Michael Mauboussin Master Class — Moats, Skill, Luck, Decision Making and a Whole Lot More

1. 0:00 – 2:06

   Show setup: Michael Mauboussin masterclass + why “expectations” fits today’s market

   1. BGBen Gilbert0:00

      Yeah, dude, we should see if, uh, any listeners wanna create some cool, like, animation for the intro music for the YouTube channel.

   2. DRDavid Rosenthal0:09

      Oh, are we gonna open source it to the fans?

   3. BGBen Gilbert0:12

      [laughing] We gotta do it.

   4. SPSpeaker0:14

      Who got the truth? Is it you? Is it you? Is it you? Who got the truth now? Is it you? Is it you? Is it you? Sit me down, say it straight. Another story on the way. Who got the truth?

   5. BGBen Gilbert0:31

      Welcome to this special episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I'm the co-founder and managing director of Seattle-based Pioneer Square Labs, and our venture fund, PSL Ventures.

   6. DRDavid Rosenthal0:45

      And I'm David Rosenthal, and I am an angel investor based in San Francisco.

   7. BGBen Gilbert0:50

      And we are your hosts. Well, today, we interview one of our heroes, Michael Mauboussin. We've referenced his work on many episodes before. He's given talks that have been my carve-outs on previous episodes, and as many of you know, Michael is the head of Consilient Research at Counterpoint Global, which is part of Morgan Stanley Investment Management. At, uh, mid-year 2021, earlier this year, Counterpoint Global had assets under management of approximately $180 billion. And for those who don't know Michael's work, boy, are you in for a treat. Uh, [chuckles] David, I think it's fair to say he's your favorite investor's favorite investor.

   8. DRDavid Rosenthal1:33

      [laughing] I love that. I love that. He might also... I mean, at this point, we'll have to- somebody have to tally up. He might be, uh, he's certainly in the top five of number of carve-outs, uh, all time in Acquired.

   9. BGBen Gilbert1:47

      For sure. Yeah, he's done, like, mind-expanding research on a ton of topics that we'll cover today on the show, and today's show, uh, of course, has a lens on how to interpret all of Michael's work over the years in the context of today's unprecedented macroeconomic environment.

   10. DRDavid Rosenthal2:02

       I li- I like that, unprecedented.

   11. BGBen Gilbert2:03

       [laughing]

   12. DRDavid Rosenthal2:04

       Good, good phrasing.

2. 2:06 – 6:14

   Sponsor segment: SoftBank Latin America Fund + QuintoAndar origin story

   1. BGBen Gilbert2:06

      Yeah. Well, for the presenting sponsorship on this episode, we have the SoftBank Latin America Fund back again. As many of you know from previous specials, SoftBank LatAm is deploying capital into the Latin America startup ecosystem, and it's absolutely fascinating. They, they just announced they have another $3 billion to invest in addition to their initial $5 billion, so clearly it is working. And when we asked Paulo and Xu, two of the partners in the fund, if we could grab some voices from the founders themselves, they were like, "Of course." So today, we are joined by Gabriel Braga, the co-founder and CEO of QuintoAndar, the $5 billion real estate tech company founded in 2012 in Brazil. Can you explain how the platform works and, and what your journey to start and grow the company has been like?

   2. SPSpeaker2:55

      Definitely. Uh, we enable seamless housing experience from, from searching for a home towards the transaction, and after the transaction, during the leaving, as long as you live in that property. So we started, uh, back in 2012, focused on long-term rentals, and we chose that segment because it was the, the most neglected part of the market. Was particularly painful in Brazil, and in addition to all the ineffici- inefficiencies in, in finding a home, I mean, duplicate listings, poor photos, incomplete info online, tenants were required in Brazil to provide a very cumbersome and expensive rent guarantee, while the landlords were afraid of not receiving the rent on time and having headaches with delinquent tenants and, and evictions. And we fixed the transaction by eliminating the need of those rent guarantees from the tenant side, but guaranteeing the rent on time for the landlord, no matter what happened.

   3. BGBen Gilbert3:55

      Mm.

   4. SPSpeaker3:56

      So right now, we are about 10 times, uh, bigger than our closest competitor. We are the largest platform in Brazil, one of the largest in the world. We have more than 120,000 ongoing rentals that we manage on a monthly basis, but just like we did in rentals, where we kind of reinvented the transaction itself, how it's done, we, we intend to do this in, in, in the home buying segment. Um, and in a bit more than a year of operation, we have more than 10,000 for-sale transactions, uh, rent rate right now.

   5. BGBen Gilbert4:28

      Wow, just so impressive. I mean, uh, one thing I've sort of been wondering as we've learned more and more about the LatAm ecosystem, can you give us a sense of how it's evolved since you started the company?

   6. SPSpeaker4:39

      We launched QuintoAndar in 2013, and it was hard to attract talent to work in a small company. There weren't many companies trying... You know, tech companies, startups that had scaled. So fast-forward, we've experienced a major shift, uh, since 2018, 2019, especially, uh, since La- uh, SoftBank launched the LatAm Fund. They basically invested in many of this earlier cohort of startup, um, some of them became, uh, unicorns, so investors coming and looking for new opportunities, you know, founders coming from all over the world and, and trying to address problems here. So I think SoftBank specifically was, was pivotal in, in this- in this process, uh, because they were very deliberate in, in investing these companies and showing the confidence in the region.

   7. BGBen Gilbert5:32

      Well, our thanks to the SoftBank Latin America Fund and to Gabriel and QuintoAndar. If you wanna get in touch with SoftBank, you can do so at latinamericafund.com or click the link in the show notes. And if you're interested in working at QuintoAndar, there's a link in the show notes for that, too. As always, this is not investment advice, although-

   8. DRDavid Rosenthal5:49

      [chuckles] It, it is advi- it's advice about investing, but not any specific, uh-

   9. BGBen Gilbert5:55

      Yes

   10. DRDavid Rosenthal5:55

       ... uh, investment.

   11. BGBen Gilbert5:57

       Yes. No doubt, it'll be, uh, educational, entertaining, um, and, and Michael's an absolute riot. So, um, you know, we may hold positions in things we talk about on this show. We may be running from the hills on some things we talk about on this show. Uh, without further ado, we'll get into it.

3. 6:14 – 11:50

   Meeting Al Rappaport and the origins of Expectations Investing

   1. DRDavid Rosenthal6:14

      ... Well, Michael, we are so excited to have you on the pod. You've been so influential, uh, to me personally, to, I know to Ben, to the show, so many folks who listen. Um, when we all met at Capital Camp, uh, hosted by, by Patrick and, and Brent the other week, uh, we knew we needed to find some excuse to, to get you on the show and discuss all the big ideas, uh, that you've had over your career. Um, and we were- Ben and I were talking, we were like: Well, what could we... Well, how could we frame this? And we were like, "Actually, the current crazy market is the perfect frame," because, like [chuckles] you've written so much about how to think about markets, and, ah, the current environment is a little wild. So, um, we thought we would, we would kind of step through your ideas, you know, untangling skill and luck, measuring moats, decision-making, complexity theory. We, we wanna talk about the Santa Fe Institute, where you were chairman of the board for many years. Um, but we thought maybe the best place to start would, uh, for two reasons, would actually be Expectations Investing. Uh, one, because you and your co-author, Al Rappaport, just published a revised, uh, edition of the book. Um, but also, two, it's kind of, [chuckles] you know, think about expectations, uh, r- probably a good frame for, uh, the current market. Um, so let's, uh, uh, let's dive in on that. Um, could you maybe start, uh, by telling us who Al is? Uh, 'cause he's pretty cool, and how you got to know him.

   2. MMMichael Mauboussin7:39

      Well, thank you, David, and, and thank you both, David and Ben. Great to see you guys. Um, you know, I- Al Rappaport's probably the most important person, one of the most important people in my life, and I can say that, um, he changed the complete direction of my life. So the story is, very quickly, is I was a liberal arts major in college. I went to Wall Street. I had no idea [chuckles] what was going on. I took no business classes. By the way, I, I... My father- I take, I take that back. My father made me take, um, accounting for non-business majors, and I got, like, a C [chuckles] in the class out of the generosity of the professor's heart. So I had no idea. So I come on, and, and part of it was remedial and so forth, but, but I was, uh... They're just, Wall Street, and I think even ven- the venture world and, and even the corporate world, filled with sort of rules of thumb and, and sort of, like, old wives' tales of how things work. And I was, I was sort of swimming in all this, and one of the guys in my training program handed me a copy of Al Rappaport's book called Creating Shareholder Value. That book came out in 1986, so I read it shortly after it came out, and for me, it was a professional epiphany. And, and I'll just say, almost everything I've done since then has been patterned on, on that work. There were three things he said that were, I, I think, remain the bedrock of everything I think about. One is, it's not about earnings that, uh, that matters, it's really about cash flow. So the ul- ultimate driver value of business is cash, not accounting earnings, and we can come back and, and deepen on that thought. The second is, and I also think really important, is that we tend to think about strategy, so what is our strategy and how do we position ourselves, and so forth, and we think about valuation as two separate things. And he made the point, I think, very, very correctly, that you have to combine these two things to understand a business and to do evaluation properly. So in other words, the litmus test of a strategy is that it creates value, and you really can't understand or value a business till you understand the competitive situation, the competitor set, the growth of the market, and so on and so forth. And then the third and final thing was in chapter seven, he had- it was called Stock Market Signals to Managers, and the argument was: Hey, executive, your stock price reflects a set of expectations about the future financial performance of your company, and it behooves you to understand what's priced in. And if you want to do really well from the point of view of the stock market, you have to not only meet but exceed those expectations. So that, to me, you know... And I, I, of course, hadn't met him. He was, like, some, some [chuckles] awesome big guy, and I had the opportunity- I started using his work in my work as an analyst, and then in 1991, May of 1991, I had the opportunity to meet with him, and it was absolutely phenomenal. So just, uh, for me, a, a real great experience as, as someone who was trying to learn from, from the master. We, uh, we maintained a relationship through the 1990s, and then toward the end of the '90s, 1998 or 1999, he said, "You know, it might be fun for us to write a book using the same principles, but in- aimed, aimed at investors." So that was the birth of Expectations Investing.

   3. DRDavid Rosenthal10:30

      That former one was sort of aimed at executives, at, at CEOs?

