Christopher Tsai (Tsai Capital): Is investing an art?

Christopher Tsai, Tsai Capital

“To be a great investor, you need to be able to read the times. You need to understand where the world is and where it’s moving.”

[00:43:16]

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Christopher Tsai

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Tilman Versch [00:00:35] Hello, audience. Hello, Christopher. It’s great to have you on. Christopher Tsai is today’s special guest. He’s coming from New York to us, and I’m happy to record our conversation. Great to have you on, Christopher.

Christopher Tsai [00:00:48] Hi, Tilman. Great to speak with you today.

Tilman Versch [00:00:51] You have this long stock market experience. I will also show a chart of your experience or performance since 2000. So, you have this long track record. I brought a bit from our community’s Zoom party yesterday with my setup here today. Our community is called Good Investing Plus, and we did a Zoom party to connect. But with your long experience in parties and investing, it’s not always the best thing to be investing when there are parties on the stock market. How were your experience with parties and excessive atmosphere on the stock market?

Christopher Tsai [00:01:28] It was a time to start managing money. In early 2000, the old economy companies actually felt like they had a hangover. Their evaluations were very low. But on the other hand, tech-enabled businesses, the so-called New Economy Companies of the time, were extremely frothy. So, what we saw was a bifurcation of the market that was really interesting. In other words, some value-oriented businesses were really, really cheap.

I remember companies like Progressive Corporation and Genuine Parts, traditional auto insurance, or auto part companies selling at six times earnings with 5-6% dividend yields. And then, on the other hand, you had companies with absolutely no earnings and real doubt about the inherent viability of the businesses trading at astronomical valuations. So, that market was a difficult but exhilarating time to launch a business just because of all the opportunities presented to people who didn’t want to join that so-called party.

Tilman Versch [00:02:49] When did you have the feeling that these party atmospheres came back to the market in which periods?

Christopher Tsai [00:02:57] Yes, certainly the housing bubble of 2000. I guess beginning around 2005, or the end of 2005, leading into the ’08-’09 financial crisis. That was certainly a period where we started to see a lot of froth again, not necessarily as significant as eight, nine years ago, and not necessarily in the same types of businesses or sectors. But there was definitely a concern going into ’08-’09.

Tilman Versch [00:03:33] How about today, this 2020 period?

Christopher Tsai [00:03:42] If you had asked me this question a few months ago, I think my answer would have been very different. And that’s because the sell-off in technology companies, particularly smaller and midsize technology companies, has been really significant. I think that a lot of the froth that might have existed in certain names has come out of it. And then, in other areas of the market, I find that it’s somewhat the opposite case. In other words, some of the more traditional businesses are expensive, in my opinion, whereas the new economy companies of today represent a greater value than the other businesses.

Some of the more traditional businesses are expensive, in my opinion, whereas the new economy companies of today represent a greater value than the other businesses.

Tilman Versch [00:04:39] You’re now 22 years plus with your fund on the market. What has made you stay interested and hooked on this game?

Christopher Tsai [00:04:48] That’s a great question. Since I was a kid, I have been a very curious person. I think curiosity is the answer to your question. It’s something that started with areas, of course, outside of business. But as I began to look at companies, the changes that go on, the new businesses being created, it’s just a phenomenal time to look at companies.

Tilman Versch [00:05:28] You did start your fund, I think at 25 or something like this. Was it a good age to start a fund on your own? Or looking back, would you sometimes wish you had gone a different path than other institutions, not like, here’s Christopher and it’s my fund.

Christopher Tsai [00:05:46] There are benefits and disadvantages, of course, to starting early. In terms of disadvantages, it was harder to gain traction because I had no reputation. I didn’t have a network of people really to speak with. I did have some experience early because I started to manage money very early. That allowed me to make mistakes, I think earlier than many investors make mistakes. I wound up working for Mario Gabelli, John Levin, a partner with Michael Steinhardt and had a wonderful experience growing up and learning from my late father. So, on the one hand, I didn’t have that network. But on the other hand, it was phenomenal to do something on my own and to create something from scratch to have the freedom to manage a portfolio without the institutional constraints that you see cropping up. It seems to me, more and more.

Tilman Versch [00:07:04] Maybe this is a question that’s quite broad. For your 25-year-old self, what knowledge and strength do you feel that looking back, you’ve missed as a 25-year-old and you had to acquire maybe also in a bit painful way over the years.

Christopher Tsai [00:07:23] You asked me about curiosity before. I think that’s also at the root of this question. Being able to constantly think about the world in different ways and not get trapped using models that you might have used or other people use is so important. It’s not a lesson that you can just teach. It’s an experience that one has to go through.

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I’ve been reading this book. I’m not finished with it, because it’s a long book. It’s Marcel Proust’s In Search of Lost Time. Proust says that the real voyage of discovery is not seeking new landscapes but having new eyes. There lies the curiosity that we’ve been speaking about. It’s important to look at the world constantly with new eyes, particularly because the world is changing very quickly, right? Businesses don’t have the lifespan that they used to have.

