAUBOUSSIN: Right. So maybe we should take those, we’ll take those in turn because they’re slightly …
RITHOLTZ: Sure.
MAUBOUSSIN: … different flavors of what we’re trying to do. So, Domino’s Pizza was the case study, so the key is that when we go through the expectations investing process, understanding price-implied expectations, step one. Step two is doing strategic and financial analysis. Step three is making buy and sell decisions. It’s really nice to have a case study to make it concrete.
Now, the case study for the original book was Gateway 2000 …
RITHOLTZ: Wow.
MAUBOUSSIN: … which lasted for …
RITHOLTZ: Right.
MAUBOUSSIN: … like three years after the …
RITHOLTZ: Out of their boxes that were direct to consumer.
MAUBOUSSIN: … seemed like a good idea at the time.
RITHOLTZ: Yeah, it was, it was called Dell.
MAUBOUSSIN: So anyway, so we …
RITHOLTZ: But that’s execution risk. Gateway and Dell had similar models. Dell just executed much better on it.
MAUBOUSSIN: They did, they did. And so, — so the idea — so the — the truth of the matter is, Barry, like this is how the smoke-filled rooms how decisions get made were like let’s find a business that’s pretty straightforward to understand that we hope will be around for a while, right?
RITHOLTZ: Right.
MAUBOUSSIN: And if they leave, it’ll be for reasons like they get bought out or something like that.
RITHOLTZ: So — so pizza, pretty understandable, right?
MAUBOUSSIN: Yeah. So, pizza, so — so the nature of the business is pretty understandable, and it is a franchise business. It’s a — it is a very beautiful business, and it’s a nice business to explain also strategically because they — they made — they have a — they made a number of strategic decisions along the way that allow us to explain why their — their business has been good and their strategic behaviors.
And — and, by the way, strategy often boils down to things like it boils down to tradeoffs. And one of the big tradeoffs that Domino’s made early on, which they were — they’ve been taken the task from time to time is that you don’t eat there, right?
RITHOLTZ: Right.
MAUBOUSSIN: You don’t go to Domino’s to eat. I mean …
RITHOLTZ: It’s only takeout and delivery.
MAUBOUSSIN: … I mean, there’s — there’s some — there’s some minor acceptance to that, but that’s for the most part true, and so one of the upsides and downsides to that basic thing, so Domino’s was. And — and again, they are — they are a very intangible-intensive business in the sense that the — the — the — the business we’re looking at is that owns the — essentially is the franchise owner, right? So, they own all these things. And their — their primary function is basically to — to get ingredients and boxes to the different franchisees, and then to advertise for everybody. So essentially, they’re an advertising machine, and that’s what they do.
RITHOLTZ: It sounds like a lot of brands, marketing, special know — specialty know-how, a lot of intangibles.
MAUBOUSSIN: And a lot of technology, so the — the other thing is they’re very good at technology and have always been very good at technology. So, for instance, if I can help my franchisee understand their labor demands, their product demands, if I can make things uniform, in fact, they do a lot of stuff that everything becomes very uniform in the kitchen, that — that allows for them to — to — to deliver efficiently, to work — work at the kitchen (inaudible), to hire people efficiently, all those kinds of things. And those are — those are really difficult advantages to — to — take — take away. And then they’ve been digital early, so, you know, ordering online, and so on and so forth.
The second example is — is Shopify, and that’s a little bit of a different thing. So, we have a chapter dedicated to Chapter 8, and it was called Beyond Discounted Cash Flow. And so, the idea is that sometimes you, you know, you look at the businesses you can touch and feel, and — and you run the numbers on it. And it just — you have a hard time coming up with anything close to the current stock price. You might immediately say, “OK, well, this — this doesn’t make any sense.”
What we — what we suggest is that for certain types of businesses, they may be candidates for having some real option value. So, what is a real option?
Well, we know about financial options, right? These are the right, but not the obligations typically. For example, a call option is to buy a particular stock at a particular price at a particular time. A real option is analogously for a real investment in the business, right? So, this is for companies.
And so, what we argue is that certain types of businesses, and the conditions are things like you wanted to be an uncertain business, right, because where there’s a lot of certainty there’s not a lot of option value, right? So, volatility is good for options.
You want a management team that’s thoughtful so they need to know how to identify, and cultivate, and ultimately execute on those options. Market leaders tend to be good because often when there are opportunities, the market leader gets the first call. And then finally, you need access to capital. When you say, “Gee, we have a great option, we want to exercise it,” you need to be able to finance it, right? And so, when those characteristics, those sorts of boxes get checked, you may have a business with some real option value.
Now, in that case, our — our — our study from 20 years ago was amazon.com, and that was probably just dumb luck that we picked Amazon, but that was — that turned out to be sort of one of the great examples of a real options company and just think about AWS …
RITHOLTZ: Sure.
MAUBOUSSIN: … wasn’t even a twinkle on anybody’s eye in 2001 when we wrote that version of it. But — but we did identify it as a company that had a lot of uncertainty and what was going on when the executive who seemed to be pretty astute at figuring these things out. And along the way, he — I mean, he made many, many mistakes Jeff Bezos did, but along the way, he actually made a lot of really interesting good capital allocation decision. So — so that just shows like for all the mistakes that he made and — and many even great executives make that they — they — they — they are able to allocate capital (inaudible).
RITHOLTZ: And — and Bezos talks about, hey, we’re not making enough mistakes. If there aren’t enough Fire Phones that are disasters, we’re not trying enough new things. You know, Amazon Prime next day delivery, Amazon Music and Video, and Web Services were all because they were throwing stuff up against the wall to see what happens. If you’re not taking a risk, you’re not getting the upside.
MAUBOUSSIN: That’s exactly right. And so, — so the question would be something like if — if you think that is a potential for a business, and it’s obviously not in the touch and feel today with things you can see today, should you be willing to pay for that and how should you be willing to pay for that? So, we have a little section on real options and we talk about how to value those in some more formal techniques.
But — but that is — and leaving aside all the numbers and all that, the key is it’s a mindset, right? And — and so there may be, you know, are — especially in public, you can get this optionality for free, that’s fantastic. But even if you’re willing — if you need to pay a little bit for it, by the way, there are other people like, you know, the Barry Dillers of the world. He’s just another guy. You just think of Barry Diller, and I think that guy understands options, as well as anybody out there, right, for the business. And so, there — there are certain executives that tend to do a really good job.
RITHOLTZ: Because he’s managed to assemble a conglomerate of very disparate businesses that misses all seem to work very well in his portfolio, for lack of a better — better word, but he is not running a mutual fund, he’s running a real operating business. So that’s how you would define optionality. Real optionality is identifying those opportunities and then taking advantage of it.