   4. MMMichael Mauboussin10:34

      Yeah, Ben, it was. And, and, um, and so... But, but the idea, that, that particular idea of expectations was clearly u- use- useful for everybody. And, um, [chuckles] so we write the book, and by the way, we signed it in the late 1990s, right? So the world's, you know, the world's ripping, and the stocks are doing great and everything, and then-

   5. DRDavid Rosenthal10:50

      Oh, boy, that sounds, like, uh, familiar. [chuckles]

   6. MMMichael Mauboussin10:53

      [chuckles] Exactly. And the book came out... Now, this, that, that may- you may have just jinxed me there, David. Uh, the book came out September 10th, 2001.

   7. DRDavid Rosenthal11:02

      Oh!

   8. MMMichael Mauboussin11:02

      So if you can imagine a worse time, you know, be- preceding, obviously, a national tragedy, but really the middle of a three-year, a brutal three-year bear market as we're coming off the dot-com, uh, boom into the dot-com bust. So, so the timing was [chuckles] not great. So I... It was very well-received, and we got... You know, there's a lot of people are still- ha- have used some of the techniques, but, but the timing couldn't have been worse. So, so we put this back together. But, you know, I, I, I went to Al and said, "Let's- would you like to work on that?" And he, uh, he, he agreed. He's, uh, he's now in his late 80s. He's amazing to talk to. I still find it... E- every day I talk to him, it's exhilarating and a awesome intellectual journey, so it was super fun working on it. And then the other interesting thing is how much the world has changed in 20 years, of course, so, so a lot of new stuff has come along. Um, so anyway, that's the story of, of, um, of Expectations Investing.

4. 11:50 – 15:44

   Expectations Investing in one framework: reverse-engineer the price

   1. DRDavid Rosenthal11:50

      Well, we wanna ask you for a spoiler in case people haven't read the, the book from the first time around, in case it sort of slipped through the cracks in anything else they were doing in 2001, um, and they haven't picked it up yet. W- what's kind of the, the big, seminal idea?

   2. MMMichael Mauboussin12:03

      I don't wanna discourage anybody from buying it, but [laughing] here it is in 30 seconds. Here it is in 30 seconds: so the idea is to say a stock price, or it could really be any asset price, a, a price of an asset, but let's say a stock price, reflects a set of expectations about future financial performance. So the first step is to say, "What do I have to believe for this to make sense?"... and you can apply that broadly. The second thing is, the second step is to say, let's introduce strategic and financial analysis to judge whether that set of expectations is too optimistic, too pessimistic, or about right. And by the way, more times than not, you're not gonna have a view that that's different than right. But if it's- if, if the- if your views are more optimistic, then you should buy the stock. If your view is more pessimistic, you should sell the stock. And then the third and final thing is, as, as a result of those things, take action, right? So buy, sell, or hold, or do nothing. But the core idea is just basically saying, "What do I have to believe? Is the company gonna do what, what, what the market believes it's gonna do? And then let me make decisions as a consequence."

   3. BGBen Gilbert12:58

      This concept is really interesting, and one that we ended up talking about in our conversation at Capital Camp, where, you know, you brought up the point that most of the time, the way people come up with a valuation or a price target or a, you know, a, a share price that they're willing to buy the company at, is they make their own model with the, the sort of the bottoms-up, bake in all the assumptions, and then say, "Okay, here's what I'm willing to pay." And you're sort of making the argument here that, you know, the market has set a price, and actually, what you should do is reverse engineer that and say, "Well, what are the assumptions that I need to believe to, uh, you know, make that a good thing to purchase right now? Make this a buy instead of a, a sell or an ignore." And, you know, uh, uh, basically trying to come up with a probability distribution for each of those assumptions.

   4. MMMichael Mauboussin13:41

      That's right, Ben, and I'm- I'll nerd out for just a second, that the, you know, sort of the original framework for discounted cashflow model was laid out by a guy named John Burr Williams in 1938, so a very long time ago. And he has a, uh, you know... So he's laying out a DCF model and, you know, it's a little bit complicated. So he's got a chapter, Chapter 15, called A Chapter for Skeptics. So he's like, "Okay, you guys are, you know, you guys are doing it a certain way, and I'm, I'm showing you something new. You're gonna be skeptical about it here." He tries to address head-on all the, all the skepticisms. And actually, John Burr Williams says, "Hey, you know, if you think it's too complicated to forecast what you think the value is, use the tools to go backwards." So he actually talked about reverse engineering in 1938, which you're exactly right. And I'm- I was trying to get my finger- put my finger on why it is that people feel so compelled to project value and compare that to price versus reverse engineering price and what it has to- what it means. And I'm not sure I have a good answer for that, but I think maybe you feel like you're more in control if you're dictating what the value is versus, uh, going backwards. So I don't know what it is, but it seems to me a much more reasonable task, right? To say: What do I have to believe? Uh, and by the way, again, like in, in investing a lot, you're gonna pass on a lot of things 'cause you're just not gonna have a differential view. So you're like, "All right."

   5. DRDavid Rosenthal14:51

      It makes me think so much. I literally just, like, wrote down in my notebook, like, you know, it's the famous Charlie Munger quote: "Invert, always invert," right? [chuckles] Like, you know, what would Charlie do?

   6. BGBen Gilbert15:01

      The Buffett quote is, "Price is what you pay, value is what you get." I mean, uh, they're, they're a pair for a reason.

   7. MMMichael Mauboussin15:06

      100%. And the other thing I'll just mention, Ben, you alluded to, but I just wanna also amplify on it, which is expectations investing, I should have been more explicit about it, is very probabilistic, right? So what we're really trying to do is think through scenarios. So the if-then kind of scenario. So we're, we- we're getting knowledge that the price today is just one of many potential outcomes. It's actually a price reflecting a distribution of potential outcomes. So we're, we, we wanna really understand the richer distribution. And, you know, again, this all lends itself to good analysis, and it lends itself to good strategic analysis and financial analysis, but, but it's, it's not, "Here is an answer," it's, uh, really trying to think about the world probabilistically, which is also a very much a, a sort of Buffett and Munger type of thing.

5. 15:44 – 23:59

   Intangibles changed everything: why modern accounting obscures economics

   1. DRDavid Rosenthal15:44

      Okay, so this is great 'cause, like, [chuckles] think about today's world. You know, I mean, uh, probably even this was changing when you wrote the book the first time with technology, but, like, uh, let's think way back, you know, in, in, in Buffett and Munger's original world. The, the expectations seem to me like they would've been so much more simple. You know, uh, this company's gonna perform in X way, cash flow is gonna be Y. Now, [chuckles] um, you know, uh, e- even if we're just talking about companies that are traded on public stock markets, like, the, the expectations built in seem to me like they're a lot more complex than just, like, uh, uh, Facebook or Amazon's cash flow next year will be Z, [chuckles] you know? Um, how, how should folks think about that?

   2. MMMichael Mauboussin16:36

      Yeah, and David, I'll just build on this, and, and, you know, this sort of now versus then is an interesting way to frame it. If you go back way to Ben Graham and so forth, you know, they focus a lot on things like book value, which was, you know, where the accounting was actually probably a reasonable representation because most of your assets were things that truly showed up on your balance sheet. But as you pointed out correctly, the world has changed a ton, and now more of our investments are intangible versus tangible. So as a consequence, what's going on in the income statement and the balance sheet and so forth, cash flow statements, is getting a little bit mixed up. So let me just give you one little stat I found interesting that we've just recently ran. Um, back in 2001, so the year the first book came out, capital expenditures and intangible investments, and this is for, like, called the Russell 3000, so basically US public companies, was about the same amount, 630, 640 billion, something like that. So just think about their- think of a starting line for a race, and they're both standing there [chuckles] at the same spot. Fast-forward to 2021, obviously, we don't have all the full numbers, but if the projections sort of hold out, it'll be, uh, the case that intangible investments now are $2 trillion and CapEx is $1 trillion. So going from the same starting point, intangible investments are 2X, the tangible investments. And so as a con- as a consequence-

   3. DRDavid Rosenthal17:52

      And can you, for everybody, just explain what you mean by intangibles?

   4. MMMichael Mauboussin17:55

      Yeah. So in, I mean, tangible and intangible, the, the basic distinction is exactly what you- what it sounds like [chuckles] . So tangible are things you can touch and feel and kick and so forth, and intangible are things that are not physical. Obviously, canonical examples would be software code, but it could be anything. It could be marketing, branding, all that kind of stuff, training your employees, and so forth. So what accountants try to do now is to look at the income statement and say, "Which of those items that are spent on, on selling general administrative expenses, which are necessary to maintain the current business, and which are discretionary investments," right? An investment defined as an outlay today with an expectation for a future return.... that are, in this case, that are intangible. So the big buckets classically are research and development, branding, but today you think a lot about customer acquisition costs, you know, all that kind of stuff. And so it's been a watershed change, and, and this is, you know, called even maybe not even a generation of investors. And so a lot of those tools that were developed, incredibly useful and thoughtful at the time, but, um, the, just because the accounting changed means that they're much less relevant today than they used to be. And so this, you know... I was listening to, um, you know, Patrick O'Shaughnessy did a really interesting podcast a little over a year ago with John Collison from Stripe and, you know, just such a thoughtful guy. But Collison was spending a lot of time, he's like: "I don't understand why the accounting works this way," [chuckles] right? " 'Cause we're spending tons of money at Stripe to try to build our business, but these are mostly intangible investments, and they're showing up on our income statement," right? "So we're expensing everything, so our income doesn't look that great."

   5. DRDavid Rosenthal19:22

      It looked unprofitable.