In 1958, McKinsey did this study. And McKinsey showed back then that the average lifespan of a company was 61 years. That’s incredible. Sixty-one years, six decades. But today, that number is 18 years. And one of the reasons, Tilman, that it’s 18 years is because technology is encroaching upon old business models. So, if you’re not thinking about the world in new ways, if you’re not curious, if you’re not constantly looking at the competitive threat that technologies posed to traditional businesses, you might find yourself in a business that’s going out of business.

So again, being curious is not something you can just teach. It’s something that you, I think, have, and it’s something that you can foster over time. Eleanor Roosevelt, by the way, said something really wonderful. She said, “I think at a child’s birth, if a mother could ask a fairy godmother to endow it with the most useful gift, that gift would be curiosity. I wish I was endowed with that gift and was able to foster it from the very beginning. I think that something in business that you learn, you either have it or not that curiosity. But I love looking at different businesses, different business models, especially today,

Tilman Versch [00:10:29] You have close to 25 years of experience in managing your fund. Which topics have you worked on since these 25 years to get better at? Are there any consistent topics that have kept you up at night? Let’s say it makes you stay late because you’re still trying to achieve and get better with?

Christopher Tsai [00:11:00] Let me draw a parallel to answer your question between investment management and the Michelin Guide. We know the Michelin Guide for restaurants. Chefs work their whole lives to get one star and then two stars and three stars. What gets them there? Well, creativity gets them there, pushing the boundaries and being the best at what they do. They’re not doing things like everybody else, by definition. There are only a handful of chefs in the world that have three Michelin stars. The problem is that for those few chefs that wind up getting those three stars, what do they then want? Well, typically, they want to maintain those three stars. And so, everything else becomes subordinate to keeping those three stars.

I think that investment management is, unfortunately, very similar to that. And so, when I started, I was inundated with the idea of structuring a portfolio in a way that would get you those three stars, if you will. So that meant looking at beta, looking at Sharpe ratios, looking at standard deviation. And what I found over time is that if you start to behave like everybody else, your performance is going to be like everybody else at best. So over time, I have refined our process. In fact, we moved away from trying to worry what other people thought about how the portfolios looked. We moved away from that a long, long time ago. Maybe three-four years into managing capital for outsiders.

So today, it’s all about structuring the portfolio in the most optimal way. What do I mean about that? I mean, it’s about structuring a portfolio to maximize return and minimize risk. And that’s pretty much all I think about in terms of managing the portfolio, maximize return, minimize risk. I don’t worry about so many items that institutional investors worry about that wind up restricting a manager’s ability to have the flexibility and create alpha. I don’t worry about what other people might think of the portfolio. The key is to manage portfolios as if nobody was looking. So that’s how I’ve moved things over time.

Tilman Versch [00:14:01] Maybe also, let me go back to the point about technology that you made. I would be curious to hear where technology and the change that couldn’t pipe technology surprised you in how you’re doing research where you saw something and was changed by technology? Were you even thinking, “Oh, this is super interesting to me.”?

Christopher Tsai [00:14:23] Yeah. There are, of course, different types of technology and different types of business models within technology. The most interesting business model to me is a platform business. So platform businesses, many of your viewers will already know what platform businesses are, but for those who don’t. Platform businesses have an architecture that’s enabled by technology. And that architecture allows buyers and sellers to come together to transact two sides of the trade. And what’s really interesting about platform businesses is that they, in many ways, resemble multicellular organisms. So there’s this mental model with biology.

What do I mean by that? I mean that if you look at life, multicellular organisms, there’s a lot of phenotypic variation. And that phenotypic variation is a result. It happens because the central metabolic processes within cells are relatively static. And so, what you wind up in life is you get variability, but you have a stable architecture. That central metabolic process is a stable architecture that allows life to create variation.

Platform businesses work very similarly. So, the way I look at platform businesses and the architecture is that you have this kind of modular component. They’re developed. They’re designed. They’re modified, and they sit on top of this architecture. That allows these businesses to have the desired combination of stability, the architecture, like the central metabolic processes inside cells. It allows them flexibility because you can rearrange the modular components as you need to over time.

What does this all mean? It means that technology businesses that are platform businesses have a much higher chance of growing exponentially than in a linear manner. They have that chance because they have the desired combination of stability and flexibility. I’m fascinated by platform businesses. You see other characteristics, like network effects, where you can bring in new users at a near-zero marginal cost. I mean, it’s very powerful. It’s one of the reasons why you get this exponential curve, often with platform businesses.

Technology businesses that are platform businesses have a much higher chance of growing exponentially than in a linear manner. They have that chance because they have the desired combination of stability and flexibility.

Tilman Versch [00:17:36] I look at your portfolio. I also have found some hardware-software businesses that intertwine hardware and software. What do you find interesting about these businesses?

Christopher Tsai [00:17:46] I like vertically integrated companies that sell hardware, which would be the equivalent of calling it installed base. So, the more hardware out there is equivalent to an installed base on which these businesses then can sell high margin software. That’s a powerful model if the product you’re selling is sticky and the software functionality is integral to that product and keeping that product new.

