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The Investor's Podcast (We Study Billionaires) - The Investor’s Podcast Network
TIP736: How the Best Investors Execute w/ Clay Finck
01:12:34
Clay reviews Lee Freeman-Shor's book — The Art of Execution, where he studied 45 of the world's top investors over seven years.
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You're listening to tip.
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Great investing isn't just about finding the right ideas, it's about how well you execute on them. In today's episode, we're exploring the Art of Execution by Lee Freeman Shore, a book that uncovers what the world's top investors do after they buy a stock and why that matters far more than you might think. Freeman Shore studied the trades of dozens of great investors and what separated the winners from the losers and how the execution of their investments played a critical role in their success. He breaks down investors into tribes, from rabbits who freeze when the market moves against them, to assassins who cut their losses with precision, and connoisseurs who ride their winners far beyond most people's comfort zones. With that, let's jump right into today's episode on the Art of Execution by Lee Freeman Shore.
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Since 2014 and through more than 180 million downt downloads, we've studied the financial markets and read the books that influence self made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host play. Think.
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Real Quick. Before we get into the content here, I wanted to mention that we're getting down to just 10 more spots left for our summit event in Big Sky, Montana. In late September of 2025. We'll be gathering in the mountains to connect with kindred spirits, share ideas, have engaging conversations, and enjoy delicious food in a wonderful setting. Our goal is to create an unforgettable experience for you and help you develop friendships that will last a lifetime. To learn more and secure one of the last spots, you can go to theinvestorspodcast.com summit on today's episode, I'll be sharing what I learned from reading the Art of Execution by Lee Freeman Shore. This book was released in 2015 and at the time Shor managed over $1 billion in multi asset strategies. In 2012, he was ranked as one of the world's top fund managers in Citywire 1000. I first heard about this book from my friend Ardal Low Groninger, who recently gave a presentation for our Tip Mastermind Community on his learnings from his career in starting his own investment firm. Ardal had mentioned to our group that he's read hundreds of books on business, investing, finance and psychology, and one book he recommended during this presentation was this book by Freeman Shor. So I picked it up and I thought it tied in really well with the concepts we discuss here on the podcast. From June 2006 through October of 2013, Freeman Shor studied the trades of 45 of the world's top investors and analyzed how they approached the game of investing. Interestingly, he had given each of these leading investors between 20 to $150 million to invest in what he called his best ideas fund. He figured that if he picked the world's top investors and invested in each of their highest conviction ideas, then surely he would be well positioned to make a killing. Well, it ended up that the fund he put together here underperformed the market. He was shocked by the results, to say the least. Only 49% of the very best investment ideas made money. And even more shocking was that some of these legendary investors were only successful 30% of the time. He had employed some of the world's greatest investment minds on the planet and asked them to invest in only their very best, highest conviction money making ideas. And yet the chances of them making money were worse than a coin toss. Despite some of these great investors only making money on one out of three investments, overall, almost all of them did not lose money. And in fact, they ended up making a lot. At this point, it wouldn't be a surprise to many of our listeners that the gains from the big winners far outweighed the losses from the losers. As Peter lynch said, if you invest $1,000 in a stock, all you can lose is $1,000, but you stand to gain 10,000 or even 50,000 over time, if you're patient. These findings led Freeman Shore down a rabbit hole of analyzing every single trade these investors made over a seven year period to try and uncover their secrets. And in the process, he discovered that stock market investing is not about being right per se, far from it. Success in investing comes down to how great ideas are executed. He writes. Here I have come to understand that if successful property investing is all about location, location, location, success in equity investing is all about execution, execution, execution. Then he shares this great quote from Thomas Edison. Vision without execution is hallucination. This reminds me of what Thomas Phelps talked about in his book 100 to 1 in the stock Market. Phelps wrote, to make money in stocks, you must have the vision to see them, the courage to buy them, and the patience to hold them. While many value investors like to get enamored with the numbers and the metrics, much of what the great investors do is peer into what a company could become years down the line. Just as an example here, investors that looked at Amazon and said it wasn't profitable and didn't have a viable business model, they couldn't see the vision that Bezos had for the company 10 to 20 years down the line. Despite the company looking optically expensive, with the benefit of hindsight, there was a tremendous opportunity there for those who understood the possibility of what lay ahead. There's also this belief amongst many that the hidden gems largely aren't available to the public or the information eludes us mere mortals. Freeman Shore believes that this could not be further from the truth and that no specialist knowledge is required to be a great investor. So Freeman Shore found that the key to successfully executing great ideas and making big gains comes down to the actions you take after you've invested in an idea and find yourself holding a winner or a loser. For that reason, he split the book into two parts. One for when you're holding what you thought was a winning stock that ends up being a loser, and the second for when you buy into a great idea and it ends up working in your favor. So let's start with part one here, which covers what the world's greatest investors do in losing situations. I'm sure that pretty much every listener has been in the situation where they've lost a lot of money and there's massive uncertainty and negativity surrounding their investment. And I'll be the first to say here that I certainly have. In this part, he has three different tribes of investors that he outlines and he refers to them as the Rabbits, Assassins and Hunters. Rabbits refers to those investors who lost a lot of money and ended up being fired by Freeman Shore, while the Assassins and Hunters were able to turn their losing situations into winning ones and adopted different methods to get them out of the hole. So the Rabbits were the least successful group of investors that Freeman Shore had invested with. He keeps the names of the investors anonymous for the book for obvious reasons. But you know, many of these investors are well known and celebrated figures on Wall Street. While most people aren't able to get access to such high profiles, freemanshore was able to get access to them because he had invested eight figures to get access. One of the Rabbits invested in Vike Communications, a UK based company that specialized in software that allowed users to make telephone calls and text messages over the Internet using their mobile phones, computer or normal landlines. Very big things were expected for this company because it basically meant that users could more or less make international phone calls for free. This seemed like a huge deal that could just revolutionize global communications. The investor bought shares in Vite Communications in October of 2007 at 2.1 pounds per share, which unfortunately was practically the share price's peak. Once