In early May 2019, I did a series of interviews with Clifford Sosin of CAS Investment Partners in Westport. In this part of the interview, we talked about Cliff’s investment process and the questions: What matters in 10 years? You can find all content with Cliff here.
- 1Cliff Sosin’s process of evaluating a company’s culture
- 2Selecting information and the key driving forces
- 3Factors that matter in 10 years
- 4Cliff Sosin’s sources of information
- 5Changes in his investment style
- 6The price he is willing to pay
- 7A typical day in his life
- 8Does your relationship to a company changes, if you own the first stocks?
Cliff Sosin’s process of evaluating a company’s culture
[00:00:07] Tilman Versch: Cliff, welcome back to the interview to Good Investing Talks. Now, we’re having another person ask questions. Welcome Moritz.
[00:00:15] Moritz Walz: Thank you. My pleasure.
[00:00:17] Tilman Versch: Nice to have you here. In the last episode, we talked about how you get and feel about the company, the company culture, go there, get a certain idea, the impression, that gut feeling, you feel the atmosphere… What other factors do you use or how do you evaluate the company’s culture?
[00:00:37] Clifford Sosin: Well, you know, I should be clear, that evaluating these things… the culture is… I am definitely a price and business model first type of investor. These are areas that have become increasingly important to me and that I think I’ve developed in, but they’re not. Part of the first thing, so, I would not consider myself as particularly good at making these evaluations. But in general, you know, I talked to a lot of former… A lot of my work involves talking to former employees. And frankly, you can get a sense just from talking to former employees, if someone was an employee who was an employee for a reasonable period of time, who left in good terms, you’re kind of getting a chance to understand what the actual people there are actually like.
Obviously, if they were fired or they weren’t there very long, you’re getting a sample of rejects. So if you can limit yourself to the sample of proper employees who could still be there if they wanted to be. You can just learn a lot by asking them about the projects they worked on. Ask them why they worked on those projects. Ask them how they value those projects. Ask them what decisions were made and why they were made. And you start to understand how the organization works in a nuts and bolts way. And if it’s a way that makes sense, that seems to be leading to the appropriate outcomes that you’re impressed by the people that you’re dealing with, and you think that they are making good decisions. And you would want to work for those people. And you just generally find that you’re dealing with good people, then you know, they’re probably indicative of your organization. And you can always ask, like, you know, “What is it like to work there?
Ask them why they worked on those projects. Ask them how they value those projects. Ask them what decisions were made and why they were made. And you start to understand how the organization works in a nuts and bolts way.
But in general, I’ve come increasingly, you know, if I’m there, and you talk to people who are there for 8 years and seem to have an important role and got promoted a couple of times and then eventually left on good terms. And they’re not very bright and you asked them questions and they give you answers like, “What did you think about this?” And they are like, “No, we didn’t think about that”. You know, then that’s probably a problem, right? They probably selected a lot of mediocrity. You know, if the guy says “Oh, I had this great idea, you know, but it never worked”. You say, “Why it didn’t work?” And he said, “Well, you know, Bob never liked it.” You know, those are bad signs. So that’s what you’re looking for. And would you like to work there? Would you like to work with this person?
[00:02:58] Tilman Versch: How do you get contacts for these interviews?
[00:03:01] Clifford Sosin: You know, I make a lot of these expert networks. You know, be risky, pay them and they do the legwork for you. It’s the lazy mans work that I am doing…
[00:03:10] Tilman Versch: So you don’t conduct…. You conduct the interviews for yourself?
[009:03:12] Clifford Sosin: Yeah.
[00:03:14] Tilman Versch: And how many do you do, usually?
[00:03:15] Clifford Sosin: We do a couple of 100 a year, I think. You know, across a variety of businesses that we’re looking at one degree of sophistication. Look, there is a bit of, I think a misconception, and I think Warren Buffett created it a little bit, of value investors sitting around and reading 10ks all day. You can’t bring information to markets by reading 10Ks. This is not saying that you don’t read the 10k, but that is, you know, like reading the 10K articles is table stackes for understanding a company.
If you want to develop an understanding of a company that is differentiated from the market, you need to actually gather information from the field.
If you want to develop an understanding of a company that is differentiated from the market, you need to actually gather information from the field. And so, I would say that talking to people who worked at, competed with our customers of the companies that you’re studying is definitely, by far the best way that I found to get a sense of how things actually work on the ground.
Selecting information and the key driving forces
[00:04:24] Tilman Versch: Interesting. In your letters you said, you’re looking somehow to find the driving forces or the clear core, and you don’t want to get disturbed by too much information. How do you do this or what are your filters?