MAUBOUSSIN: I think that’s right. And — and — and he’s been doing this for a long time, by the way. This is not like a reason to take this for a long time so.
RITHOLTZ: By the way, I …
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RITHOLTZ: … previously had one of your colleagues on as a guest, Dennis Lynch, who was quite fascinating. He’s really an interesting individual.
MAUBOUSSIN: Dennis is awesome, yeah, not just is a — not only a great investor, but a great — a great guy. And this is — these are things that tend to get underestimated, by the way, is that organizational cultures are really important. And, you know, he’s just created an environment that I think is of — is about a good environment for investment organization as possible.
RITHOLTZ: And that’s very challenging to do. People don’t realize how hard — especially during COVID and everybody remote, maintaining that is really difficult.
MAUBOUSSIN: I agree. And I — and I think part of it is that — I mean, there are two things that I particularly admire. One is there’s a clear drive toward learning, being a learning organization. So, there’s a premium on people thinking and learning and so forth.
And second is I think he thinks a lot about trying to put people in a position to be as effective as they can be, so putting people on a position to — to do what they do well and what they’re passionate about. And yeah, a great, great guy. And I love — I mean, I love that episode, by the way, and I think that he’s — he’s — he’s perfect.
RITHOLTZ: Really (inaudible).
MAUBOUSSIN: And he — and he doesn’t do a lot of those things, so it’s great for you. That was (inaudible) for you.
RITHOLTZ: No, that was a lot of — that was a lot of fun. So, let’s talk a little bit about market efficiency. One of the questions that when we were kicking around some ideas for this is have the market’s gotten more efficient over the last 20 years given — given the speed information moves around, given the integration of technology and artificial intelligence? Is the 2021 market the same market as the 2001 market?
MAUBOUSSIN: Yeah. I think the answer to those questions are always no that they’re not the same markets and they’re almost always grinding toward more efficiency, right? So — and I think if you did 2001 versus 1981 and go back over time, right, for all the reason you just cited that information is — is nearly cost — costless to acquire and so forth.
Now, the one thing I’ll also say that — and — and — and — and I, by the way, am — am very enthusiastic about systematic strategies and quantitative tools. I think these are all things that, even as discretionary investors, we need to integrate these things in a very thoughtful way. All that said that in — in active management, the notion of judgment is not going to go away anytime soon.
And so, — and — and judgment as distinct from like — I’m just forecasting or, you know, that kind of stuff, but judgments are not going to go away. And so, we need the — so when you think about in a very short-term, so short-term trading or systematic strategies are just going to be — they’re just so powerful. You know, if tomorrow is going to be a lot like today or day after tomorrow a lot like today, systematic things are going to — are going to be much better than humans in those kinds of environments.
But again, if you look out five or 10 or 15 years, I mean, we talked before about these patterns of how industries evolve and so forth, you know, machines have a very difficult time understanding those kinds of things. And — and humans can be, I think, a little bit more thoughtful about understanding who might win, who might lose, for what reasons, things like measuring culture and so on and so forth. So yeah, I mean, it’s always — it’s always a tough game and is — I — I just don’t see it’s going to be getting a ton — a ton easier over time.
RITHOLTZ: So — so the market is becoming more efficient. Let me — let me ask that slightly differently. Are — are we quicker today to discount the future or so? And — and we briefly talked about the electric vehicle makers. If we’re looking at Lucid, and Rivian, and those companies, footnote 100 years ago, there were 90 different automobile companies before we were left with five and then three and now — in the U.S.
And now, here we are with everybody rolling out EVs and lots of new E.V. companies coming out. Are — are we better able to look at this group and say, oh, yeah, eventually, everything is going to be E.V. and, therefore, these companies have value or are these closer to the meme stocks? And — and I’m not asking for an opinion about any specific company. I mean, how are investors generalizing with any of these sectors, but we can use EVs as an example?
MAUBOUSSIN: I mean. it’s a great question, Barry, and a — and a few things come to mind. The first thing I should mention, there’s a fairly recent academic paper. This is within the last few months, and we — we can maybe post it on the show notes or something to this effect. And it was — it’s studied about 10,000 IPOs since 1975.
RITHOLTZ: Wow.
MAUBOUSSIN: And then it actually went and tracked the future earnings and discounted them back to a present value and said how close was the IPO price to the actual performance of the business over time. And it turns out — I mean, probably not shocking we use it. On average, it was about right, but there is massive variance and there is massive skew, right? So, the answer is the market tends to get this broadly speaking, but for any particular company, not particularly well. So that’s my first comment to say I — I will enter all this for some — some degree of humility.
The second thing is there’s a concept, and we talked about this in the book as well, but it’s very well-known concept of reflexivity, right? And so, we tend to think about fundamentals and price action as two separate things, right? So, people always draw, you know, the price is a thing that’s squiggling all over the place and fundamentals, those things sort of plods along, you know, and — and so price is sort of chasing around.
What George Soros and many others have talked about in the concept of reflexivity is these two things feedback to one another. So the very fact that when price is up and a company can sell equity, that allows its resources to pursue fundamentals in a way that it may not have been able to otherwise, right, and so on and so forth, right? And, by the way, the positive feedback works on the way up and it also can work on the way down, just to be clear.
So, I think even in electric vehicles, we have seen a big dose of this reflexivity. And then the other thing that makes this all very complicated is what’s going on with interest rates and discount rates, right? And just — I — I’ll just spend one moment to explain this because it’s actually quite interesting. If you go back and look at the history of interest rate, so on the X axis you would draw, you know, the history of real interest rates, so adjusted for inflation. And then on the Y axis, the price earnings multiples, making use like a Shiller cyclically adjusted price earnings multiple as an example.
If you plot what PE multiples do, it’s actually an inverted U, so same as differently high interest rates associated with low multiples.
RITHOLTZ: Makes sense.
MAUBOUSSIN: That — that makes sense. Kind of medium ones are associated with higher multiples, yeah, that seems okay. But you would expect this to be a continued linear relationship, so the low interest rate is, in fact, they’re really high multiples and, in fact, that’s not what happened. It curves back down and low interest rates are again effectively low — low price earnings multiples.
So, what’s going on here? And the answer is usually, historically, low interest rates have been associated with sluggish growth so …
RITHOLTZ: Because the Fed is usually cutting rates in response to …
MAUBOUSSIN: Right.
RITHOLTZ: … obsession. It’s — it’s when you look at the causal relationship, how you end up at low rates? Well, in this case, it’s following a financial crisis or a pandemic, but historically, most cases are because the economy is in the (inaudible).