   6. MMMichael Mauboussin19:23

      Yeah, they look unprofitable, but this is inc- we're building incredible value, right? Incredible wealth. And so, you know, the, one of the adjustments y- one can make is to, to, to capitalize those investments and so forth. But, but it's a, it's a such an interesting... And that's why this, this original message from Rappaport of cash flows, not earnings, is so, so in my mind all the time, right? I think this is a really big change. And what's exciting for me, and I think as, uh, executives or even investors should be thinking about this, is that we're a little bit in the Wild West of this. We- no one really knows how to, to, to think about and grapple with these, uh, intangibles from an accounting point of view. But if you're really trying to understand a business, uh, what I always recommend doing is getting down to the basic unit of analysis. You know, how does this company make money? And really focusing on that and really refining laser focus on that to understand it. And, and again, the, the numbers are becoming less, uh, insightful for giving us guidance how to think about that. And, and then the other thing that's been interesting, I think the last twenty years, it's been true for a long time, but increasingly, software-based companies can be much more global. They can grow much faster, and they can be much more global than businesses in the past. And that's an- that's another thing, another feature. Uh, by the way, it helps some businesses, but when you have a lot of intangible assets or you're built on an intangible edifice, it also makes you vulnerable, right? So if your, your product or service does not work, there's not much there left, [chuckles] right? So-

   7. DRDavid Rosenthal20:46

      Right. You're not gonna sell for book value. [chuckles]

   8. MMMichael Mauboussin20:49

      No, exactly. So if you think about, you know, sort of the tails, pushing out the tails relative to traditional businesses, that's the way, I think, the way I think about it. There, there are more extreme good things and more extreme bad things than, than what we had witnessed in the past.

   9. BGBen Gilbert21:03

      Maybe to go back and rearticulate something the way I understand it, with a s- a little bit of a slightly less charitable, uh, lens toward the venture landscape. Uh, uh, for the longest time, venture capital investors have not had a financial investing fundamentals background. They often come from being entrepreneurs and, you know, not, not necessarily the original VCs, but a, a, the recent trend. And so you have people that don't ha, uh, have a robust or certainly as robust as the people you work with, Michael, an understanding of financial statements. And so th- th- the idea that, um, uh, intangibles are investments is sort of, like, inherent, it's like, duh, and then it just feels weird that it doesn't show up in the right place in your financial statements. So it's almost like this kind of, um, uh, hard-headed view that VCs have had is now being forced to be adopted by the broader investment community because, as Marc Andreessen puts it, "Software is eating the world." And so more and more of the very valuable companies in the world are, uh, sort of think about their investing internally, the same way that, you know, the non-financial sector [chuckles] of, of venture capital, uh, has thought about them for thirty, forty years.

   10. MMMichael Mauboussin22:17

       Yeah, I mean, I agree, I agree with all that, and, um, I do think that the market has sorted this out to s- to some degree, even public companies, right? So I think we have... We're close to a record number, if not a record number of public companies today that, in quotes, "lose money." Um, and I think that, you know, so not- you can lose money the old-fashioned way, [chuckles] where just your costs are bigger than your revenues. But, but you can lose fun- lose money the, the, the way we're talking about, which is you're actually making very productive investments, and as a consequence, the, the, the... And, and by the way, let's just take it one step back, is the, the number, when I talk about cash flow, the number we really care about is so-called free cash flow, which is earnings minus investments. And, you know, some people think, "Oh, you want positive free cash flow?" Well, the answer is not really. I mean, what you want is, you- if you can invest at a high return, you want to invest as much as you humanly possibly can, right? That, that you have access to. And I always like to point out that Walmart, for the first fifteen years that it was public, had negative free cash flow for each of those years. Walmart was profitable on the income statement, but they were investing like crazy. And why was that good? Because their stores had great economics, so, like, knock yourself out. And so that's the same... It's a s- little bit of the same mindset.

   11. DRDavid Rosenthal23:21

       So much easier for a Walmart to untangle because you can just look at the cash flow statement and be like: "Oh, I see your operating cash flow is excellent, then you're investing in CapEx on the..." Uh, what's that? On the investing cash flow, uh, portion of the, the cash flow statement. So you can disentangle that. But with these software companies, it all, it all gets tied up in OpEx, right? So, like, you're investing in acquiring customers and hiring engineers, et cetera. That gets, uh, that gets muddied. It's like, you can't just look at one number and be like: "Oh, I see your operating cash flow is excellent, so you're doing the right thing." [chuckles]

6. 23:59 – 28:20

   Security Analysis course: four-part structure and how Mauboussin ended up teaching it

   1. BGBen Gilbert23:59

      Uh, I wanna talk about company analysis. So, so Michael, you published the awesome Measuring the Moat paper a few years back that has become, uh, basically the bible for how to do this. Uh, and we thought maybe the right way to dissect this, uh... I think you teach Ben Graham's legendary security analysis course at Columbia Business School. So, like, how do you think about this concept in the course, and how is the course structured?

   2. MMMichael Mauboussin24:24

      ... Yeah, so the course structure, and, and, and we can dwell on the competitive strategy piece, but I, I usually like to think about it in four parts. The first is just thinking about markets. And, you know, the fundamental question is, are markets efficient? Are they inefficient? If I'm a- whether I'm a venture capitalist or a public market investor, if I have hopes to d- generate sort of attractive returns, how do I go about that? So how do I differentiate myself to do that? So that's a whole thing on markets, and that ties a lot of back to the Santa Fe Institute stuff, so we'll come back. We'll, we'll put that to the side for just a moment. A lot of work on valuations, we've talked a bit about that. And then the third module is competitive strategy, so, so Ben, that's what we'll dive into in just a second. And then the last piece, which by the way, is the most- the newest part of the course, is on decision making. And [clears throat] what I came to realize, you know, probably 15 or 20 years ago, was what differentiates good to great investors has little to do with their sort of technical skills, like their ability to build spreadsheets or whatever, and much more about their temperament, and in particular, their ability to make decisions under some sort of stress or tension. So we'll come back to decision making.

   3. DRDavid Rosenthal25:25

      So real quick, I gotta ask, what's the story of how you came to teach this legendary course? [chuckles]

   4. MMMichael Mauboussin25:31

      Yeah, uh-

   5. DRDavid Rosenthal25:32

      'Cause this is so awesome. [laughing]

   6. MMMichael Mauboussin25:34

      [chuckles] I mean, all this stuff is luck, right? So I joined, uh, what, what at the time was the First Boston Corporation, it's now, uh, Credit Suisse, as a food industry analyst in 1992. So-

   7. BGBen Gilbert25:47

      So liberal arts minute, uh, major, gone food industry.

   8. MMMichael Mauboussin25:50

      [chuckles] Exactly. So, so think General Mills and Kellogg's and Campbell Soup and all that kind of stuff. That was my industry. And, um, so I'm, you know, I'm a new guy, and I'm, like, plugging away. And a guy... And by the way, I'll just say that from the very beginning, I loved to hang out with the technology guys, 'cause I just thought they were the coolest guys and they got to work on all the cool stuff, right? Um, that's how I got to know, like, Bill Gurley, very early in Bill's career when he was an analyst, and just like a cool guy working on cool stuff. So there was a guy there who- named Charlie Wolfe, who just the greatest guy. And Charlie was actually a tenured professor at Columbia Business School, who decided to have a sabbatical year, decided he wanted to do equity research, of all things. And, and every firm turned him down except for First Boston, and they gave him a job. This is like now the late '90s... Late '70s, early '80s. And they said, "Well, what, what industry would you like to follow?" He's like: "Well, there's this new thing called personal computers. Uh, maybe I could do that." And they're like: "Personal computers? Yeah, nobody cares about that." [laughing] "Yeah, go ahead and take that industry." So anyway, so Charlie was the PC analyst and like, you know, so there's, like, Apple coming public and-

   9. DRDavid Rosenthal26:52

      Oh, man. And he was an academic. He, he-

   10. MMMichael Mauboussin26:55

       He's an academic.

   11. DRDavid Rosenthal26:55

       Uh-

   12. MMMichael Mauboussin26:56

       A trained academic. Yeah, trained academic. So he walks into my office one day and he goes, "Hey, you know, uh, I'm working on the PC stocks, and I wonder if, uh... I'm thinking about brands," you know, like so Dell and Compaq and all these. He's like: "What do you know about brands? You know, you're the food guy." [chuckles] So I was like: "I don't really know that much about brands, actually," but I'm like: "Here's some stuff I've done, and, you know, you can check it out." And of course, just to be clear, this is me coming right off working on the Rappaport stuff, right? So I'm using an approach that, you know, you'd- you could argue is a little bit more academic than what was traditional on Wall Street at the time. So he comes back the next day and he goes, "Yeah, there's not that much about brands in here, but you should teach at Columbia Business School." [chuckles] So I was like-

   13. DRDavid Rosenthal27:33

       Oh, wow

   14. MMMichael Mauboussin27:34

       ... "Wait, what?"

   15. BGBen Gilbert27:35

       [chuckles]

   16. MMMichael Mauboussin27:35

       So how do you make this connection? And I, I think at the time, you know, they- he had had a connection to this school, and they were looking for people to teach security analysis, right? Which is this sort of-

   17. DRDavid Rosenthal27:44

       I mean, this is the course that Warren Buffett, the whole reason he went to Columbia was to take this course-

   18. MMMichael Mauboussin27:49

       Yeah

   19. DRDavid Rosenthal27:49

       ... right? [chuckles]

   20. MMMichael Mauboussin27:50

       I mean, yeah, I don't want- I also don't wanna- I don't wanna overstate all this. I mean, it is called Security Analysis, and, and Graham did teach a version of all this, but many people have taught it over a long period, you know, so in other words, it's not, there's nothing- I'm not unique in any way in this way. But [clears throat] so then he asked me to teach it, and, uh, I went up there. And, and you can also, when you're in New York, you can bring in great guests, and so it's a, it's a fun experience for the students. So I started doing that in the summer of 1993. In 1995, I shifted to the spring, and I've been doing it every year. So this, this year, uh, 2022, will be my 30th year of doing this in a row,

7. 28:20 – 31:54

   Measuring the Moat: defining and quantifying competitive advantage

   1. MMMichael Mauboussin28:20

      which is actually really cool. So that's the story on how, how I got there. And so let me, let me now delve into to Ben's question about competitive strategy, and I'll just say that, I, I don't know if people really recognize this, but the very first version of Measuring the Moat came out in 2002, so nearly 20 years ago. And I'll just say that that was among probably the top three hardest things I've ever done professionally. And the reason was not so much that any of the ideas were that difficult, but it was an incredible exercise in synthesizing, right? So like many other people, I'd read Michael Porter, I'd read Clay Christensen, I'd read all the... I knew the Brian Arthur l- literature on increasing returns, and so forth. But the question is, how do you bring this together in a way that's sort of cohesive, that allows an investor or an executive or somebody to understand-

