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- [00:00]
A
Hello, everyone, and welcome to Investing by the Books, a podcast by Red Eye. I'm your host, Eddie Palmgen, and today we're delighted to have Ryan Bunn on the show to discuss a classic investment book. Ryan Bunn is a curious investor living in Denver, Colorado, where he is the lead portfolio manager for reference equities, global and international small cap strategies. Ryan has over 15 years of investment experience across both the public and private markets. And for this episode, he he has selected the Art of Speculation. Written by the legendary investor Philip Caray. The Art of Speculation was first published in 1927, and we're thrilled to discuss it on the show today. Here comes our conversation with Ryan Bunn. Hi, Ryan, and welcome to Investing by the Books podcast.
- [00:52]
B
Hi, Eddie. Thank you very much for having me today.
- [00:55]
A
It's great to have you on. Where are we reaching you today?
- [00:58]
B
I am in my office in Denver, Colorado.
- [01:02]
A
Great. And to begin, for those not familiar with you, how did your passion for investing begin?
- [01:08]
B
Yeah, my interest began at a young age. My mother introduced me to saving and investing. I had a few shares of a mutual fund in elementary school, and I'm old enough that we would look up the prices in the newspaper. But I'm also young enough that I kind of grew up during the tech bubble. And so over time that transitioned to an Ameritrade account and everything moved on the line. So I've been investing for a long time, but really I'd say I have a passion for strategy and business models as well. Growing up, I always had some sort of side business going on. I distributed candy, got in trouble for that in middle school. I had some ebay businesses in high school. And so, you know, even today, my passion is kind of I love talking to management teams, learning about their businesses, the business model, the strategy, and, you know, it's a joy to do that professionally.
- [01:59]
A
And how was your path to become a professional investor?
- [02:03]
B
Yeah, so I did not know you could become a professional investor until after college. So I was a bit sheltered that way. But I started as a consultant out of undergrad and basically did market research and due diligence for large private equity firms, firms. So that was my introduction to seeing the buy side, I guess. And I immediately kind of fell in love with that, doing that research. And after consulting, I spent the next six years doing direct deals in private equity. So I've been been trained as a private equity investor. Again, thinking about the whole business, buying the whole business. And so that was, you know, really where my foundation was laid for the past 10 years I've been investing in global small caps, taking that same approach into the public markets.
- [02:53]
A
And you're also a ferocious reader. I've understood you have a stacked bookshelf behind you.
- [03:00]
B
Yes, that is true. I don't know when this started, but maybe five or six years ago, I started purchasing used books just from the bibliographies of the books I read. And anytime someone referenced the book was interesting, you know, I realized you can usually get them for. For five or ten bucks. So I started buying. And then when, when you're surrounded by books, it's hard not to pick them up and read them, you know, so. So that has kind of compounded over time.
- [03:25]
A
And how many books do you have now, approximately?
- [03:29]
B
Oh, man, I don't. I don't even know how to guess it. Maybe, I don't know, five hundred or a thousand. This is, these are the good ones. In my basement's kind of overflowing with, like, other ones. But, you know, one of my favorite authors is that Nassim Talib. And I think he, you know, he's talked about a library of 30,000 books, you know, in libraries that you won't even read half of the books you own. So I'm nowhere near that.
- [03:54]
A
So you have many books and today you have selected one. I guess it was not that easy. But the one we will speak about is the Art of Speculation. Can you briefly tell us about what the book is about and its structure?
- [04:07]
B
Yeah, so the Art of speculation, it's almost 100 years old and it was written by Philip Koray, who is a mutual fund investor, and it's basically his just reflections on the market. There's a lot of how to. He goes through how the exchanges actually work, how you buy a stock, how you short sell. But he also, towards the end of the book, gets really deeply into some investment philosophy. And that was where I really got interested. I think it's actually a seminal work in investment philosophy and I think most philosophies that are in practice today you can actually trace back to some of Karay's teachings.
- [04:51]
A
And the title sounds quite promotional and short term to me at least. The Art of Speculation. Why do you think it's worth reading?
- [05:00]
B
Yeah, there are a number of reasons. First, I love reading old financial history books just for the reminder about how things very rarely change. So Karay, even to your point on the title, the art of speculation, 100 years ago, investing in equities was viewed almost as gambling. It was a scary proposition. People really focused on the risk and even through the book, Carre talks about the psychological aspect of equity investing, of market swings. You find that the headlines today for the markets, they're the same as existed 100 years ago. And I think that grounding is very important, and it's always great to get that directly from people at the time who experienced it.
- [05:53]
A
And the author of the book was, as you mentioned, Phil Carrey. Can you tell us about him? Who was he?