MAUBOUSSIN: Sluggish, and go back to the late 1930s and early 1940s was another episode of (inaudible) very low (inaudible). So — so the argument here is if you have companies that can grow strongly through this low interest rate or low discount rate environment, they actually get the double positives, right? One is the growth, actually, they do put up the numbers. And second is they get the benefit of a low discount rate. So — so it’s a combination, you sort of throw those things into the mix and you get sort of these — these sort of a somewhat weird (inaudible).
But — but again, whenever you’re in the early days we talked about before for electric vehicles or anything else, when you’re in early days, you’re going to — there’s — there’s a — that there’s a lot of jockeying around for position, and it’s often not crystal clear who the ultimate winners or losers will be.
RITHOLTZ: So — so let’s talk a little bit about share buybacks. You have a whole chapter on that. There is some controversy about share buybacks. Some people like them, some people think it’s a waste of money.
I’m going to disclose my take. I think as long as there share buybacks, it creates an advantage for the most of the company’s doing the share buybacks versus the companies that can, whether that’s a cause or effect is — is arguable. Hey, if you can’t afford to do the share buybacks, you’re probably doing something else wrong. But that said, tell us a little bit about share buybacks. What’s the significance of them and what does it mean for performance?
MAUBOUSSIN: By — by the way, I — I just can’t get over this controversy. For some reason, I don’t understand — I just don’t understand why people seem so flummoxed by this issue because it seems pretty straightforward to me.
RITHOLTZ: Because the anecdotes, there are terrible, terrible anecdotes. General Electric, what a ton of — of stock back on its way to a — and I could give you a dozen other memorable examples, but that’s a — a little bit of availability bias. You know, we — we — that’s what we’ve seen. And so, people always tried out the worst anecdote.
I think the — my favorite anecdote is Dell spent more money when it was a freestanding public company on stock buybacks, then they earned in profits their entire existence up until they were taken private, you know, a decade ago.
MAUBOUSSIN: Well, now — now we’re going back to the intangible argument and their — versus their cash flows. By the way, can I tell — I’ll just tell a little — I’ve made this a little bit out of school …
RITHOLTZ: Sure.
MAUBOUSSIN: … (inaudible) tell this little out of school story.
So, in 2010, I was invited to give a talk to the senior executive team at General Electric. And this is right on the heels of the financial crisis, right? So, this is a near death experience, right, especially for G.E., the Financial Services Division, and so on and so forth, right? So, this is not a good — you know, it’s — it’s a very challenging time.
And I — I know where the stock was at the time is all pre-split stuff, but it was probably in the low teens, I mean, like that, right? And so, I’m getting a cup of coffee before my presentation, and I — I bumped into the Chief Financial Officer, and he says, “Man, the worst thing that I — that we did is we bought back stock in the 30s.” And I looked at him directly, and I was like, “Dude, you’ve done a lot worse stuff than that, right?”
(LAUGHTER)
And so, you might say, OK, OK …
RITHOLTZ: So, wait, it’s not the accounting fraud and the restatement of earnings …
MAUBOUSSIN: No.
RITHOLTZ: … and all the — everything at G.E. Capital, it was the share buybacks that were a problem.
MAUBOUSSIN: What — what (inaudible) all that? And I — I just — leaving aside all that stuff, actually I thought — my — my thought was going on the back of my head was much more about broader capital allocation and …
RITHOLTZ: Right.
MAUBOUSSIN: … M&A activity …
RITHOLTZ: Strategy and …
MAUBOUSSIN: … and M&A like what they bought and what they sold versus a buyback.
RITHOLTZ: And what they didn’t buy, the opportunities they chose to pass on.
MAUBOUSSIN: So, let me — let me — okay, if I’m allowed to nerd out just a bit, first of all …
RITHOLTZ: Please.
MAUBOUSSIN: … there — there is some — there should be some people who should ask some psychological equivalence between dividends and buybacks, and — and an execution that are different and distinct. And if done properly, buybacks can be slightly beneficial relative to dividend. But let’s just say that these are a mechanism of return capital, the shareholders albeit, only those people who are sellers are willing to take it. So, here’s — here’s my nerd — my nerd out moment, which is I call it the Value Conservation Concept, and this is really the key point.
So, let’s say you have a company that’s worth 1,000. I’m just making this up. And you have, you know, X number of shares outstanding. And they decide they’re going to return $200 to shareholders, right? Of the 1,000, 200 is going to go to shareholders. But it could — it could be a dividend, it could be a buyback, it could be anything. It could be they could burn the cash in the parking lot, right? So, the point is that the value of the firm after this is executed will go from 1,000 to 800, period, right? Again, it doesn’t matter what they do with the $200. It’s going to go from $1,000 to $800.
OK. So now let’s walk through three scenarios. One scenario is the stock is overvalued, right? Let’s pretend that was the G.E. situation. The stock is overvalued, so they buy back overvalued stock.
Well, the value of the firm we just established goes from $1,000 to $800. That doesn’t change. What does change is the relative positioning of the selling shareholders versus the ongoing shareholders. In this case, the selling shareholders are getting, in quotes, “more than they should,” so they’re benefiting. And the ongoing shareholders are suffering, right? So, they’re getting — their per share value just went down, right? And we can demonstrate and we actually do it in the book. We can demonstrate them mathematically.
Scenario two is a buyback undervalued stock, right? So, what’s happened now is the sellers are getting less than what they’re supposed to be getting. So, they’re, in a sense, getting ripped off and what’s left is the per share value goes up, intrinsic value goes up for the ongoing shareholders, right?
So, one of the points I always make to money managers, I — is I say to them I presume you own stocks because you believe that they’re undervalued. Is that a fair assessment? If the answer to that is yes, then you always want companies to buy back stock because the presumption is somebody is selling for too low a price and your per share value is going to go up. Now, dividend, of course, this goes to everybody, leaving aside tax effects, everyone gets treated completely equally.
So now, what we talk about in the book is this thing called the Golden Rule of Buybacks, which basically says you should buy back a stock only when it’s below fair value, and basically all other operational initiatives have been met, right?
And again, Barry, I’ll just let you put on your sort of owner of a business hat as well. You probably think to yourself, all right, we’ve got financials, what I want to do is invest in all the ways in the business that I think would add value to our organization. And then if there’s something left after — left over after all that, then we’ll think about what to do with that money, right?
But your first inclination is let’s invest back into ways …
RITHOLTZ: Right.
MAUBOUSSIN: … to build value for our — our long-term value for our franchise, right? So — so to me — okay, and then the last thing I’ll say about buybacks versus dividends, which is really interesting, and I think this is a very real thing, which is it’s a completely different psychological thing for executives. So, when they pay a dividend, they deem that to be a quasi-contract. And they are loathe to cut dividends, they want to raise the dividend, and the dividend is a sacred thing that we want to preserve …
RITHOLTZ: Sure.