So, if you think about an iPhone or a Tesla car, the hardware is, in the case of Apple, it’s the actual device, the phone. In the case of Tesla, it’s the car. And on top of that, these companies are selling high-margin software. So, it’s a nice combination. It’s equivalent to the Gillette razor blade model where the company would sell the handle and then the blades on top. The handle being the hardware, and the blade being the equivalent of software today.

Tilman Versch [00:18:58] After this champion technology, I want to go a bit back and also use these long-term experiences you have on the stock market. One question that is also quite interesting is related to your family. I think your father had a certain footprint in the financial community and also had a certain name in the community. How do you find your journey and way to build your reputation of being Christopher Tsai and not just like your father’s son?

Christopher Tsai [00:19:31] My father gets a lot of attention. I’m happy to answer that. But before I answer that, I want to talk quickly about my grandmother. My grandmother, Ruth, was a really interesting lady. So she was a stockbroker herself. She was the first lady that traded stocks, bonds, and commodities like gold on the Shanghai Stock Exchange. This was from around 1939 to 1942, I think, December 1942, when Japanese troops invaded the Shanghai International Settlement, and the Shanghai Stock Exchange closed.

I mean, if you think about it. Back then, that was very unusual to even have access to trade on an exchange. This was in Shanghai in 1939. She was an interesting lady, not only for that but because she was great with people. I think that she taught my father a lot and influenced my father and his choices, to not only go into investment management but to move from investment management into other areas like deal-making and running companies.

But my father, at heart, to answer your question, was a momentum investor. I guess the best way to characterize how he thought about companies was to tell you and your viewers about a story about a situation in 1990, maybe 1996 or 1997, or something like that. I was looking at this consumer product company. I spoke with my father, and he said, “Oh, you need to look at this medical products company. It’s much more interesting. And I said, “Okay. Well, what is it?” And he gave me the name. And back then, you couldn’t just download all these reports. So, I called the company up. I got the 10 Qs, the 10 Ks. I started looking at the business.

About a week and a half after I started going through all the material after the material arrived, I called my dad up, and I said, “Hey, this looks really, really interesting. I think I might buy some.” And he said, “No, no, don’t worry about that company. I sold it already.” So, that was his approach to looking at companies. Very short-term oriented, very trading oriented, transaction-oriented. I learned very early that I was not only not good at that kind of approach, but it didn’t sit well with my mentality. So, I differentiated myself in the sense of how I look at companies. Much more fundamentally based, much more long-term oriented. We look at taking positions that we can keep for a decade or more.

With all that said, Tilman, I will say that I learned a very valuable lesson from my father. He never dismissed high multiple companies just because they had a high multiple. I think that the world has changed a lot since just 15-20 years ago. And by that, I mean the world has moved toward technology. Technology is the equivalent infrastructure of railroads. I mean, so much doesn’t happen without software and technology. That’s the infrastructure today. And you have to understand the economics of that infrastructure, the accounting of research and development, sales and marketing. It’s very different from a traditional company. Many businesses that appear to be expensive that have high multiples are actually not expensive.

The problem with many investors, I think, is that they’re screening for businesses. They are naturally repulsed when they see a multiple above whatever, 20-25, maybe lower. But sometimes, the multiples are just so misleading. So, you have to do your work. You have to dive in. You have to be curious, as we were talking about earlier. Walt Whitman said, “Be curious, not judgmental.” You have to be curious. Dive in. Do the work. Understand, is this company cheap? Is it not?

You’re not going to find great businesses just by screening for low multiples. It doesn’t work anymore. So, that’s something I learned from my father. Don’t dismiss companies that appear to be expensive. Now, he might have bought them for the wrong reason, but that’s a lesson that I’ve certainly taken from him. I learned that early on.

Tilman Versch [00:24:55] Are there lessons you’ve taken directly from your grandmother.

Christopher Tsai [00:24:58] She had a saying, “Don’t be a square table when you can be around one.” She intuitively understood Dale Carnegie.

Tilman Versch [00:25:08] This means?

Christopher Tsai [00:25:10] It means that there’s no need to be abrasive in how you speak with other people. I think that Fred Rogers, I’m not sure if many of your viewers know who Fred Rogers is, but he was the character Mr. Rogers, a popular TV show in the states geared toward children. And he said, “There are three ways to ultimate success. To be kind, be kind, be kind.”

Everybody is going through the same kind of emotions. Everybody has difficulties. You don’t know what those difficulties are. Everybody has a bad day from time to time. Everybody has joys, desires, needs, wants to be loved. My grandmother understood that. She knew how to deal with people. Not to be abrasive, not to be square around the edges. Dale Carnegie espouses that way of behaving. And so did Fred Rogers, who was one of my mentors. I should say idols.

Tilman Versch [00:26:21] The topic idol is quite an interesting one. In investing, when you decide to go down the bit of long-term oriented value investing rabbit hole, you generally build the way you invest on the shoulders of giants and try to copy them to a certain extent. But I think the interesting thing happens when you modify and enhance the work from the past and use the ideas of Buffett, Munger, Soros, whoever has built. What is your example for these modifications and tuning and enhancements?