[00:04:41] Clifford Sosin: Well, I wouldn’t say it’s too much information. I would say that if you look at an investment if you’re making long-term investments, your 10-year investments that are in theory going to be sold to someone who is also thinking into the future. You’re thinking pretty far out there. And so a good investment…. I mean, it’s really not complicated: You want a compelling value proposition to consumers. You want real reasons why other people won’t be able to duplicate this or erode your economics via competition. And that’s it. I mean, you care about market size or whatever, the price you pay, but those are the things that you’re thinking about.
And so a good investment…. I mean, it’s really not complicated: You want a compelling value proposition to consumers. You want real reasons why other people won’t be able to duplicate this or erode your economics via competition. And that’s it.
And so it’s not that there’s too much information, the point is that to think about, take the information that you get and sort of asking yourself: We’re sitting here 10 years from now, was this quarter sale, week sales due to weather? Are we going to look back on that as the seminal moment where, you know this company, where that was it, like it all fell apart? And the answers to when you frame it that way, for a lot of things, is like no. Obviously, 10 years from now no one’s going to remember this. But on the other hand, you know, sometimes they will. And so that is a great filter; you know, just ask yourself, “10 years from now, are we talking about this?” The answer is no, you know, don’t very about that very much. But on the other hand, you think about the things that will matter in 10 years, you know. And then take those seriously.
I had a friend who was at a particularly important moment in his career. We’ve had this discussion a few times and he had a few very important decisions to make. And I said, you know, I don’t want to use his name, and I said “Listen, you know how we talk all the time about how like, think about things 10 years from now and don’t sweat the stuff that won’t matter in 10 years? Well, this is one of those moments where it’s going to matter in 10 years.”
Think about things 10 years from now and don’t sweat the stuff that won’t matter in 10 years.
Factors that matter in 10 years
[00:06:44] Tilman Versch: And what are the factors that matter in 10 years?
[00:06:45] Clifford Sosin: Oh, what I talk about…. You know, what you talk about….
[00:06:48] Tilman Versch: Not the example of your friend, but in general.
[00:06:51] Clifford Sosin: Yeah, no. I mean, you want a compelling value proposition that will still be relevant and compelling in the distant future. And you want barriers to competition that are real and there. And that’s it.
And so anything that would make you worry that the value proposition, why they’re not good or will be undermined by some other, something else or anything that would make you worry that the barriers’ competition will arode away those are serious problems. But other things are not issues.
You want a compelling value proposition that will still be relevant and compelling in the distant future. And you want barriers to competition that are real and there. And that’s it.
Cliff Sosin’s sources of information
[00:07:32] Tilman Versch: Well, I would like to know where you get your information. I mean, of course, reading 10ks is one way, but which newspaper, for example, do you read? Which magazines? Which internet websites do you use? Can you give us an idea of that?
[00:07:52] Clifford Sosin: So, I get exposed to a certain amount of information through all the usual channels. I read the Wall Street Journal most days. But I wouldn’t say there isn’t anything special about that, but the real information gathering that we do, I would say it takes the form of hypothesis testing. So, what I would say is when you’re studying an investment, the analogy is like that of the sciences. So you look at the situation, you develop a hypothesis. That hypothesis then makes predictions about what should be true in the world. Your diligence then comes down to validating or invalidating those predictions. The information that will validate or invalidate those predictions can vary incredibly widely. And if you think about it, if you think about the theoretical thesis; there’s like theorists and then there’s practitioners, experimenters. In investing, we play both. So you start as a theorist and you asked maybe this is what’s happening and then you put your experimenter’s hat on and try to go figure out whether or not it’s true.
There’s like theorists and then there’s practitioners, experimenters. In investing, we play both. So you start as a theorist and you asked maybe this is what’s happening and then you put your experimenter’s hat on and try to go figure out whether or not it’s true.
The experiments people run in physics are totally uninformative unless you have the theory. So, I’m reminded of when, I forget the other guy, but Einstein had the prediction about general relativity, and the light of the sun bending around at the solar eclipse. And you know, a bunch of people right after World War I, they sort of went around the world and they’ve got measurements of the sunlight during the solar eclipse, and they found that it bent as predicted by Einstein, and not as predicted by Newton. And that was a very big validating fact for general relativity. That experiment is totally silly. Absent the theory, the two conflicting theories.
So, the work that we try to do, in terms of gathering data or evidence, is really around, oftentimes around that specific hypothesis tester. Now, what’s also true is that, as you observe the world, it feeds back into your theories. So, you get new questions from new things you learn.