MAUBOUSSIN: … at all costs.
As a consequence, by the way, if you look at a long-term series of dividends versus other capital allocation things like M&A or CapEx, dividends are really stable series and they do go down to recessions and support, but it’s a super smooth series, right, because companies are really reticent to — to cut them. And they’re — and they’re pretty conservative about growing them.
By contrast, buybacks are deemed to be sort of this residual, right? Yeah, we paid all our bills. We made all the investments we like. We got some money sitting around. What do we do with it? Let’s buy back stock, right, and so the — the — the volatility of buybacks from one year to next.
So — so we went through COVID. What was the first thing they got cut? It wasn’t dividends, I mean, dividends went down, but it was — it was buybacks went from …
RITHOLTZ: Right.
MAUBOUSSIN: … a lot to very little in a very short period of time.
RITHOLTZ: Right. And someone did research showing that something like 75 percent of announced buybacks are executed, a big swath never get completed because the world intervenes, and sometimes you can’t do what you said you were going to do.
MAUBOUSSIN: Now that one we — I checked that because that was true, that was — that was true back in the 1990s, that is not really …
RITHOLTZ: No longer the case?
MAUBOUSSIN: … true in United States. In the United States, most pro programs get executed, but that was — that was a true thing, and it’s more true internationally than it is in the United States.
RITHOLTZ: Interesting.
MAUBOUSSIN: Yeah. So — so, to me — and, by the way, this is a whole another thing going back to how to think about markets. I mean, I — I actually think one of the very — and many quantitative guys do this, but one of the very simplistic ways to think about markets is simply take — take the S&P 500, for instance. Take the dividend yield plus the buyback yield, in quotation marks, and then — and then that — that yield ends up being your return.
Now, the last thing I’ll say before I don’t want to make …
RITHOLTZ: By the way, there’s an ETF for that shareholder value.
MAUBOUSSIN: Yeah, shareholder value.
RITHOLTZ: That’s dividend plus …
MAUBOUSSIN: That’s — that’s a good one. So, the last thing — lest I come across is totally like favorable buybacks. Let me just say and you alluded to Dell, I mean, there are companies that buy back stock for the wrong reasons, right? And so, the — the wrong reason would be something like to increase earnings per share or to offset dilution from stock-based compensation programs, and so on and so forth. Those aren’t necessarily bad, but those are not the proper motivations, right?
RITHOLTZ: Well, the — the last one, it — it seems that because of the way we treat stock options as a sort of non-cost, and it takes real capital with buyback shares to make up for that, it kind of can mislead investors or it looks like you’re hiding this dilutive thing you’re doing in a way that isn’t always transparent. And some companies have been more egregious than others.
MAUBOUSSIN: And I agree with that 100 percent, so I would just say that the stock-based compensation discussion — and — and, by the way, some SBC programs are great and others are not as good and so forth, so there’s no one-size-fits-all, but that’s a separate discussion from the buyback discussion. So, I — I would just say that those two things should not be intermingled with one another, and I think your observation is exactly correct. They are all sometimes brought together in a way that may not be productive.
RITHOLTZ: But — but you were going to say one more thing about stock buybacks, which generally is you think, it’s a net positive for — for shareholder price.
MAUBOUSSIN: Well, I think that that’s a — that’s an empirical question, which has been answered for decades, so the answer to that is — is yes. And — and, by the way, people have this perception companies buy back stock when they’re high and they — they don’t buy it when it’s low. That’s actually not true. I mean, it can be (inaudible) …
RITHOLTZ: Really? Because — because I remember in ’08 and ’09, nobody was announcing stock buybacks …
MAUBOUSSIN: That’s right.
RITHOLTZ: … but I do have a vivid recollection of ’99, 2000 everybody was buying back stocks.
MAUBOUSSIN: Yeah, but if you do the numbers, the aggregate numbers are actually pretty good. And — and, by the way, this is now another a very big macro comment, which is companies are pretty good at selling stock when it’s high and buying it when it’s bad, when it’s cheap as a …
RITHOLTZ: That’s quantitatively — I mean, empirically, we know that for a fact.
MAUBOUSSIN: That’s — so they’re pretty good. So, when they’re retiring it, well, yes, that’s — that’s an interesting. And, by the way, that — the — the reason I bring that up and why that’s important is that when we talk about alpha, for example, alpha is a measure of excess returns. And, of course, it nets to zero by definition within a closed group …
RITHOLTZ: Right.
MAUBOUSSIN: … (inaudible) markets are not closed, right? They’re actually open and they’re open to their other entities interacting. And the biggest other entity interacting is actually corporation. So, if companies are selling expensive and buying cheap, that means there’s companies are gathering some of the alpha.
RITHOLTZ: So, it’s funny you say that because I’m trying remember, which quants said it. And I don’t want to put words into Cliff Asness’ mouth. Somebody had written stock buybacks are legal insider trading. You know how well the company is going to do, so if you’re selling stock, it’s you’re less confident. And if you’re a buyer as a corporate entity, you should be doing so because you think the company’s future prospects are bright and, you know, exactly why.
MAUBOUSSIN: Yeah. And, by the way, the other thing I’ll just mention is that just to be clear that buybacks were — I mean, there — there — there are histories like Teledyne is very famous for having bought back stock in the 1970s and so forth. But buybacks were the Wild West in the 1970s, right, because you could be — you could be charged with stock price manipulation.
So, the — the SEC put in a safe harbor provision in 1982, so there’s no real discussion. And, by the way, people don’t, you know …
RITHOLTZ: Right at the start of the best bull market in history.
MAUBOUSSIN: Right. So, 1982 is a really important day because you — if you’re thinking about returning capital to shareholders and — and you’re thinking about the complete dividend plus buyback (inaudible) nothing before that — there’s no comparability before and after ’82, so the safe harbor is important.
So — so even if companies have — have a asymmetric information, the safe harbor assures that if they execute their — their trades in a certain way with particular volumes …
RITHOLTZ: That’s it.
MAUBOUSSIN: … (inaudible) and all that.
RITHOLTZ: Hence, the regal insider traffic.
MAUBOUSSIN: Hence, they’re good — hence, the regal insider.
RITHOLTZ: Right. Hey, listen, who better to know a company’s own prospect than the management of — of the company? And that’s probably reason why quants like buybacks and a lot of people track insider buying and corporate buybacks because, theoretically, there should be a pretty solid signal in there.
MAUBOUSSIN: Absolutely.
(COMMERCIAL BREAK)
RITHOLTZ: So, we talked about Shopify, we talked about Domino’s. I want to bring corporate management back to something you wrote in — in a previous book, “The Paradox of Skill,” which states the higher — the level of competition, the more luck improves events. Now, we know how that works in sports. How does that work in investing? How does that work in business?