the share price started to fall, the investor purchased more shares which is what you should do when you're sticking with the stock for the right reasons. As the stock continued to fall, the investor continued to stick with it, but refused to put more money to work. Two and a half years later, in July of 2010, the investor decided to sell his entire position. He was down a whopping 99%, selling at 0.02 pounds. Ouch. Unfortunately, I also know this feeling as I lost around 99% of my capital on my very first investment that I made when I was 18. My lesson from that was not to take stock tips from your good friend's uncle, who's a stockbroker and presumably knows what he's talking about. If we assumed an average return of 8% in the market going forward, it would have taken this investor 60 years to make all his money back, which in aggregate would require a 9,900% return just to break even. Freeman Trore writes here, the rabbits often dug tunnels that were so deep they never saw the light of day again. Why did they make this mistake? So many times I've used a slightly jokey name for this investing tribe, but the fact is their flaws were very human. He then goes into the 10 key factors that led to these types of investment mistakes. The first one refers to research that Amos Tversky and Daniel Kahneman shared, which can be referred to as the framing bias or anchoring heuristic. Essentially, the mistake with a company like Vike was that the investor had a story in their head that they were anchored to. Despite the stock continuing to drop and huge red flags being present, the investor was anchored to the blue sky story and always viewed the stock as attractive. They think the stock may be down, but the thesis is not broken, so the price will eventually turn around. The key lesson here is that when something happens that you did not anticipate which has negatively impacted the investment thesis or story, then it's critical to update your views in light of that new evidence. In the case of Vike, the new disturbing evidence that arose was dismissed and they were lucky to get any money out at all because in 2011 the firm was delisted and eventually went bust. Related to this is the primacy error, which describes the way that first impressions have a lasting and disproportional effect on a person. A classic example of primacy error in real life is love at first sight. It's also demonstrated by newly hatched ducklings. The first living thing that a newly hatched duckling sees immediately after hatching, they take to be their mother with the Rabbits. First impressions were often everything. As a result, they thought it was no big deal when they first started to lose money on the name. The investor who bought Vike was so in love with where they thought the firm was going, it took them two and a half years of watching the stock decline to finally change their mind on the company's future. When a business is underperforming and the stock is falling, I think it can be easy to trick ourselves into thinking that the tides are just about to turn. When a business that's executing on all cylinders becomes a company that's faltering, then it might take quite a bit of time for that business to turn things around, if they ever do. Another interesting bias he shares is the endowment effect. Let's imagine a scenario where you buy an ounce of gold today for $3,000 just to use round numbers, and let's say that tomorrow I offer to purchase that from you for 2000. I think most people would kindly decline that offer. However, would your response change if I opened up the newspaper and showed you that the price of gold had crashed overnight to $1,000? Most people probably still would not take the $2,000 I offered them, primarily because they now have a vested interest, so they believe that their bar is worth more than the price being offered. This is known as the endowment bias. If the market price really did crash to $1,000 and I asked you what you would take for your gold, the response would still likely be $3,000 or more, since that's the price you paid and now that's the price you're anchored to. Freeman Shore found that based on his own experience of managing a team of investors, large losses that happen over a short duration are almost impossible to accept, especially when they're substantial. It's easier to hold onto a losing position than realize the loss by selling. Rabbits were far too concerned with the price that they had paid and largely wouldn't seriously consider selling until the price had exceeded what they originally paid for the stock. Investing is sure a humbling game to play once you realize that that even the greatest minds on the planet can be totally wrong and off the mark. Freeman Shore's findings suggest that you should expect to be wrong at least half the time. Even the very best investment minds are. Another bias he points to is the self attribution bias, which is when we blame others or external factors for our misfortunes but take full credit when things go well. It's one of the key reasons that investors don't learn from past mistakes, but just keep on repeating them, he writes here. It never ceased to amaze me how many times the same two villains popped up in the stories told by Rabbit's harboring a losing position. It's either Mr. Market or the market is just being stupid. Or his sidekick Mr. Unlucky or it wasn't my fault I was unlucky because of XYZ reason that no one could have foreseen. No one wants to admit that they were wrong. It's more comfortable to seek out information that confirms our existing beliefs and rather than disproves it. One of the things that Freeman Shore found in his research was that when the going gets tough, it's common for the leader or manager to outsource responsibility. Many times they'll include more people in the process because when there's more people involved, they can relax because you know they're not the sole person that's going to be blamed if things go badly. You can of course imagine seeing this at top investment firms that utilize investment committees where the group makes decisions together. Or you can see it within companies where the board members don't want to make the big decisions, so they hire financial consultants or external advisors to help them make the decision for them. Another interesting point here that he shares that I hadn't really considered before is that many managers are less inclined to walk away from a large losing investment than a small losing investment. It might be really easy to say I was wrong by selling a 1% position at a 20% loss or but if you put 20% of your portfolio into one stock and all of a sudden it's down 50%, you're probably much more likely to think that that stock's now trading at a huge discount. He refers to this as the denomination effect. Another way to frame it is that we find it far easier to spend lower denomination dollar bills than higher dollar bills. So we might go out and buy $5 coffee 20 times and you know, feel nothing because we're spending these small amounts. But spending $100 all in one swoop can be a bit painful for someone who likes to save money. The same concept can be applied to our portfolios. Alright, so what could the rabbits have done differently to prevent these catastrophes? Freeman's Shore suggests always having a plan. Investing is all about probabilities, and odds are that there are stocks in your portfolio that are going to be losers. He recommends having a plan for what you would do if a stock you own falls by 20% or 50%, for example, when faced with the painful loss making position, most people do nothing. I've had two stocks that I've sold myself over the past year. That would be Evolution AB and Technion. I didn't sell because I was necessarily bearish on either of them, but I felt that I had potentially missed the mark on the quality of these businesses. It would have been easy for me to say that eventually these stocks will recover, but the market was telling me otherwise. I allocated that capital to names like Topicus, Lumine and Booking holdings, which the market has so far rewarded me for over the past six to nine months, which is a very short time period and I think the key word there is so far. I feel like this next point is a bit controversial or contrarian. Freeman Shore he