Christopher Tsai [00:26:55] I love that question. First of all, let me just say that I’m not a huge fan of this concept of value investing because all intelligent investing has to be value investing. We were looking for growth companies, but we’re trying to get them at value prices. I spoke earlier about McKinsey’s study about the lifespan of companies. 1958 was 61 years. Today, it’s less than 18 years. So if you think about that, what’s the effect of that? The effect of that is that it’s very hard to stay within just your circle of competence. Let me give an analogy of skiing. Are you a skier, Tilman?

Tilman Versch [00:28:03] No.

Christopher Tsai [00:28:05] For the skiers out there, I think we can agree that it’s not fun skiing the same terrain all the time. And not only is it not fun, but it becomes not very pleasant when you start skiing terrain that you’re no longer capable of handling. To be a good skier, I think you want to be able to ski the easy mountains. We have an easy mountain here not far called Catamount. You want to be able to ski Catamount. You want to ski the harder mountains, the most difficult mountains in the world like, I don’t know, Verbier or Jackson Hole.

I look at skiing similarly to investing in the sense of, you know, where’s that circle of competence? So, you want to identify your circle of competence for sure, but I don’t think that that’s enough anymore. So, Buffett said, “Stay within your circle of competence.” I don’t think that’s enough anymore. It’s not enough because technology again is encroaching upon traditional businesses. It’s not enough to say I’m going to buy a company like Gillette and hold it forever because this company can’t possibly be disrupted by technology. Well, wrong. Look what happened with Dollar Shave Club. Dollar Shave Club was successful because it operated with a new business model enabled by the internet. That is technology at heart disrupting the traditional model. So, think about that.

You need to understand where the competitive threats are coming from. That means not only staying within your circle of competence but constantly expanding that circle of competence so you know where competitive threats might come from. Again, you’ve got to be curious. If you’re not curious, then you’ve got a problem, I think, in this business, particularly today.

Tilman Versch [00:30:25] If you’re actively trying to leave your circle of competence, and this might also lead to investment, how do you make sure that you’re not the Patsy on the table?

Christopher Tsai [00:30:36] Yeah. I wouldn’t say I just want to leave. I don’t want to leave my circle of competence. I want to expand my circle of competence. I want to build upon the knowledge that I have in the areas I’m comfortable with.

If you’re a beginner skier, you’re not going to just ski Verbier. You’re going to start with the smaller mountains. And that’s my analogy with skiing. You want to start where you’re comfortable, but you want to challenge yourself and do so carefully in a measured way. Be realistic, don’t fool yourself. Try to continue to gain knowledge and improve your understanding. If something is too difficult, then that’s where you’ve got to stop. To answer your question, that’s a very personal thing that you need to be honest with yourself.

And people, I mean, the community that we have of wonderful investors, such smart investors could be very helpful in expanding one’s circle of competence.

Tilman Versch [00:31:59] Which non-investing concepts have you integrated into your investing approach? Why are they helpful for you? If you explain them, the normal investor says, “What?” Do you use them for your way of thinking?

Christopher Tsai [00:32:18] Yeah, I mean, there are a lot. There are a lot. I mean, investing is not just logical. If you’re approaching investing in a purely logical way, I think you’re going to fail. And the reason is because markets are composed of people, and people are behavioral. They have fear and greed.

I think Charlie Munger said it, right. He said, If economics isn’t behavioral, I don’t know what the hell is. So, I mentioned this because you want to understand these cognitive biases and the effect that that has on investors. You want to understand some of these other core principles like compounding and elements from physics.

Human nature, for example, moves at the pace of geologic time. What do I mean by that? Well, I mean that from an emotional standpoint, they haven’t changed. That’s an idea that’s super important to understand. We’ve got roughly 20,000 years or so recorded human history, right? You’ll realize that in over 20,000 or so years of recorded human history, human nature hasn’t changed. Then, you understand that these cognitive biases that we all are susceptible to haven’t changed either.

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So we take an idea from elsewhere, from psychology or from our understanding of how the Earth has formed over time very slowly. We’ll apply that idea to understanding human nature, to understand the fact that people are going to behave pretty much the same way that they always have. And that can be helpful, particularly in periods of dislocation in the market. There’s also another. We’re talking about the Earth and geology. And, of course, this idea from physics, from math, which is simply compounding.

I don’t mean compounding just in the sense of money. I mean, compounding is very real and powerful when it comes to money. Einstein pointed that out in compound interest. But compounding is a powerful force that can really help one in terms of behavioral edge and knowledge that knowledge compounds. So you want to continuously learn and build upon your knowledge because it all compounds. So, that’s something else that I think we can take from physics, that idea, and apply it to not just investing but to how we live our life.

And now that I’m thinking about it, there’s a Japanese concept called Kaizen. Kaizen is at the root of how I think about Tsai Capital and how I think about my own life. Kaizen essentially means change for the good. Kai is the change, and Zen is for good in this case. So, it’s about continuous, incremental changes over time and how they lead to substantial improvement. That’s a powerful idea that I think that we could use, not just investing, but in our lives in general. Continuously refining something takes time, but the effect compounds.

Tilman Versch [00:36:58] Are there any examples you want to share on Kaizen and how you lift it?