MAUBOUSSIN: I mean, I think it works across all these domains. And just to — to — and — and I’ll just restate what you just said, “The Paradox of Skill” says activities were both skill and luck attributed to outcomes, most things. As skill improves, luck becomes a more important determinant of the outcome. That doesn’t seem to make any sense.
And so, the key is to think about skill in two different dimensions. The first dimension is absolute skill. And I think we had all agree that was really our comment coming about market efficiency. We look around the world, I mean, just look at the technology at our fingertips, the best practices, the training for athletes and so on and so forth. I mean, I think we’d all agree without a doubt that it’s as good as it’s ever been in terms of how we — absolute levels of skill. And — and we can document that when we measure things versus the clock. So, for example, running and so on and so forth.
But the second dimension is really the key one for “The Paradox of Skill,” which is a relative skill. And the — the key to the whole paradox is it says something like when — what has happened over time is the difference between the very best and the average shrinks over time, so everyone becomes a little bit closer to one another. The standard deviation, performance shrinks over time.
And so, you know — you know, because, Barry, you’re a car guy, right, so you might — you might appreciate this. But, you know, my understanding — because I — I read one or two papers about this, but, you know, the — the differential in the quality of car finishes in the 1960s and 70s, I guess, was very high. So, you know, you bought a Mercedes Benz, it really was a better, but together …
RITHOLTZ: There’s a bank fall. When that door slammed, you knew …
MAUBOUSSIN: Yeah, right, a bank fall, OK …
RITHOLTZ: … you own a Mercedes.
MAUBOUSSIN: … versus you bought some other cheaper …
RITHOLTZ: Tin can, right.
MAUBOUSSIN: Right, exactly. And so, now it turns out that you can buy pretty much any car. They may not — they may not be bank vaults, but they’re all pretty well put together, right? And their finishes are all pretty good, and so on and so forth. So, there’s a good example of how you might envision how that’s changed over time.
So, I think yeah, in terms of, you know, just — when you — if you want to apply it to businesses, best practices and businesses tend to be embraced, and so automobile manufacturing might be one example of that. Managerial best practices tend to find their ways and to see people’s minds, training through school, business schools, and so on and so forth. So yeah, I think, broadly speaking, this is a — a universal concept.
RITHOLTZ: So — so let me have you address two examples of this that I think are instructive. One is allocators of capital. If you’re in the investment management business, there really shouldn’t be giant outliers in performance over long periods of time. There might be over a couple quarters or even a year. But for the most part — and we’ve seen some of this over the past couple of years. A few funds have exploded, done really well. Some — some hedge funds that have been all in on crypto, some people that were way early to the work-at-home — work-from-home stocks or Tesla or what have you, is the expectation when you see like somebody leading the pack by an extraordinary amount that eventually that just mean reverts, and — and there’s a degree of lucky timing.
I’m not even saying luck, but just lucky timing versus skill. How do we look at outliers and market performance?
MAUBOUSSIN: Yeah. I mean, part of the — the — the answer if you’re — if you’re trying to avoid getting consumed by “The Paradox of Skill,” in other words, were — were — is the answer is look for easy games, right? So, you — if you think you’re a skillful person, you don’t want to compete with other super skillful people, you want to find games where your skill tends to be the highest, right?
So, you know, you’re Annie Duke and instead of playing with the high stakes table, maybe you play at the next stakes down where your profit per hour is higher because your skill differential is higher as you may be making less money, but your higher skill differential. And so, that might be — this is the interesting sort of almost comeback to that idea that when there are new markets that open up, it can be the case that lots of people are sitting at the table, right? If you want to continue with this poker analogy, lots of different people with varied skills are sitting at the table, some of who know what’s going on, others who don’t. And that those — those can be actually easy game. So …
RITHOLTZ: And that’s an opportunity set that you’re not going to get if you’re only buying S&P 500.
MAUBOUSSIN: That’s right. And then that — those — those eventually get tightened up, right? So, the people that are not the losers end up losing money, and then they leave the table for — for whatever reason. And then the — those seats get filled by more skillful players, and so on and so forth. So eventually, that gets sorted out. But you — there’s — there’s a — a long history of markets even as we’ve evolved toward more efficient, broadly speaking, where the easy games of pot popped up.
And, you know, even like I was talking to a buddy of mine who is an early options trader, and he’s like, you know, they would start …
RITHOLTZ: Like in the 80s and 90s.
MAUBOUSSIN: Yeah, it’s like the 80s — like the 80s, yeah, the 1980s, and he’s like, oh, they introduced options on certain commodities, right? And they hadn’t traded them before in this particular exchange. He is like going and he’s like some people start putting up, you know, bids and offers for things that he like. He started figuring out he could put — he could put on like these costless spreads at a guaranteed profit. And he’s like, “This doesn’t make any sense. It’s not going to last very long,” but like my HP-12C works and I’m just taking advantage of it while — while I get it, right?
So, part of the answer, I think, the — the — the response — the careful response will be something like don’t — don’t say like these people are automatically just lucky people. The question is are they playing in an easy game where they — they bring somebody to the table that others don’t have just yet.
RITHOLTZ: They’ve identified the opportunity and are — and are taking …
MAUBOUSSIN: Right.
RITHOLTZ: … advantage of it.
MAUBOUSSIN: Now, the problem with — the problem with easy games, generally speaking, is it …
RITHOLTZ: They don’t last.
MAUBOUSSIN: … well, A, they don’t last, but B, if they do last, they tend not to be super scalable. So, in other words, it’s often you — you can’t make billions and billions and billions of dollars in an easy game because people, you know, figure it out. So, they usually tend to be smaller and nichier (ph), and so forth.
I mean, I remember I was talking to a quant firm based in London, and they said that they’re — they had some little strategy that was dealing with Chinese in — retail investors. And they said this thing is like a little money machine, like every day that we — we (inaudible) goes …
RITHOLTZ: But the keyword is little.
MAUBOUSSIN: … it — it just can’t, we just can’t do it in bigger size, but it’s such a nice little thing we just let it keep going. But he’s like — but — but it’s — it’s just like, you know, a steady — a steady drumbeat of the profit.
RITHOLTZ: So, we see that all the time when a firm returns capital to their limited partners and say — they say, “Hey, we have enough money to mine this inefficiency, but it’s not big enough to share with other people.” And the exceptions when people try and push the envelope is you get a long-term capital management situation where they leveraged up these inefficiencies. And eventually, the chickens come home to roost.
So, let’s put aside the investment side of luck versus skill and talk about how does this manifest in business. You — you have — you have lots of professional consulting companies, McKinsey and go down the list. You have all these great business schools churning out these MBAs and these JDs that are super smart, super insightful. They’re — they’re steeped in all the wisdom of the business cases that have happened. Into that environment, do we really see luck playing a role in what companies end up being successful maybe for a few quarters or years? Does that happen?