- [05:59]
B
Yes. And so the way I came across this book was actually Warren Buffett referenced Koray. So Kray, he was born in 1896, but he lived a long and very fruitful life. And I believe he attended one of the Berkshire Hathaway annual meetings in the mid-90s. And Buffett mentioned his track record, mentioned how great of an investor Craig was. And so I think that's what led this book to ending up on my bookshelf. Cray himself had a pretty interesting life. I believe he was a pilot in World War I and then began working as a bond salesman for what became Paine Webber. But ultimately, in the mid-1920s, he started one of the first mutual funds in the country. It was called the Pioneer Fund. He ended up running that for 50 or 60 years and developing this incredible track record of 12 to 13%, compounding over that, you know, very lengthy period of time. So, you know, just based on that track record alone, I was interested to hear what he had to say about
- [07:03]
A
the markets and how many books did he write?
- [07:07]
B
Yeah, so I believe this was his second book. So his first book was called Buying a Bond. I think Warren Buffett actually read that, and it may have led him to actually meet with Kray before he even started. Graham Newman. So Buffett was aware of what Cray was doing for a very long time. And I think Cray also has an autobiography that was put together kind of later in his life. So I think I have that on order on the bookshelf somewhere that I'll need to pull out someday.
- [07:35]
A
And I think his first book was published in 1924.
- [07:39]
B
Yes, that's right. And then he followed up with the Art of speculation in 27. So much of it was written before the Depression, but even though the market hadn't crashed, he was still keenly aware that he was speculating in the equities he owned.
- [07:55]
A
And there was also a revised edition of the book, right?
- [07:59]
B
Yeah. So the edition I have, which you can buy today, is from 1930. So there were a few updates. I'm not exactly sure how much change from the 1927 version, he would have had a few months to get this out and think about the Great Depression and to see if he wanted to change any of his viewpoints.
- [08:21]
A
It's quite spectacular to read the book and see how well ahead he was. I mean, you mentioned that he's been very influential and you can see later works that has been some of the most read books in investing literature. Can you mention some of those that he inspired?
- [08:40]
B
Yeah, obviously he had an influence on Warren Buffett. You know, there's a lot of what he says that I actually see reflected in the writings of Philip Fisher, you know, who's commonly, you know, kind of viewed as a key Buffett influence as well. You know, Fisher, I think, is viewed more as a growth investor. Carre, I believe, would have been more kind of on the value side. He was not deep in technology or things like that. But they both had a very similar, you know, way that they approached fundamental investing. And I think that's where the roots lead back to in a lot of Kray's teachings.
- [09:18]
A
It's interesting to see that he's using words and sentences like the intelligent investor, these kind of terms in the book. So definitely one step ahead there. But if we go into the insights from the art of speculation, what is the most important that you have learned?
- [09:35]
B
Yeah, I mean, I think kind of connecting it to the investment philosophies that we see today. One of the quotes that stood out to me was he talked about an owner of a stock is favored by the law of compound interest. And so today you hear the word compounder all the time. I've got at least three books that have compounder in the title on the bookshelf. And so when I saw that Corre, you know, he had this insight of retained earnings, reinvested will compound value for that equity shareholder. And at the time, you know, in 1927, this was, you know, fairly groundbreaking. People were not discussing stocks in this way. Equities were viewed as dangerous bonds and valued on dividend yield. You know, so I thought that was very cool to see. And. And he even goes. He kind of provides an even broader framework on fundamental investing. So there's a section called Men, Materials and Money. And Cray, basically, he starts from first principles and literally says, what is a business? What am I owning when I own stock? And what drives that business to create value? And he comes up with those three points. And today, most fundamental investors, they're investment philosophy. They want strong management teams, you know, which in Cray's time, we've been the Men, they want a competitive moat. And to Cray, that was materials. So what materials and assets did the business own that, you know, created competitive differentiation and then finally money. And, you know, Craig didn't talk specifically about valuation. When he talked about, you know, the money in the business, it was the capital. And so, you know, that encompasses valuation, but also the balance sheet strength, the liquidity the business has, you know, which are all kind of risk metrics that I think get pushed aside sometimes. But he was really looking from first principles on how do I buy great
- [11:38]
A
businesses and coming back again to the, to the speculation. I mean, he writes a lot about this aspect of investing. What does he really mean with that?