   2. BGBen Gilbert29:09

      Not to mention, these were abstract concepts. I mean, you read them and they click, and you're like, "Oh, yeah, uh, it, you know, uh, Competitive Strategy by Michael Porter, this totally innately makes sense," but then that next level of literally measuring-

   3. MMMichael Mauboussin29:22

      Yeah, so the thing is, I mean, you can start with basic things like competitive advantage. Interestingly, by the way, and I have all the Porter books, and I read many of them when I was very young, and I, I- they're, they're really rich, but they're difficult. They're not fun. They're not easy books to read, and in fact, I usually recommend that people who are interested in understanding Porter read a book by a woman named Joan Magretta called Understanding Michael Porter. So if you wanna get... You know, 'cause she's a journalist, she worked elbow to elbow with him for many years, and she actually explains the ideas, I think, more clearly than he does, with a lot of examples. So, um, here's an interesting question: What is the definition of a competitive advantage? That's, you know, if you say a moat, and, you know, it turns out that Porter himself never really defined it. And so we argue that a competitive advantage should have two features. One is an absolute one, one is a relative one. The absolute one is you should have returns today or returns that are promised to be above your cost of capital, right? So in other words, you're taking... A cost of capital is simply an opportunity cost concept. So if I'm taking a dollar here, it should earn above what it, that dollar could earn somewhere else of, uh, uh, in terms of opportunity costs. And then the relative one is you should be better than your competitors, right? If we can define a competitive set, you should be better. That's a competitive advantage. So, so that's, Ben, your, your point's exactly right. We wanted to start with something a little bit quantitative, in the sense you could hang your hat on it. That, and that- and we try to measure that by things like returns on invested capital.... the return on invested capital concept also helps us, uh, as we start to think about one of the latter phases of this. So, so we basically broke the strategy into three pieces. One is, I call it lay of the land, but basically, what am I, what am, what am I dealing with here, right? So we do things like entry and exit i- in the industry, market share changes, pricing flexibility. So these are all sort of broader th- to get a sense of the field that you're dealing with, right? So for instance, if you have an industry where the market shares are whipping around all the time, you know, one- it's really hard to be king of the hill for a long time if market shares are really transitioning a lot. By contrast, you'll get, like, soft drinks. These guys slug it out for one market share point, right? So that's a really stable industry. Then we talked about industry dynamics. So this would be the classic porter stuff, where this is where you roll up your sleeve, value chains and the five forces. Um, I also put the Christensen stuff on disruptive innovation there. By the way, disruptive innovation is, I think, a very helpful theory. I think most people don't really understand exactly what he's talking about, so it's worth understanding, like, going back to his basic principles. And then the third and final piece is, um, uh, maybe there's a fourth piece, but the third piece is, what is the source of this company's competitive advantage, if it has one? And the, and the simplest way to say it, you know, is usually

8. 31:54 – 34:31

   Low-cost vs differentiation: margins, capital velocity, and what financials reveal

   1. MMMichael Mauboussin31:54

      low-cost producer or some sort of differentiation. And what's also neat about the low-cost producer differentiation is we can tie that back to return on capital, right? So basically, the simple model is low-cost producers tend to have low margins and high capital velocity.

   2. BGBen Gilbert32:10

      And what's capital velocity?

   3. MMMichael Mauboussin32:11

      So capital velocity would just be... So it's, it's gonna be- margins are gonna be profits divided by sales, and capital velocity is sales divided by invested capital, right? And so then we, we do the calculations, we cross out sales, then we have S- NOPAT earnings divided by invested capital. And that's return on capital, right? So low margins, high velocity, that means you're turning your capital fast. That's a low-cost producer. High margins and low capital velocity, that's a differentiation. So you think about, here's a way to make it more concrete. Think about a supermarket. They don't make a lot of money on all the items they sell, but they send out to sell a ton of stuff, right? You think that versus Tiffany's, I don't really know Tiffany's business, but Tiffany probably they s- make a lot of money when they sell stuff, and they don't sell it that frequently. A jewelry store, generically, right?

   4. DRDavid Rosenthal32:54

      Or like Amazon versus Facebook, right? Like...

   5. MMMichael Mauboussin32:57

      Yeah. So what happens is immediately you show me the income statement or, or even adjusted statement, financial statements, and I can tell you right away, like, if they're gonna have a competitive advantage, sort of how are they going after it, right? Which is interesting. So, um, yeah, so Measuring the Moat, I think, is- was, was an attempt to try to be structured in thinking through this stuff. And I, I was very, um, specific about a- putting a checklist at the end, and I think checklists are interesting just because they, they force you to make... to, to think about all the different issues. Not all the issues are gonna be relevant for all the companies, but just to make sure that you're being systematic in thinking through the various issues. And it sounds a little bit trite to talk about, like, [chuckles] you know, like, like David was saying before, sort of these markets are a little bit crazy, but, but it, it... So it sounds a little bit trite to do this kind of work, but I just feel so much better trying to really understand the economics of a business, right, before I, before I get involved with it. So anyway.

   6. DRDavid Rosenthal33:44

      I'll tell you a funny story, that this is the influence you had on me. Um, so I first discovered your work, uh, through Bill Gurley talking about it when I was a, you know, super young whippersnapper VC a decade ago. And I took, you know, I read, read, m- read, uh, Measuring the Moat. I actually pulled up my copy of it, uh, ahead of this, and, um, literally, like, the whole thing is highlighted. [laughing] Like, like, there's like... uh, like, why did I highl- even bother highlighting this? 'Cause there's- it's only the words that aren't highlighted. But I took your checklist at the end, and I was like, "I'm gonna make this part of my, you know, early-stage investing process." And I tried it for a couple, then I was like, "Whoa, wow!" [chuckles]

   7. MMMichael Mauboussin34:22

      Too much work. [chuckles]

   8. DRDavid Rosenthal34:23

      Applying this, applying this to a seed-stage investment is, um-

   9. MMMichael Mauboussin34:26

      Yeah, it's hard. Yeah, it's hard.

   10. DRDavid Rosenthal34:26

       Uh, it, it requires a little bit of a mental leap, but, uh, but it was, it was so fun.

9. 34:31 – 43:57

   Early-stage investing as options + industry entry/exit cycles in complex systems

   1. BGBen Gilbert34:31

      Ooh, David, that is a great bridge to, to complexity investing. Like, the, the future is so freaking unknown for early-stage companies. Michael, I'm curious, uh, how, how do you apply this in an early-stage-type company, where the world could change so much between what the nascent company is now and what it will become?

   2. MMMichael Mauboussin34:55

      I mean, these are really hard questions, and they're sort of two pieces. One is, you know, how would you value it, and then how do you just think about the business itself and how the world might unfold? Um, and we should come back to... You know, when I think of complex adaptive systems, you know, I think about a certain features. I mean, to break that term down, complex just means the interactions of lots of agents, right? Adaptive means that those agents learn. They try to anticipate their environment and react to it, but the environment changing itself changes how they learn and changes their behaviors, right? So it's, it never... the sy- system never settles down. And then system is the whole is greater than the sum of the parts. So when you think about the world that way, there's a very big evolutionary component to it, which means that's why we can't, I think, have a difficult time anticipating where the world's gonna go. That said, um, Ben, I think that one thing that I often think about young companies is really options more than, you know, like, a sort of bond or something boring like that. And, you know, an option, you know, options theory's been around for a very long time. Obviously, Black-Scholes in the 1970s sort of defined mathematically some of the key principles. It's not a perfect mapping to the real world, but not too bad. And then in the late 1970s, early '80s, academics started saying, "Well, these ideas are interesting for financial options, but we can apply them to real businesses as well." And so, uh, how do we think about that? So where real options tend to be valuable is when you have sort of three or four characteristics in place. First is, it's good to have volatility in the, in the, in the market, right? So there's, this is an interesting thought that's a little bit backwards, right? So typically, if you say for a financial asset, your discount rate is some sort of cost to capital. Lower is better for value, right? So if I have a lower discount rate, I'm gonna have a higher value, right? All things being equal. So I think everybody sort of gets the math of that.

   3. DRDavid Rosenthal36:38

      Look at the current market, where the discount rate is-

   4. MMMichael Mauboussin36:41

      Yeah, yeah

   5. DRDavid Rosenthal36:41

      ... zero or negative. [chuckles]

   6. MMMichael Mauboussin36:42

      And we could talk about that. And, but, but options are actually interesting because an option is the right, but not the obligation to do something.... Right, so you take out the downside. So in an option, what you want is lots of volatility. You want lots of volatility, right? Which is sort of counter. So the more volatile the world is, the more valuable the option is. And so that's, I think, an interesting thought for there. You also want... This is where there becomes a big premium on management. So management's ability to understand options and exercise them intelligently is extremely valuable. And you could think about the history of corporate executives, some of whom have been amazing at identifying and exercising options. You know, two easy example would be, of course, Jeff Bezos, but it- but he has been [chuckles] -

   7. BGBen Gilbert37:25

      Yeah

   8. MMMichael Mauboussin37:25

      ... I'll just say it, he's been great at it. Um-

   9. BGBen Gilbert37:28

      Could say there's maybe nobody better, huh?

   10. MMMichael Mauboussin37:30

       Yeah, there's maybe no- been nobody better. Um, and then the other thing is interesting is a, is a feature, is, uh, access to capital, right? Because if you, even if you decide to exer- to exercise an option, you need sometimes have to do things, like you have to pay for them, right? [chuckles] And, uh, I think that there was a lot of really interesting stuff intellectually going on in the early 2000s, so 20 years ago, right? But it was a huge bear market, and people were coming, a huge hangover from the dot-com, and there was just limited access to capital. As a consequence, there are probably a lot of really interesting things that didn't happen.

   11. BGBen Gilbert38:00

       Just look at Webvan and Pets.com, and look at Instacart and Chewy today. [chuckles] You know, like, these weren't bad ideas, it's just the access to capital went away.