claims that when you find yourself holding a loser, you should do one of two things. You should either sell out completely or significantly increase your stake. He writes here, if a stock price is down after your investment, the market is telling you that you were wrong. If you really believe you were right to invest in that company, then you were clearly wrong in the timing. The sooner you acknowledge you have made a mistake and take steps to deal with it, the better your odds of achieving a successful outcome. Ask yourself the key question I now ask all of my investors. If I had a blank piece of paper and were looking to invest today, would I buy into that stock given what I know now? If your answer to the above question is no, or maybe then you should sell it. If you conclude that you would not buy the shares today but find that you cannot push the sell button, be aware that this is because of endowment bias and not a logical investment thesis. Sell. End quote. So I personally don't believe that we should follow this advice at all times. I see many great investors simply hold onto a stock during a drawdown and it isn't always necessary to add, especially if you already have a substantial position already built. Freeman Shore also points out the importance of humility. The Rabbits were incredibly smart. Many of them had MBAs, CFAs and other letters after their name that suggested they had an analytical advantage over the rest of the market. Believing that you're smarter than the market can lead to overconfidence, which can be a really dangerous mindset. The first reason for this is that it assumes that the market is made up of buyers and sellers who are not equally smart. And second, knowing more often leads a person to missing the forest for the trees. History is riddled with poor forecasts and predictions made by smart people. For example, in 1998, Nobel Prize winning economist Paul Krugman stated the growth of the Internet will slow drastically. By 2005 or so, it will become clear that the Internet's impact on the economy has been no greater than the fax machines. Sometimes it can be easy to say that the market has it wrong when we see a declining stock price. But sometimes the crowd can be surprisingly wise. In fact, the market can even be right, even though everyone who makes up that market is individually wrong. So let me explain a bit by what I mean by that. Michael Mauboussin did an experiment in 2007 with his 73 Columbia Business School students. He had a jar full of jelly beans and asked his students to guess how many beans were in the jar. Answers ranged all the way from 250 to 4,100. The average of all the guesses was 1,151 and the actual number in the jar was 1,116. Despite the average only being 3% off the mark, only two of the 73 students gave guesses that were closer to the real number than the average. So it's really interesting here that your typical student was far off the mark in the estimate of how many beans were in the jar, but the average was still really close to what the real value was. So how that might translate to the stock market is Most people can be totally wrong about a stock, but the stock price that the market is offering you can still be relatively close to its underlying intrinsic value. Another point that Freeman gets to here is that you don't have to make your money back the way you lost it. For a stock you bought at $100 that's now $50, it's easy to say that you made a mistake and you'll wait until you break even before getting out.
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Once you realize that your original investment thesis is no longer intact, then it's likely best to just move on and earn higher returns elsewhere. Minimizing our losses is essential. Of the 946 investments that he analyzed, 2% had lost more than 80% and 14% lost more than 40%. So once you're down a substantial amount, then it takes these massive gains just to get back to even. If you're down 50%, you need a 100% gain to break even. If you're down 80%, you need a 400% gain to break even, and so on and so forth. The other thing about stocks that are down significantly is that the big comebacks are rare. Some investors, when they're down 90%, might think that it's just dead money and they might as well just let it ride. Of course, there are examples of these comebacks, but we shouldn't bank on them without a good reason for it. I would say that the major takeaway is just to be open to changing your mind when you find yourself holding a losing investment. In many cases, if a Stock drops by 50%, the market's telling you that you're wrong. And you need to have a pretty good reason for continuing to hold shares. If the business's fundamentals seem to be pretty strong still, then you may consider adding to your position. And if the thesis has substantially changed, then it might be time to consider getting out. Many times I've referenced here on the show the case study of Meta in 2022. In November of 22, shares were down below $100 a share, and this represented a 75% decline from its previous high. And believe it or not, Meta traded for less than 10 times earnings at that time. There were, of course, some good reasons for that. The company experienced a revenue decline on the year for the first time ever, Zuckerberg seemed pretty adamant on investing tens of billions of dollars into the Metaverse, which showed practically no promise of delivering a return for shareholders. Apple introduced some privacy changes that reduced Meta's ability to track users across apps, which impairs their ad targeting and measurement. Costs were out of control and they had a declining user growth and user engagement. In light of the rapid rise of TikTok, it felt like anything that could go wrong for Meta was going wrong at that specific point in time. Fast forward to June 2025. Here shares of Meta are just shy of $700 a share, representing nearly a 700% rise from the low in November of 22. Zuckerberg reined in costs to increase profitability. They laid off over 20,000 employees and slowed hiring, signaling to shareholders that they were being more disciplined in their capital allocation decisions. Meta overcame the Apple privacy changes with the help of their AI models that improved ad performance, driving higher ROI for advertisers. Ad revenue in 2023 increased by 16% after that decline they saw the prior year. And most importantly, the narrative completely changed. The PE ratio of Meta went from around 8 to 37 in less than a year. That's over a 360% increase in the share price just from multiple expansion. Unless you believe that Meta's business model was broken and in the midst of a permanent decline, then it likely wouldn't have been wise to sell shares in light of that decline. I think the case is clear that Meta's moat is pretty strong and they're able to at least sustain their existing business for a number of years, ignoring any potential for future growth. Being able to weather through drawdowns of great companies, I think is an essential skill set. It can be incredibly difficult to separate the signal from the noise and determine whether the business's long term success is in jeopardy or not. I like to give a business some sort of leash for underperforming in terms of its fundamentals. Every stock is bound to eventually have a bad quarter. And let's say if a stock has, say, six underperforming quarters in a row, for example, then that might be time for me to consider moving on. And maybe the company simply wasn't as good as I initially assessed it to be. The other thing to realize is that it's totally normal for a stock to suffer through a decline. If we assume that investors value a company based on its future cash flows. You can play around with the DCF model and quickly see that you can get a 30 to 50% difference in the business's intrinsic value just by slightly tweaking some of your assumptions. So as the daily news flow comes through and the company releases their quarterly updates with some decent volatility in the results, you're going to see these occasional 20 to 30% declines in about any business. We just don't know exactly when they'll occur and how severe those declines will be. Having the ability to sit through drawdowns can give an investor an immense advantage. Peter lynch once said the key