- [11:51]
B
Yeah, I mean, you know, again, back 100 years ago, people, you know, equities were fairly new, you know, and Cray, he's. He's a, he's old. He has a lot of history, I guess. So in the book, you know, he was born in the late 1800s, but he worked with people who were investing after the Civil War. So he's actually looking back, referencing the investments that were available to people between the Civil War and the Spanish American War. And so at the time, I think you could have owned some railroad stocks and that was nearly it. And Karay, Starting in the 1900s, industrial stocks, businesses that were not railroads, were new to the markets and were viewed as very exciting. And to Cray and most investors at the time, that was even speculation because it wasn't as stable of a cash flow stream as railroads. So to him, I think nearly everything was speculation. And I also think there's a very important lesson there. I spend most of my time looking at small cap companies. And in reality, today in the public equity markets, there is a lot of speculation and gambling going on. There are a lot of listed businesses that will not be around in five to 10 years. I think it gets lost sometimes when you look at the s and P500 and you look at indexes that average it together, you know how risky parts of the market are. But correct knew that he's got a chapter specifically on wildcat miners, I believe, and back in before the Depression that you would just take out a newspaper ad to say you were prospecting for gold and you could raise money that way. And most of them were frauds to the point where, you know, I think it was even referenced that someone found gold. And then they wrote back to New York and told the bank, hey, you have to cancel this listing. We did find gold, so it's not a fraud anymore. Now we're not selling the shares. So, you know, it was a very speculative time. And Corre, you know, he knew that and I think that that led to the title.
- [14:00]
A
Yeah. And, and it's, he even writes that it is quite impossible to draw a sharp line and say of those on the one side, these are investors and those on the other, they are speculators. It's. And in fact, speculation is inseparable from investment. So I guess that's what I really take away from this book, that you need to take some risk and there is some speculation involved, but you can do it more or less risky.
- [14:30]
B
Right. And that's, you know, I think the last chapter, you know, I think he called it When Speculation Becomes Investing and that, you know, it's where he's got all of his kind of insights wrapped up to tell you, you know, how do you go from gambling to truly being a prudent investor?
- [14:46]
A
Yes. And he has the 12 Commandments for speculation. I mean, we can't go through all of them, but if you would have to choose up to three of them, which are the most important in your view?
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B
Yeah, sure. So, you know, the 12 commandments, the amazing thing is I think they, they are all still true today, you know, which I give him credit for that nearly 100 years ago, you know, I think his, his first commandment is to never hold fewer than 10 stocks in five industries. And so, you know, this is a very early look at diversification. And I think this is interesting for a couple reasons. You know, first, you know, Corre, he didn't need academic research, you know, and a mathematical definition of risk to understand the value of diversification. You know, he wrote about 100 years ago, on the other hand, a 10 stock portfolio today we would not view as particularly diversified. So I think he also understood the ability to outperform markets requires some level of concentration. And if you have 60, 80, 100 stocks, you become the index. I think in his first principle, as he's talking about becoming an investor on your own, he's describing the way that you have to construct your portfolio to even have a chance at generating alpha.
- [16:10]
A
Any other lessons you would like to bring up from the Commandments?
- [16:13]
B
Yeah, the second one. And Philip Fisher actually talks about this as well. But Kray says to consider yield, the least important factor in analyzing a stock. And so it was a little bit different in his time. In 1930, investors would basically compare the dividend yield on a stock to a bond they could buy. And that was the way that valuation was done. So obviously his insight was that there's more value to a stock than just a dividend yield. And on the one hand, today, this seems very obvious. Nobody invests, I don't think, based simply on dividend yields today. But at the same time, today, investors get very excited about buybacks, which are synthetic dividends. And so I think I see a lot of investment pitches where people are so excited that there's a lot of cash and the company is now finally going to buy back a bunch of stock. And in reality, you're kind of adding that buyback yield to the dividend yield and getting excited about the return you're going to earn. But implicit in that is that this company has nowhere to reinvest this capital. And so, you know, I think Karay is getting at that as well. When he's talking about ignoring the yield, it's because he was looking for businesses that were going to redeploy this capital very productively inside their business. And so, you know, I find even today, you know, this lesson I don't think has been internalized by the market. And so, you know, I thought that was very cool to see him kind of thinking that way.
- [17:50]
A
I would definitely agree with that. And there's also a lot of private investors, definitely, who are looking for just high yield. That's the only thing they're basing their decisions on. And there's books on how to find the best yielding stocks and how to prioritize and so on, but it's actually about getting that return on your capital and compounding it and reinvesting.
- [18:15]
B
In Gray's head, he's speculating in equities. So if you're just looking at the yield, you might as well take the extraordinarily low risk of a bottle. You know, don't be a speculator if you want that yield. And if you're. If you're, like, getting a slight premium on the yield, I don't know if the risk is necessarily worth it.
- [18:34]
A
And if you would choose the third one out of the 12 commandments, which would that be?
