Tobias Carlisle (2:29)

Yeah, I think that's. I think that's an important. I do say that he did it consciously or unconsciously. I don't. I'm sure that he's read the Art of War, but I doubt that he's basing what he does on these things. I just thought it was. I've read the Art of War lots of times. I read it in high school and lots of different translations, too, and really struggle to sort of see why folks liked it so much. But in. In Covid, in the Pandemic, I had little kids and I had a small business, and I read some of. And I've read Buffett's letters since I was about 17 as well. And it was. I just read something in Buffett and I. And it just clicked for me the first time that he probably had this, you know, the. The three things that are the three ideas that I really wanted to get across at this idea of, like, trying to. This invincibility, victory without conflict, and unassailable strength. And I really think those three. That's. That's in. That's basically the Art of War in a nutshell. And I think that that's also Buffett's three things that he really does that. And they're all sort of related to each other, but that those are the three things that stand out in my mind.

Matt Zigler (3:35)

Do you think those are the three things that are like. That's why they're timeless. That's why, Toby, as a parent during COVID you weren't just strategically trying to do a leveraged buyout for, you know, stay at home lunch money for a topic or something. Why. Why do these echo across time?

Tobias Carlisle (3:54)

The. The invincibility one? First of all, and I sort of talk about this at the first. The first main case study I took, I start with apple because I want to sort of give a success that was. Everybody sort of recognizes now as a success and explain what I saw in that success. But then the first part of the book is the general reacquisition, which I had just started studying Buffett when General Rehab. And that happened in 1998. I was 18 or 19 when that happened, and I'd literally been reading Buffett for a year. So you know how you. You get obsessive when you first discover an idea. And I had read Making of American Capitalist, all of the Buffett sort of Books that I could find all of Buffett's letters. And I thought I had this pretty good idea of what he was looking for. And then he did genre, and I was like, that's just a complete. That's the record scratch that. Just. It's nothing like what he's been talking about doing up to that point. And particularly because he had done the Coke deal, he'd put a third of Berkshire's cash into Coke. Like, within three years, it had tripled. So it was now a significant portion of Berkshire. And then by 1999, it had gone up 14 times. And it had gone from being, you know, I think that a lot of us would have struggled with Coke. I forget exactly what he paid, but I think that everybody recognizes that basically he had paid full value for Coke in the US because betting on this international expansion, which then happened and worked really, really well. And so Coke was this massive winner, but it had sort of gone past what it was worth on a fundamental basis. But Buffett is of this sort of never sell idea for a variety of reasons. One is that you may never. Coke is a great business. You may never ever get another opportunity to buy it cheaply. So why would you sell it and lose that opportunity? But equally, you pay a 35% tax rate on your sale, and so is it, you know, after you take away the tax, is it worth making that sale? It's at the hard fact that Wedge is so big that you really have to think about it quite a lot. And on top of that, Berkshire, Buffett had really been recognized for the great investor that he was by the late 1990s. And it was a. Berkshire itself was trading at three times this sort of. And I think Coke was 50 or 60 times. And so. And it's a huge chunk of Berkshire. So I can see him thinking, if this reverses course and Coke goes down and Berkshire loses its premium, that's a long way down for Berkshire. And so how can I solve this problem? And this is one of the things that Sun Tzu talks about. It's this idea of defending first, avoiding ruining. And he talks about a lot of ways that you defend. And I think those. I think they're absolutely fascinating and that it's worth sort of reading the Giles translation of the Art of War to sort of understand those. But he engineers this merger basically with General Re, which was an insurer, a reinsurer, was US focused, wanted to expand internationally, couldn't do that because they were too focused on quarterly earnings. If they missed a quarterly earnings. And that's a disaster for the stock. But all insurers have assets that they're insuring against. And Jen Reese book was largely bonds and Berkshire's book. Because Buffett is an unusual man, he runs it in a different way. It's largely equities, but they run at a much lower level of assets to the premiums that they write. So they can have these more volatile assets in there, generally more traditional. Had a big bond book and clearly Buffett could see that if he could engineer this transaction where he's paying a little premium for genre, but doing it with Berkshire stock because the Berkshire stock is so much more expensive relative to its assets, the bulk of the value ends up in Berkshire shareholders hands. But he has this new portfolio that comes across with it which is all of the bonds and dilutes down the Coke shareholding. And then what happens in 2000? Everybody sort of knows now that we had that we had that pretty significant bust. Coke halved and the bonds in general's book rallied. Which is, doesn't happen every single time that there's a crash, but there's often this flight to safety where the yields on bonds go down and bonds rally so the bonds go up in value. And that's what happened. So he did this defensive deal that rallied through a crash and he let the bonds roll off and reinvested them long in equities at getting very good prices. And that set up Berkshire for the next decade or 25 years that we've seen since. So at the time it was sort of. I misunderstood it. At the time I felt it was misunderstood because he was issuing shares which he says he doesn't like to do. He'd never really done it in size before because you're giving away a really good asset for some, some other possibly less good asset. You're diluting your shareholders. And he was doing it with an insurer that had a slightly different philosophy to the one that Berkshire had. But you know, close enough, as it turns out, there was one little wrinkle to that transaction and that was that he took on a book of derivatives that he didn't sort of fully appreciate the, what those derivatives were or the, the implications of having those derivatives. So a derivative is just a contract written between two parties where they have some sort of reference, you know, commodity or security or something like that, and they just agree to pay each other an amount of money if it moves in a particular way. But they're written so in such complex fashion. And there's often a lot of.

Matt Zigler (10:02)

There'S.

Tobias Carlisle (10:02)

A Lot of contingent parts and moving pieces to these transactions so that both sides think that they're profitable at any given time until they sort of resolve the contract at the end. And so they're not recording these things properly in the books. And so Buffett finds them and says, this is a potential disaster. We need to get ourselves out of these. And in a very benign market, they still sort of lose $400 million, extricating themselves from these deals, which is probably like penalties for early, you know, dissolving the contracts. As it turns out, it's probably the best thing that he ever did, because through 2008 and 9, a lot of these derivatives contracts blew up, and they blew up insurance companies, aig, and a few of these other ones. So it was a good move on Buffett's behalf, even though it looked like a bad move. And then he writes about it subsequently as if the whole thing's a giant mistake and the derivatives are weapons of mass destruction. So everybody gets this. This inference afterwards that generally was a mistake. Weapons of mass destruction really blew us.