MAUBOUSSIN: Oh, yeah, I mean, I think for sure. It’s actually funny because I — I participated in an academic seminar (inaudible) like a non-academic, but an academic seminar. It was literally about this exact topic, which is how much — what is the role of skill and luck in corporate strategy setting. And — and interestingly, there is an academic that took this luck side and an academic that took the skill side and, you know, the answer, of course, is somewhere in between those two.
I think your question you’re asking is a slightly more subtle one, which is has it changed over time. And I think that the answer is that again as …
RITHOLTZ: As the skill levels rise …
MAUBOUSSIN: Right, that’s the basic principle is there’s more uniformity in the skill levels that it becomes.
Now, look the answer is for many famous business breakthroughs — and clearly, this is very true, for example, drug development …
RITHOLTZ: Right.
MAUBOUSSIN: … that had almost seems like it’s — I mean, those are — I mean, I don’t know if we call them block, but we’d say that …
RITHOLTZ: There’s a high degree of randomness in what’s successful …
MAUBOUSSIN: High degree of randomness.
RITHOLTZ: … and what’s not.
MAUBOUSSIN: Exactly. And so, you know, you think about, you know …
RITHOLTZ: Although to be fair, some of the new technologies …
MAUBOUSSIN: Yeah.
RITHOLTZ: … the — the — I forgot what it’s called, the — the nose on a chip that allows the testing of these bajillion variations using semiconductors and software rather than …
MAUBOUSSIN: mRNA, what about …
RITHOLTZ: Right.
MAUBOUSSIN: … mRNA was an amazing — you think about …
RITHOLTZ: That’s a decade plus in the making, too. People think it’s a recent discovery. It’s almost 20 years of R&D.
MAUBOUSSIN: But that’s an amazing — like you said, 20 years of R&D sort of ready like all dressed up with no place to go …
RITHOLTZ: Right.
MAUBOUSSIN: … just yet. And then when it became time go …
RITHOLTZ: Time …
MAUBOUSSIN: … it went.
RITHOLTZ: Right.
MAUBOUSSIN: And, by the way, that thing — I mean, I — my understanding is that these guys had that thing ready to go probably …
RITHOLTZ: A couple years ago.
MAUBOUSSIN: … March or April — for specifically COVID-19 …
RITHOLTZ: Oh, for COVID.
MAUBOUSSIN: … yeah, March or April of 2020. In other words, it was ready to go like almost right away, which is astounding.
RITHOLTZ: Right.
MAUBOUSSIN: It’s — you know, there’s one other thing I’ll just add, Barry, that, you know — and we wrote a piece. It was in a slightly different context, but it — the piece was called “Turn and Face the Strange.” You know, it was about why organizations are slow to change.
By the way, the inspiration for that piece was actually a presentation that Dick Thaler gave at the MIT Sloan Sports Analytics Conference, so this is going to seem a little bit weird that a behavioral economist talking at a sports conference. But Dick’s point was something like this, which is there are certain things that we know work analytically in sports, you know, the three-point shot going for it on the fourth down, stuff like that. And …
RITHOLTZ: But it seemed to have taken forever …
MAUBOUSSIN: Forever …
RITHOLTZ: … to actually …
MAUBOUSSIN: … for teams to actually embrace. And the question is why don’t teams do it much faster. So this is an interesting one where they’re — they’re — you know, we know that it works, in quotes, “we know.” And — and yet the — the answer is it’s not part of the conventional wisdom, and it’s not part of the coaching guild. It’s not we learned as a player when you’ve grown up. And so, it takes almost a generation or two for these things to get woven in.
Now — now if you watch NFL going fourth on fourth down, for the most part (inaudible) — well, (inaudible) if it’s for the most part, but it’s happening much more …
RITHOLTZ: It happens much more.
MAUBOUSSIN: … frequently …
RITHOLTZ: Right.
MAUBOUSSIN: … much more frequently, so people have gotten the memo on these things, specially the younger coaches and so forth.
RITHOLTZ: Right. The — the interesting story about Thaler is when Michael Lewis’s “Moneyball” came out, Thaler sends Lewis an email or a letter saying, “Hey, you’re talking about Kahneman and Tversky’s work, this is all behavioral finance,” which is what eventually led to Lewis’ book 10 years later “The Undoing Project” because he didn’t realize he had really written a work — a book about their work, kind of fascinating. And even with “Moneyball,” it still took a decade or two for teams like the — the Boston Red Sox to start using things that Lewis had written about years and years before and ultimately led the Red Sox to championship.
MAUBOUSSIN: You know, it’s interesting. My understanding is that Danny in — in writing “Thinking, Fast and Slow,” which came out about a decade ago, talked to a number of other writers to potentially collaborate with him on that. One was Jason Zweig, and I think Jason (inaudible) …
RITHOLTZ: Who edited about three-quarters of the book.
MAUBOUSSIN: … so Jason I spent — think — think has spent a long time …
RITHOLTZ: Yeah.
MAUBOUSSIN: … with him on it, but the other one was Michael Lewis, interestingly.
RITHOLTZ: Oh, really?
MAUBOUSSIN: And so, I think he actually spent a fair bit of time with Michael back when he was thinking about this. And I think he obviously went to ultimately — and, by the way, again, he’s a beautiful writer, so I (inaudible). So he ended up doing on his own. But that’s an interesting — but I think, like you said, between the Thaler thing and spending time with Kahneman himself, I think that that sort of made it clear to Michael Lewis who is just, by the way, an insanely — love that podcast you did with him, too. He’s just an insanely talented guy and — anyway.
RITHOLTZ: Yeah, he’s — he’s been a — a regular — some of the stuff he’s written about finance is just so unique and comes from such a — a special angle. There’s — there’s nobody else who has his ability to identify the consensus, find the band of misfits that are challenging the consensus and are ultimately proven right. And it’s just such a great story. It — it works so well, whether you’re talking about baseball or finance or …
MAUBOUSSIN: COVID.
RITHOLTZ: … high — high-frequency trading or like — I love that in “Premonition.” It’s the Bush White House’s strike team that essentially creates all of the COVID response that was ready to go. And we really — this really didn’t need to be three-quarters of a million deaths, it’s quite fascinating.
Well, we are way off topic, and I’ve allowed you to allow me to disrupt myself. So why don’t I jump since we’re — since we’re already talking about all sorts of other things, why don’t I jump to our favorite podcast questions? And since we’re talking about COVID, what have you been doing to keep yourself entertained during lockdown. Tell us what Netflix or Amazon Prime shows or podcasts you’ve been — been staying busy with.