- [18:40]
B
Yeah, the last one, I'd say he says, seek facts diligently and advice never. And so, you know, he's basically saying, do your own work. I think this is another investment piece of advice that we view as kind of trite today, but it's never lost its relevance. I think maybe it's done differently today. It used to be people hanging around Wall street and whispering to each other, I guess, going into the Great Depression. But today there are obviously platforms where you can follow people's exact portfolios. And on the one hand, this transparency is amazing in the industry. It's great to be able to have people put their money where their mouth is and kind of show how their research is doing. But to me, the reason you have to do your own work comes back to the conviction you have in the stock. So for Karay to build his track record over 60 years, he was incredibly patient. And I'm sure to outperform, he would hold stocks through very nasty drawdowns. And the only way you can do that is when you personally know the business and have the conviction when the market is telling you there's something terribly wrong with this business to hold on. I think we're all familiar with Amazon after the tech bubble, trading down 95% or $5 a share. Somebody sold that share at $5. And my guess is it was not a person who'd met Jeff Bezos and understood the business model. My guess, it was someone whose friend or uncle told him three years before they should buy Amazon, and they watched it drop 95%. And so I think this is something that you see with all great investors encouraging you to do your own research, do your own work. And I don't think it's necessarily that you can't find great ideas. Other people mentioned it really comes down to how do you hold that stock for the long term?
- [20:44]
A
And when I looked at the 1927 edition, the first one, I saw there that there were actually just ten commandments, and then he extended it to twelve in the. In the revised edition. So one of them was to do your own work. The one you mentioned was already in the first one, but he added another one, which was to avoid inside information as you would the plague. And then he added, be flexible. Ignore mechanical formulas for valuing securities.
- [21:12]
B
Interesting. Well, to, you know, I guess thinking back to the Great Depression, right. I mean, this was a time when insider trading was effectively legal, you know, so that was definitely a market nuance that is, you know, hopefully different today. And, yeah, to your point, I'm being flexible on the valuation metrics. Yeah, valuation is something I'm sure that was in his head at all times. And I would say that means that another one of his lessons was to avoid leverage. And so that means he actually had that in the book before leverage hurt a lot of people in the Great Depression. It's interesting. I think his book has so many lessons, and the wording and verbiage he uses is different. So he talks about, you know, when he says avoid leverage he means don't, don't buy on margin. And I think today, you know, I don't think there are that many investors, you know, hugely margined in their trading accounts, but there are many investors that are in, you know, triple levered ETFs and many investors using year zero day options. And so, you know, we found a way to embed leverage into these markets in a way that, you know, isn't described as margin. But the lesson still is there from
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A
Karay and we touched upon it a little bit regarding how relevant his ideas are today. But maybe there's something else you would like to mention.
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B
Yeah, this topic I think is a little scary to mention I guess as an active investor. But Kray is a couple chapters where he talks about market cycles. And so on the one hand active investors especially as we come, we're in a very extended bull market I would say today. And so talking about market cycles means you've been wrong for at least a decade. And so it's not a popular thing to discuss. But Cray, he was aware of the macro environment. One of his lessons was when, when stocks are very high, when things are frothy, hold some short term bonds. So he was aware of the market cycles. I think when you look at Buffett, as much as Buffett says buy and hold and passive indexes are great, he plays market cycles and he's done it very successfully. And today he is record cash. And Howard Marks, he writes books about market cycles. So I think it's amazing that all these great investors with amazing track records, they're aware of what the market is doing even if it's tough to talk about and you don't want to make predictions on the top or the bottom. They found a way to profitably navigate around the psychological swings within the market.
- [24:02]
A
It's clear that you are a big fan of Kare and his ideas. But is there anything that you don't agree with him on?
- [24:10]
B
Yeah, there are a few things that haven't aged perfectly from the book, I guess, you know, at, at the time and in the book, you know, his insight on retained earnings comes from some analysis he was able to do looking at stocks that paid dividends versus stocks that didn't pay dividends. And that's where he could kind of see the, the reinvestment begin. And you know, this was very challenging to do. You know, people were taking pen and pencil, you know, and trying to calculate, you know, all these returns. You know, the graphs that show up in these books were hand drawn at the time so when you see a stock chart from 1990 to 1930, someone was literally drawing that. So I think to him, he was at the early stages of statistical analysis, technical analysis. And he's got a couple chapters in the book where I think he's excited about this and he sees that maybe there's some insights that come out of this a hundred years later. I think what's more interesting to me is that his fundamental investing tenets have aged better than finding, you know, some key or some trading mechanism buried in the charts. And I imagine, you know, if. If he had written, you know, another investing book in 1970, I think he would have dropped some of those chapters.
- [25:30]
A
Yeah. But it's fascinating to read it, I think, to understand how the markets have changed. I mean, there's just, of course, terminology, but also how you would invest, how accessible it is, how expensive it is to invest. And there's a lot of lessons in that aspect as well, I think.
- [25:47]
B
Yeah, that's very true. I mean, you know, he's from a time of ticker tape, right, where, you know, you had no idea what price the stock was trading at when you bought it. You know? Right. Like even Warren Buffett, Omaha. Right. You know, you're. I don't know how many minutes behind the actual stock market you are today. We're talking nanoseconds or something to get your price quotes. So it is a different environment, for sure.