Matt Bogumil (11:02)

Up.

Tobias Carlisle (11:04)

And it didn't work. Whereas I actually think it was a triumph. It worked really well. And it's just a good example of the deals that I put into the book. I think that they're misunderstood, but seen through a different light, they sort of make a little bit more sense. And that's also a Sun Tzu type idea. You sort of don't let people know exactly what you're doing because it allows you to then keep on doing that thing. So that's the first part of the book.

Matt Bogumil (11:29)

It's so good and so many thoughts come to mind, but one that I don't want to lose Anybody that discovers Buffett at different points in time. We think we have it figured out and we know what the next move is. And I love that you brought it up, because it feels like we're always wrong and surprised and just going back in time. You said Coke. I think some people were surprised. He bought it January, but then Burlington Northern, that comes up in your book. And then Apple. I remember very well when he bought both Burlington and Apple, because the firmware I was, we owned those and we paid attention, and Burlington ended up being bought from us, away from us. But anyways, I want to ask you about Apple because you bring up a certain context to the story. A few years before Buffett bought Apple, two big names, David Einhorn, Carl Icahn were interested in Apple, but from a whole different angle, pushing for a sudden quick change. Buffett comes in, buys without speaking much up about it until much later builds up a big position. It's a victory without conflict. Can you zoom in with us on that transaction?

Tobias Carlisle (12:34)

Absolutely. So I have written about Einhorn and Icahn doing the Apple deal in the past because I thought it was one of those iconic deals. It was at the time that I wrote about it, it was the cheapest stock in my screener. I had written about it for a magazine saying this is like an iconic kind of business with incredible earnings and it's just trading too cheaply. And it had this, it used to follow this pattern where sort of in between iPhone launches, people forgot about it or they would worry that it would not make it to the next iPhone launch or something like that. And it would get cheap and then they'd launch the iPhone. Everybody. Oh yeah, I forgot Apple's out there. It does really well. And then it would run a mile and then they would forget and it would get cheap again. And so one of the occasions when it got cheap, Einhorn and Icahn built this big position in it. I think Einhorn came out first and he said you've got this big cash holding, which is ridiculous in comparison to the size of the business. It was like $150 billion in assets and a $60 billion in, sorry, $150 billion in cash. It might have been $60 billion in fixed assets, something like that. Just outsized relation to the rest of the business. And the reason was because it was largely trapped overseas. If you repatriate it to the states, you pay tax on it as it comes back into the states. So they didn't want to do that. You can leave it overseas and reinvest outside of the US but they also used to say tech companies are high growth companies. They don't do buybacks because we might need that cash for expansion in the future. And Ironhorn's response was, well, if you're a high growth company, why do you have so much cash on your balance sheet?

Matt Bogumil (14:09)

What?

Tobias Carlisle (14:09)

Why does it there? Why isn't it invested? Why aren't you investing? And he had this, he had this way of dealing with it where he said we're going to issue these things called IPREFs because you know, they had ipods and iPhone that was like I prefs are going to be the Apple thing. It's going to pay out fixed amount of money every year like a preference share does and it'll help us reduce the size of this cash on the balance sheet. It's a little bit too complicated. For most investors to sort of understand what he's saying and how that solves the issue. And so it didn't really have the impact perhaps that he would have liked it to have had. But Icahn comes along and everybody knows who Carl Icahn is. He's an activist. He's been a raider in the 80s. He's kind of loud and he makes his point very bluntly. And he says, just buy back a whole lot of stock. And the timing is kind of interesting because Tim Cook has only just taken over, so he wouldn't. I don't think they would have been able to do it with Jobs because Jobs just too forceful a personality maybe just tells them to go away. But Tim Cook is new in the role. He's. He's a much sort of smoother kind of personality. And he's, he's known for engineering. He comes from the engineering side, which is the production side of the iPhone. So they're thinking he's going to streamline all of that sort of stuff, the supply chains and so on. And here his first challenge is dealing with these activists who wanted to buy back stock, which probably that's a good idea. So he does. Ultimately, they start buying back stock and that just movement in the right direction is enough to kind of mollify Icahn and Einhorn. And they sell down their positions. The stock does pretty well and they sell down, but there's this lull in between. And then all of a sudden, a few years later, Buffett pops up. Pops up having bought a giant position in it, which people found perplexing because it's tech. Yeah, he's stumbled with IBM and he said many, many times he won't invest in tech because he doesn't understand it. And I think that's a. When Buffett says he doesn't understand something, what he means is I can't see where the business will be in 10 years time. I'm not certain about the business's competitive position in 10 years time. It's not. I literally don't understand tech. It's. It's a little bit more nuanced than that. So he buys this big position in Apple. Everybody says, what are you doing? It's a tech company. He stumbled with IBM and he says, it's not a tech company, it's a consumer products franchise. Which is funny because that's exactly what Jobs said when Jobs came back and it was John Scully, I think, who was the guy who took over from Hooked, like ousted Jobs, and he said it's crazy that Jobs says that this thing is a consumer products company. It's not consumer franchise, it's a tech company. And so Scully sort of ultimately failed and Jobs came back in again. And then here's Buffett saying, yeah, this is a consumer franchise. And he illustrates it by saying he knows people who would rather give up their second car than give up their cell phone, which like that's a no brainer. Your cell phone's so crucial to your business and private life that you need a cell phone. So. And they're $2,000 a pop and it's ubiquitous and it dominates the, the investment landscape. And if you own a, the iPhone, then it's like you, you probably own a laptop. You probably own, you might own an, you probably owned an ipod, you might have a desktop. You've got this whole ecosystem of Apple stuff. You might have Apple TV, you've got iTunes, you're spending a lot of money with. Apple creates a very sticky ecosystem of stuff once you're in. And Buffett takes on the position and he has this, he puts $40 billion to work, which is an extraordinary amount of money. I don't think there are any other investors in the world who have that scale of money to invest in a single transaction and would pull a trigger on it and do it. And then he gets this forex return over. So 4010 to 160. It sort of starts dominating Berkshire's returns because we now have to run the capital gains through the income statement becomes this dominant to Berkshire anyway. So it's an extraordinary, I say it's the greatest trade ever because nobody else in the world could have put that amount of money to work. That proportion of their book in that scale in that company. Everybody knew Apple, everybody knew Buffett, anybody could have done it. He delivers this huge investment returns four times and then he slowly sells down. So I think that you've seen the whole arc of the investment and then he's done it without any of the ill feeling or bad words or negativity that Ironhorn and Icahn had. And I say that that's an example of one of these ideas in, in Sun Tzu, which is this victory without conflict, which that's, it has a lot of different meanings, but that's literal. That's the literal meaning of it. It's victory without conflict. He's just found a way to win without having to fight with anybody or fight to put the position on. It's it all in his sort of inimitable ways. He's done this Thing that is, he's made it look easy.