MAUBOUSSIN: Besides Masters in Business?
RITHOLTZ: Besides, yeah. That’s a given, so we’ll skip.
MAUBOUSSIN: OK, okay, because that’s a given, OK, yeah. So — so, Barry, my — my — my confession is, which you probably know, is I don’t watch a lot of TV.
RITHOLTZ: I know that.
MAUBOUSSIN: And so, I — I don’t have any good answers on that. I do — I do enjoy podcast and, you know, and probably the one I listen to the most frequently is — is Patrick O’Shaughnessy’s Invest Like the Best. And I think he’s done a really nice job.
RITHOLTZ: So great.
MAUBOUSSIN: But I’m also a big fan of like Tyler Cowen, so conversations with Tyler, Russ Reynolds — Russ Roberts, pardon me, Russ Roberts.
RITHOLTZ: He — by the way, Russ Roberts has been doing these sorts of interviews before any of us started.
MAUBOUSSIN: Yeah.
RITHOLTZ: He’s been doing it for like 20 years.
MAUBOUSSIN: So, I’m fans of all those guys, but I usually go — I usually go if there’s someone who pops up who I find to be an interesting guest. That’s usually what motivates me to do that. So that’s mostly what I do.
And then I do — I have to say that I — it’s been an odd thing. I’m a — I’m a fairly big sports fan, so I do enjoy watching sports. So, I have to say that in 2021, for example, even the NFL, I’ve enjoyed it probably more this year than I have in a very long time just for whatever reason. So …
RITHOLTZ: But you missed it the previous years?
MAUBOUSSIN: … you know, because — I mean, they played the games, but it was a very different environment. It just feels like it’s a little bit back to normal, and I’ve really enjoyed that.
RITHOLTZ: So, let’s talk a little bit about your mentors. Who helped shape your career?
MAUBOUSSIN: Well, there are a number of them that come to mind, many of whom are great. Well, Al — Al Rappaport we’ve already talked about. And that — I mean, he would be sort of first and foremost, and not just as someone who was a mentor and a teacher to me, but also a collaborator and — you know, so that — that’s the whole package.
Bill Miller has to be up there. You know, Bill — Bill introduced me, for example, to the Santa Fe Institute. And I don’t know if you saw this, but Bill recently made a …
RITHOLTZ: Big donation.
MAUBOUSSIN: … very large …
RITHOLTZ: Fifty million dollars, something like that, yeah.
MAUBOUSSIN: … $50 million million, which is a transformational gift to that place because it’s a relatively small place. And so, that will ensure that sort of the complexity scientists on the scene for — for — for a long time to come, which was really extraordinary. But, you know, it’s not just — I mean, I think Bill is another one of these guys that has an insatiable intellectual curiosity, has a good — has good taste for ideas, and just a very thoughtful guy.
The two other come to mind. You know, this little — sound a little bit odd. One is a guy named Brady Dougan who is — was a former CEO of Credit Suisse. Now he has his own firm. But Brady — when I was growing up at equities in — in the — at Credit Suisse back in the day was always a big supporter and when I went back to Credit Suisse in 2013, it was because he was there and he offered me a really exciting opportunity to do — do that.
And probably the last guy I’ll mention is Dennis Lynch. You know, I think Dennis — you know, it’s interesting as I was thinking about what — what to do next and just sat down with Dennis. And, you know, he’d been early reader of a lot of stuff with Don and again creates an incredible environment for work. Every day is super exciting for me to — to get going. I can’t wait to get going every single day. And as usual, I have a — a longer list of things to do than the things I can get done, it’s just — it’s like one of these really fund sensations, so those are people I would mention.
RITHOLTZ: That’s fantastic. So, I know you read a lot, so let’s talk about what you’re reading now and what some of your favorite books are.
MAUBOUSSIN: Oh, man, a lot. So, I should be more prepared for this one.
RITHOLTZ: And P.S., I normally shoot these questions over to people, but you’ve — you’ve been through this — what is this your third …
MAUBOUSSIN: I know.
RITHOLTZ: … or fourth appearance?
MAUBOUSSIN: Yeah.
RITHOLTZ: So, I figured out, let me — let me just have …
MAUBOUSSIN: I know.
RITHOLTZ: … him ring it.
MAUBOUSSIN: I know, that’s bad. So, well, what I’m reading right now is actually two books simultaneously. Richard Rhodes has a new biography of E.O. Wilson, the very famous biologist. And — and, you know, Richard Rhodes is a very famous talented biographer, and it’s just a beautiful book.
And I — I was familiar with E.O. Wilson. By the way, E.O. Wilson wrote a book called “Consilience,” which is, you mentioned — you keep saying consilient — you know, Head of Consilient Research, and I assume every time everybody hears that, they go, “I don’t know what that he’s talking about.” So that’s where — let’s connect that, we’ll close that, and we’ll close that loop right there. And so, I really enjoy that book.
I’m also reading a book now by Paige Harden called “The Genetic Lottery.” So, this is really about genetics, and what we have learned about genetics and equality.
A couple other books I really enjoyed this year is Steven Pinker’s book on Rationality has been wonderful. I don’t know if you read that or know it, but …
RITHOLTZ: I haven’t — I haven’t read it yet.
MAUBOUSSIN: … I — I was familiar with many of the ideas in there, so it wasn’t like it was brand new stuff, but he present ideas in a very clear and compelling way — and ways actually would help me even pedagogically as a teacher to explain it to other people.
And probably I would say my favorite book this year was a book by Fred Logevall on — it’s a biography of JFK. So he’s embarked on a two-part series on JFK, so this is the first one from the time he was born to 1917 to when he wins the Senate in the 1950s. And then the — the second piece will be, obviously, sort of packed in the last roughly eight or 10 years of his life.
But I, you know, and I obviously knew the basic profile of Kennedy, but it was — I learned just a ton about him. I learned a ton about his family, which I found to be — and it’s just beautifully written. So, you’ll learn a lot about world history along the way, and so on and so forth. So those will be taught at someone’s elementary …
RITHOLTZ: So — so those last two, “Scientist: E.O. Wilson: A life in Nature,” and then “JFK: Coming of Age in the American Century.” Those are the two books you just — you just mentioned.
So, our final two questions, what sort of advice would you give to a recent college grad who was interested in a career in either investment management or financial research?
MAUBOUSSIN: Well, by the way, in many ways, it’s a very exciting time, I mean, we talk about these intangibles. And, you know, from a point — from the point of view, understanding how those work and so forth that it’d be pretty exciting. But, you know, the key for me is always to — there — there are sort of two things, and they’re — it’s probably a little bit hokey. But the first thing is you really have to set out to try to learn as much as you can, and so a lot of that is reading and studying on your own.