Christopher Tsai [00:37:05] I think that getting rid of distractions is certainly one element of being more focused and refining one’s process. So, the idea of Investment Management can be very different for different people. It can mean different things to different people. I’m trying to improve our processes continuously. That takes shape in different forms. Minimizing distraction is certainly one of those areas I’m trying to focus on. I mean, it can be as minor as turning off the sound when you get an email because each little email creates a beat. And it’s very distracting when you’re trying to do deep work on something. It could mean, you know, making sure you go to sleep every day at a certain time, maximizing sleep, sleeping in alignment with circadian cycles, all of these little things. It’s different for every person.

Tilman Versch [00:38:26] You already mentioned the biases humans have. How have you built your setup that you have these biases under control? It’s maybe not the right picture, but measurable, and that you have certain data sitting in to block you acting bias driven?

Christopher Tsai [00:38:46] Well, the key is to figure out what biases you’re most susceptible to, I think. I have an idea of what biases I’m most susceptible to. What I’ve done is I’ve created a checklist. So, whenever I think about buying certain security or selling a certain business, I’m just going through my checklist to make sure I’m not falling prey to some of the biases that I feel I’m more prevalent to being affected by.

I also think it’s important to slow down. We have an action bias inherently. Unfortunately, it’s super powerful, and it makes one do things. Especially portfolio managers, right? So many portfolio managers feel like they can’t just sit still, not for themselves, but because they want to show their clients that they’re working.

I had a client once with who I had a meeting, and this person said, “Christopher, it doesn’t look like you’ve done very much in the past nine months. I see one cell. I don’t see anything else.” It was a loaded question. It was a question that was not only loaded but misguided. And perhaps in this person’s field, the idea of doing something constantly is what you need to do because that’s what generates revenue. That’s what clients expect. It might be something that you’re doing on an hourly basis for your client. But the investing business is completely different. Investing business just runs in the face of what so many people are accustomed to seeing. I should say successful investing runs in the face of what so many people are accustomed to seeing. We don’t pay to buy and sell all day long. We get paid for being right. It will be costly if we’re constantly doing things that are not sensible.

Tilman Versch [00:41:28] Many of our viewers might be younger investors as well, like yourself 20 to 25 years ago. Which habits now did you let learn to let go over time? Or maybe break a bit more down. What’s the difference between you today and you of 2002?

Christopher Tsai [00:41:51] Yeah. Well, this links very nicely with the previous question about action and having an action bias. I was much more frantic 20 years ago. It’s important to slow down. You make less mistakes. You think deeper. You think more clearly. I think that was reflected very much in the portfolios. There was much more turnover in the portfolios if you go back 20 years than there is today.

Tilman Versch [00:42:28] How did you achieve to slow down?

Christopher Tsai [00:42:33] When you realize how much money you’re leaving on the table by selling out of winners in great companies too early. I think you learn pretty quickly when you start doing the math.

Tilman Versch [00:42:47] Yeah, it’s painful. Maybe let’s switch to another side of yourself. You have this side of being an art collector. And with art, I associate these two intertwined invitations. The invitation to open your mind and the invitation to see differently. How do these two invites help you be a good investor or a good human?

Christopher Tsai [00:43:16] Yeah, I love that. I love the question. We can talk not just about being an artist, like a painter or sculpture, but even if you think about being a fashion designer or musician. What are all these artists have in common? Well, they have one thing, particularly in common if they’re successful, they can read the times. Good artists can read the times.

To be a great investor, you need to be able to read the times. You need to understand where the world is and where it’s moving. So that’s one area in that I think there’s a nice parallel between art and investing in that side or successful artists and investing.

Tilman Versch [00:44:18] How does spending time on art and also collecting art change you in seeing things? How does this lens of an artist influence you?

Christopher Tsai [00:44:31] Spending time on art for me is an outlet. It’s a wonderful way to start thinking about a situation, perhaps not so logically, but more intuitively. Again, a great intuitive artist can read the times, which is reflected in their work. If you look at their work, there’s an intuitive quality to what they’re saying. I think it’s important that one opens one mind to thinking not just logically but in other ways.

As I’m answering your question, I’m reminded of a guy named Rory Sutherland, who wrote a fantastic book. One of the things that he said in this book called Alchemy is that we need to think logically, but with psychologic. We need to think about how people behave. Now, people are mostly not icons. They don’t, for example, calculate the expected utility of a purchase. There’s an emotional element. There’s a lot of emotion in art. There’s a different way of seeing the world. And I think it’s important that we stay open to that and not get trapped again, thinking about the world in just one way, not using models that might not reflect reality.

Tilman Versch [00:46:25] Are you creating art yourself?

Christopher Tsai [00:46:29] Oh, gosh, no. The closest I get to creating art is the portfolios that I create for our clients. I look at Portfolio Management to some degree, like, I would envision myself if I were an artist painting a painting. I was putting the painting together with 12 or so companies. We own 12 companies today. I don’t know how many shades of color that might entail, but it’s about putting something together in a certain way, right. Portfolio concentrations, types of businesses, how businesses might react to each other, or react in the opposite way of another company. So, I think about constructing portfolios as a bit of an art form and certainly managing them as a bit of an art form, but I still draw stick figures, Tilman. I didn’t develop that side of my brain very well.

