Christopher Tsai, what is the ultimate goal of investing?

We are back with a new format: The home studio talk! It was a pleasure to welcome Christopher Tsai (Tsai Capital) as our first guest in Berlin.

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We have discussed the following topics:

Welcoming a special guest in our new studio

[00:00:00] Tilman Versch: Dear audience of Good Investing Talks, it’s great to have you back, and now I’ve changed the set-up as you see in this video. Normally I’m sitting here doing the videos for you and the podcasts, but today I changed seats to welcome a special guest in my new home studio. It’s Christopher Sai of Tsai Capital. Hi, Christopher. It’s great to have you here.

[00:00:22] Christopher Tsai (Tsai Capital): Tilman it’s amazing to be here in your new studio.

[00:00:25] Tilman Versch: Thanks for coming over and I hope people like this format. If they like it, please leave a comment and subscribe to the channel if you haven’t done so. But now let’s jump into the conversation. Christopher, you have built Tsai Capital for 23 years and it’s normally not like the usual thing to be in business for 23 years as a fund manager. A lot of funds churn or leave the industry and go do something else or go broke or whatever.

[00:0057] Tilman Versch: How did you survive for 23 years?

[00:01:00] Christopher Tsai (Tsai Capital): We’ve had a consistent investment approach that has allowed us to outperform over time. I think that if you’re not outperforming over time, you’re not adding value to your clients. So there’s no reason for you to survive. So that’s the first element that has allowed us to survive as being able to navigate through various market conditions—bear markets, bull markets, flat markets. But more importantly, I think is having a client base that is truly aligned with that investment approach.

Having a client base for us that is aligned with the long-term investment approach and having clients who understand that often the best time to invest capital is when your stomach says something different. We need clients who think like we do. We need clients who think about investing and contributing capital when markets are down and we have that aligned client base and that’s really been highly beneficial to us over time.

Christopher Tsai (Tsai Capital) on building a client base

[00:01:58] Tilman Versch: How do you get relations with people who are interested in acting against their stomach feeling?

[00:02:06] Christopher Tsai (Tsai Capital): Well, it’s not easy. I mean, it’s not easy for the investment manager as well because we’re all human. We all have a certain emotional response to different environments. I think that knowing the kinds of clients in their outlook up front is really, really important. It’s critical. In other words, as Charlie Munger said, you should choose your clients as you would your friends.

As Charlie Munger said, you should choose your clients as you would your friends.

And it’s very true. In order to survive over a long period of time, you really need that alignment and it’s an interview between– It goes both ways. It’s not just clients interviewing Tsai Capital, but it’s me interviewing clients and making sure that there is that alignment. In educating them, making sure we are all on the same page. We have a letter on our website that is written not to attract clients, but it’s actually written to dissuade clients from investing and the reason why we do it that way is in order to make sure there’s transparency upfront and there’s a total alignment.

[00:03:16] Tilman Versch: How long does it usually take till clients are aligned with you and how much back and forth is this?

[00:03:25] Christopher Tsai (Tsai Capital): Well, typically, if there doesn’t seem to be an alignment, almost immediately then there’s never going to be an alignment. So we tend to know that fairly soon. Now sometimes you need to sit down with the prospective investor and try to understand what his or her ultimate goals are. And we want to make sure that we can fulfil those expectations as well. But it’s usually fairly evident to us from a very early stage of that so-called back-and-forth interview. In other words, if the prospective client asks you know how much money or what kind of return you think you can make over the next year, that’s automatically a red flag because we don’t think that way. I’m sure, many, many firms think that way, but it’s just not our approach. We’re thinking in terms of five years plus.

Christopher Tsai (Tsai Capital): The ultimate goal

[00:04:18] Tilman Versch: You mentioned the word ultimate goal. What is the ultimate goal of you as an investor?

[00:04:25] Christopher Tsai (Tsai Capital): The ultimate goal is to continue to learn and continue to adapt to changing environments. You asked me earlier how we’ve survived. So we talked about an aligned client base and being able to add value to clients, but being able to add value to clients is also a function of being able to adapt to changing times. So one of my goals is really to be able to adapt to changing times because the investment landscape changes constantly.

One of my goals is really to be able to adapt to changing times because the investment landscape changes constantly.

The early portfolio

[00:04:59] Tilman Versch: Maybe walk us through this adaption. So you started out 23 years ago and maybe your portfolio is a good signalling for this. How was it then and how has it changed over time?

[00:05:11] Christopher Tsai (Tsai Capital): Yeah. Now that’s a great way of looking at it, focusing in on the portfolio. In the early days, there was such a fascination with these so-called new economy companies, the Internet companies of the time, and many of them were just worthless businesses. They had they had poor business models. They had no viability to turning a profit, but the market was really obsessed with them, especially around going into the NASDAQ peak in March of 2000.

Consequently, so-called old economy businesses at the time, the industrial manufacturers, auto insurance companies, anything that didn’t have that kind of tech element, those businesses were really hated. So if you look at our portfolio in those days, you can see that the portfolio was really full of these acid-heavy, old economy, types of businesses that we’re trading at very low price-earnings multiples just because they were overlooked by the street and the focus at that time, as I mentioned, was on technology companies, particularly anything with a dot com in the name.

So as time has gone on, we’ve realised that you don’t necessarily have to be in those types of businesses that everybody was obsessed with at that time. But we do like the idea of asset-light, highly scalable companies that are run by truly talented management teams, businesses that have the ability to reinvest capital at high rates of return over a very, very long duration. So our portfolio over time has moved increasingly toward asset-like businesses, scalable businesses with large total addressable markets and with deep competitive moats.

Tesla

[00:07:08] Tilman Versch: So how does Tesla fit into this framework? Because it’s far from being asset-light, and it’s one of your largest positions.