to making money in stocks is not to get scared out of them. During Lynch's time running the Fidelity Magellan Fund, he delivered average annual returns of 29% per year over 13 years and experienced three drawdowns of 20% or more for his fund. The inevitability of drawdowns also highlights the importance of knowing what you own and having conviction in where a business is heading. When you know a company has a durable competitive advantage, a strong balance sheet, and a proven track record of generating shareholder value, you're far more likely to stay the course when others are selling in fear. It's also empowering to know that volatility and drawdowns are the price of admission to earning superior returns. Many people simply can't stomach the volatility of the stock market, which presents an opportunity for those who know what they own and can effectively navigate through those drawdowns. This brings us to the discussion of the Assassins and the art of killing losses. This chapter felt a bit more like taking a trader's approach to investing than that of a long term value oriented investor, but some of the principles can still apply. I think the assassins did an excellent job of limiting their losses and not letting their emotions get the best of them by relying on a framework that drove their decisions. So this ties into the earlier point of having a plan in place. Once you enter a position, it can be easy to have a position going against you and to simply change your thesis on that investment. For example, perhaps you bought into a high quality growth stock. All of a sudden it's turned into a turnaround play with many underperforming segments. Another point he has here that I liked is one of the things that I think good investors do well is to only make big decisions when they're in a good emotional state. So if you're exhausted, overly stressed, or just not in a good state of mind, then it's probably best to avoid making big decisions because it's just much more difficult to think rationally. This is exactly when you're prone to be making a big mistake is when you're not feeling well and you're making these decisions based on your emotions. On the topic of drawdowns and reevaluating positions, I think it's also important to think about why the market is selling off a certain name. So at times there are these exogenous factors that essentially bring the entire market down. So think about March 2020 during COVID or the Great Financial Crisis. Essentially anything that was publicly traded was being sold off because of this liquidity shock and the tremendous amount of uncertainty that was in the market during these times. I think it's especially important not to panic sell because history tells us that stocks have always recovered from such exogenous shocks. Now, when it isn't this type of shock, we need to take a real close look. So through mid June 2025, the S&P 500 and NASDAQ are roughly flat on the year. So if you own a stock that's down say 30%, then it's likely due to the business itself or the industry they're in. One well followed example is LVMH, which is currently down over 50% from its high a couple years ago. I don't have a strong view personally on the company, but many believe that it's a well run business with very good management. Growth has slowed after the boost they had post Covid and revenues even saw a decline in 2024. It appears that LVMH is suffering from softer demand in China, which represents around 30% of their business. And they reported that sales in Asia, excluding Japan, dropped over 10%. So LVMH seems to be in this situation that they have a number of things simply not going their way. There's this weakness in China, the uncertainty around tariffs, and then investors just might be a bit concerned about the succession plans as Bernard arnault is now 76 years old. According to FinChat, LVMH is at an EV to EBIT ratio of 13. That's the lowest that metric has been since 2016, and it's even lower than the drawdown in March 2020. And one caveat I'll add here is that the company's implemented some price increases and I think this might put pressure on their growth that they're going to see in the future. So, you know, not all multiples are created equal. Just because this multiple is lower than March 2020 doesn't necessarily mean that today's price is a bargain. So if they overdid the price increases and earnings end up declining, then Investors might find that the multiples you're seeing today could potentially be high. Again, I'm no expert on the luxury industry, but those are just my general thoughts. Freeman Schorr he shared some research on how investors behave after selling a loser. Research from Mike Thaler and Eric Johnson suggested that once a person has sold a losing investment, their behavior can potentially turn a bit risk seeking, which they refer to as the break even effect. Some professionals might feel that they need to turn their losing situation around or else they face potentially being fired. When you sell out of a losing position, you're really making two decisions. First is of course, that that stock is no longer a good idea to have money in. And second, your money would earn a better return being invested elsewhere, which is referred to as your opportunity cost. But the lack of another compelling opportunity should not prevent us from exiting a poor investment, as we always have the choice of temporarily holding cash before we get it allocated elsewhere. Selling a position can really be a difficult experience for many, even if you feel like, you know you should not be holding that business. Research from Kahneman and Tversky found that the pain experienced from losing $50 is far worse than the joy we experience from winning $50. This means that we can find it easy and pleasurable to sell a winning stock and difficult and painful to sell out of a losing stock. And the idea of the potential for regret if the stock rallies after we sold can really paralyze us into inaction and indecision. This brings us to discuss hunters who are the investors that found themselves in losing situations, but instead of selling out of their position, they doubled down and bought more shares. As I alluded to earlier, once a stock has a big drawdown, statistically it doesn't have a great chance of recovering and making new highs. So it's a bold decision to double down on a stock that's down, say, 30 or 50%. These types of moves are typical of a contrarian value investor. They see a future that the market largely disagrees with, and they're able to find these market inefficiencies. In taking this approach to buying discounted assets, you have to be very patient because it can take some time for the market to appreciate that underlying value. Peter lynch once stated, I'm accustomed to hanging around with a stock when the price is going nowhere. Most of the money I make is in the third or fourth year that I've owned something. I like to think about how certain stocks attract a certain shareholder base. If a company has growth rates in excess of 40% for a number of years, that is going to attract a lot of growth investors, which elevates the share price. And as the shares gain momentum, this will inevitably attract momentum investors. And many value investors will get out when the valuation gets a bit ridiculous. When that growth slows, the shares start to sell off and it might enter a secular downtrend. If that growth continues to stall. Once the stock falls below a certain point, the momentum investors are probably the first ones out. And if the 40% growth metrics simply aren't there anymore, then the growth investors will be next to jump ship, causing a further decline in the share price before the shares hit some sort of floor and value investors create that new base in the share price. There are cases where Warren Buffet would have been considered a hunter by buying beaten down shares. The most classic example is him buying American Express. American Express was a textbook case study of being greedy when others are fearful and buying a good business when the market unfairly punishes the share price. American Express went through the salad oil scandal in 1963, where the company was liable to pay tens of millions of dollars in the scandal, which sent the share price plummeting. But