Tilman Versch [00:47:39] Same here. We are fascinated by art, but just like, art, not art literate or whatever.

Christopher Tsai [00:47:47] My two kids are amazing artists. I literally couldn’t even come close to what they were doing.

Tilman Versch [00:47:57] It’s great that you have them in the family, the artists. So, let me make the comparison you already did a bit more actively. How is collecting great art and getting a great art portfolio different from building a great portfolio of great companies?

Christopher Tsai [00:48:16] It’s not. And that’s the lesson that I took away from my father, actually. My father understood the importance of buying the best. And the best, of course, can mean different things to different people but you want to buy the best.

You want to buy the best art. That doesn’t necessarily mean the most expensive art. It means quality. You want to buy quality. Quality means something different to different people, but you want to focus on quality. You want to buy the best in art. You want to do that in real estate. You want to do that in investing, in buying companies.

For us, we’re looking to buy the most competitively advantaged businesses that we can find that have a real economic moat, that have a real long runway of growth that can grow exponentially. Again, many of those companies tend to be platform businesses. So, we lean toward technology-enabled or technology businesses that are platform businesses. But ultimately, at the core of all of this, at the core of art, at the core of real estate, at the core of investing, I think about it the same way, buy the best.

Tilman Versch [00:49:51] What are your filters for quality on both sides?

Christopher Tsai [00:49:56] We’ll leave real estate out, and we’ll talk about art quickly. What does it mean? Well, I’m interested in original thought. I’m not saying that artists shouldn’t take inspiration from other artists. All artists take inspiration from other artists.

Tilman Versch [00:50:20] All investors also do.

Christopher Tsai [00:50:23] Well, yeah. And there’s this lovely parallel. That has to go beyond just taking inspiration. The art has to push something further. There’s a quality when the artist and the work they produce come together. And that is reflected in some sort of vision or explanation of the world that takes what we’ve previously known further. The artist is trying to explain the world. Ultimately, that’s what all artists are trying to do. It’s trying to explain the world. It uses different models. But that’s ultimately what it’s doing. So, good artists are often inspired by others, but they take things further.

Now, the parallel to investing. As you mentioned, the 13 Fs are readily available. Investors often take inspiration or copy other investors by looking at the 13 Fs, Shameless cloning of other investors. And that can be a real big problem, especially when that initial foundation is not solid, right, whoever that idea is coming from. If that idea is not right, then there’s a problem. It’s a problem. It should be understood. I think this is not a good way to go about managing portfolios, not just copying the smartest people, and this is why.

Let’s assume all of the investors that one is copying are correct. They don’t make mistakes. Let’s just assume that. The problem is that if you haven’t done the work yourself and you haven’t really understood the nature of a company, the inner workings of the company, how that company should be valued, where that company is going, what are its advantages. If you don’t understand all of these things, in a market downturn or a period of overvaluation, you will not hold on to that name. You’re going to make a mistake. You’re either going to hold it too long, or you’re going to sell it too early. You won’t have the conviction if you haven’t done the work.

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So, fine. Take inspiration from great managers. I have no problem with that. I think that’s a great way to start. Right? Why make your own mistakes when you could start at a higher level? Right? If you think somebody is a very intelligent manager, and he or she just bought this particular company, why wouldn’t you want to look at it? I mean, that’d be pretty silly. But you better do your own work. Because if you don’t do your own work in a market dislocation, you will never have the conviction to know what to do. And the one thing that we know is that markets will be in periods of overvaluation and undervaluation. There will be major sell-offs, periods of euphoria. Those periods are coming.

Tilman Versch [00:54:14] So, you’re looking in both in art and investing for kind of creative figures or builder figures that build something new based on the foundations that existed before and enhanced this.

Christopher Tsai [00:54:28] I think what you want to do as an investor is definitely align yourself with great managers. And the interesting thing is that in the world that we live in today, I think the great managers, for the most part, you can find them. Several of them are public figures. In my opinion, they’re taking businesses in a different direction. They’re just so far ahead of the competition, or they’re just great. They’re skilled allocators, right? A great manager can be a great manager in different ways. So, I’m definitely inspired by certain managers, either for their vision or capital allocation abilities.

Now, one of the great capital allocators, for example, would be, I think, Bill Stiritz. And Bill Stiritz did a phenomenal job with Ralston Purina. That was well known. I mean, his track record was well known. But then he went out and launched Post or took over Post. It wasn’t a secret. You can follow some of the great capital allocators and some of the great managers in terms of what they’re doing with a business or their vision that is often readily discernible as well. You know where to look.

Tilman Versch [00:56:17] How important are people for you?

Christopher Tsai [00:56:19] Very important. One of my mentors, who’s actually just a few blocks from here, is Ron Baron. And Ron Baron talks a lot about culture, people, way underrated, can’t be screened for.

Tilman Versch [00:56:40] We have to meet them, get to know them, and build trust over time.