- [26:11]
A
Yeah. This kind of tape reading. But if you could meet him today, if he was alive, what would you ask him?
- [26:19]
B
Yeah, I would love to know about his process. So that's something. He didn't discuss it in the book too much. It's clear his philosophy, what he looked for in businesses. But I would love to know, was he pounding the pavement? Did he know the management teams he was investing in, how he actually went about analyzing the businesses that he invested in? Similarly, for any investor with an amazing track record, I always love to know how they think about valuation. As you mentioned, one of his rules was there's no mechanical, specific valuation formula to rely on. It is more art than science on valuation. And so I know Buffett has. He's talked about this a lot as well. But it's always valuable, I think, to hear how great investors truly know when to pull the trigger on an investment.
- [27:17]
A
Have you read his autobiography?
- [27:20]
B
Not yet, but I'm very excited to. And I'm hoping that maybe when he talks a bit more about himself, maybe he'll tell a bit more about, you know, what he was doing. Yeah. And I Think, you know, not to bring up Buffett too much but, but going back to Buffett again, you know, I think there are increasingly great stories you hear about Buffett with, with the crazy diligence he was doing, you know, when, when he was a young investor, which I think also gets lost. You know, today he can sit in Omaha and you know, I think it's different but he, he was on the ground pounding pavement, you know, showing up at Geico on the weekends, chatting with people. I imagine Carre would have very similar stories. That would be very cool, kind of
- [28:01]
A
due diligence insights, some field work and channel checks. Yeah, that would be exciting to read about. I haven't read the autobiography yet either, but I'm intrigued to do so after this conversation. But let's shift focus a bit and hear about you as an investor. You are the founder of Reference Equity. Please tell us about the firm.
- [28:24]
B
Yeah, so Reference Equity, we are a small cap focused boutique investment firm. We're long only. We have two strategies, Global small cap and international small cap. And we're attempting to take this investment philosophy described by Karay and others and apply it into what we view are inefficient small cap markets. We have fairly concentrated portfolios and ultimately our clients view us as a way to diversify against the mega caps in a space where it's still possible to find alpha kind of in a fundamental way. I love the day to day job of just doing this research on stocks. The other reason, the motivating factor for me to, to kind of found my own firm is, you know, active management is in a tough spot today, you know, so, and the reason is, you know, people have been kind of overcharged and they've been underd, delivered by active managers for, for decades now. And as evidence of that, you know, passive investing has, has taken a lot of share in this market. You know, it's, it's hard to know if passive, you know, we'll take every last dollar and maybe this is a debt industry, but in my view, you know, this is a market cycle. Active investors are going to be able to outperform once again. But the industry needs to be disrupted. And in my view there's a way to do this research that Caray and others were doing at a radically lower cost than currently is charged in the industry. And so I think there's really a way to bring some disruption, bring value back to clients, directive management. And so, you know, I'm very passionate about this and that's really the driving reason behind Reference Equity and What is
- [30:23]
A
the reason for lowering those costs?
- [30:28]
B
Yeah, I mean, so obviously since Karay's time, technology has progressed greatly. And so there are a number of different ways to kind of take a blank slate view of how this industry should work. So first and kind of most simply are just productivity tools. What Korea. The time and effort and analysts he would have needed to go through 10 years of financials can be done much faster now. Similarly, the operational costs of the industry have been driven down drastically by technology. But the real unlock comes again when you take a blank slate and think of what do clients need and how am I going to deliver it and kind of seamlessly connect it. So our portfolios at Reference Equity, by being fairly concentrated, we don't need a huge analyst team to cover thousands of stocks. Our investment philosophy is very specific. We know exactly what we're looking for, so we're able to be efficient that way. At the same time, we're thoughtful about who our clients are. So there's some clients like say state pension funds, they bring an enormous compliance burden that's very expensive to serve. And so it's a fact of life. But if you don't have those clients, you don't need those costs to serve. So by connecting clients, philosophy, process and the strategies we run all together, it ultimately allows you to reduce costs across the entire spectrum, which results in massive savings.
- [32:06]
A
And you mentioned investments globally and in small caps. Why have you chosen that approach and are there any limitations to that?
- [32:15]
B
Yeah, so there are a number of reasons why global small caps are very attractive. First, as I mentioned, our investment philosophy is very specific. And to outperform you have to find a few very exceptional businesses. To find them, you need to be searching in a very large pool of investments to find these truly top decile types of companies. So the global small cap markets, there are thousands and thousands of potential investments that we can look at. And we view that as an advantage for us that there's a massive pool in to where we can create portfolios of exactly what we're looking for. The other reason that being global is very important to me is the world is global. Now we benchmark companies across their competitors around the world. And there are a lot of insights to be gained by comparing the business models that exist in Japan or China and Europe and the US and comparing and contrasting and understanding, you know, who truly has the best business model, the most unique competitive advantage. And so taking that very wide view, you know, I think keeps us well informed of what the true cutting edge is kind of in the Markets.