Amex's cash cow was totally unrelated to the scandal. So just to make sure that the cash cow wasn't really impacted in the minds of consumers, Buffett went around and did this scuttlebutt research by visiting businesses to see what their view was on Amex in light of that scandal. And all of his research suggested that not only was their core business in a really good position, it was actually accelerating despite the core business firing on all cylinders. The stock traded at less than half the market multiple and had a double digit growth in revenues and earnings over the previous decade. Buffett made this stock a 14% position in his partnership, and the shares compounded at over 30% per year over the next five years before he exited that position. So there could be a number of things at play as to why a manager wouldn't add to something if it's at a better value than when they initially entered the position. The first could be that they simply don't have the cash to do so and they aren't interested in selling their existing positions. Another reason that's more fascinating is that they don't want to introduce career risk. If a manager were to bet big on a name and double down and be wrong, then that could really hurt their reputation as an investor. And it could potentially lead to investor outflows forcing them to sell at potentially inopportune moments. Michael Lewis book Moneyball also highlighted the prevalence of career risk on Wall Street. With all of the peer pressure that can be present, loss aversion can be amplified. For investment professionals, the pain of being the one investor who went bust and is publicly humiliated is much greater than the joy of having the best investment returns. This incentive can lead managers to pick a strategy that is least likely to fail, rather than doing what they actually believe is best for their investor base. Viewing things through this lens, it can make sense why many managers aren't excited to add to their big positions that are down substantially. This brings us to part two of the book, which covers how these great investors handled the winners in their portfolios whose share prices had increased. So in this part, Freeman Shore gets into what he refers to as the Raiders and the connoisseurs. Raiders are those that bought a winning stock but sold out too early, and connoisseurs are those that bought a winning stock and rode their winners. Starting with the Raiders, the Raiders are the stock market equivalent of Golden Age adventurers having penetrated through the dense jungle, found the lost temple or buried treasure, they filled their pockets with all their ancient coins and gems they could find, then turned their tail and ran. Unlike Golden Age adventurers, they are rarely chased by angry locals or rivals. The only boulders rolling after them are in their imaginations, and they are terrified of getting caught and losing everything. Since our winners can offer hugely asymmetric payoffs, Freeman Shore does not suggest behaving in the way that the Raiders did. One of the investors he invested money with had an incredible hit rate on his investments, making money on 70% of his bets. And however, he hadn't made any money for his investors because he would constantly let go of his winners on a small gain of 10 or 20%. I recently had lunch with a fund manager who had bought Copart back in the 2000s and he ended up selling it in 2011 because he thought it was getting a bit expensive. Since then, Copart shares are up by more than 20x and then another example I'll share here is this year I interviewed Francois Verchon. In his letters he writes for his partners. Each year he shares what he refers to as podium of errors, where he highlights the mistakes that he's made over his career. His gold medal for 2024 was Cintas. While he never purchased shares in Cintas, it was a company that he understood the business. He understood its competitive advantages perfectly, and it was a pitch right in the middle of his sweet spot. But when he analyzed the company in 2016 after a major acquisition, he determined that the stock was a little bit too expensive for his taste, at 26 times earnings. Since then, the shares of the company have compounded at 25% per year, netting a gain of over 700% for investors over the past nine or so years. Although it can be tough to watch a company on your radar continue to run while you don't own it, it's even more tough when it's a company that you knew well but decided not to capitalize on the opportunity. Similarly, Freeman Shore found time and time again that selling a great business early was a mistake. Furthermore, because of this failure to hold winners, the Raiders would inevitably run into some large losses in due course that would wipe out the small gains that they had proudly locked in. He writes, Here I quote the most successful investors I worked with all had one thing in common. They had a couple big winners in their portfolio. Any approach that does not embrace the possibility of winning big is doomed. End quote. It's easy to see why some investors can be quick to lock in gains on winners like the Raiders did. Freeman Shore lists a number of reasons for this first, selling for a profit just feels good. When we win, testosterone and dopamine are produced and these hormones produce a feel good response. So once you do it once, we'll want to do it again and again. We need to be in touch with our emotions as investors and recognize that just because we have an emotional pull towards taking a specific action doesn't mean we should follow our instincts in that direction. Since it feels good to take a profit, holding onto a winning stock is like practicing delayed gratification. We're delaying that feeling of taking a profit one day after another each time we decide to hold onto a stock. So in a way, holding our winners is similar to choosing a healthier meal over pizza and ice cream and taking a walk instead of lounging on the couch all day. Second, buying and holding is frankly, a boring endeavor. It's more fun to make moves in your portfolio and think you're being smart by taking a small profit in one name to allocate to another opportunity. Chris Mayer outlines the importance of having a long holding period in his book 100 Baggers. As the typical 100 bagger took 20 to 25 years to Pan out. As I outlined in my episode last week, I believe one major edge that an individual investor can have is is simply patience. We live in a world where people are obsessed with the short term. What's the market going to do this year? What do you think of the tariff announcements, where's interest rates going to go? The list goes on. People are bored and they want something to happen which leads them to tinker with their portfolios. Philosopher Blaise Pascal stated, all men's miseries derive from not being able to sit quiet in a room alone. End quote. Many people would admit that stock XYZ will produce much more earnings 5 years from now, yet they're still selling or even avoid the stock now because they expect a poor quarter coming up or some other short term problem. Or worse yet, they're worried about, you know, general market concerns or these macroeconomic headwinds. Since so many people are bored and are looking for excitement, it's no wonder that many investors are interested in the current hot industry, new IPO or the latest technology trend. They aren't necessarily looking for the best risk adjusted returns, but for something that will help temporarily cure their boredom. As an antidote to boredom, it's probably better to pick up a hobby like golf or traveling rather than filling the time with forecasting, macro or constantly making portfolio changes. Freeman Shore recommends generally hanging onto your big winners because they're just so rare. The successful investors he studied all had a couple of big winners while ensuring that the bad ideas did not materially hurt them. Having a process that prevents you from winning big because you take profits once a Stock is up 20% means that you could potentially be the person who gives away a winning lottery ticket. Our gut instinct might tell us to do the exact opposite of what these successful investors do, which is to sell our winners too early and hang onto our losers with the hope of them bouncing back.