   12. MMMichael Mauboussin38:09

       Yeah. So that's all really, that's all really interesting, too. But, you know, go- even just strategically, I, I think that the key is still to go back to the basic formula, which is the basic unit of analysis is what we're doing makes sense. The only other thing I'll add is that I... In, in doing this, doing this work over the years, one of the things I've always found is underappreciated, is sort of the role of entry and exit in industries. And, um, I recommend my students, uh, spend time understanding entry and exit. I think very few people are, by the way, are, are familiar with these statistics, typically. Um, but I think that one thing that's important to recognize is that as an industry starts, um... And by the way, the, the guy that did the main work on this, and it's beautiful work, is a guy named Steven Klepper from, uh, Carnegie Mellon. Uh, Klepper died a few years ago, but this is really cool stuff. And so what Klepper showed was that almost every industry, as it gets going, there's a huge upswing in the number of competitors. Uh, and the market is- a- again, think, think evolution, right? So the market's sorting out what it likes, and then once it's figured out kind of what it likes or what works, then there's a huge downswing, right? So that's consolidation or businesses going out of business, uh, bankrupt or whatever it is. And so you get this pattern of up and down, and, uh, that's another really interesting thing to think about when you're looking at early-stage stuff, which is say, "All right, where are we in this whole cycle?" And by the way, when, when it rolls over, you know, so in other words, the number of companies is declining, it's actually a really interesting time to invest. Because usually the industry itself is continuing to grow, and it's a fewer number of companies that are capturing the spoils, right? So it's, like, a really interesting dynamic. Um, we wrote a little bit about this. I mean, Klepper is obviously the guy, but you can do this for industry after industry. Certainly, automobiles would be classic example, radio, um, a lot of it in the internet, for sure, disk drive. So there, there are lots of cool examples of this pattern playing out over time. So those are just some thoughts that might be, that might be fun to think about and play with.

   13. BGBen Gilbert40:06

       One thing to drill in on is... So you, you mentioned with the early-stage investing, uh, the idea is you could think about it more as, uh, um, optionality, versus the same way you would think about investing in a late-stage company. Are, are you sort of making the argument that, um, and you can deploy a little bit of capital, and it's effectively buying an option on the potential that the, the way the world shifts, that company becomes big? That that's sort of the way to think about an early-stage investment?

   14. MMMichael Mauboussin40:33

       I think that's right, Ben. And I think the other interesting thing is, you know, we wrote a big piece on public to private equity, probably a year, a little over a year ago. And one of the things that I thought was really cool in that report was, uh, an analysis done by a few academics on the return profiles for three sets of investments, asset classes. The first were venture, right? So I think they looked at, um... I get the number right, I hope. 30,000 venture deals? Some gargantuan number of venture deals, and then they looked at 15,000 buyouts. And then we looked at 30,000, uh, periods for public companies. And so what you're looking at is the distribution of payoffs, right? So... And I'll, I'm gonna say what everybody already knows, right, which is the, the, the median venture deal earns nothing, right? And many venture deals lose money, but the tails are super extreme. So that's a really interesting way to think about essentially an option payoff, right? And then buyouts were a little bit, you know, same, you know, about, like, 25% lost money, but most of them kind of did okay, but a little bit more right, you know, more right, more skewed than, than, than the public markets. And then the public markets look much more like a bell-shaped distribution. So- and it says the interesting question is, like, what is the best set of frameworks to map what we actually know empirically the payoffs look like? And that's why even in venture, it's like you think about, especially early-stage venture, I mean, you know, whether the thing's worth fifty million or a hundred million, if it's gonna be worth ten billion [chuckles] in, in ten years or three years, like, it doesn't really matter that much what you pay for it today. So that's why these sort of extreme outcomes obscure the, the sort of first day. And, you know, that's why you always, you, you know, these funny stories about people like, "Oh, we passed on Amazon because it was too expensive," [chuckles] or it's like... You know, it, it, it was- it made sense at the time, but in retrospect, obviously, those things don't look like they make sense. But, but they do make sense, actually.

   15. BGBen Gilbert42:27

       Yeah. I mean, to, to the, to the extent that something is in the pool where it could be the next Amazon, if it's truly early stage, then it's worth kind of any price at that early stage.

   16. MMMichael Mauboussin42:37

       Right.

   17. BGBen Gilbert42:37

       But the, the trick is determining if it is of the set of companies that truly could be the next Amazon.

   18. MMMichael Mauboussin42:43

       Right. And, and another thing I'll say, Ben, is that that's why you're also building a portfolio of these things, right? So you would... I mean, some, obviously, if you're, for example, a founder or whatever, you're gonna have most of your-... skin in that one game, but if you're a venture person, you're gonna spread out your bets a little bit and hope, hope that, and, you know, these are very familiar patterns, that you just hope a couple things in your, in your fund are the ones that hit and sort of pull the, pull the wagon along for everything.

   19. BGBen Gilbert43:06

       Yeah.

   20. DRDavid Rosenthal43:06

       Well, I think the reason why I had a tough time as a young VC, um, applying your measuring the moat checklist to early-stage investments is, is I didn't realize the paradigm of, uh, like, what the asset was that I was buying. It was an option, and so you should think of it as an option, this framework we're just talking about, versus if you're buying a public [chuckles] security, you should think, wh- I don't even know what the right word is of, of that type of, um, asset that you're buying, like a, uh, of an option versus a-

   21. MMMichael Mauboussin43:43

       Yeah, it's just more of a cash-flowing business that's clear and, um, and more almost like a fixed income, you know, where w- we, we have sort of visible and predictable to some degree, cash flows. Yeah, no, exactly. I think that's not a bad way to think about it. Yeah.

10. 43:57 – 49:27

    Working backwards from extreme prices: Tesla, reflexivity, and meme dynamics

    1. BGBen Gilbert43:57

       Okay, so before we move on from your, your class, uh, and since we're-

    2. MMMichael Mauboussin44:00

       Right [chuckles]

    3. BGBen Gilbert44:00

       ... in valuation land a little bit here, uh, and we are in, as they say, unprecedented times, um, h- let's take an exam- the most extreme example of having to work backwards from price. So for fun, let's look at Tesla, and, and say, like, h- when the margin of safety is as narrow as it's ever been in making an investment in any asset, because multiples based on a- any aspect of a business are at all-time highs, uh, how, how are you sort of walking through an exercise with your students of working backwards from some ungodly valuations of companies, and where it still may make sense to invest?

    4. MMMichael Mauboussin44:38

       Yeah. And by the way, not surprisingly, Tesla's been a s- company we've analyzed [chuckles] in our class a bunch of times.

    5. BGBen Gilbert44:45

       [chuckles]

    6. MMMichael Mauboussin44:45

       Usually, by the way, at the end of the class, I bring in, uh, portfolio managers who assign stocks for the students to work on, and Tesla's been one that's been sort of a perennial one for many of the reasons you just described, Ben, um, sort of the head-scratching component. Well, um, yeah, I, I, I... You know, you, you just have to sit, sit down and pencil it out and think to yourself... And, and by the way, Tesla's another example of sort of this optionality. You know, are there things that they're doing that are not visible that could be of value in the future? So you have to pencil all that stuff out. The other thing I'll say about Tesla, which is, um, you know, we have a bit about this in the book, but the idea's been around for a very long time, is this concept of reflexivity. So we tend to think that, you know, there's this thing called the value of the firm, and I'm sort of the observer, and if the value's, you know, uh, higher than the price, I'm gonna buy it and make money, and so on and so forth. And we forget that, this goes back to complex systems, that there's an inter- interaction between the observer and the actual, uh, thing itself, and, um, that reflexivity basically says the very act of bidding up a stock changes the fundamental outlook for that company, and so on and so forth. And I think that-

    7. BGBen Gilbert45:48

       Especially if they can raise gobs of money at that new-

    8. MMMichael Mauboussin45:52

       Precisely

    9. BGBen Gilbert45:52

       ... valuation.

    10. MMMichael Mauboussin45:52

        And I think that that, to the, to there... You know, so I think that it was not too many years ago that, that Tesla was sort of skating on thin ice in terms of finances and so forth. And then as the stock took on a life of its own, the stock went up a lot. That allowed them to raise capital and get themselves on much stronger footing, and then that, that buys them time, buys them runway to do other stuff. So I think this idea of reflexivity is a really big one. Now, you know, and, and by the way, the, the idea, I mean, the idea's been around for a very long time, but the term reflexivity I think was coined by George Soros, so just to be clear where that intellectually comes from.

    11. DRDavid Rosenthal46:25

        Oh, I didn't know that.

    12. MMMichael Mauboussin46:25

        Yeah.

    13. DRDavid Rosenthal46:25

        That's awesome.

    14. MMMichael Mauboussin46:25

        A very old idea, but reflexivity. Now, the key is, like, when do you get off this thing, right? Because reflexivity works in two directions, and you can think about one... Another area where re- reflexivity's been historically a very big deal is in mergers and acquisitions and sort of conglomerate roll-ups. So you think about businesses buying other businesses, and their stock does well, then they use their stock to buy another business, and they keep doing this, and so on and so forth. And, you know, often where the gig e- ends up is that they have to do deals that are so large to perpetuate their growth rate, to perpetuate, to fulfill the expectations, that it just becomes, like, essentially, a, a, an insurmountable task. So I think, I think that's one way to think about some of these businesses. Now, you know, the meme stocks, that, by again, we- we've had flavors of this. You know, people think it's all new. We've had flavors of all this stuff for a [chuckles] really long time, so there's really not that much new to that. I think maybe perhaps that people can organize themselves more efficiently because they can use online tools and that they can transact essentially free or very low cost. That allows- that takes frictions out of the system. That allows it to be m- perhaps a little bit easier, but there, there, there have been basically versions of this for a long time. Now, again, some of these meme companies have been pretty smart about raising capital as well. So again, they've bought runway, um, and maybe bought some optionality through that. But, um, you know, most of these movies don't tend to end well, just, just to be clear. So, so we'll see how this, all this stuff hap- uh, unfolds and finishes, but they tend not to be, they tend not to be good endings.