Christopher Tsai [00:56:45] You don’t always have to meet them because I think that so much is available to us today in this technologically-enabled world. There are so many interviews. So many people know each other. Obviously, it’s great to meet the managers, but I don’t think it’s necessary.

Tilman Versch [00:57:10] Interesting point. Maybe let’s go back to art and investing comparison. What is harder for you; to give away a great piece of art or to give away a great company you’ve owned for a long-time?

Tilman Versch [00:57:25] Hey! Tilman here. I’m sure you’re curious about the answer to this question. But this answer is exclusive to the members of my community, Good Investing Plus.

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And without further ado, let’s go back to the conversation.

Q27

No companies he sees as destructive to humanity

Tilman Versch [00:58:06] Back to my last question on art. Art is also about dreaded tragedy, deep feelings, loss. Also, sometimes even brutality, trauma, and misuse of power. If you think about art and the artist’s process, how does this side of art help you become a better investor and human?

Christopher Tsai [00:58:33] There are certain companies, Tilman, that we just wouldn’t buy. I’m not going to name them, but the reason we wouldn’t buy them is not because the economics are not good. In fact, in one case, I think it’s quite an undervalued business at this point, but we wouldn’t. I personally would not feel comfortable supporting a company that I thought was in many ways destructive to humanity. And, you know, quite frankly, we don’t need to own it. There are too many other options. By too many, I mean, you know, we own 12, right? We could just buy one or more of the other 12 or another business. We don’t need to own something that is, in my opinion, not good for humanity.

To add to that, quite frankly, the best businesses tend to create Win-Win situations. They’re not zero-sum game situations. Those zero-sum businesses tend not to have those long-run ways of growth. They’re not as durable. They might perform extremely well for a shorter period of time, but they tend to fail. We want a win-win. We want to operate within a win-win framework, not only in terms of how we’re managing money for clients but also in terms of the businesses in which we’re placing our clients’ assets. They need to be companies that operate with a win-win framework. They’re most durable.

Q28

Investing only in win-win frameworks is possible, he believes

Tilman Versch [1:00:45] Can there always be Win-Win frameworks?

Christopher Tsai [01:00:49] I think so.

Tilman Versch [1:00:50] Why?

Christopher Tsai [1:00:52] I mean, if the question is, can you only invest in Win-Win frameworks? I think so. Can all businesses be Win-Win? I’m not sure. But can we only invest in Win-Win frameworks? I believe so. That’s what we’re looking for.

08

How does Christopher Tsai value the future?

TL;DR: All value comes from the future, he says. He explains why Apple could be worth more than Nokia, Palm and Research in Motion combined in 2007 (2022).

Q29

Today and the future cannot be valued separately

Tilman Versch [1:01:09] In our conversation, we talked a lot about the past and transformation, and also a bit about the future. What role does the future play in your analysis? What are you also willing to pay for the future as an investor?

Christopher Tsai [1:01:29] Are you talking about company valuation?

Tilman Versch [1:01:37] Company valuation. Also, there’s this idea of the value investor we are all inspired of not paying for the future by very much, just paying for the substance or the future growth. With technology and change, it’s also important to be rightly positioned to get the future and be positioned in the right companies with this exponential growth in the future.

Christopher Tsai [1:02:06] Yeah, so I think that somewhere along the lines, investors started to speak about paying for the current business and in paying for the future as if they were completely separate. If you think about the value of a company, what is its value if it had no assets or liabilities? Let’s just say you’re valuing the future sales of a company? Well, it’s the discounted cash flows called the owner earnings.

If it had assets or net assets, well, that part is the present value of the business. So, if there were no cash flows, the business would have no value unless it had some assets elsewhere. So what we want to do is think about, well, what part of the existing business is going to continue and what part might be on top of that? That’s the optionality. If you think about it, it’s all the future. There’s no way of really getting away from the future. Does that make sense?

Q30

Competitive positioning decides how much value lasts

Tilman Versch [1:03:41] It makes sense. Maybe this question doesn’t fit, but what you’re appealing then to pay for the future now doesn’t make that much sense because the future and the current valuation are intertwined. How do you get the certainty that you’re right with investing in this future that comes out of the data you get from the business’s current situation?

Christopher Tsai [1:04:06] Yeah. I mean, at the end of the day, it’s trying to understand the company’s competitive positioning. We spoke about Gillette earlier. What I’m trying to emphasize for the purpose of this conversation is that all value comes from the future. The question is, does some of that value come from an existing business model or existing product? Or does some of that come from something entirely new?

If we think about Gillette, Gillette is a great example because it’s been around since the early 1900s. Its core razor blade business was unsurmountable for generations, but Dollar Shave Club comes around sells direct to consumers with a competitively priced product, a good product. And they still have a tremendous market share from Gillette. So, if you were looking at Gillette right before Dollar Shave Club launched, you would say, “Okay. Well, how much am I paying for the current business? And how much am I paying for the future?”

The problem was that the current business would no longer be in the future, if that makes sense. So, all value is coming from the future. Unless there’s a net asset value on the balance sheet that is somehow not reflected in the cash flows, it’s not double-counted somewhere. It might be land. That you count on now, and that’s likely not going to change in the future. So that would be part of your calculation of intrinsic value, but for the rest of the business, you have to look to the future.