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Right, back to the show. As Peter lynch once Put it some people automatically sell the winners and hold on to the losers, which is about as sensible as pulling the flowers and watering the weeds. If we follow the notion that winners tend to keep on winning, then selling a stock that is up to buy a new stock is like rolling the dice once more. As we know that only 49% of top investors good ideas would go on to make money. The odds of these investors picking a big winner is much, much lower than that 49% metric. Freeman Shore also touched on the perverse incentives that can be present in the active management industry. The main theme is them making an investment decision for a non investment reason. For example, if a manager is awarded a bonus based on one year or three year performance, then they may be keen to sell a stock that is run up to ensure that they get that bonus at the end of the year. Or if the fund has recently outperformed the index, then they may be keen to sell the stocks that have run up with the expectation that those loftier valuations will have difficulty maintaining that same performance. And you know, that's a reasonable assumption, but it's such a short term decision in nature. Managers can especially get trapped in the comparison game of focusing on their fund's performance relative to their peers or to the index, since this is the primary selling point in attracting fresh capital. So the manager that sells a Stock that's up 30% on the year might get a pat on the back because you know, they're outperforming the index that year. They receive a nice bonus at the end of the year, but they might actually be doing their investors a massive disservice in the long run. With all this discussion on short term versus Long term thinking, many of our listeners are probably familiar with the famous marshmallow test. In the test, a marshmallow is placed in front of a young child and is told that if they don't eat the marshmallow in the next 30 minutes, they'll be rewarded with an additional marshmallow. The researchers then left the child alone in a room with the marshmallow sitting in front of them with no distractions such as TV or music. In just a few minutes. Most children tended to get fidgety and in most cases the child would succumb to the temptation and shortly thereafter downs the marshmallow. But let's face it, half an hour in a room with no toys must feel like 30 years to someone that age. Freeman Shore writes, the point of this test is that it demonstrates a phenomenon known as intertemporal choice. If something is offering us immediate pleasure, such as taking profits, we struggle to see the pain it will cause in the future. We become nearsighted and sacrifice potentially large long term gains for small short term ones. Raiders cannot help but Eat the Whole Marshmallow End quote. And this brings us to the final type of investor outlined in the book. This is the Connoisseurs. The connoisseurs are the last and most successful investment tribe discussed in the book. They treated every investment like a vintage of wine. If it was off, they got rid of it immediately, but if it was good, they knew that it would only get better with age. When it came to the marshmallow test, the connoisseurs would have been the ones who resisted the urge to eat the marshmallow. One of the funny points that Freeman Shore makes in the book is that connoisseurs aren't any smarter than any other investors. In fact, they had a worse hit rate on average. Their secret sauce was that when they did find the occasional winner, they won big. As Freeman Schwarr puts it, they rode their winners far beyond most people's comfort zone. He shared a few more points here that he picked up from the connoisseurs. They tended to look for businesses that they viewed as low, negative surprise companies this is an excellent point that Joseph Szerposhnik actually brought up on the show a few weeks ago. You want to be able to have a clear view of where a business is likely to be a few years down the road. So it needs to be somewhat predictable and it needs to keep you out of what Joseph referred to as bad situations. When you buy an unprofitable business, or an over indebted business, or a company that's clearly very cyclical or unpredictable, you increase the odds of eventually finding yourself in very, very bad situations. When you find a company with a good management team, a moat to protect their existing business, at least for the intermediate term, and you have a strong balance sheet, then you can be reasonably confident that earnings will be higher five years from now. You tend to prevent yourself from getting into those bad situations. Perhaps there are times where the entry valuation is a bit high or earnings don't grow quite as fast as you'd like. But it's better to see a minus 20% return in this situation than getting minus 80% after chasing the next hot unprofitable tech company that's nearly impossible to predict. The second point he makes here is to look for big potential upside. So I equate this to finding companies with a long Runway to grow. So if we look at a company like Coca Cola, for example, their international revenue really hasn't grown much in recent years as global soda consumption is in a decline. So their core business and their growth is largely dependent on price increases. So we can't really expect a lot of growth going forward from a company like Coca Cola. Additionally, they also pay a pretty sizable dividend. And this indicates that management really isn't looking to invest a lot into future growth. And then I look at other big companies like Amazon and Tesla, for example, I see enormous potential for growth in these companies. So they don't pay a dividend. They're reinvesting significantly in the business, hoping to be much bigger 10 or 20 years down the road. And you know, I don't own shares in these companies. I'm just sharing some high level examples in here. As a result, the potential upside, I think for Amazon and Tesla is significantly higher than say a Coca Cola. All right, third point here. Connoisseurs were also very concentrated in building their portfolio. So, you know, when they're confident in an idea, they built up big positions. They could end up with 50% of their total assets invested in just two stocks. And it was those stocks that would make them so successful. And then the last point here, of course, they would let their winners run. In the book, Freeman Shore shares a few case studies of stocks that were held for a period of around three years, which I wouldn't really characterize as a super long term investment. The big money really comes years down the line. So if we look at a stock like Costco, for example, it's up just over 100% in the last three years and it's up over 2,000% in the last 20 years. So $10,000 invested three years ago would be worth just over 20,000. But that same 10,000 invested 20 years ago, it would be worth over 200,000. So depending on your rate of compounding, oftentimes the real magic starts to happen after year 10 or so and the sum that you end up with will be substantially larger than your initial investment. And that doesn't even consider the opportunities to add to your investments along the way. However, as Hendrik Bessembinder highlighted here on the