Matt Zigler (19:21)

There's a relationship here. And it's a word that. I think Nassim Taleb is where this one comes from for me, which is Via Negativa. And this shows up over and over again thematically. I'm curious if you could just unpack what Via Negativa means. Why do you keep using this in the book?

Tobias Carlisle (19:42)

So that's an idea. I think that that idea comes from Charlie Munger originally.

Matt Zigler (19:47)

Yeah. Forced out of there, I agree.

Tobias Carlisle (19:49)

Yeah. But I also think. I know that Taleb has referred to it too. But my original. The first person I heard it from was Charlie Mung. And he. He quotes Carl Jacoby saying, invert, invert, always invert, which is. And then he's. Then he has this quite funny line where he says, just tell me where I'm going to die, so I won't go there. Like, that's the idea. That's how you do it. That's fine. And the idea is that you succeed by not failing in a game with a risk of ruin. Which investment has a risk of ruin? Life has a risk of ruin. If you die, there's nothing that comes, nothing in this life anyway, that comes after life. If you go bankrupt, there's nothing that comes out of that comes after that. It's this idea that if there's some finality to something, then you need to be careful to avoid that finality. And there are mathematical proofs that sort of show this. There are lots of different ideas that stem from this basic principle. But the way that you avoid the finality, avoid the ruin or the bankruptcy is this process called Via Negativa, which you use. And you're basically just trying to not screw up, don't mess up, avoid the things that have killed people in the past. So too much debt is a really simple way to go bankrupt. So Charlie Munger would say, what don't you understand about no debt? He would say. People would ask him, now, when you say little to no debt, what do you mean? And he'd say, what do you misunderstand about no debt? So those kind of ideas, like just avoiding the mistakes that people have made in the past, there are lots of businesses that have these huge operating leverage where the operating leverage cuts two ways. When it cuts down, they go very negative and they can run out of resources really quickly. If you pair that with a heavily indebted balance sheet, then you. You sort of. That's probably going to fail. It's very fragile. But I guess that's that's the Taleb idea, I guess, that you sort of make yourself robust, avoid fragility. And that's, that's the, that's the idea. And I think it works in lots of different realms. Via Negativa is just not doing that which you should not do, and trying to do it consistently. And I think it's an easier approach often if you take an investment idea or you take any sort of think project that you would like to do and you run a checklist of the ways that it could fail and if you get to the bottom of the checklist and you haven't been able to sort of exclude this idea, then maybe it's something that you should consider doing like rather than the other way around where you're sort of looking for a reason to put something in. You're looking for the reasons to not put something in. And if it passes all of those gates, then maybe it's a candidate for inclusion. And that's, that's how I use Via Negativa.

Matt Bogumil (22:32)

What I'm hearing is survival. You don't want to end up. Right, you don't want to end up in a situation. If there's a single. And Buffett had this story that I think it's in your book. When he's giving a talk at a school and he's telling a story of holding a gun, you'll tell it better than I do. But if there's one scenario that kills you, don't play, tell the story. I think the survival is such a powerful lesson here.

Tobias Carlisle (22:53)

No, this was at the University of Florida and he was talking about the smartest guys in the room. Was that Enron or was that. No, no, sorry, Long Term Capital Management. He was talking about Long Term Capital Management where he said basically they had worked out that there were. Statistically they were like Six Sigma, seven Sigma, Eight Sigma events like that's. I forget now exactly what I wrote in the book. But Seven Sigma is like one and a half a billion times. Eight Sigma is. Or Six Sigma is one and half a billion times. Seven Sigmas one in one billion times. So it's not going to happen. It's very, very unlikely that this thing happens. But the problem with the markets is that, and this is a Talebian idea that the tails are much fatter, that the, the things that shouldn't occur or the things that should occur very rarely occur with much more regularity than they, than they should. And they said the Thousand Year Storm comes through the markets about once every seven years. Like it just it just statistics, just for whatever reason in the markets. We and everybody can see this in the markets all the time. And now is a good example of it. Every single factor is basically upside down. Small is losing to large, growth is losing to value, and so on and so on. And so you have to be able to survive these periods of time. And one way of guaranteeing that you don't survive is by levering up and then becoming sort of path dependent. You require that the way that you think is going to work, should work. And I think that what factors do and what we observe about the markets, you don't have to make it a factor. You can just say buying cheaply. If you buy something cheaply, it can take seven years, but 10 years for it to get back to its value. And it could recoup all of that value in one year. It could happen in a few months. It can happen very quickly. It's just. You can't see it's not a constant growth towards intrinsic value. And I think Dillard is a good example of that. DDS is a ticker that folks can go and have a look at. It's very undervalued. It has been undervalued for a very long period of time, but it's been from the period that it was undervalued to the time that one of Buffett's lieutenants, I forget exactly which one it was, had a position in it, and it did nothing for seven years. And then in the seventh year, it went up 300%, 1,000% or something like that. And so over the life of the holding, it's like a 36% compound return. That sounds really good, except it was dead money for seven years. And then in the seventh year, all of the return happened. Painful.

Matt Zigler (25:24)

What do you think? Another word that just. It comes up and you put life around this one circle of competence. I think people love to throw that out. But now you're introducing other angles for how we can think about this expression, right?

