TIP440: Beating the S&P500 since 2004 w/ Bryan Lawrence

Podcast Summary

• Understanding Business and Industry Structure: Invest wisely by asking five key questions: does it fit within your circle of competence, is it a great business, does industry offer competitive advantages, is management aligned, and is valuation attractive?

  Brian Lawrence of Oak Cliff Capital emphasizes the importance of understanding a business and its industry structure before making an investment. He follows a rigorous process of asking five key questions: does the business fall within our circle of competence, is it a great business with durable cash flows, does the industry structure offer competitive advantages, is the management team aligned with investors, and is the valuation attractive relative to cash flows? Lawrence's investment strategy has led Oak Cliff Capital to outperform the S&P 500 since its inception. He also highlighted the importance of education and information in the field of investing, which is the mission of The Investor's Podcast.

• Understanding great, cheap, and misconceptions for successful investing: Charter, delivering 700GB data/mo for $65, is a great value provider in a favorable industry. Misconceptions about 5G led to temporary dip, offering investment opportunity.

  Successful investing involves understanding if a business is great, cheap, and if there's a temporary misconception making it undervalued. Charter, a provider of Internet services under the Spectrum brand, is a great example of such a business. It delivers a significant amount of value to its customers, with the average household receiving 700 gigabytes of data a month for just $65, which equates to less than 60¢ an hour. Moreover, Charter operates in a favorable industry structure, serving as a duopoly or emerging monopoly in most of its markets. However, for an investment to be worthwhile, it's crucial to buy the stock when the market holds a misconception about its value. Four years ago, investors worried that Charter's profits would be impacted due to the hype around 5G networks and the potential for cellular networks to replace cable connections. However, upon closer examination, it was determined that delivering a byte of data over a cellular network is 70 times more expensive than over a cable network. This misconception led to a temporary dip in Charter's share price, providing an opportunity for investors to buy the stock at a discount.

• Cable internet's lower cost structure attracts customers despite competition: Charter's cable internet remains competitive due to lower costs and comparable pricing, despite lower data usage, making it a strong contender in the market. Fiber providers' high upfront costs result in higher prices, while Charter's established base and bundled cellular plans provide a competitive edge.

  Despite the increasing competition from fiber internet providers, Charter's cable internet business remains attractive due to its lower cost structure. The average cable customer uses about 10 gigabytes of data per month, which is significantly less than the 700 gigabytes used by a cable customer. Yet, the price for cable internet is comparable to that of cellular or fiber internet. This pricing disparity, combined with Charter's ability to deliver data at a much lower cost, makes it a strong contender in the market. Furthermore, the high upfront costs of building and expanding fiber networks mean that fiber providers will need to charge higher prices to earn a return on their investment. Charter, with its established customer base and lower costs, is well-positioned to maintain or even increase its profits in the face of competition. Additionally, Charter's entry into the cellular business by bundling cellular plans with its internet plans at a discounted price further strengthens its competitive advantage.

• Charter Communications enters cellular market using Wi-Fi routers: Charter Communications' Wi-Fi router cellular service has potential to reach 100M people, offering durable cash flows, tax advantages, and management buying back stock. Understanding businesses' underlying value is crucial for long-term investment success.

  Charter Communications, which provides cable and internet services, is expanding into the cellular service market using Wi-Fi routers, potentially disrupting the cellular business with its more efficient network. This service, which is currently used by over 3.5 million people, has the potential to reach over 100 million people within Charter's footprint. The investment firm presenting this idea sees it as an opportunity to invest in a great business with durable cash flows, which can increase over time and provide tax advantages due to their long-term holding. They also believe that there is a temporary misconception making the stock cheap, and the company's management team is buying back stock. The firm reads extensively and talks to other investors to find great businesses with durable cash flows, which are more predictable and allow for long-term holding and tax advantages. They emphasized that stock prices are volatile, with the average stock going up and down by 80% in a year, making it important for investors to understand the underlying business and not be swayed by short-term market fluctuations.