    15. BGBen Gilbert47:50

        And how do you reconcile most of these movies don't end well with, uh, uh, the Bill Gurley's comment of the only way to, uh, um, get through the downside is in to enjoy every last minute of the upside? Like, uh, i- in general, people should be fully invested, so what do we buy? [chuckles]

    16. MMMichael Mauboussin48:09

        Yeah, no, I think that, and I, and I, I don't- I, I m- the context may be slightly different, and I don't wanna put words in anybody's mouth, but I think Bill's attitude was... Bill's, Bill's take is a bit more to me like this idea of market timing, which is, you know, you, you, you think to yourself, "You're- I'm really clever, and the market seems really expensive, so I'm gonna sell it, and then when it gets cheap, I'm gonna buy it back," and so on and so forth. And what history tells us in that is that none of our- none of us are that clever, and we just don't know, and I think that's a little bit of what Bill was saying with the venture thing, is that things feel a little bit rich, and, gee, we should be, you know, we should be throttling back a little bit, but we, we, in retrospect, have a hard time being good at doing that. So that would be my context there, uh, the context I would take that in. But, um-... Yeah, no, I, I, but I think, I think the idea the movie doesn't end well, is that, that [chuckles] is pretty easy to document, right? We can- we've seen that plenty of cases. And, you know, I just love... I mean, Matt Levine at Bloomberg is, is a genius, and, you know, he's got this thing called the boring market hypothesis, which I've always loved, and I think there's something to that, right? Which is, you know, 18 months ago, we sort of locked people up. They had nothing to do. Uh, they had no sports to bet on. We put a little extra money in their pocket through [chuckles] stimulus, and they're like: "All right, you know, here, here's something we can do to keep ourselves entertained and, in some cases, make some money" And so that sort of sparked the thing. But, um, yeah, we'll see how, we'll see how it unfolds.

11. 49:27 – 51:30

    Sponsor segment: Modern Treasury (payment operations)

    1. DRDavid Rosenthal49:27

       All right, it is now time for our second sponsor of the episode, and you all know who it is. Not only close friend of the show, but the only company out there whose entire team has been [chuckles] on... a guest on Acquired. That's right, we are talking about Modern Treasury, the worldwide leader in payment operations. Uh, for customers of theirs like Gusto, Pipe, ClassPass, and Marqeta, who manage complex payment flows, Modern Treasury automates the full cycle of money management, from payments to approvals, reports, reconciliations. With Modern Treasury, all of that stuff that used to be done by manual finance teams happens in software and APIs.

    2. BGBen Gilbert50:12

       Yeah, if you're finding yourself there sitting, you know, in your company, in your prop tech or fintech or a marketplace, and, you know, s- there's money moving around, and you're like: "Boy, we kind of have a duct tape process to make sure that this system always syncs with that system. Like, engineering built a thing, but finance is using a different thing," I think you need Modern Treasury.

    3. DRDavid Rosenthal50:30

       You absolutely do. And, uh, as you also probably know by now, [chuckles] they're one of the absolute hottest fintech startups out there, uh, on the market today. They have raised, uh, $50 million from top firms like Y Combinator, Benchmark, and Altimeter, and they are really just, like-

    4. BGBen Gilbert50:51

       Killing it, I think is the correct term.

    5. DRDavid Rosenthal50:54

       And because the only thing that they are more nerdy about over at Modern Treasury than payment operations is Acquired, [chuckles] they have made that reverse interview that they did, uh, that the whole team did with us as an LP episode, available for free to everyone. You can go on over to moderntreasury.com/acquired, or just click the link in the show notes. The episode is right there. You can listen to it, and while you're there, learn more about Modern Treasury.

    6. BGBen Gilbert51:23

       Learn the secrets of Acquired as, uh, as investigated by the Modern Treasury team. Our thanks to Modern Treasury.

12. 51:30 – 56:54

    Decision-making under uncertainty: base rates, pre-mortems, red teams, and journaling

    1. DRDavid Rosenthal51:30

       You said a minute ago that the difference that you've found between great investors and average investors is the quality and, uh, temperament of their decision making. How should people think about that?

    2. MMMichael Mauboussin51:42

       This has been an area I've, I've been fascinated by, and I think that the- the, as a, as a world, we avail ourselves of these tools too infrequently, right? We should be doing more of this. Um, you know, Ben brought up a point early on, which I just want to reiterate, which is sort of thinking about different scenarios for how the world might unfold, and I think that one of the biggest mistakes we tend to make is that we tend to think we know the future better than we actually do, right? So the idea is to maintain sort of an open-ended understanding of how things might unfold. Um, so there are a, a number of tools, I'll... And I'll, I'll rattle them off very quickly. Um, most of them are about opening up your mind, and one of them is about feedback. So the first one on opening up your mind is this idea of base rates. And, and for those that are not familiar with this, you know, when we, when we f- are faced with problems, the typical way we solve a problem is to gather a bunch of information, right? Combine it with your own analysis and your- in your experience, and your own input, and then you project into the future, right? And it feels very natural because you've gathered the information, and you're, you're obviously using your own, uh, devices to figure things out. Base rates are actually a very different exercise, which is it says: "Hey, let's think about this problem as an instance of a larger reference class. Let's, let's just basically ask, what happened when other people were in this situation before us?" And it's a very unnatural way to think about the world, right? Because you have to leave aside your own views, you have to leave aside all the stuff you've gathered, and so on and so forth. But it's a very... I mean, psychologists have demonstrated this is a very, very robust component to your decision making. So understanding and thinking about base rates, I think, is a really powerful thing, and if you asked me to- if I could go back to my 20-year-old self and say, whisper in the ear and say, "There's one mental model to, to sort of put into your life," I would, I would say base rates. Another idea is pre-mortem. Same idea. Pre-mortem just basically... And there's an interesting psychological piece to this, but ba- predi- pre-mortem just says: Let's pretend we make an investment today, pretend, then we launch ourselves into the future. So now it's, you know, a year from now, it's 2022, whatever, and this investment has turned out sour. It's been really bad. And then each of us independently, and this is important, each of us independently writes down why this turned out badly. So in other words, each of us is gonna write, you know, a 200-page- 200-word Wall Street Journal article, dated 2022, as to why this turned out badly. And it turns out that, again, you don't have the intellectual baggage of having made the investment, and your mind is opened, and there's some interesting reasons why future to present is better than present to future, but again, a mind-opening exercise. The third thing is this idea of red teaming. So again, people are very familiar with this, probably the most, uh... Cybersecurity is a good example now, right? So the blue team defends, the red team attacks, and you say: "All right, we're gonna... We, we, we think we're secure, but we're gonna hire hackers to try to hack our own system, you know, they're the red teamers, just to see how vulnerable we are." So red teamers are people that are organized to structure- to s- to, to challenge thinking, cha- challenge the prevailing views of things. And it's really hard, right? Because even organizationally, we fall into these mindsets. We all start to believe the same thing, and you need someone to sort of to jar you into reality. And then the last one is journaling, um, and that's th- this idea of feedback, and I think it's, it's just brutally hard in our world, whether it's venture, even as an executive, if it's public markets, doesn't matter.... It's brutally hard to give yourself honest feedback about what's happened, right? So even if something turns out great, um, did it turn out great for the reasons you thought it would, right?

    3. BGBen Gilbert54:54

       Mm.

    4. MMMichael Mauboussin54:55

       Or were you just lucky, did you just come up lucky? Or maybe sometimes you did all the right things and it turned out poorly, but it was the right decision, right, at the time, given the information you had. So this idea of journaling is just keeping a decision log and, and reviewing it periodically to make sure that you're thinking about things properly, and then you're giving yourself honest feedback. And the ideal is to do it probabilistically. If you can write down, "I think there's an X percent probability this is gonna happen by a Y date," it gives you, uh, the apparatus for a scoring system that can be super helpful. And again, it's not a ton of extra work because you're doing it already, right? You're just being now- we're just being overt about it and writing it down. And so that's another thing that I think people can do in terms of their decision making to improve. It takes a little bit of discipline. It's not like a ton, lot, ton of time, but it takes discipline to do that, and I think those that do it, uh, do it, uh, well, uh, certainly benefit from, from it massively.

    5. BGBen Gilbert55:47

       For sure. And I, I wanna, uh... Just because you were relatively quick in your, uh, moment there on base rates, uh, uh, I wanna take a quick break and, [chuckles] and read this passage from, uh, uh, from Kahneman and Tversky. Because for anyone who hasn't, like, studied base rates and is like, "Oh, I should Google this," after Michael talks about it, this one little quip will be like the beginning of the rabbit hole for you. So the, the quote is, "An individual has been described by a neighbor as follows: Steve is very shy and withdrawn, invariably helpful, but with little interest in people or in the world of reality. A meek and tidy soul, Steve, uh, has a need for order and structure and a passion for detail." Is Steve more likely to be a librarian or a farmer? Okay, so everyone-

    6. MMMichael Mauboussin56:33

       [laughing]

    7. BGBen Gilbert56:33

       ... has some, some idea in their mind at this point.

    8. MMMichael Mauboussin56:35

       I was hanging, I was hanging there, Ben. [laughing] I got you this one.

    9. BGBen Gilbert56:38

       Now, of course, the, the, the- your intuition says a librarian, but in fact, there's something like 10X or 20X the number of farmers in the world. So the, the- you should really just look at the base rate and go, "I'm gonna ignore everything you just told me and say farmer." But of course, our brains trick us, and we all say librarian.

13. 56:54 – 1:16:33

    Skill vs luck: the continuum, the paradox of skill, and persistence in venture

    1. MMMichael Mauboussin56:54

       One of the things we might wanna talk about is a little bit of this stuff on luck and skill. So can we, can we dive into that a little bit?

    2. BGBen Gilbert56:59

       Please.

    3. MMMichael Mauboussin56:59

       Because-

    4. BGBen Gilbert56:59

       Oh, my gosh, here-

    5. DRDavid Rosenthal57:00

       Please. Oh, this is one of my favorite books.

    6. MMMichael Mauboussin57:02

       So look, I, I just think that one of the most fascinating topics out there is this idea of untangling skill and luck, so I was able to write a book about it about eight or nine years ago and-

    7. DRDavid Rosenthal57:12

       What, what inspired you to write the book, by the way? It's, it's so good.