Tobias Carlisle (25:39)

So the one that Buffett gives, which is a very good one if you're a baseball player and you follow Ted Williams Science of Hitting, he famously divided the strike zone into 77 cells, each the size of a ball, roughly. And he knew that if the balls came through this handful of cells, he describes it as a ticket to the mages. And if it came on the outside, nowhere near these cells, then he was going to strike out. And so his insight was just don't swing at the stuff that's going to make you look ordinary. Swing at this, only swing at the stuff that's going to make you look like a genius. And I think that that's, that's basically what Buffett is doing as well. There's a lot of. And I think it's, it's, it's mentally less taxing to find a way to reject things outright. So you might. This is also via Negativa, where you just. You're looking for a reason to reject it. And often it's just. It's too much brain damage to sort of understand this thing. It requires too much thought. It's too complex. And the complexity itself is the thing that should turn you off. And there was a great quote yesterday from Munger that I saw on Twitter where he said, we've made a lot of money doing simple things, and I can't think of any anytime that we failed because we did something good that was too simple. You know, simplicity is not the problem. Complexity is the problem. And so circle of competence is being very clear about what you understand and what you don't understand. And in some sense, being an investor is trying to push back the edges of that circle of competency. You get better and better at understanding things and having a bigger quiver full of arrows to shoot at something. But the main idea is that you really have to understand something. And understanding something is the way Buffett would define understanding something, which is, can you predict where it's going to be in the future rather than looking for the highest rate of growth, looking for the most predictable rate of growth, and then building your investment around that idea. So that's how I think of circle of competence. It's, can you predict it forward? Do you understand what's going to happen in the future with this thing?

Matt Bogumil (27:45)

I think it gets us in trouble because we might know exactly where it ends. But whatever is outside is so much more alluring because we can't even figure out how it can go wrong. And if somebody has a convincing story, we'll go there. And that brings me to a question about errors and Buffett. And you write in the book about omission and commission, two types of errors. Buffett is very comfortable missing out on things, but he doesn't like to commit serious mistakes either, although he talks about them. Can you explain how the two differ and how a wise investor can navigate this territory?

Tobias Carlisle (28:23)

So the idea of. He calls them sins of omission and sins of commission. And the idea comes from the Jesuit. I'm just blanking on his name a little bit at the moment. You guys know Who I wrote about in the book, the Jesuit will do.

Matt Zigler (28:41)

I know who you're talking about. And now I can't think of it either.

Tobias Carlisle (28:44)

Machiavelli with a soul. So basically, it's. Everybody knows Machiavelli wrote the Prince, and it's this, like, all of the evil. And there's. He has this, like, mirror. Like the mirror that they call Machiavelli with a soul. I'm just. It'll come to me in a moment. But it's his. It's his quote. Better to. Better to commit sins of omission rather than sins of commission. And the idea is omission is something that you don't do, that you should have done. And that's a type of error. I'm going to mix them up a little bit. So I want. It's a type 1 or type 2 error, and then there's a sin of commission, which is doing something that you shouldn't do. And the second error, the much worse error, because you can. You can survive with sins of omission. You can just keep on forgetting to do things and failing to, you know, failing to take opportunities. Basically, you can fail to take opportunities and still make it to the end. But if you take the one thing you do, the one thing that you shouldn't have done, and it's got a potential for ruin, you know, there's a fish hook in there somewhere. And we've probably all seen this happen many, many times. People have made silly mistakes and blown themselves up. And so the sin of commission is the thing that you try to avoid. So better to not act. And Buffett has this great line where he was talking about fomo. Well, before anybody was calling it fomo. He said, how do we know that? We don't like the prices today, and we much prefer the prices in the past, but how do we know that the prices in the past weren't the ones that were the aberrations? And now's a great. It feels exactly like that way to me in the market right now. The prices to me look pretty stretched in some parts of the market, the ones that are going up and the stuff that's not really working, that looks pretty cheap. Do you want to be, you know, you want to be in the stuff that's going up, or do you want to be in the stuff that's going down? The stuff that's going down is the cheap stuff, and the stuff that's going up is expensive stuff. And so the FOMO says, go and buy the expensive stuff because it's going up and it'll give you that short term. You might feel good for the next quarter or year or could be, who knows? It could take five years. And there's no guarantee that we're going to see those prices that we saw in the past ever again. We may never see them again. But we do know historically that we have sort of cycled up and down and there's probably a pretty good chance that we do so that Buffett saying, don't commit the sin of commission now this is better to be a sin of omission. If this thing works, then good luck to everybody who participated in it. I didn't understand it at the time and so I don't get to participate in it. I'll have to wait for my turn at some other point in time. It's getting comfortable with that. Which is not easy.

Matt Zigler (31:28)

No, no. Because there's a lot of FOMO that can be mixed into this. I want to ask about. I'm wrapping two ideas together that you didn't necessarily wrap together, but I think of them together. You say defeat is the result of self defeat. And I'm putting this in, especially with my financial planning hat on preparing for all possible scenarios. So it's like you dream up everything you think could happen. You run them all through the Monte Carlo machine or all your valuation analyses and all your other tools and yet that defeat is still self defeat haunting you on the inside. How the hell do you grapple with this? How does Buffett grapple with this?

Tobias Carlisle (32:05)

Right. So it's a question of temperament versus intellect. And the intellect is the part that sort of tells us what we should do and makes us, you can understand something on a rational level and still do the wrong thing on an emotional level. And that's the challenge is to control the emotional temperamental side, to let the rational side. And this is a theme that I come to quite a few times through the book. And I, and Sun Tzu talks about it too. He said it's the, it's the hot blooded guy who gets himself in trouble, who's, you know, it's emotions of greed or anger or fear. Those are all hot blooded emotions versus the cold blooded person acting rationally who doesn't get swept up with the crowd, who tends to do a little bit better. And it's, it's something that Sun Tzu spends quite a lot of time talking about controlling yourself, provoking the other side, getting them to make the, the emotional response. Graham spends a lot of time talking about it. And I think that it's hard that I can think of lots of examples of it. There's this. One of the books that I read that I loved is this. It's about the long con. So a long con is when you. And this is a thing in America and the 1800s, early 1900s, people would travel on a train and they would sit down beside someone and say, hey, I've got this scam that I've got, but I need some help with it. You're going to pretend to be somebody, and we're going to go and meet these people, and I just need a partner to make it look a little bit more legit. And of course, the person who is being invited into the scam, that's the person who's being scammed. And all of the people who. They go and meet up in it with the person traveling on the train. And so people used to ride around on trains, find some guy, and then say. And the idea would be that you can only con a dishonest man if you're an honest man. You can't be conned because you just wouldn't participate. He'd say, I don't want to con somebody else. I don't want to rip off somebody else. And so they would go these incredibly elaborate schemes to rip these guys off. And it was that their greed had sort of switched off the rational part of their brain. And then on the other side, they would do something quite shocking, like they would pretend that someone was murdered. They would have, like, a chicken bladder with blood in their mouth, and he would spit out a little bit of blood as he was shot with this gun with a blank in it. And then the guy who was, you know, who had put up the. The money to make the whole thing happen, who was the mark, he would run away thinking he'd made this great escape from some deal that had gone wrong, that he was. He'd put up the money and then he'd run away. And so he would never complain to the police because he thought that he was sort of implicated in this thing as well. And I like that idea of, like, I think that the markets are a little bit like that, too. You know, that. You know, that you shouldn't be doing this thing. You know, rationally, you shouldn't do it because it hasn't. You know, eventually all these things come back down to earth. It's just so painful while it's going on. FOMO is making you do things that you shouldn't do, and so you behave in ways that you wouldn't when you're much in a cooler state. And so temperament is very important in the markets, more important, Buffett says, than intellect. And it's a recurrent theme through. I think that it's really the most important thing that Sun Tzu talks about, and I think it's the most important thing that Graham talks about in the intelligent investor. So the security analysis is much more on the mechanics of doing an analysis where the intelligent investor is more about the psychology of investing. And I think that where there are. And there are lots and lots of parallels between the two, particularly in relation to psychology. And so I think that temperament and psychology are underappreciated aspects. And people think that there's this, like there's this secret information out there that if they can get it, then they'll succeed. When really it's just doing what you already know and not messing up, staying inside your circle of confidence, all of those sort of things.