• Understanding great businesses and patiently waiting for low prices: Thoroughly research and understand businesses, then wait for volatile share prices to buy at attractive prices

  Successful stock picking involves understanding great businesses and being patient for volatile share prices to offer low buying opportunities. Oakcliff Capital spends most of its time researching and understanding businesses, owning 11 and having several dozen others in mind. Idea generation comes from various sources, including reading and networking with fellow investors. The deep research stage involves reviewing 100 companies annually, immersing oneself in the business, and becoming the best-informed investor in the public markets about it. This thorough process allows Oakcliff to build positions in great businesses at attractive prices.

• Engaging with management for deep insights: Successful value investors engage with management, present their thesis, ask probing questions, and adjust assumptions based on new information to maximize returns.

  Successful value investing involves a deep understanding of a business, direct communication with management, and ongoing learning and adjustment. Long-term investors aim to engage with management, present their thesis, and ask probing questions to gain insights. If the investment case remains solid and assumptions hold true, investors project future operational and financial performance, calculate expected cash flows, and discount them back to the present share price. If the Internal Rate of Return (IRR) exceeds 20%, the investor is likely to buy the stock. However, the journey doesn't end there. Continuous learning, cross-checking, and comparison of actual performance to projections are crucial. IRR is sensitive to changes in assumptions and share price, so adjustments lead to adding or subtracting positions or even accepting mistakes if necessary. Joining a community like the TIP Mastermind can help accelerate learning and build valuable relationships in the value investing journey.

• Investing legends experience underperformance: Underperformance is normal in value investing, focusing on long-term benefits and maintaining a disciplined approach can lead to superior returns

  While tools like Yahoo Finance provide valuable insights into market trends and news, even the most successful investors, like Oakcliff Capital, experience periods of underperformance compared to the S&P 500. This underperformance is an inherent part of concentrated value investing, as highlighted by Warren Buffett and other investing legends. Investors should understand that underperformance is a normal part of the process and focus on the long-term benefits of their investment strategy. Bryan Lawrence of Oakcliff Capital emphasized that their edge comes from a combination of information and structural advantages, rather than just analytical skills. By staying informed and maintaining a disciplined approach, investors can navigate these periods of underperformance and ultimately achieve superior long-term returns.

• Patient Capital and Long-Term Time Horizon as a Source of Edge: Investing with a patient capital and long-term time horizon allows for deeper analysis of select companies and taking advantage of opportunities during underperformance, but accepting short-term underperformance is a challenge for some investors.

  The investment firm's main edge comes from its patient capital and long-term time horizon. By having a significant portion of their own money invested in the firm, they can afford to take a long-term view and weather short-term market uncertainty. This approach allows them to glean more information about their select companies and take advantage of opportunities during periods of underperformance. However, this strategy also means accepting periods of short-term underperformance, which can be challenging for investors with impatient capital. The speaker acknowledges that this paradox of underperformance leading to outperformance over the long term is a difficult concept for many investors to accept, as only a small percentage of money in the stock market is invested using a concentrated value strategy. Despite the evidence supporting this approach, many investors prefer to diversify widely rather than risk underperformance in the short term. The speaker also touches on the challenge of deciding when to reduce exposure to a stock, suggesting that it depends on the investor's level of conviction in the company's intrinsic value.

• Psychological pressure to sell successful investments: Confirmation bias can make it difficult for investors to accept disconfirming evidence and sell successful investments, leading to potential losses. Objectivity and extra scrutiny are necessary to mitigate this effect.

  The increase in the value of an investment, even if it's based on unchanged assumptions, can lead to significant psychological pressure to sell the position. This pressure arises from the confirmation bias that develops when an idea has been successful, making it harder to accept disconfirming evidence. Additionally, the larger the position size, the more pronounced this psychological effect can be. It's crucial for investors to remain objective and subject their successful investments to extra scrutiny, as the human mind tends to become resistant to new ideas, especially when they challenge cherished beliefs. As Max Planck and Thomas Kuhn have noted, scientific progress often requires letting go of deeply held ideas, which can be a challenging process.