    8. MMMichael Mauboussin57:16

       It's funny, I love this statement when you ask, like, "Where do these ideas come from?" Because [clears throat] the, um, I, I was not a big... I, I, I'm a big, huge sports fan. I played lacrosse in college, actually, but I was kind of an anti-baseball guy, so I didn't, uh, I I didn't mind baseball, but I didn't really like baseball that much. But then I read Moneyball, and I was like: "This is awesome!" [chuckles] "This is, like, so interesting," right? And I think I was the first person on Wall Street to write about Moneyball, because I wrote a, I wrote a piece about it, like, within a week or two of the book coming out because I was so fired up. And, and, um, you know, part of what they're trying to do is figure out, like, forget about what the person looks like, whatever, let's figure out what wins, and so these are things that are skill contribution. So that got me thinking a lot about this in terms of the- and then it got me focused on the analytics community, where this thing is really important. And then, um, I wrote a book called Think Twice in 2009, and Think Twice is about decision making. It's really an homage to Kahneman, actually, so, like, the kinds of stuff that Ben just read about. And I had j- I had a chapter on luck and skill, and I was like: "This is the coolest thing ever," right? And I made it chapter two, right? So I'm like, "Oh, people are gonna get this r-" The first one was on base rates, actually, right? And this is chapter two, so I'm like, "We're gonna get r-" And my editor reads this, and she comes by, she goes, "Oh, I don't know. This, this skill, luck stuff is too complicated," you know?

    9. BGBen Gilbert58:28

       [chuckles]

    10. MMMichael Mauboussin58:28

        "Put it at the... You know, if you want to keep it, put it at the end," right? So I'm like: "All right, all right, whatever." So, so it's, like, one of the last chapters. And so, uh, like, I would get friends to read it, and my friends would go, "Oh, you know, I liked your book, but that chapter on skill and luck, now that was cool." So I'm like: "I knew it! I knew I should have put [chuckles] that in the beginning," right? And so I was like, "So this is like a spin-off, like those TV shows," like, oh, that, you know, like Mork and Mindy spun off from Happy Days or whatever. Like, this is like a spin-off. So I'm like, "Okay, this luck, skill thing, there's a lot more here." I also read Fooled by Randomness by Taleb, obviously in 2001, as many people did, and I, uh, obviously, the basic point hits you in the head like a two-by-four, that there's more randomness in the world than you anticipate. But I felt that it was lacking in the sense that it didn't really give you the tools to quantify any of that stuff, right? So I was like, "Okay, I'm, I'm loaded up now. I've got this idea that this is really important." By the way, the subtitle of the book is Untangling Skill and Luck in Business, Sports, and Investing, right? So it's all stuff I find interesting. And so, uh, so that, so um, that, that encouraged me to go, go down the path. And so l- it, it actually may make sense just to very quickly define some terms, right? So skill, we're gonna say, is the ability to apply one's knowledge readily in execution or performance, right? So you know how to do something, and when you're called on to do it, you can do it. So you have to go play violin at Carnegie Hall, like, snap your fingers, you're gonna crank, right? You're gonna be awesome. Luck, um, is much more difficult to define, and by the way, it gets into philosophy very quickly, so you have to put a pole down to figure out where you want to stay. But I'm gonna say it has three key attributes. One is it happens to an individual or organization. So it happens to you or your company or your favorite sports team or whatever, okay? Second is it can be good or bad, and I, and I don't mean to suggest that it's symmetrical, because it's not, but there's a good positive side and a negative side. And third is, and this is the squishiest one, is it's reasonable to expect a different outcome could have occurred. So if we rewind the tape of time and we played it again, it would be reasonable to see a different outcome, right? So that's, I'm gonna say, is luck. And so when you, when you have that in your mind, there are a, a couple things that come out really, really interesting. One is what we call the luck-skill continuum. So you could think about activities along a continuum. On the one extreme would be all skill, no luck, right? Uh, nothing really over there, but you think about chess matches or running races, right? There's- the fastest person is usually gonna win, right? Then you think about the other extreme, which would be all luck, no skill, so roulette wheels, lotteries, right there, fair. Okay, so there's no element of skill in those whatsoever-

    11. BGBen Gilbert1:00:46

        Public market investing.

    12. MMMichael Mauboussin1:00:48

        ... Yeah, so and it's actually interesting. Well, well, well, hold on to that thought because we wanna come back to that in just a moment. And so then you have everything arrayed between those two extremes. And by the way, we did, we did in the book, we did it for fun, which was professional sports leagues based on a season. And you can see, for example, that basketball is the sport that's furthest away from randomness, so the most essentially skill d- dictates the outcomes. So, um, Ben, you were sort of joking a little bit about that, about where public market investing is, but I wanna... I actually wanna build on this, 'cause this is actually probably the most popular book, the concept that came out of the book, and it's called the paradox of skill.

    13. DRDavid Rosenthal1:01:20

        Ah, so good. This is so mind-blowing.

    14. MMMichael Mauboussin1:01:22

        Yeah, and I... This, again, none of these ideas are new with me. I got this idea from Stephen Jay Gould in his book called Full House from the mid-1990s. And so the idea is that when you think about-

    15. DRDavid Rosenthal1:01:32

        Is this, uh, the biologist?

    16. MMMichael Mauboussin1:01:34

        Yeah.

    17. DRDavid Rosenthal1:01:34

        Yeah.

    18. MMMichael Mauboussin1:01:34

        Evolutionary biologist.

    19. DRDavid Rosenthal1:01:35

        Exactly.

    20. MMMichael Mauboussin1:01:36

        Exactly. Good call, yeah. So the paradox of skill says, "In activities where both skill and luck contribute to outcomes," which is most stuff, "as skill increases, luck becomes more important." And you're like, "Well, wait a second, how does this work exactly," right? So we can think about skill in two dimensions. The first is absolute and the second is relative. So the first is absolute skill, and I think that we'd agree if we look around the world, whether it's sports or business or investing, the level of absolute skill has never been higher, right? If I gave you what is at your fingertips today and put you back in the 1960s as an investor, for instance, you could run circles around your competition, right? Because you just have better tools available to you. Um, and, and certainly sports, we, we can see that, especially s- sports measured versus a clock, right? Things are... People are just faster and so on and so forth. The second dimension, though, is the really important one, which is relative skill. And what we've seen in domain after domain is the relative skill gaps have narrowed. The difference between the very best and the average is less today than it was in the past. And you could think about all sorts of tons of reasons. For example, sports leagues are super easy, right? Because you think about, like, the NBA used to be, you know, certain types of players from a certain part of the country, and now it's a completely global market. The best players anywhere in the world will be found and drawn.

    21. DRDavid Rosenthal1:02:49

        Like, Wilt Chamberlain could just, like, totally dominate back in the day, but if Wilt were playing in the NBA today, like, he would have a lot more-

    22. MMMichael Mauboussin1:02:56

        Right. In fact, you know, that... This is how the whole thing got going, was Stephen Jay Gould wrote about Ted Williams, who hit .406 in 1941, that very magical year. And, and, like, by the way, if Ted Williams, interestingly, if he... And he was a almost exactly a three-standard deviation event. And if you're a three standard devi- I don't know what the 2020 numbers will prove to be, but if you're a three standard deviation event in, in the most recent full season, you hit, like, .385 or .390. So it's awesome, right? You win the batting title going away, but-

    23. BGBen Gilbert1:03:21

        And that's what? The top one and a half percent or something for everyone?

    24. MMMichael Mauboussin1:03:23

        Yeah, top one and a half percent, right? So you're not breaching, you're not breaching that .400 level, which is super interesting. So the point is, if you... Now you think about two people with absolutely wickedly high skill levels, but they're completely equal, then the outcome's gonna be a coin toss. It, it, it appears to be random, even though they are incredibly skillful. So it's funny because I still play, play, like, beer league hockey, and so the hockey guys are all, "The hockey players are the most skillful guys," and it shows up as a very random sport in our system. [laughing]

    25. BGBen Gilbert1:03:52

        [laughing]

    26. MMMichael Mauboussin1:03:52

        And I'm like, I'm like: You're missing the point. It's not that they're not skillful players. They're amazing players. It's just that they're all equally skillful, right? And so as a consequence, differentiating, just as you said a moment ago, David, differentiating yourself, it's extremely difficult to do, and as a consequence, it all feels like a big coin toss. And so, um, Ben, just to, to follow, come back on investing, I think that's what we see in investing, which is in public market investing, that the numbers appear to be more random. They, they appear to be random or partially random, in large part because markets are so good. It's not because markets are bad, the markets are actually really good. Now, the other thing I'll say about venture in particular is that there is persistence of performance, right? So-

    27. DRDavid Rosenthal1:04:30

        Oh, I was gonna ask about this, yeah.

    28. MMMichael Mauboussin1:04:31

        One of the me- ways we measure sort of ongoing skill is this notion of persistence. So if you do well in period one, you'll do well in period two, right? So if you're really good at math tests, you take a math test today, and you take one in two weeks, you'll do well both times, right? So it indicates skill. Um, and by the way, there's almost always this concept of regression toward the mean. If you do really well, you go... Okay, so I wanna come back to regression in just a second. So persistence, if you... Persistence is an indication of skill, right? And so it turns out, if you look at venture capital in particular, um, it- oh, in public equity markets, very limited persistence, right? So if you did really well last year, your, your expected value is closer to the average the following year. Um, buyouts, they used to be persistent. Now, it seems to be much more closer, not so much persistent. But venture, we still see a lot of persistence, and that's the top 10%, maybe top 20%, do really well over time. So if you can get access to one of those funds and invest with them, you tend to do very well. So the interesting question is: Why is that, right? That's an interes- you guys might have better views on that. I have, I have a pet theory a- as to why that is. But there is persistence in venture, in particular, and that stands out relative to a lot of other asset classes. And then here's the last thing I want to say about this luck and skill thing, which is, and this goes back to base rates, right, which is-

    29. DRDavid Rosenthal1:05:46

        Wait, we can't let you get away with that. We want the pet theory. [chuckles]

    30. MMMichael Mauboussin1:05:50

        Okay.
14. 1:16:33 – 1:34:25

    Career and market reflections: finding “easy games,” future mega-caps, and shifting leaderboards

    1. BGBen Gilbert1:16:33

       All right, well, that's a great discussion, a great lead-in to a discussion on, uh, on Michael, your career path. So the, the world of investing today is so much more competitive in every asset class than it was even in the, you know, mid-late '80s. David, especially, as you're alluding, in startup investing. I mean, it was, uh, shooting fish in a barrel at that point, and now it's, you know, you, you, you, uh, you need to do a lot of things to be the best. And Michael, I'm curious, if you were 18 years old today, what do you think you would do with your career?