Matt Zigler (36:11)

And not being a mark helps.

Tobias Carlisle (36:13)

And not being a mark. Well, it's like how often in the markets do you feel like? I know I see some of these things going up and I think the people who are in those things are marks. But you can't tell them at the time. You can't say it at the time. I had a good friend who says you can't criticize momentum on the way up because it makes you look. It makes you look like you don't know what you're doing. And you can't criticize it on the way down because it makes you look cruel.

Matt Bogumil (36:37)

Right.

Tobias Carlisle (36:40)

If anything's working for someone, you just let them enjoy it.

Matt Bogumil (36:44)

You have this big point that I don't want to lose here, but Ben Graham had this revelation hundreds of years ago that I don't remember the exact quote, but everything around us changes. Technology changes, companies change, but the humans running the show don't. And we might have AI and different tools and we might be able to trade from our smartphones and do things, but at the end of the day, it's a human with a heartbeat and emotions. And I'll add one more thing to it, J.P. morgan, the person said how more people lost more money because the neighbor was getting richer faster than they are. And this is as true. So we get sucked in not because the market went up. We get sucked in because the neighbor told us, right, he just bought a.

Tobias Carlisle (37:24)

Brand new car, can't stand to see.

Matt Bogumil (37:28)

Your neighbors get rich, and you want to be a part of it. Toby, I want to ask you about what I see a kind of a dichotomy in the investment process. So you have this deep analysis, deep research, deep preparation. Buffett is legendary. Being, you know, patient and disciplined. You write about the many calculations that lead to victory, and then everything around us moves really fast. How do we reconcile, especially now that the tools allow us to research an annual report in two seconds. It used to take an afternoon to read an annual report. I can tell you what's in it, or I might think I know what's in it in two minutes. How do you reconcile that deep research and the fast paced world that's just speeding up?

Tobias Carlisle (38:11)

Well, I think the reality is that there aren't many good opportunities available at any one time. Most of the time, most things are too expensive and most things aren't worth investing in. So you've really only got the Venn diagram of things that are worth investing in and worth investing in. Right now is pretty small. So I think that your time is best spent working on the things that are worth investing in, even if at the time that you're looking at them, they're too expensive, with the hope that at some point they may become undervalued enough for you, or they may offer enough return in prospect for you to take a position. So I think that's the way most discretionary, fundamental investors operate. They have a. There's 300 stocks in the world that are worth owning. They know them all pretty cold. They know what they're looking for and they know the price that would give them the right risk to reward ratio in that. So they, so they're updating Bogan. This is probably what you do. You probably have that list of stocks. You probably have a pretty good idea. You're updating them on a quarterly basis so you know roughly what you want for them. And then you're just waiting for a systematic event, a systemic event where everything gets cheap or one of them stumbles. And so Apple, I think, was a good example where it's not interesting. At one price, it is interesting. Another price, unh, recently UnitedHealthcare, you know, stumbles. And then Buffett buys a big position. So he knew it really well and he was waiting for that opportunity to get enough of a return out of it. And I think that that's the way I deal with it.

Matt Zigler (39:52)

Anyway, I want to jump to Wu Wei, which I love bringing the ancient Chinese words into the investment conversation. Nothing makes me happier. So this is, this. We're kind of tackling the winning without fighting Taoist idea here. Effortless success, all that stuff. I'M going to double it all the way home. Can we talk about Wu Wei and the. The Japanese trading houses as an example that you give?

Tobias Carlisle (40:21)

So the. The Art of War comes from this Enlightenment period in. In China, where they had one. One empire had collapsed. They had had this hundreds of years of warfare, and they had started writing these Enlightenment books. And the Art of War is one of these Enlightenment books. It comes out of exactly the same period. And the other ones are the Dao Te Ching and the Zhuangzi. And they are associated with Taoist thought, which is a philosophy. And one of the ideas in this. In this Taoist thought is this Wu Way, which is. It has lots of different sort of interpretations, lots of different ways that you can use it.

Matt Zigler (41:04)

But like everything in Taoism, they're all like fun little riddles, right?