show, just a small portion of stocks are able to compound at above average rates for 20 plus years. The Pareto principle shares that 80% of the results are derived from 20% of the inputs. But in the stock market it's more like 100% of the results are derived from just 4% of the inputs. So from my perspective, if I know I'm not holding a really great company, then I just want to get rid of it as soon as possible. Now there's this widespread belief in the investment industry that more stocks in your portfolio will lead to less risk. So first off, they tend to not bet big when they find a great idea. And when the stock runs up, they either trim it, they think it's the prudent thing to do from a risk management perspective, or they might even have regulatory limits that prohibit a position from getting too large in the portfolio. This regulatory limit puts a very narrow view on the world. You could own 100 stocks that are all very risky. And you know, some might perceive that as safe because you own 100 stocks. On the other hand, one could argue that a one stock portfolio that just includes Berkshire Hathaway is, you know, very low risk, assuming you have a 10 plus year time horizon and you still be pretty diversified because you have all these different types of companies that Berkshire has exposure to. So more stocks does not always mean less risk. Freeman Shore also points to another study that outlined the benefits of concentration for active managers. Professors from Harvard and the London School of Economics, they analyzed the stock picks of active managers from 1991 through 2005. And instead of looking at the overall returns of the managers, they looked at how the managers top positions performed. And they actually found that when you group together the top positions of every manager in the study, the aggregate portfolio ended up doing pretty well and the lowest weighted positions significantly underperformed. So that actually goes contrary to what Freeman Shore talked about at the beginning of the book, where a lot of these managers didn't know where their best ideas come from. And intuitively I think that it makes sense that these great investors best ideas did do well. So I was once chatting with an active manager about the positions he held. He held two software names that were very similar businesses. So the first name was his top position, really great company. It was growing really fast. It's just a core holding of his he's had for a long time. And then the second name was just a regular holding, it was a regular weight assigned in the portfolio. And I had asked him about his thoughts on the smaller weighting because I was a bit confused why he owned it given that it's a similar business, but it's compounding at a lower rate. So presumably the return is going to be lower given that the valuations were fairly similar. So he simply said that he has regulatory limits on that top position and he just couldn't find anything better than that. If that investor were managing his own capital with no restrictions, then he likely would have made that top position significantly larger because he saw it as low risk, high returns. But the dynamic is different when you manage money for outside shareholders and you have these regulators watching you. So it goes to show that there are totally rational reasons as to why a manager would invest differently for outside investors than they would go about investing their own money. And to no surprise, his top position is also a key driver of his great performance in his fund. So being more concentrated would have really played to his benefit and potentially even not brought about any more risk at all in the portfolio. The study reference also suggested that professional investors can have a reputable skill set in picking stocks, but one of the problems they've run into is having the ability to pick a portfolio of good stocks, you know, say 20 of them that have a high probability of delivering market beating returns. So perhaps the best managers can find one, two or three ideas per year and maybe have a handful of good ideas at any one time. Then owning a portfolio of 20 to 25 stocks can prove pretty troublesome. Freeman Shore does share some cautionary tales to trying to be a connoisseur, though being a connoisseur can be the most popular thing to do in bull markets when everyone's making money. This is when concentration can hurt. You imagine buying Microsoft in the late 99 or many tech stocks in 2021. A bulk of a bull market's returns come in the final third of the cycle, which is when the most number of investors are going to get lured in and become the most greedy. It's also very easy to fall for groupthink. When a handful of reputable investors own a stock and it seems to just keep going up, then we might trick ourselves into being in a safe situation when it's actually most dangerous. High momentum to the upside can give us the illusion that we're doing the right thing when entering a trade. If you're worried about a trade or investment going too far and want to hedge your bets, you could potentially trim your position over time, especially when you feel that the stock is getting a bit of ahead of itself and relative to the fundamentals. Bubbles today are still a widespread phenomenon and we really won't be able to tell if we're participating in one or not until after it's already burst and the speculators have been washed out. Getting to the conclusion of the book here in working with many of the best investors in the world, Freeman Shore discovered that their success ultimately came down to execution. He has a brief 5 point winners checklist at the end of the book that I can share here. First, focus on your best ideas only. Odds are that you're better off investing more into your best or second best idea rather than your 50th best idea. Second, position size matters. This ties right into the first point. He encourages those who want to outperform not to over diversify. Third, be greedy. When you're winning, run your winners. You need to embrace the possibility of winning big. Embrace the right tail, the statistical long shots of the distribution curve. Stop trying to make a quick 10 to 20% and give your investments the possibility of growing into 10 baggers. Fourth, materially adapt when you're losing. Either add meaningfully to an existing investment or sell out. Both give you the possibility of changing the ultimate outcome. You can turn a loser into a winner. Expect to find yourself in a losing situation, have a plan to materially adapt and stick to it. And finally, fifth, only invest in liquid stocks. Make sure any publicly listed investment is liquid enough to enable you to execute your idea, and there's really nothing worse than knowing what to do, wanting to do it, but being unable to do it. So what he's really getting at here is that if a stock's illiquid, you might not be able to buy it or sell it as you please. So you might as well avoid such stocks that have a chance of giving you that issue. One of my other big takeaways from the book was that although we can know that a select few stocks are going to drive the majority of our returns, we really have no way of knowing which stocks those are going to be in advance. I had a discussion with my co host Stig Broderson the other day about his biggest