So if you’re looking to the future, even with a business like Gillette, you’re thinking, “Okay, this is pretty stable.” Well, it’s not stable. So, at the end of the day, my point is that you have to understand the competitive positioning of the company. It’s all about the competitive positioning of the company. Can that company continue selling what it has sold in the past? What’s the value to that? And is there something that might transpire in the future? What’s that worth?

So, what I’m trying to figure out is, you know, what the future cash flows of a company are going to be? What’s the market value of the company today? Compare those two and understand the optionality of the business. In other words, is there optionality? Is there potential for future cash flows that are just not reflected in the market value?

That’s where it gets really interesting is where you’re paying for something for the current business, but you’re not paying for any optionality? That’s the unknowable part. And that’s where it gets really interesting because Richard Zeckhauser said that big returns come from the unique, unknown, and unknowable. If we can somehow get optionality and not pay for it, that can be really fun. That’s a good thing.

Q31

Optionality he does not think he is paying for

Tilman Versch [1:08:23] Is there any experience where you had this that you could share with us?

Christopher Tsai [1:08:29] We see optionality in a lot of the businesses that we own today. Our 13 F is public, so I would consider market and intrinsic values. Optionally, a lot of the businesses that we own are working on products or services that are not yet reflected in the valuation today. But I don’t think we’re paying for that. So, if they hit, if they’re successful, that’s great. We would just increase our IRR. And if they don’t hit, I don’t think we’re paying for it today.

Q32

Mark Twain and the Apple iPhone example from 2007

Tilman Versch [1:09:28] For the end of our interview, is there anything you would like to add that we haven’t discussed?

Christopher Tsai [1:09:34] Was it Mark Twain that said, “It ain’t what you don’t know that gets you into trouble, it’s what you know for sure that just ain’t so.” I think we should all keep Mark Twain in our mind as we think about what we own, why we own it. And again, always remain curious, not judgmental. Try to understand that if something doesn’t make sense to us, or something doesn’t make sense on the surface, maybe it makes perfect sense, just not to us.

I’ll give you an example. If you go back to 2007, Apple had just launched its iPhone. Many investors at the time said, “Well, the market value of Apple makes no sense.” They said it didn’t make sense because Apple was worth more than Nokia, Palm, Research in Motion, all those companies combined. How can that be? And what people didn’t understand, or at least a lot of people didn’t understand, was that Apple was shifting to an entirely new business model. And it had a product that had tremendous network effects that were not understood. And the market didn’t understand that the other companies would actually be completely disrupted by this new business model, by this new product, by new technologies converging. So, the market as a whole got that.

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And that’s why Apple was worth more than the competitors combined. But the short sellers didn’t get that. They were close-minded. They were looking at the world through a lens or with models that no longer made sense. They didn’t understand the changes. But if you think about it, if a company has a positive future, a bright future and its competitors don’t, the value of the company that is leading disruption in taking market share and growing profits will not just be worth one multiple of all its competitors combined, but as time goes on, it will be worth two times, five times, ten times, 100 times and ultimately an infinite number of times, as all the other businesses continue to lose cash flow, and the present value of those future cash flows decreased, and the intrinsic value of those businesses decrease.

We’re seeing that same argument today in certain areas, where the value of one company might be worth all the competitors combined. People are making the same mistake because ultimately, that one company boot will be worth two times, five times, and ten times and an infinite number of times of all the other companies combined that may no longer have any cash flow. It’s just mathematics. It’s a numerator over the denominator. But it’s catchy, right? It’s a very catchy thing when somebody says, “Heck, this makes no sense. This company is worth all the combined value of the other players.” It’s very catchy. And it’s powerful, for some reason. I haven’t figured out why that’s such a powerful argument, but it’s very powerful. We all have some cognitive bias there, or at least I have. It’s a powerful argument.

But if you actually break it down and you figure out, “Okay. What does that mean? What is the value of a company? How’s the math thing compared? Numerator over denominator. What’s happening to the denominators? What’s going down? What’s happening to the numerator? Well, it’s going up because the future cash flows are increasing. Right? The present value of those cash flows is increasing, and intrinsic value is increasing. So obviously, it becomes multiples, not just one or two times. So be curious, not judgmental, as Walt Whitman said, and always look at the world with new eyes.

Tilman Versch [1:14:45] Then thank you very much for your insights. I hope we also opened the eyes of some of our viewers and listeners. Thank you very much for staying until now. And thank you very much also to you for sharing your wisdom.

Christopher Tsai [1:15:01] Thanks for putting together this amazing podcast with such great investors. I’m proud to be a part of it, Tilman. Thank you.

Tilman Versch [1:15:08] You’re welcome. And bye-bye to the audience. Bye-bye.

Tilman Versch [1:15:14] As in every video, also here is the disclaimer. You can find the link to the disclaimer below in the show notes. The disclaimer says, always do your own work. What we’re doing here are no recommendation and no advice. So, please always do your own work. Thank you very much.

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