- [33:35]
A
And are there some countries or regions where you don't look?
- [33:40]
B
Yeah. So you know, at the end of the day we, we are still very conservative investors. We are entrusting management teams to reinvest the capital to create that compounding of earnings. So there aren't really any specific. I guess we're not on frontier markets. We like to be in places where businesses have existed for many years. We can do historical analysis, but at the same time it really comes down to how accessible are companies and management teams. Are they willing to be transparent? Because we have to know what they're thinking. And so for those businesses that are willing to kind of work with the markets and be partners to their shareholders, that's really where we find ourselves.
- [34:28]
A
I'm based here in Sweden, as is Red Eye where I work. Our view of small caps might differ. Sometimes when we speak to US investors, for example, where do you draw the line for what is a small cap?
- [34:42]
B
Yes. So at reference we've given ourselves a flexible mandate. We'll invest in companies up to 10 billion US dollars, but our average holding is about a 3 billion dollar market cap. We have a few sub $1 billion. And again, you know, we're not in micro caps. We're not in very esoteric spots of the market. You know, our view is that global small caps are risky enough, it's a big enough pool and we're able to find stable businesses with very long histories, kind of at that size range that still allow for the potential for multiple decades of growth as they grow up in the mid and large cap companies.
- [35:24]
A
And you mentioned fairly concentrated. What does that mean in numbers?
- [35:30]
B
Yeah, our portfolios have roughly 30 stocks in them. So we're not at Care's 10. You know, we're not a very aggressive hedge fund with maybe eight to 15 stocks. You know, the small cap markets. And again, you know, if listeners don't, don't follow the small cap markets, it's easy to kind of lose sight of them a little bit, but they're incredibly volatile. So in our 30 stock portfolio, you know, stocks will be plus or minus 50% every single year. It's almost impossible to avoid that type of volatility. So to play in that market, we find 30 stocks is the required diversification to have a return stream that is comfortable for everyone.
- [36:14]
A
And how big could one position be in the portfolio?
- [36:18]
B
One position could be up to 10%. I think our largest positions are in the 6% range today. And again, we do want to make sure the portfolio is diversified just because in Small cap land. You never know what might happen next for a large cap. And Cray actually, he mentioned this in his book the Unknown and he talks about an earthquake happening. And today in our global investment world, it's amazing that for many large cap multinational companies, they've literally diversified away risks of natural disasters. An earthquake in one country does not really impact Coca Cola that much, which is amazing. It's not the same in small cap, you know, so the idiosyncratic risk of these stocks is very high. We're keenly aware of that. And so we use diversification as our friend.
- [37:14]
A
And what is your ideal turnover in the portfolio?
- [37:18]
B
Yeah, ideally very low. The way our process works, it's more of a private equity process. So we spend months looking at individual businesses. Ultimately, we're able to typically find two to four new investments a year. So in a 30 stock portfolio, you're looking at kind of 10% turnover of the names in the portfolio. We also managed portfolio weight, so typically turnover kind of approaches 15%.
- [37:47]
A
Okay. Because one of the things that Phil Caray is writing about in the Art of Speculation is that an essential qualification of the successful speculator is patience. So how do you practice that in reality?
- [38:02]
B
Yeah, absolutely. I mean, and I think, you know, our goal is to, you know, hold many of these businesses, you know, for over 10 years and truly have that patience. You know, it's, it's easy to talk about buying and holding, you know, it's easy to say that you should never sell businesses. But in reality, you know, and I think Craig was aware of this too, you know, we make mistakes. And when you invest in the business, you know, we try to do, you know, as much diligence as we can before you invest. But diligence continues after the investment. You, you continue to learn more about the business, you continue to get closer. Once you've invested, you can often have more, you know, open and honest conversations with management teams if they view you as a collaborative shareholder. So as you learn more and more, you know, in a 30 stock portfolio, you are going to find mistakes. So we're certainly going to be wrong on at least five of the 30 stocks in the portfolio. And when we discover that Cray also said to sell your losers, you need to get out and put that capital in a place where it can be better served. We're trying to strike the right balance of that patience with our own fallibility.
- [39:18]
A
And as a small cap investor especially, I think you're more often forced to be selling your shares because there's a bid on the company and these kind of extraordinary circumstances as well.