• Understanding personal biases and expectations for asset management: Find a manager who aligns with your investment goals, values, and risk tolerance, and practices a proven strategy that resonates with you. Look for trust, transparency, and a long-term focus.

  Identifying the right asset manager for an individual investor requires a deep understanding of one's own psychological biases and expectations. As Stig Brodersen pointed out, many people ask for high and stable returns with no downside risk, which is an unrealistic goal in the stock market. Bryan Lawrence suggested reading "The Psychology of Money" for insights into human behavior and its impact on investing. He emphasized that understanding the emotional drivers behind buying and selling decisions can help investors avoid the negative feedback loop of volatility in the market. Ultimately, the key is to find a manager who aligns with your investment goals, values, and risk tolerance, and who practices a proven investment strategy that resonates with you. Trust, transparency, and a long-term focus are essential qualities to look for in a potential manager.

• Impact of Chasing Performance on Long-Term Returns: Avoiding the temptation to chase hot-performing managers and fire underperforming ones can result in a 4% annual increase in long-term returns, equivalent to a 70% increase in total returns.

  Individual investors can significantly impact their long-term returns by avoiding the temptation to chase hot-performing managers and fire underperforming ones. This behavior, known as "chasing performance," can result in a 4 percentage point annual reduction in returns over a long period, which equates to a substantial 70% reduction in total returns. Instead, investors should find a strategy that suits their individual psychology and stick with it. One such strategy is investing in a mix of index funds and cash, which reduces volatility and lowers fees. Another strategy is concentrated value investing, but this requires careful selection of a skilled manager with a proven track record, aligned interests, and a clear strategy for managing portfolio volatility. Fund managers can optimally align their interests with clients by using the combination of performance-based and asset-under-management fees, which incentivizes them to focus on the long-term performance of the fund rather than just expanding their AUM.

• Oak Cliff's Fees Aligned with Client Performance: Oak Cliff charges fees only when clients make money, with the belief that fees should not be a profit center. The firm's alignment of interests with clients is a key aspect of their approach, resulting in significant outperformance.

  At Oak Cliff, the investment firm being discussed, the management's fees are not a profit center, but rather, they are spent on research that aims to improve performance. The firm's foundational belief is that management fees should only be charged when clients make money. The firm's fees are split between the clients and the firm, with the firm making money through return on their capital and a performance fee. The alignment of interests between the clients and the firm is a key aspect of Oak Cliff's approach. The firm's outperformance, which has been achieved while holding an average of 16% cash, has been significant, with 3 percentage points of the outperformance being fees to the firm. The firm's philosophy is to have ready cash during market downturns, as they believe this position will allow them to buy cheaply from other investors.

• Affordable Assisted Stretching with Iflex and Financial Advice from Public.com and NerdWallet: Iflex offers professional stretching services at an affordable price, while Public.com provides a high yield cash account and NerdWallet helps make smarter financial decisions.

  The Iflex stretch studio franchise provides high-quality, professional assisted stretching services at an affordable price in one convenient location. The Mayo Clinic supports the benefits of stretching, which can increase flexibility and improve joint range of motion. For entrepreneurs looking to enter the rapidly growing health and wellness industry, prime franchise opportunities are available with Iflex, founded by the creators of The Joint Chiropractic. Additionally, financial advice from trusted sources is essential. Public.com offers a high yield cash account with an APY of 5.1%, which is higher than many competitors. NerdWallet can help individuals make smarter financial decisions by comparing and finding the best financial products. A memorable side story shared during the podcast was about Jillian, a previous podcast guest and wife of Preston, who graciously agreed to redo an interview when the recording failed the first time. At the Berkshire meeting, Jillian, an accomplished writer, will be selling her books and aims to impress Warren Buffett by selling enough copies to avoid disappointing him.