So, the work that we try to do, in terms of gathering data or evidence, is really around, oftentimes around that specific hypothesis tester. Now, what’s also true is that, as you observe the world, it feeds back into your theories. So, you get new questions from new things you learn. So that’s not to say that there isn’t a certain amount of just general observation, because if you get to focus on what you think is true, then obviously you could miss the really relevant thing around you. So there’s a certain amount of just like browsing the landscape. But in general, when you think of where the work really gets done, it’s digging deep.
And so, I’ll give you another example. We invested in a company called LifeLock, and LifeLock sold a product that protects people against identity theft. And at the time we invested, there were essentially two competing theories about LifeLock. One theory was that, by people who were bears, I guess. And it was that the product didn’t do any good. That it was only sold because people were deceived. And that the people who owned it were trapped in it, that they were basically victims of deception and wouldn’t ever own it if they knew what it really did and didn’t do.
And the other argument was that actually: No. It is a product that does good, that it’s a branded product that people are basically paying a premium for. And that’s why people are happy to have it. That’s basically a brand. And a particular type of brand that we spend over time exploring. And review on the investment, basically came out of that. And so, this actually leads to some testable…. You can do some work, you can actually test this. And so, what do you do? Well first, we did a bunch of work. For example, we found this question of the frequency of identity theft. So it turns out there were national statistics on the frequency of identity theft. And so that’s great, but then you’re like, okay, but does Life Lock work? And there’s no obvious way to measure that. Except, what we did was, we found people who used to work in the call centers and we ask them, “How many people worked in the call centers and how many calls per day did you have and what portion were identity theft?” And it turns out that there was a dedicated team to deal with people and we were actually able to get a reasonable estimate of the frequency of identity theft amongst Life Lock users. I forget the exact number, but we found a meaningful reduction. So the product works.
And there are other reasons why it would be beneficial, even if it didn’t have a meaning reduction. So, that was true, it definitely had benefits. The next thing was this idea that people are only buying because they were deceived. Well, I mean, the company sells it every month, every quarter, so we can just go look at the ads. And so you get an understanding of the law, you have an understanding of the product. We need to look at the ads. Does this fairly represent the product? I mean, advertising is promotional, but within the bounds of advertising, is this reasonable? And our perception is, “Yeah, definitely”. Okay, so the current buyers are clearly not deceived, but that didn’t get to the installed base. Maybe all of the people who have it are deceived. And so, this actually leads to an experiment.
So what we did was, we were able to identify a group of LifeLock users with a third-party survey provider. And we identify and we presented them with a survey, where we ask them questions about LifeLock. How did you get it? And like, you know, have you ever suffered identity theft or do you know someone? A whole lot of questions. And were interested in answers, but not that interested.
The important thing was that half of the survey respondents, in the middle of the survey, they were presented with a slide, which said, “Here’s what LifeLock does and here’s what it doesn’t do”. And it was to the best of our understanding, but it probably was designed to more narrowly define what LifeLock does. So, if someone was doubting it, it would be negative to LifeLock, understated to LifeLock’s ability.
And at the end of the survey, we then ask all of the survey participants, would you, do you plan to renew? And the question we’re trying to get to was, if you could inform people about what LifeLock does or doesn’t do, would they renew?
And what we found was that there was… what we’re told, people did statistically see, they evidently reduced the renewal rate. But it went from like 93 to like 75 or something like that. So it was clear that while there was some portion of people who, once you spent more time explaining what it does and doesn’t do, wouldn’t want to have it. The vast majority were perfectly happy with it, even once you’ve taken the time to explain to them exactly what it does. And so, now I think once you’ve gathered that evidence, it becomes really hard to believe the hypothesis that this thing is a big fraud and deception and all the rest. It makes it much easier to buy it on the stock once you’ve gotten to the core of the matter.
Changes in his investment style
[00:14:19] Tilman Versch: Your investment style has probably changed over time or in the past years. I mean, you mentioned earlier, in the first video that the role of management has become more important for you today. Is there any other thing that has changed in the past years?
[00:14:39] Clifford Sosin: Oh, yeah. Look, if you, you know, we operate in a…. Social Science is not physics. So the models that we use to describe how society works are really crummy by comparison. They’re really, basically glorified heuristics. And as a consequence, a lot of those models are very incomplete or wrong, but they’re right enough in a certain time and place that they make reliable enough predictions that you can use them to a point.
And as a consequence, a lot of those models are very incomplete or wrong, but they’re right enough in a certain time and place that they make reliable enough predictions that you can use them to a point.