Tobias Carlisle (41:08)

And. But that's. That's part of it, right? You get that. You sit there and you kind of meditate on this fun little riddle for a while. And I've had a lot of fun with wu wei. And it comes up lots of different ways through. You know, I think that they talk about it as being sprezzatura, which is that Italian, like, effortless way of dressing that looks really good, or savoir faire, which is the French sort of social fluency. And wu wei is basically that there's things are going to occur the way that they are going to occur, and you should align yourself with the way that things are going to occur. And if you find yourself sort of in conflict with this stuff, then you're. Then it's not going to work out the way that you want it to. It's going to work out the way that it was always going to work out. So you try to find ways to align yourself. And that's, for me, that's Wu Wei. And so Buffett talks about this a little bit in. Not directly, but he says he was in this failing textile mill manufacturer, that they got it very cheaply, but for a variety. It was just every time it turned around, it was losing a little bit more and it was being out competed. And then he switched to insurance and television stations and See's Candy. And there were businesses that had these tailwinds attached to them where they were just growing and doing a little bit better all the time. And so that's my interpretation of Wu Wei there, that you're just in a business that's doing well and will do well in the future, as opposed to sort of, you know, being in conflict with this stuff and trying to Muscle your way through, force your way through. Like that's the idea. Not forcing, sort of allowing things to occur as they will occur, but then putting yourself in a position to benefit with it. Floating along with the tide at the beach rather than swimming against the tide. I think it's a great term. It's a great, you know, if you're a contrarian, which I am, a lot of us are, it's. So it's probably the thing that you need and you want these in business results and in, and in life.

Matt Bogumil (43:02)

I ask myself sometimes what kind of a stock could I forget about? Right? There are some stocks I definitely can't. I have to check on it and keep, you know, paying attention to it. But I, I wish I could have more stocks that I could completely forget about for a while. They'll do the work for me. Toby, I want to ask you about position sizing and concentration. And Buffett not only, as you mentioned throughout this conversation, bought a lot of quite a few companies at different points in time. He also allowed them to, to run, you know, he allowed them to grow to a big portion of the stock portfolio. I want to ask this with a certain backdrop in this point in time. 2025 equal weighted market cap weighted S&P 500. Matt and I, with Chris Mayer and Robert Hagstrom talked about it, how it's the same portfolio but the outcomes are completely different. You could take Buffett's portfolio but give Apple only 1% instead of 40%. The outcome is completely different. I want to emphasize it because the position sizing matters as much, if not more as the stock selection itself. We're so obsessed about which stocks we're going to put in instead of asking how much are we going to put in. Do you have some thoughts?

Tobias Carlisle (44:12)

I have, I have a lot of thoughts actually because I wrote a book called Concentrated Investing and the entire book was on, was on the position sizing. It's a hard question to answer. I know that I forgot the Shogo sale. I should come back to Sogo Shosha, that's the Japanese trading conglomerates. I should come back to that in a moment. But the long run performance in the market from a statistical perspective has been for smaller stocks to outperform larger stocks. And one manifestation of that is for RSP, which is the equal weight S&P 500 has outperformed the market capitalization weight S&P 500. So weighting by market capitalization seems to systematically lead you to underperform. So we're not talking about market capitalization. Weighting. We're talking by. We're talking about waiting on a risk reward basis. And that's an idea that Mohnish Prabhrai has discussed. And it's an idea that was popularized by. I'm just blanking on his name now. The mathematician. Princeton, Newport Partners. A man for all seasons. What's his name?

Matt Zigler (45:24)

Thorpe.

Matt Bogumil (45:24)

Thorpe.

Tobias Carlisle (45:25)

Thank you. Ed Thorpe. Ed Thorpe popularized that idea, but it was based on the paper from the Bell Labs.

Matt Zigler (45:34)

Again, Kelly Criterion.

Tobias Carlisle (45:36)

Thank you. The Kelly Criterion with the idea, sometimes I'm worth something.

Matt Zigler (45:40)

You're killing it.

Tobias Carlisle (45:41)

You're killing it. I've got aphasia.

Matt Zigler (45:43)

I'll forget everything at CVS later. Don't worry.

Tobias Carlisle (45:46)

That was two books ago for me. So I've completely wiped the slave queen from things. And the idea is that, again, the Kelly Criterion is sort of Art of War in a nutshell, in a single formula. And the formula is, the idea is that you avoid ruin at all costs, which is a size in question, and you size up your better opportunities by the frequency and magnitude of the outcome. So frequency is how often it wins, and magnitude is how big it wins. And you can derive a. A number, and then you can size that number. And it's the outer limit of sizing, but it's also the optimal sizing. So supposedly it's that you should be betting that amount of money, although lots of people have done well betting some fraction of Kelly. And anything less than the outer limit is technically fractional Kelly. So you can bet less than that number. But the idea would be that you size up your better opportunities and then you can go through the mathematics of it, which I do just very briefly in this book, without sort of discussing the mathematics of it, I just discussed the implications of the math. And one of them is that, and this is something that I think a lot of investors figure out over time that they would rather put in. They size up their positions by how likely they are to work rather than by how big the payout is. Because if you're sizing by the size of the payout and it's in something that only wins very infrequently, then the chances are that you won't win in your portfolio. You'll miss the opportunity in your portfolio. So you want to size according to the frequency. So the more often it wins, which is another way of saying that the higher the likelihood that something succeeds, the higher the position sizing you can put into your portfolio. And so you might look at something like Apple and say the downside is very limited because it had a huge cash balance on its balance sheet and it's a very good business. And so it might have quite a significant upside and growth potential. And so you would say that the risk is low, payout is, the likelihood of the win is pretty high. So therefore we should size this up. And then that would be a bigger sizing than an equal weight. And so that's the way I think about sizing a little bit. And that's derived from Buffett and from the math and from, I think it's also a Sun Tzu type idea. Like Sun Tzu discusses these ideas in his sort of roundabout way. It's not necessarily in probability, but he talks about, you have to know how you're going to win before you enter into the position. And if you enter into the position and then try and figure out how you're going to win, you've made a terrible mistake. So that's, that's one of the ideas of victory without conflict too, is that you should, and all professional investors will, will have the. They know how the position works out and they know what they're looking for to succeed. And they would not put a position on not knowing how it can succeed or what they're looking for. That would indicate whether they're succeeding or not. And sizing is a big part of it. You can oversize a position that is a pretty good idea. If you oversize it for its frequency and it loses, you lose a lot of your portfolio. If you undersize, that's, that's closer to a sin of emission. That's okay. You might not get as much of a payout. You get some payout. And so that's, that's always the tension. You've got these rare opportunities. You want to put a lot of money into them, but equally, if they don't work out, then you lose a lot of money. So that's the challenge.

Matt Zigler (49:10)

I'm dragging you back, hopefully not kicking and streaming to Japanese trading houses, because I think this is, this is really good. So can you walk us through that, that part.