• Successful people face challenges despite great achievements: Even large funds with top managers like Warren Buffett face difficulties in generating returns due to increasing fund size and limited investment opportunities

  That successful people, as depicted in the upcoming book featuring interviews with top achievers like Warren Buffett, have all faced tough times. The size of a fund for an asset manager, such as Buffett's, can impact performance. A smaller asset under management (AUM) makes it easier to show great returns, but a larger AUM allows for greater revenue and more extensive research. However, a larger fund size also brings challenges, such as limited opportunities for investments due to the smaller number of companies with large equity market capitalizations. This can make the search for ideas more difficult and potentially lead to strategy shifts or even a return of capital to become a family office.

• Evaluating a fund manager's growth and inflation considerations: Assess a fund manager's skills and strategies as they grow larger, and consider a business's ability to outrun inflation and provide essential services to succeed in an inflationary economy.

  The ability to evaluate a fund manager's skillset and the size of their portfolio are important factors in investing. As a fund manager grows larger, their skills and strategies may need to change in order to effectively manage larger sums of money. Buffett's transition from small partnership to large conglomerate is an example of this. Additionally, inflation is a crucial consideration for equity investors. Businesses that can add value to customers in excess of their prices and raise prices faster than their costs will thrive in an inflationary environment. Companies like Charter, which provide essential services, have a better chance of passing on price increases to customers and outpacing inflation. Overall, investors must evaluate a business's ability to outrun inflation and own the necessary infrastructure to succeed in an inflationary economy.

• Investing in businesses with pricing power and infrastructure advantages: Choose companies with the ability to raise prices and maintain infrastructure for attractive returns, while avoiding those with constant renewal and intense competition.

  Businesses with the ability to raise prices in excess of inflation and maintain infrastructure are more desirable investments than those that face the challenge of building infrastructure from scratch or face intense competition. The examples given include Charter Communications with its existing network infrastructure and companies like TransDigm, AmSafe, and Guidewire, which have monopolistic or duopolistic positions in their respective industries. On the other hand, businesses that require constant renewal and have to compete with numerous other players, such as automakers, may struggle to pass through increased costs. The investor emphasizes the importance of careful selection when building a portfolio.

• Understanding the value of cash during market downturns: During market downturns, cash may be worth holding due to increased value of existing investments and potential new opportunities, but it's crucial to understand the true meaning of 'cash' and consider the opportunity cost.

  The decision to hold cash or invest in stocks depends on the expected Internal Rate of Return (IRR) of potential investments. During market downturns, the value of what is known about existing investments and potential new opportunities may increase, making it worth holding cash to take advantage of these opportunities. However, it's important to note that cash held in traditional savings accounts may not be true cash during financial crises. The speakers in the discussion emphasized the importance of having a clear understanding of what "cash" means in this context and carefully considering the opportunity cost of holding cash versus being fully invested. Despite the potential opportunity cost, the ability to lean in when others are panicking can lead to significant gains.

• Oakcliff Capital's Diversified Cash Strategy: Brian and John of Oakcliff Capital maintain a cash strategy with JPMorgan, shifting towards U.S. Treasuries during uncertain times, acknowledging cash may not be attractive during high inflation, and staying vigilant for investment opportunities.

  Brian and John of Oakcliff Capital maintain a diversified cash strategy, which includes a mix of money market funds and U.S. Treasuries. They prefer to keep their assets with JPMorgan due to its safety and liquidity, but during uncertain economic times, they shift towards Treasuries. They acknowledge that cash may not be as attractive during periods of high inflation, but they remain vigilant for investment opportunities. If you're interested in learning more about Oakcliff Capital and their investment strategies, visit their website at www.oakcliffcapital.com. Remember, this podcast is for informational purposes only, and it's essential to consult a financial professional before making any investment decisions.