- [39:31]
B
Yes, it's absolutely true. Historically, on average, a fair driver of our selling has been into buyouts. So companies are taken away from you. You need to redeploy that capital. You know, it's, it's usually at the worst time. You know, of course M and A activity is, is most, you know, active when, when things are really good. So it's often hard to reinvest that capital, you know, but we're never sad, I guess to get nice premiums on, on the quality businesses we own.
- [40:00]
A
Yeah, it's, it's something I hear sometimes from people. They are hoping the, the case for, for owning the stock is, is a lot of it is attached to hoping that there's a bid on the company. And now I have kind of realized that when you hear that, then you know, it's probably a value trap. You will just sit waiting for that bid and if that's the only thing you want out of it, your, your upside is pretty capped because then probably the company can't grow as much and redeploy the profits at a good, good clip.
- [40:29]
B
So I, I completely agree with you. And yeah, it's amazing how you can do the valuation work and see this upside and think someone should buy this and make 50% and why aren't they doing it? And then you look at the M and A that actually gets done and it's a sad save the markets. But CEOs are more interested in buying growing businesses regardless of the price because that looks great in their financials going forward. So I do think we oftentimes as value investors trick ourselves into seeing these 50 cent dollars when maybe no one's really willing to do the work to extract that 50 cents.
- [41:11]
A
Then of course it's different if you have so much capital that you could actually do the buyout yourself and create value in that sense. That's the more activist style.
- [41:22]
B
Yes, absolutely. And it's interesting that you mentioned that my background in private equity and I worked at an activist hedge fund for a brief time as well. And I think there is a lot of opportunity, particularly in small cap, to collaborate with businesses. Companies in the small cap markets, they are resource constrained. They don't have the ability to hire consultants to do new projects or outsource a lot of due diligence on a large acquisition pipeline. So I think increasingly investors are going to come back to the small cap markets and realize that there's a way for shareholders and management teams to really work together to create value and so I think that it's an exciting opportunity when the world remembers that small caps exist someday.
- [42:17]
A
That's a good point. And as an investor, how do you structure your days? Do you have any habits that are helping you? I guess you're reading some part of the day, but how does it look like?
- [42:28]
B
Yeah, you know, I think I keep waking up earlier and earlier and I think it's just as you get older. But, you know, the best part of the day to be, you know, is being able to drink coffee and read in the morning, you know, as the sun's coming up. So, you know, it's amazing that part of your job can be doing that. Right. And it's a productive time spent. So I tend to do all of my reading and hard tasks in the morning and I'm increasingly pushing to the afternoon, more of the Excel modeling, client service, operational, things like that. And I think that's served me well. The nice thing here in Denver is the US market's open at 7:30, so everything's kind of up and running nice and early.
- [43:13]
A
And when you select a book, I mean, you said you have hundreds of books. How do you choose which one to read next? Or do you read one consecutively or multiple at the same time?
- [43:23]
B
Yeah, so I've started reading multiple at the same time. So I am a person that has a very difficult time putting down a book without finishing it. And you know, and I know great readers tell you you have to do this, you have to quit on a book you don't like. And I still struggle with that. But what I find is I'll just start another book. And so I end up with kind of three or four books kind of floating around the house. And, you know, I'm not only reading investment books, you know, sometimes that, that can be a bit of a slog. You know, reading about railroad bonds in depth, you know, from Cray, is, you know, sometimes not the most enthralling. So what I've started to do is, you know, I love having having the books in the house because I could just look at the bookshelf and just see what looks interesting. You know, is it an old war novel? Is it a mystery novel, Is it sci fi? Is it investing? And I find if I pick something that I'm kind of drawn to at the time, I can get through it faster. So I keep rotating around that way.
- [44:22]
A
And how do you keep track of all the lessons from the books?
- [44:27]
B
Yeah, so I actually have. I use Evernote for this, but it could be OneNote. I have a section for every book I read. I tend to take pictures of the pages I like, so I end up uploading them into the Evernote sections with the notes. So, you know, after, after 10 years of doing this, I have quite a repository. You know, I mostly do this for the financial books, but an ability to kind of search through different quotes and pages and things I found interesting, which actually makes reading the books more rewarding, you know, being able to, you know, it's hard, I guess, if you're just starting to get into reading these old financial books, but once you do, understanding that Buffett knew Carre and his writings reflect, you know, Philip Fisher, who wrote a book just a few years later, and you start to weave all these pieces together, and it actually makes it more interesting to understand, you know, what's being written about.
- [45:18]
A
And besides the investing books, what other types of, like, categories or types of books are most relevant, do you think, in your role as an investor? Where do you learn the most from?