Tobias Carlisle (49:22)

This is one of, this is again, one of the things that, when this is a reasonably recent transaction of Buffett's in 2020, he announced that he had bought positions in a basket of these Japanese trading conglomerates. And they have this interesting position in Japanese industry where they were set up during the Meiji era and they were supposed to be Japan's interface with the world, where they would, because Japan is reasonably resource poor and they needed resources, so they needed to go out and establish an iron ore mine, or they needed whatever it might be, these inputs. And then they vertically integrated all of these industries, which means that they would take the iron ore and they would turn it, smelt it into iron, turn it into steel, turn that into the next thing and so on. And so they've got these sprawling conglomerates that touch lots of different nations and industries, and there's quite a lot of complexity in them. And that complexity has been, as I discussed earlier, it's sort of a curse because it's so complex with cross shareholdings and hard to unpick what's happening in them. At the same time, Japan's not known for its corporate governance. It's got. I don't think that it's necessarily a bad thing the way that they conduct themselves because they look after their shareholder or they look up, sorry, they look after their employees, they look after their suppliers, they look after their customers. It's just that their shareholders are at the very end of that list of people. Whereas in America, we probably have shareholders first and then work the other way down. But the Japanese very like, they really do live this thing that we're. And I put this in the context of endurance and durability, and they are very. That's survival. That's another way of guaranteeing survival. And Japan is known for having. They've got some of the oldest businesses in the world. They've got these businesses that have been around for, I think, a thousand years, some of these temples that are rebuilt every hundred years and they just move position a little bit, but otherwise it's the same. It's the same temple. And so in 2020, the Japanese trading houses had got too cheap. The dividend yields were in low single digits. High, sorry, high single digits. So they're like 6, 7, 8, 9%. And they were too cheap on it, on many other metrics as well, and quite generating lots of cash flow in a pretty diverse set of businesses. So pretty safe and secure. And they, under Abe, they had introduced these new. This new, like, regulatory environment where they're going to try to make them a little bit more shareholder friendly. And they've continued those reforms on to this day, and that does continue on. But the real genius of Buffett has sort of recognized these Japanese trading conglomerates perhaps as kindred spirits to Berkshire Hathaway in the sense that they're, you know, very diverse cash flows and a focus on durability and endurance rather than, you know, optimizing at every. At every step of the way. So he's put these positions on, but then, you know, to make it at which anybody in the world could have done, and lots of people did do. But to make the. To make the transaction peculiarly Buffett, typically Buffett, he issues debt in Japanese yen at 0% interest rates, which he hadn't done before. He did the transaction as well. So he's essentially getting free carry. These Japanese positions are supported by Japanese debt with zero interest rates. He's getting 6, 7, 8, 9% dividends. So he's getting an $800 million dividend out of it every year, hoping for. And then ultimately he did get capital gains at the same time. And so it's just an extraordinary confluence of events. And then because he tells them, we're not going to go over any limits that you require. If you require us to stay under 10% or 15% or 20%, we will stay there. We won't go over it without discussing it with you, although we'd like to. And then they have these discussions and Greg Abel has gone, and they've now they've got lots of projects that they work on together in addition to sort of being an increasingly big shareholder. So I think it's an example of two things. One is, Wu Wei is this idea of just letting these things work. And the other one is this idea of following the moral law, which is a. Which is a Sun Tzu idea where you sort of act in the best interest of your people who you're looking after. You know, you act as a fiduciary because the issue is always this sort of principal agent conflict where how do you get the principal to act in the agents? How do you get the agent to act in the principal's best interests? And incentives is one way of doing it. But also having someone who you know is prepared to act in the role of a fiduciary, which Berkshire and Buffett, they've always done that. They've cultivated that reputation and they've sought to uphold it. And I think that's a crucial part of their success. And I say in the book that the, the moral reason for following the moral law, which is like just doing the right thing, is that it's the right thing to do. But there's also a good strategic reason for doing that. And that's because you're more likely to win if you do that, because you get better allies, allies who will behave in the right way. People want to join you. People will sell to Berkshire at a discount to what they can get somewhere else because they prefer that the Business will be run the way that Berkshire will run the business, but Buffett will let the CEO of the business run the business. They're not going to fire lots of people, they're not going to load it up with debt. And all of those things are important to people who sell their business. So Berkshire does well with these sort of people who are already inclined to be kind of honest and look after their employees. See, it's from Berkshire's perspective. It's also a good thing because now he's dealing with people who he wants to deal with and they're probably businesses that are run quite well and quite fairly. So it all sort of works in this virtuous circle.

Matt Zigler (55:05)

It also helps explain why the guy I knew who was taking out 0% interest free credit card loans to buy Canadian royalty Trusts in like 2007 and explaining his genius, he didn't become Warren Buffett.

Tobias Carlisle (55:20)

You might not be, I don't mind it as an idea, but he couldn't transfer, he couldn't get the 0% interest rates for long enough.

Matt Zigler (55:28)

Well, the 0% interest rates met the financial crisis in his case. And so all the things came crashing to a halt. And there's an offline story for how that one reconciled itself, but it was one, he was very proud of this scheme until he was very, very embarrassed by the scheme, let's put it that way.

Matt Bogumil (55:46)

Yeah, there's a profound lesson that you just shared, the reputation and the relationship building. And I think it really matters because the investment profession might feel very transactional. And Buffett went about it in a completely different way. And he reminded us again and again about the reputation, how much it takes to build it, how little it takes to lose it. Toby, I want to ask you about a reference you make in the book about which is a French expression and intuitive pattern recognition. Buffett just sees something at a glance and he knows this is the right thing. Can you talk about that? We're talking about this deep research, but at the same time, he has so much accumulated knowledge that it doesn't take a second look for him to know that this, this makes sense.