One really important way that I think many investors ultimately fall by the wayside is that they fail to consistently update their models of the world and to throw out the models that have become dated. And so, if I just think about how I’ve, when I was a younger investor, I certainly wouldn’t have thought about investing in a company like a Carvana, which loses glops of money and it’s fairly young and there’s a whole lot of reasons that I just wasn’t mentally equipped to do that. And so, over the years I’ve been sort of adding ways of thinking about the world, which I think have somewhat broadened what I can do. And I’ve also thrown out biases that I think, where people had an appropriate bias against technology companies when the companies were purveyors of technology per se. Because they correctly observed that the tech, if you were selling, I don’t know, some new [inaudible 00:16:32] organize…. Something with making semiconductor chips. And then the way to make semiconductors chips is made is rapidly changing, and there are lots of competing technologies, the half-life of your technology, being particularly relevant, can be very short. And so it’s very difficult to invest in a technology where… in a business where the reason you’re advantaged is dependent on many things that are moving very fast. And thus unlikely to endure.
So I think people correctly figure that out, but they then incorrectly apply that heuristic to many businesses, including businesses that use technology today to basically build a normal business. And I sort of remind people that you know, 140 years ago making toasted flakes and transporting them by rails was high-tech stuff. And very few people would go to General Mills and think like a technology company, but it was. And so there is an opportunity, I think, to better understand companies that use technology to build businesses that are enduring for reasons not related to technology. And I‘ve spent a lot of time sort of broadening my understandings there. So I’d say that’s one big area that I’ve evolved in. And that’s maybe a little evolution that comes to something like that.
The price he is willing to pay
[00:18:04] Moritz Walz: And if you have found such a company, are you willing to pay higher multiples for the company, for good quality, or are you still looking for a cheaper price? Because many investors are; if they have a great quality business, they pay higher multiples. How do you handle that situation?
[00:18:23] Clifford Sosin: Yeah, I don’t think about it like that at all. Just the framework; I don’t use that framework. I think about what the company is going to be in 5 or 10 years and how confident I am in that and the range of outcomes that are reasonable and how confident I am in that range. So, think about it this way, there’s a range of outcomes that’s assuming I’ve diagnosed this company properly, there’s a range of outcomes. But there’s some chance that I’ve not diagnosed this company properly. That’s harder to think about, but you’d have to factor…. But like if you’re making a bet on, it depends on the mental models you’re using and how much confidence you input in that range. And then, if you have ranges that you’re equally confident in, you’re kind of interested in comparing the means. Although you do care a little about the distribution of correlation, but I mean, you care basically about the means, and you want to buy the one that’s going to do better.
I think about what the company is going to be in 5 or 10 years and how confident I am in that and the range of outcomes that are reasonable and how confident I am in that range.
And so, you know, a high-quality business, such as you describe, what that would have to mean to me to be a high-quality business is that, in 5 or 10 years it’s going to be bigger or more profitable by a larger quantum per share, for owners than a low-quality business. And so that comparison basically evaporates if you just say like, you know, 5 or 10 years from now, what is this worth? It no longer becomes relevant to sort of say high quality or low quality. I don’t know if that… Does that make sense?
A typical day in his life
[00:19:46] Tilman Versch: Yeah, yeah. And maybe, one more question. How does a typical day in your life look like here? A typical week? I mean, are you traveling a lot or reading, as you said 10ks all day or what does it usually look like?
[00:20:03] Clifford Sosin: Yeah, my days vary a great deal. But in general, I don’t travel a ton. I actually don’t spend nearly as much time, I think, as other people do meeting with companies in person and my comment of having a vibe when you walk into the place, is true but it’s also not often that I do that much of. For the most part, I spend my days either on the phone doing these calls with experts, or I often am reading or listening to companies’ earnings calls. A great way to learn about a business is to start with maybe the 10k and the investor presentation. And then pull up the last 2 or 3 investor presentations and the last 4 conference calls. And I queue them up on my phone, and I put my headsets on and I go for a four-mile walk and I listen at double speed, and I come back and have lived through like, you know, a year in the life of the company. And then you say to yourself, you know, was that interesting? Like, what do I think, do I have a theory here? And then maybe you can then say, maybe I’ll do some calls and then you sit on a few calls and sort of, you know, people who maybe work there or whatever and ask a few more questions and then decide if you want to keep working and what your hypothesis might be and so forth.
And then you say to yourself, you know, was that interesting? Like, what do I think, do I have a theory here?
So, I would say that, you know, the productive time is spent doing that. I also, I spend a fair bit of time studying generally. I think people overemphasize how much time investors need to spend studying companies one by one. I think that if you think about investing as the serendipitous outcome, good investments are like a serendipitous outcome, where a prepared mind meets an opportunity. And so people who just study opportunities one after the other, are neglecting preparing their minds.