You know, whenever my kids graduate from college, you know, you sort of give them a hug and say congratulations, and then say, “Recognize tomorrow morning you wake up and your education begins,” right? So, it’s — it’s an ongoing process.
And then the second thing is it’s — it’s tricky to do when you’re young, but the key is, as soon as you can, is to find an organization where you feel comfortable and can contribute, and just the culture of the organization work where you work is such a big deal.
I guess the — the — the thing that maybe is what people are asking for more overtly is — is it would go back to this thing on easy games. If you’re sort of saying like where — where are the things exciting, the answer is to try not to do what everybody else is doing. Are there pockets or areas where you can do something that’s a little bit different and a little bit maybe more niche for now or something that might grow or evolve.
RITHOLTZ: Quite, quite interesting. And our final question, what do you know about the world of investing management today that you wish you knew 30 or so years ago when you were first getting started?
MAUBOUSSIN: Yeah, I mean, I think that the — I mean, I — I don’t think that I didn’t know this, but I think I underappreciated, which is just the central importance of people for all this stuff. And, you know, one of the pieces that’s in one of our queues, so something we’re going to write on, I very fully outlined in this report is a report about feedback.
So, one of the really difficult things in our world is to get feedback especially in investing. So, if you’re, you know, buying and selling stocks, ultimately, it’s about the stocks performing well. But, you know, there’s — there’s very little quality in intermediate feedback.
But I start to piece off by talking about riffing off of work by Phil Tetlock at the University of Pennsylvania on the super forecasters. And what they were able to sort of figure out is that these super forecasters have certain profiles, and those profiles tend to be a key part of what makes them effective on what they do. And there are lots of aspects of it, but one — only one that I’ll mention that’s really important, which is this idea being actively open-minded. Active open-mindedness is the key, right? And that means that you’re not — not only are you willing to — to contemplate points of view that are different than yours, but you’re actually willing to seek them out.
And I’ll just say that, you know, we all like to think that we do this. The answer is no, not really, right? Because once you’ve made up your mind about something, the past at least pathways resistance is just like look for stuff that confirms it and just keep on moving, right? Because if you confront — if you have to change your mind, there are two things. When you have to change your mind, which itself is a pain, and then you may have to change what you do, right, which is actually another pain, right? So most of us would rather not be bothered with that. So — so that would be the one thing.
I’ll just say investment management is — is it’s this drum beat, but it’s the people and — and the culture is becoming really the secret sauce to — to long-term success.
RITHOLTZ: Really good answer. It’s funny we — we started talking about — we started talking out about inflation and never got back to it. When I have my — I have my expectations and my view point, and whenever I want to share a chart that supports that view — that viewpoint, I always try to describe it on Twitter as today in confirming my priors hear something that agrees with something already said, so at least there’s a tiny hint of recognition that, hey, you’re not thinking, you’re just — you’re just finding something that agrees with you and sharing it, which we all do. But at least if you admit it, you’re — you’re part of the way to a (inaudible).
MAUBOUSSIN: I would say, Barry, I don’t know exactly when we met, but I — I remember one — it was an early instance where I wrote something and then you wrote me back and you said, “Hey, man, you — you wrote this thing and it’s not right.” And, you know, you — you got this state basically thing, I think was like weapons of mass destruction, you know, prediction market or something like that.
RITHOLTZ: I don’t remember. What — what — what was it?
MAUBOUSSIN: It was, I mean, like weapons of — I — I wrote something about weapons of mass destruction and — and, you know, Iraq or something. You go, “This is not right.” And I thought to myself like, you know — first of all, so, of course, it’s — someone is telling you’re not right. But — but the way you did it was really interesting, and I thought really constructive. So, it was not like dude, you’re an idiot. It was not like that, it was …
RITHOLTZ: I saved those emails for other people.
MAUBOUSSIN: Yeah, yeah, maybe — maybe — maybe, but at least that’s not the way you came across. You came across saying like, “Hey, I think you got this thing wrong. Here’s some other stuff that you may want to consider when you think about this topic going forward.” And I was like, “You know what? I’m down with that, but that’s good,” like I’m …
RITHOLTZ: Shockingly diplomatic.
MAUBOUSSIN: Right, it was – maybe it was shockingly diplomatic, but that’s the way to do it. So, it wasn’t about you — you took it immediately away from being about me and immediately about there might be other ways to think about this.
RITHOLTZ: Did it change your mind? Did it affect your thoughts?
MAUBOUSSIN: I think it did change, I think it did change my mind because I think — and I think you ended up being sort of the front end of what ended up being the correct interpretation of what was going on. And …
RITHOLTZ: Well, that I do all the time. It’s a lonely place. But I will tell you the — the challenge is when you’re right about that sort of front-end stuff, you’re not always right. We thought …
MAUBOUSSIN: Correct.
RITHOLTZ: … you’re going to be wrong frequently. You have to be ready to say — and that’s why every year I put out, hey, this is what I got wrong. Here are my mea culpas.
MAUBOUSSIN: Yeah.
RITHOLTZ: Because if you don’t do that, you have no right to say to a Michael Mauboussin …
MAUBOUSSIN: That’s right.
RITHOLTZ: … hey, dude, I think you’re not right about this, take a look at …
MAUBOUSSIN: Right.
RITHOLTZ: … take a look at this.
MAUBOUSSIN: Right, exactly. So anyway, I — I appreciate that because you — you actually did it in a way that was tactful, and respectful, and provocative.
RITHOLTZ: You sure that was me. I think that was …
MAUBOUSSIN: Pretty sure it was you, pretty sure it was you.
RITHOLTZ: … pretty much someone else.
MAUBOUSSIN: Pretty sure it’s you.
RITHOLTZ: He’s tactful and respectful.
MAUBOUSSIN: Just – dude, just take credit for it.
(LAUGHTER)
RITHOLTZ: All right. I’ll — I’ll — I’ll definitely — I definitely will.
Hey, Mike, this has been just fantastic. Thank you so much for being so generous with your time.
We have been speaking with Michael Mauboussin. He is the Head of Consilient Research at Counterpoint Global at Morgan Stanley’s Investment Management Group.
If you enjoyed this conversation, well, be sure and check out any of the previous 392 ones we’ve done prior. I — I promise by the time we get to 400, we’ll — we’ll start getting this right.
We love your comments, feedback and suggestions. Write to us at mibpodcast@bloomberg.net. You can follow me on Twitter @ritholtz. Sign up for a daily reading list at ritholtz.com.
I would be remiss if I did not thank the crack staff that helps us put these together each week. Paris Wald is my Producer. Michael Batnick is my Head of Research. Atika Valbrun is our Project Manager.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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