    2. MMMichael Mauboussin1:17:09

       Yeah, well, I don't know. That's a [chuckles] that's a little bit too hard to answer, but if you're talking about investing, the first thing I should just say is that at any point, you know, it doesn't seem like it's easy, right? [chuckles] Like, it only seems easy when you think back on it, you know? So when I started... I mentioned when I started teaching at Columbia Business School, you know, I, I just want people to conjure up in their mind, there was no internet, right? When I want to do financial, like, I, I- when I f- when I want to do financial statement analysis, I would r- request from our library a mimeograph of the 10-K. You know, so like, this is just a different world than what we're used to today, right? So, so just... And, you know, we used to fax our reports and mail our reports to clients. Mail them!

    3. DRDavid Rosenthal1:17:51

       Oh, my God.

    4. MMMichael Mauboussin1:17:52

       So if you want... Yeah, exactly. So you want to see my report on Kellogg, it would come in the mail, right?

    5. DRDavid Rosenthal1:17:56

       Well, wasn't this, uh... This was one of Bill Gurley's, like, big, um, distribution innovations when he was an analyst, right? Is he would fax a, like, newsletter, right?

    6. MMMichael Mauboussin1:18:05

       Do you know the story on that? It's a great story because there was a guy-

    7. DRDavid Rosenthal1:18:08

       I want to hear the story. [chuckles]

    8. MMMichael Mauboussin1:18:08

       Yeah, there was a great analyst at Goldman Sachs named Dan Benton, who ended up being a great investor on the, uh... He had a hedge fund, a great investor as well. Dan, super talented guy, probably top-ranked guy in his sector, had a really loyal following, and decided one day to, to go to the buy side. So he was leaving his job, and he had a very popular newsletter that was s- sent out at a very specific time slot. And so Gurley's this young guy, and he's obviously kind- you know, like, also very marketing-oriented and very alert, and he realizes, "Well, this guy's leaving, but everyone's used to getting this fax at, [chuckles] you know, like 8:00 PM on Tuesday," or whatever it is. So he's like: I'm gonna launch above the crowd, and it's gonna, it's gonna come at the exact same time that Benton's thing used to c- come.

    9. DRDavid Rosenthal1:18:49

       Oh, that's brilliant.

    10. MMMichael Mauboussin1:18:49

        And it's just gonna be pure substitution. [clears throat] It was completely brilliant. And, you know, not... I mean, obviously, that's great marketing, but it was also great content, right? He j- he had great stuff, so the combination of those two things really hel- helped catapult him. You know, again, it's content, but it's content and good distribution. So-... yeah, so that, that's the point I wa- but that's the point I do wanna make. It, it doesn't seem that easy at the time. But going back to your question, I'm, I'm slightly dodging your question, Ben. [laughs] No, but I'll go back to your question, which is, um, the, uh, as a, as a broad concept, if I were to go into investing, the one thing you wanna think about is this idea of looking for easy games, right? So the, the metaphor is poker, right? Which is if you like to play poker on Friday- so if I, if I call you guys up and I go, "Hey, David, Ben, I'm having a poker game at my house Friday night. Would you like to come over?" You'd be li- and, and to me, like, to make money, you'd be like, "Oh, yeah, yeah, that's cool. Like, who else will be there?" [laughs]

    11. DRDavid Rosenthal1:19:38

        Who else is playing? [laughs]

    12. BGBen Gilbert1:19:40

        And I should be, like, very unimpressed by the list. [laughs]

    13. MMMichael Mauboussin1:19:43

        Exactly. Be like, "Oh, really rich guys who are really bad at poker."

    14. BGBen Gilbert1:19:45

        [laughs]

    15. MMMichael Mauboussin1:19:45

        You'd be like, "Okay, I'll be over. That's cool." Uh, by contrast, if I said, "Oh, no, I've got these really good players who are as good or better than you are," you'd be like, "Okay, I think I got better things to do," right? So part of it is, like, thinking about who's gonna play the game. And, um, you know, and poker's a, a nurturing metaphor in the, in a sense that it's a net... an, a zero sum in the sense that, you know, $100 walks into the room, $100 will walk out, but who has it will change in the course of the, of the game. And so that's a little bit true about investing as well. So part of it is thinking a lot about the game that you're playing. And so are there opportunities, whether those are nich- nichier parts of the market, whether they're different geographies or something like that, where you feel like you can be the smartest person at the poker table? Now, the challenge is often that it's difficult to scale those kinds of things. It's often easy to do that in a sort of nichy way, but it's hard to do it in a very big, big way. But that's, that would be the first thing I, I would say. Um, the other thing I'll just say is, just in broadly speaking, is that I'm always a little bit... You know, I have, I have, uh, three of my kids are out of college, I've got two in college, one's a senior, and, you know, so they're, they're going into the world, right? And I've always been ambivalent about finance because, on the one hand, I think it's, it is an amazing like... Like, what you guys, what you guys do is super fun, and, uh, you, you never cease learning, and it's really interesting. On the other hand, there are a lot of big problems that need to be solved in this world, and I, and I would love to see our best and brightest young people try to g- get after those problems, or at least allocate some time or time and energy to doing those kinds of things. So I've always been a little bit ambivalent. So part of that might be, you know, if I were a younger person, I, I probably... By the way, I would've- I should have studied computer science, and had I, had I been born five years or 10 years later, I almost certainly would've been a computer science major instead of a government major. [laughs] Um, 'cause I always, I always, [clears throat] I, I mean, I, and I actually did a little bit of, tiny bit of programming back even in the day. But, but, um, so I think those kinds of skills, and, and, and my- the CS thing is less the skills, actually, programming skills, that I find so attractive.

    16. DRDavid Rosenthal1:21:41

        Mm-hmm.

    17. MMMichael Mauboussin1:21:41

        What I really find attractive is a sort of a way of thinking about the world, which I think is a pretty good way of thinking about the world, so for the most part. So I think, uh... yeah, so I think that those are the kinds of things I would start to- And, and, you know, so the question is: Is there a really big issue out there that I'm passionate about? Could be climate, could be some sort of health mitigation, whatever it is. And are there ways that I can sort of, uh, make a dent at that problem? Uh, you know, that, that's the kind of stuff I'd also think about. But, but if it's investing, the answer is try to find a game where you think you can be the smartest person or have the opportunity to be the smartest person in the room.

    18. BGBen Gilbert1:22:13

        Do you have any inklings about, uh... And it's okay if you don't right now, but I, I think ev- everyone listening can sort of muse for themselves, "Where do I feel like, uh, there's not enough smart people running, and I can go be king of the hill over here?" Do you have any inklings about where that, that might exist in the world?

    19. MMMichael Mauboussin1:22:28

        No. I mean, investing, I don't, I don't... Like, I would just try to stick to investing where I, I think it's the most clear. Um, there are a couple things that are interesting. One, certainly, I would just- I would go geographically, right? So are there markets where I can land on the ground? You know, whether they're frontier markets or what we would call smaller emerging markets, where, where really the due diligence and shoe leather will get you ahead of the game. In the US, it might be, uh, for example, in private equity. A lot of people talk about this, but if you're doing buyouts, are there, are there seg- segments of the markets or geography of the country, for example, where you think you could do something that's interesting? Um, the other thing, in public markets, one of the interesting ideas is that most public companies are now in index funds or ETFs or something like that, and so they're, they're fairly well-trafficked and studied. The question is, can you develop a list of companies that are not followed by analysts, that are not in indexes, that are not in ETFs, right, that might be a little bit neglected? Um, so that might be an area where, again, you show up, and you're the only person playing at that poker table, something like that. So, so there might be some creative ways to think about that. And, um, the, the other area, of course, which is now very much in its infancy, is decentralized finance or crypto or so on and so forth. So there'll be many fortunes made and many fortunes lost in that area, but the question is, can you set yourself up in such a way to be, you know, again, the, the... d- d- doing something ethically good and, uh, profitable?

    20. BGBen Gilbert1:23:58

        All right, one last question in our little fun, uh- [chuckles] ... wrap-up round here.

    21. MMMichael Mauboussin1:24:01

        [chuckles]

    22. BGBen Gilbert1:24:02

        So in the... It took us all of human history to see the first trillion-dollar market cap company, and then in, like, 18 months, we had a couple more $2 trillion companies. Do you think we'll see a $10 trillion company, and how, how soon do you think we'll see that?

    23. MMMichael Mauboussin1:24:18

        [chuckles] I think the first one's easier to answer than the second one, right? [laughing]

    24. BGBen Gilbert1:24:22

        [laughs]

    25. MMMichael Mauboussin1:24:22

        So at some point, that seems very likely.

    26. BGBen Gilbert1:24:23

        I'll give you an infinite timeframe for something that generally increases.

    27. DRDavid Rosenthal1:24:26

        What poker table do we, are we playing at here? [laughs]

    28. MMMichael Mauboussin1:24:28

        Uh, exactly. Whether that's in my lifetime is another question. So, you know, part of it is, um, it's, you know, I think that David alluded to this before, I mean, it's hard to get your head wrapped around the impact on valuation of just declining interest rates, right? So I don't know where the, the 10-year Treasury note today is, around 1.4 or 1.3%, something like that. If you'd told me, um, 10 years ago, 20 years ago, 30 years ago, and, and said, "At some point, we're gonna have a 130 tenure," I would thought- I would say you're bonkers, and I would've bet a lot of my money that that would not come to pass.... and, and those things are real drivers of value, especially if you have some component of growth. We wrote a report last year called The Math of Value and Growth, and we just show how just theoretically, the mathematics really are crazy. If you have relatively rapid growth and high returns and a low discount rate, it just really, uh, cranks value substantially. And I think part of the one to two trillion dollar sprint was a function of this, this sort of backdrop, right? And by the way, it's not just equities, of course, it's across the board. I mean, you guys were talking about this, you know, credit, so bo- bond spreads are let down, you know, venture, a lot of money flowing, and valuations are up across the board. Um, so that's common. So, um, so the, so the answer is, Ben, I don't know. The other thing I'll just say that I found fascinating is, um, as, as part of the thinking about the new version of Expectations Investing, I went back and looked at the top 10, uh, the top 10 companies today by market capitalization and the top 10 in twenty- 2001, right? So 20 years ago.

    29. BGBen Gilbert1:26:05

        Ooh.

    30. MMMichael Mauboussin1:26:05

        By the way, I don't know if you guys wanna guess this. This is actually pretty interesting. So how many companies that were top 10 in 2001 are top 10 in 2021? What would you guess, out of the 10?

Episode duration: 1:34:25