I also, I spend a fair bit of time studying generally. I think people overemphasize how much time investors need to spend studying companies one by one. I think that if you think about investing as the serendipitous outcome, good investments are like a serendipitous outcome, where a prepared mind meets an opportunity. And so people who just study opportunities one after the other, are neglecting preparing their minds.
And so I spend a fair bit of time also just preparing my mind, which fortunately all this is fun for me so it isn’t really work. But that means reading books, it means listening to podcasts, you know, so you’ll find me driving out of my house to go get coffee and then walking around drinking my coffee, listening to like a book on Audible. And you know, for most people, they’d say, “Are you working?” and I’d say, “Well yes, I look homeless, but I’m not actually homeless”. And so, I do a fair bit of that.
And also, it’s super important in investing, in life in general, but you have to take care of yourself, you have to recognize, just, you only have so many good hours to commit to things. And so, I try to exercise at least 2 out of 3, or 3 out of 4 days. I spend time with my kids. I spend the mornings puttering around my house until 9 o’clock, and I take my daughter to school. So, there’s a fair bit of that, and doesn’t look productive. But I’m sure if I stop doing it, there’d be a short-term surge in productivity, followed by a substantial long-term decline.
The other funny thing about this job is like, it’s a weird job in the sense that I’ve sort of joked that I’ve had maybe 10 productive hours in my life. Like, the productive hours, that the sort of two hours that you spend, or the hour that you spend learning about something new, where you start to realize that this is going to be great. Before that, you’re preparing. After that, you’re validating. But there’s just like this little hour in there where you sort of have the epiphany and I don’t know how to make more of this. I’d love to, it’s the best part of the job, but like the rest of the time is just wasted.
Does your relationship to a company changes, if you own the first stocks?
[00:23:36] Tilman Versch: Does the relationship or view to a company change after you own the first stocks?
[00:23:41] Cliff Sosin: Does my view change after I buy shares?
[00:23:44] Tilman Versch: Yeah, or relationship in general.
[00:23:47] Cliff Sosin: Oh, with the management team?
[00:23:48] Tilman Versch: Or like if there’s a certain different affection or you [crosstalk 00:23:52]…
[00:23:52] Cliff Sosin: Get a fall for them over time?
[00:23:55] Tilman Versch: Somehow, yes.
[00:23:56] Cliff Sosin: Well, there’s a lot of evidence, that in general, once people buy some stock, they’d like it more. It must work on me too. I try to like it before I buy it. I don’t do like sort of starter positions and stuff like that. But you know, the technology must be at work with me. My friend Rob Vinall likes to say: People’s biggest mistake in investing is selling too soon. So why not just fall in love with the companies? It’s more fun and you do better.
And so, I think he’s got a good point there. So ever since he told me that, I’ve allowed myself to like my companies more. But, I don’t necessarily, you know… Eventually, you do sell things, and so it’s important to realize that you have to weigh what you have, versus your opportunity cost. And it’s important over time that when an investment, either you’ve learned disconfirming evidence, it’s inconsistent with your hypothesis, and it’s now wrong, or just that it’s no longer… If you will look at it in five years, maybe it’s going to be a double, but maybe you’ve got something else and it will be a triple or quadruple. For a triple, you would have to be crazy not to sell the one to buy the other, as much as you’ve enjoyed getting to know the management team and that sort of stuff.
There are people who say, “Oh, I’ll invest with great management teams”, and there are certainly benefits to investing in great management teams. But I’ve invested in companies with so-so management teams, but where there are great businesses, at great prices and you know, if you factor in the cost of the management team or the sort of mediocrity of the management team into the price, it can still be a great investment.
In terms of my…. You know, when you own something, I definitely do a fair bit of work overtime, following it. It’s not sort of because I have to, it’s because I enjoy it, but also it doesn’t hurt. And you do learn about a business over time and your knowledge and understanding of it deepens and that’s fun. And you do sometimes, depending on the company, get to know the management team and if you do get to know them, that can prove to be a nice part of the business, where you kind of build a relationship over time with the people who are running the business. That obviously doesn’t happen every time, depends on the company. And, you know, it’s not… There are people who say, “Oh, I’ll invest with great management teams”, and there are certainly benefits to investing in great management teams. But I’ve invested in companies with so-so management teams, but where there are great businesses, at great prices and you know, if you factor in the cost of the management team or the sort of mediocrity of the management team into the price, it can still be a great investment. So maybe I won’t name names, but that relationship doesn’t feel as rewarding over the years.
[00:26:24] Tilman Versch: Thank you very much for the next part of our interview.
[00:26:26] Cliff Sosin: Thank you.
[00:26:27] Tilman: We’ll see in the third as well.