Tobias Carlisle (56:30)

Well, I'm glad, I'm glad you brought that one up. And I, I, I, my pronunciation, I've only read this word and then pressed the, the Google thing that says this is how it said that kudoi, which is, which means stroke of the eye. Yeah, it's a common expression in the sort of strategy literature. And it comes up over and over again and it's, it's in Clausewitz's on war where he talks about great captains having the kudoi, which is basically that they had been military men in battles their entire lives and they could walk out. And he says Napoleon had this, Frederick the Great had this, Napoleon. And there are lots of examples of Napoleon just arriving on a battlefield and seeing something and knowing how to immediately capitalize on that thing. Because he had. It's some pattern recognition or something like that. But the idea is that in an investment context that you have to. And I use the bnsf, Burlington Northern Railway as an example of this, because I use it as an example of two things. One is that there is this method you have to be. You have to go out and do have to research, read the financial statements, understand what's happening with these businesses in order to make a decision. But at the same time you have to have sort of done it enough times that you can put it into a pattern of something else. And I think that the BNSF1 is particularly interesting because again, it's this really strange transaction for a buffet watcher because he likes these businesses that grow without Capex. And here he's buying the poster child for Capex. Really. There might not be a more capex intensive industry. You have to build the railway, the rail lines and the rail and then you have a regulated return from what you've built out. And railways haven't been great investments for most of the life of the railway. There was this AI Capex boom, similar for railways when they first came out, where people were building these railways and investing huge amounts of money in them and they just didn't earn enough of a return for a long period of time. They've always been low returning businesses. And Burlington Northern from the outside certainly looked like another low returning business. I think it was doing 11% on its equity, but that price that Buffett was paying for it made it look more like a 6% return for him. But what folks who were watching hadn't appreciated was that there was going to be this change the regulatory environment where they were going to accelerate the depreciation fall, which means that on a cash flow basis you pay less tax essentially and so that boosts your returns. The other thing that he had seen was that as the sort of environmental concerns, it's a lower carbon way of transmitting goods around the nation. It's also uses less fuel. So it's more fuel efficient than trucking by about a third. It's a third of trucking, I think is what they say in the book. And in addition to that, it had this railway, it was geographically more to the west of the US and so the US had traditionally been doing a lot of business with Europe. And as its focus switches to the west coast and the Pacific and Asia, then more traffic will travel over BNSF's rails. And so he. The Kudo is. He's able to put all of these. The tax implications, the change in the regulatory environment, the change in environmental concerns, the geographical, all of these things. And he was able to sort of sift it down into one decision, which was to go ahead with this transaction. And then I sort of unpack it a little bit where so much cash flow. It was. I think it was $44 billion headline, $26 billion in cash exclude. And they already owned a little bit of it before they did the transaction. But then they had. The money came back out of it pretty quickly. The yield on it was 10 or 11% pretty quickly in terms of dividends. And they've grown since. So they've got all of their cash back out of bnsf. They've reinvested in the assets at the same time because the cash flows have been pretty good. And so independent analysts put the valuation of it at between 100 and 200 billion dollars, which is a very wide range. I appreciate, just for the sake of being correct rather than precise. I think it's like I'm using that very wide range because they paid 44. So it's a huge win, and they've got all their cash out, and it was a result of this coup d', oeuil, which is just the ability to summarize the opportunity that's complex into one decision.

Matt Zigler (61:08)

Reading a book like this makes me appreciate how many words I've only read and never tried to say out loud, because we're getting to Kudoy. Like Clausewitz. I. I'm realizing I've only ever read his name. I've never heard anyone say his name. And.

Tobias Carlisle (61:24)

And it's German or Prussian. Yeah, none of us.

Matt Zigler (61:29)

All right, so this is not a spoiler, but I'm taking you to the epilogue. I want to talk about Charlie's blueprint at the end. And what do you think the compliments here? I want to land us on this idea because I think this is a really special way to epilogue this book.

Tobias Carlisle (61:46)

Yeah, I'm glad the book is about Buffett, and I think Buffett's genius, and I think that he's a strategic genius as well. He's a genius in many different ways, but the genius of strategy, he clearly has, too. And I think the fact that he adheres to Sun Tzu, who I think has also sort of delineated all of the elements of strategy pretty clearly 2 1/2 thousand years ago. Game theory is probably the modern equivalent of the Art of War. And you could make an argument that there's a lot of game theory in the Art of War as well. That's the logical extension of all of this strategy stuff. But I thought that I needed to make some acknowledgment of Munger's role in all of this too, because Munger's responsible for a lot of the ideas. And I think Buffett says that he has been the general contractor building to Munger's blueprint, which is the way that he describes it that Munger said, don't invest in these things that really don't have any of the Wu Wei. Like, avoid this stuff that's just going to die, even though you can get it cheaply. Look for things that are going to grow and compound over time. And he's also a big part of the character. I think Buffett's very good character as well. But Munger's sort of more explicit about the character stuff being important, although Buffett has done that as well. But Munger's certainly explicit about character and behaving in a particular way. And so I just wanted to sum all of those things up in the epilogue and give Charlie his due for what he had contributed to Berkshire Hathaway and to Buffett.

Matt Zigler (63:17)

I think it's important and it sets up the next book, the Dowding of Raisins and Turds or wherever you want to take.

Tobias Carlisle (63:25)

Charlie Munger and the Kama Sutra.

Matt Zigler (63:29)

And so it shall be written. Tobias Carlisle Plug the new book. Tell people where to find you on the Internet.

Tobias Carlisle (63:39)

I'm holding up the COVID now for folks who are listening on audio only, but it's called Soldier of Fortune, Warren Buffett, Sun Tzu and the Ancient Ancient Art of Risk Taking. The books available at Amazon, Kindle hardcover paperback audio is coming shortly. I am on twitterreenbackgr E E N B A C K D and I run Acquirers funds which has two ETFs, Zig and Deep, which are deep value US domestic equity investors. I'm very grateful for you two guys spending the time with me. Matt Bogumal, thanks so much. It's been an absolute pleasure.

Matt Bogumil (64:19)

It's a really good book. I highly recommend it.

Tobias Carlisle (64:22)

Oh, that's very kind. Thank you.

Matt Zigler (64:23)

Always a pleasure. Don't get confused and watch the Soldier of Fortune movie from the 50s.

Tobias Carlisle (64:27)

But if you do tell us about.

Matt Zigler (64:30)

That or the magazine, read the magazine. You could do that too. Hit all three. You're watching excess returns on YouTube. Bogomield thank you so much. Toby. Thank you so much. We'll see everybody real soon.

Tobias Carlisle (64:42)

Thanks guys. Thank you for tuning in to this episode. If you found this discussion interesting and.

Matt Zigler (64:46)

Valuable, please subscribe on your favorite audio.

Tobias Carlisle (64:49)

Platform or on YouTube. You can also follow all the podcasts.

Matt Zigler (64:52)

In the Excess Returns network@excessreturnspod.com. if you have any feedback or questions, you can contact us@excess returnspodmail.com no information on this podcast. Podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.