winners. Some stocks he's bet big on and they've been flops, and others have been huge multi baggers. A couple of his positions are up 7x or 9x from their cost basis, but the thing is, he had high conviction going into both his winners and his losers. So he just, like everyone else, didn't know which investments were going to be the big winners. But once the market validated his initial thesis, he held onto his positions so they could become multi baggers 7x or 9x. And he was also open to changing his mind if the market was telling him that he was just dead wrong. Before we close out the episode, I wanted to briefly discuss the great work that my colleagues Sean o' Malley and Daniel Malka are doing over at the Intrinsic Value Podcast each week, Sean and Daniel, they break down a company's business model, competitive advantages, and valuation, and it's by far one of the best resources I found for company breakdowns. So I'll actually be having Sean on the podcast here in a couple weeks to discuss a few of the names they've added to the Intrinsic Value portfolio. And just this morning I was going for a walk to start the day and I was listening to their episode on Reddit. When Reddit initially IPO'd in 2024, my mind immediately thought, well, here comes yet another unprofitable tech company that will continuously dilute shareholders. However, Sean and Daniel are really as sharp as they come from an investment perspective, so I wanted to hear them out on the idea and hear their thoughts. And additionally, I'm actually a user of Meta's advertising platform and I've been pretty pleasantly surprised by just how good Meta is at sending my small business customers for my brother and I for our e commerce store. And I figured that if Reddit could somehow also crack the code on advertising, then there's likely some solid potential upside for investors. After listening to Sean and Daniel's episode and taking a look at the company's most recent earnings reports, my opinion on them from an investment perspective has changed a good amount. Just to throw some numbers at you here, so in the Most recent quarter Q1 of 25 revenues increased by 61% year over year. Revenues came in at 392 million. On the quarter daily active users were up 31% year over year to 108 million. Gross margins came in at over 90% free cash flow came in at a positive 126 million, giving them a 32% free cash flow margin. So after 20 years of unprofitability, they seem to be well on their way to becoming a dominant social media company. That's very profitable when you look at a company like Snapchat, another social media company, they IPO'd in 2017 and they're still deeply unprofitable today. Over eight years later in Reddit, they only have a fourth of the revenue that Snapchat has. So I was just really impressed by how well Reddit has executed recently. And they're generating a lot of free cash flow alongside 60% growth in their top line revenue. And interestingly, Sam Altman, the co founder and CEO of OpenAI, he's invested in Reddit for over 10 years he's been invested. And you know, this might make Reddit more of a beneficiary to the improvements we're seeing in AI. Another interesting stat I found was that Reddit is the sixth most searched term on Google. And to Sean and Daniel's credit, they initially passed on the stock because the valuation was a bit high. A few months back it was over $100 a share. As the valuation came down, it declined. They ended up adding it to their portfolio at $87 $10 per share. And then the stock swiftly rebounded to over 140 per share. So they have a nice gain on that position. And there are a few things that are pretty interesting to me about Reddit that I'll briefly highlight here. The first is really the potential with their advertising business. So this is really the core of how they generate revenue. When we look at the United States, their average revenue per user is around $6 in the most recent quarter, and that metric is up 30% in the past year alone. Meta, on the other hand, they generate an average revenue per user of $17 per user here in the US and that really showcases that Reddit still potentially has some room to monetize their user base. Although I wouldn't really expect them quite to get to the level that Meta's at because presumably they just don't have the data that Meta has on their users. Additionally, the AI models are really key in delivering these results for advertisers. And you know, these models are just getting better and better. So businesses are incentivized to spend more on advertising as these models get better, and they're getting more bang for their buck with their advertising spend. I'm also somewhat of an active user of Reddit. John. He explained that there are really two types of Reddit users. You have those that go to Google, they search a question and just add Reddit at the end of the query. And then you have users who just scroll Reddit's feed or they're on the app, just scrolling through the app and I fall into the first category, the former. For example, I was looking up someone to get golf lessons from here in Lincoln, and I got an excellent recommendation from Reddit. So Reddit's great for answering all sorts of very specific questions, whether it be something local or something within a very specific niche or industry or whatnot. And scrolling through Reddit from time to time, I've just been really unimpressed by their advertisements. For one, I found the ads to be largely irrelevant. I just don't think the ads are that good. I just don't think they're very compelling. And you know, this could be seen as both a positive and a negative. So if the ads don't look all that great today relative to Facebook's, for example, then perhaps that in itself hurts the investment case. But on the other hand, it might mean that there's substantial room for improvement with the delivery, the targeting of the ads, and thus drastically increasing the average revenue per user. And just to put things into perspective here, in the trailing 12 months Reddit produced over 1.4 billion in revenue, most of which came from advertising. And today the digital advertising market is estimated to be 700 billion. So Reddit is just minuscule in this massive and growing market. Anyways, I just wanted to share some of my high level thoughts on Reddit. If you haven't checked out the Intrinsic Value podcast, I would highly recommend it. It's a great way to just learn more about many companies you already know and love. You know, Amazon, Visa, Nintendo, a lot of great names that they've covered. You know, given that analyzing stocks can just be so time intensive, it's nice to have this resource that's 16 to 90 minutes that gives just an excellent overview of whether it'd be interesting to dive in deeper or not. All right, so that wraps up today's episode on the Art of Execution by Lee Freeman Shore. I enjoyed giving this book a read since it touched on a few different concepts that I haven't seen in other books. So with that, we'll close out the episode there. Thank you for your time and attention today and I hope to see you again next week.
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Thank you for listening to tip. Make sure to follow we study billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com this show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.