- [45:32]
B
Yeah, you know, I would say I learn a lot from reading, you know, kind of leadership and management books, you know, that maybe CEOs themselves are reading. And, and I, I like doing that because, you know, then in conversations with management teams, I think it gives me better questions to ask, you know, how are you supposed to evaluate leadership if you don't know what the cutting edge of leadership is today? You know, so oftentimes I find that, you know, to be just as valuable, you know, as understanding, you know, historical psychology in the financial markets. At the same time, I'd say I think the reason I love investing is I think reading nearly anything is helpful. You know, sci fi, you know, can give you a futuristic look at the world, you know, and maybe that helps you in some of your growth investing, you know, classic novels and Tolstoy, you know, you get a sense of what it was like to live in the late 1800s, you know, and, you know, how hard it was, you know, to motivate the, the serfs, you know, that were supposed to be helping you with farming, and then you can connect that to leadership today. And, you know, how do you motivate people to work for your business and incentivize them? You know, so I find these parallels in nearly everything I read.
- [46:50]
A
And it's definitely difficult to give book recommendations because you're. You have so many different books to choose from, and it's, of course, very personal for our listeners, who they are, what, where they are on their journey and so on. But are there one or two titles that you think more investors should read to become better?
- [47:13]
B
Yeah, so there's a very dry one, but a good one. It's called Creating Shareholder Value by Alfred Rapoport. And that business mathematically shows how growth either creates or destroys value. And so I think having that understanding is important for any type of investor. And it's really the math kind of underlying craze insight as well as the insight of others into the retained earnings. So that was a book I read a long time ago and really opened my eyes, I guess, to how to think about business models, you know, and it kind of connected to the models I'm putting together in Excel, understanding truly what are the drivers of value there, you know, I think another book I, I read recently was what I Learned About Investing from Darwin. I think that's the name that was a much easier read and a really wonderful, you know, kind of way to look at fundamental investing, connecting it to Darwin with some very interesting chapters. So a much lighter book, but I found a lot of insights in that one as well.
- [48:20]
A
Perfect. Pulak Prasad is the author of the second one. We'll put those in the show. Notes. Have you written anything yourself or do you have any ambitions to write anything that could be compiled into a book? Maybe.
- [48:33]
B
So I've started writing short blog posts for the last couple years and so, you know, I find I really enjoy the writing. It's great to get thoughts on paper. You know, I think from listening to your podcast, you know, you always ask authors would they write another book and they seem to universally hesitate and I would say no. So I don't know if I, you know, I would love to. Being a published author seems very cool and I think I would love to do that. I'm just wondering why all the authors say that they never want to do it again.
- [49:06]
A
I think most of them are saying it because they are worried about their, their marriages. It's not so much about them not wanting to write. It's of course a lot of work and they need to put in the time. But it seems like it's, it's such a drag for their whole, like the rest of their life is really on hold or it can't be as active. So that's main driver. According to what I have heard in
- [49:32]
B
the conversation, there's something about this process, you know, so I enjoy writing. I don't mind that. So I don't know, there's something about the process of making it a book. It's sounds like that becomes extraordinarily challenging. So, you know, I Give a lot of credit to all the published authors I guess you have on here.
- [49:47]
A
Yeah, that's definitely one of the reasons why we have this podcast and why we are so keen on reading books and you as well. There is high quality. There's so much work being put into making a book, hours and hours. And you can buy that for, I mean, 5 or $10 for the old books, secondhand maybe, or $20 for a brand new book. It's, it's, it's not much for what you can get out of it.
- [50:11]
B
Absolutely.
- [50:13]
A
Ryan Bunn, thank you so much for coming on Investing by the Books podcast to talk about you and the great book that you selected, the Art of Speculation. Do you have something more you want to add here before we finish up?
- [50:25]
B
You know, I'll just say thank you for the opportunity and thank you for writing this podcast. You know, for, for all the listeners. I mean, anyone that, that'll read something longer than a tweet today, you know, I, I think it's valuable time spent, so it's great to have this passion continuing.
- [50:40]
A
Great. And lastly, where can our audience follow you and potentially get in touch?
- [50:44]
B
Yeah, so I'm on LinkedIn, Ryan Bun Bunn, and the firm's website is referenceequity.com. there's a link on the website that you can email me directly. So I'd say if anyone is even considering reaching out, please do. I love chatting with people and meeting new people in the space, so we'd love to have some connections coming out of this.
- [51:05]
A
Perfect. Thank you so much, Ryan, and all the best.
- [51:07]
B
Wonderful. Thank you, Eddie.
- [51:10]
A
Thank you for listening to Investing by the Books, a podcast by Red Eye. Follow us on Twitter Brad Eye and email us at IB Podcast to improve. We'd love to hear your feedback, so please rate and review us. Notice that the content in this podcast is not and shall not be construed as investment advice. This information is meant to be informative and for general purposes only. For full disclaimer, visit Redeye Se. I'm your host, Eddie Pomian, and until next time, I sincerely wish you the best of luck on your journey through life and investing.