[00:07:14] Christopher Tsai (Tsai Capital): So that’s a really interesting question. So they’re investing billions of dollars of capital per year. However, what’s misunderstood by the street is that their returns on incremental capital are really, really high. So last year, we figured the returns on incremental capital were around 80%. I don’t know of another 700-plus billion-dollar company that has returns on invested capital of about 80%. The returns on equity returns on total capital are also in the mid-30s. So this is a business that has a lot of the characteristics that we look for across the portfolio. So we’re talking about large total addressable markets.

They’re not only in auto, but increasingly in electricity and power generation, power storage, they have multiple verticals in which they’re moving into, which have massive addressable markets. So you have a large market, trillion-dollar markets. You have high returns on capital and equity, and you have high returns on incremental capital. You have a culture of innovation. You have a management team that is extremely skilled in allocating capital and you have deep, deep economic modes across those verticals. So if you step back and you look at Tesla and you dive into how the business is performing, how the business has developed, it fits all of those characteristics that we look for in the other 20 companies in the portfolio today.

[00:08:53] Tilman Versch: How do you come to this 80%?

[00:08:56] Christopher Tsai: So we look at the capital that they contribute in terms of property, plant and equipment. We look at their inventory, and we back out any items on the balance sheet that are not part of that calculation, any cash and cash receivables. And we look at their net profits after tax and we calculate that kind of return. So it’s a truly incredible business. And I think those returns on incremental capital are now showing through more obvious numbers. So you can easily calculate return on equity and return on capital.

But returns on incremental capital you have to do a little bit more work, but ultimately the two start to come together and that’s why you’re seeing returns on equity and returns on total capital moving up. And I think more and more investors are starting to realise that this is a business while capital intensive in many ways is actually capital light in other ways. And as the company moves increasingly toward software, with 60 to 70% gross margins, you’re going to see higher returns on capital or at least higher returns on incremental capital. And you’re going to be able to kind of figure out the direction of the company. And I think that will start to show through on a lot of the other metrics as well.

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Thoughts on Tesla management

[00:10:56] Tilman Versch: You mentioned the talent and management that’s important for you. And with Tesla, we know one of the key managers, Elon Musk, but he’s now also busy with Twitter and other projects he got into. What are the other players at Tesla, outside of Musk, that have impressed you?

[00:11:18] Christopher Tsai (Tsai Capital): I mean, Tesla has 200,000 or so employees. So this is a deep management team. If Elon were to disappear tomorrow, this is not a company that disappears. The foundation has been laid at this point for continued success. There are two wonderful biographies of Elon Musk and Tesla that have come out over the past several years. One actually came out a number of years ago by Ashley Vance. What Ashley Vance so nicely talks about in the book is how Elon has always been involved with so many projects, and this is not something new to him. He’s been involved with numerous companies and at the same time, from the very beginning. So he is skilled at allocating his time, and he’s skilled at managing multiple businesses. And I wouldn’t be surprised that in the coming years, you see him step back from the CEO role at Tesla.

[00:12:30] Tilman Versch: And who are the figures in the back that lead? Because 200,000 people are like it’s a wide definition of management. Yeah, you have shared alignment of members of the production and people you can align with stock options, but like there are a few who make the key decision.

[00:12:50] Christopher Tsai: Well, I mean there are many and I think I don’t want to speculate as to who actually winds up taking over. I do think it will come from somebody within Tesla, but I think there are many opportunities. It remains to be seen as to who he’ll appoint and he can be erratic in that regard as we know. But I think it’ll be somebody from within Tesla. I think their management team is quite deep.

Focus

[00:13:18] Tilman Versch: Maybe let’s jump from the framework of having many activities back to your business-building journey we already touched upon a bit. What side outside of the pure investing focuses helps to build your business?

[00:13:34] Christopher Tsai (Tsai Capital): Focus is really super important and I think different people are able to focus in different ways, right? Everybody’s life is different. So there are people who like to get up early in the morning and they start their day right away. So that would be me. There are the night owls, right? I guess your night owl. So you work best in the evening. I find that being able to go to sleep early and wake up early resonates with me and I’m the most productive that way. How do I go to sleep early? Well, with all this, you know, media and activity that happens during the day. Meditation at the end of the day helps.

So I practise a form of meditation called Transcendental Meditation, which I’m sure many of your viewers are well aware of. It’s been very helpful to me. You’re supposed to do it twice a day for 20 minutes. I don’t always make twice a day, but when I do make twice a day, I can feel the difference. So TM, Transcendental Meditation has helped me to focus a lot. Just regular exercise has helped me to focus a lot. So that just works for me. So sleep, exercise, and meditation. And it really hasn’t varied. I started my business many, many years ago, more than two decades ago. I started out in my apartment on the Upper East Side of Manhattan.

And I would literally get up around 6:30 in the morning. I would make breakfast, and I would go to work on my dining room table. And I would take a lunch break at 12. And then I would go back to work and then I would end the day at 5:00 and I would exercise. And that kind of routine hasn’t really changed over those many, many years and just very regimented in that regard, but that has helped me also to not get distracted along the way.

Networking

[00:15:42] Tilman Versch: And now you’ve talked a bit about the I or U and the way of building your business and your focus and keeping this, which is important because I’ve talked to other investors that also tell me that I have to focus and be able to keep up with the struggle investing means. But let’s switch to the “we” because also in our pre-talk you mentioned network, network, network is important to build a business like you did. Maybe you can elaborate a bit on this and also what helped you to network in spaces where you might have a competitive advantage over other investors.

[00:16:19] Christopher Tsai (Tsai Capital): Sure, we all have to use the cards we’re given. Some people are given more cards than others. One of the cards that I was given was being able to live in New York City. New York City is an amazing city in which to live in terms of its networking opportunities. There are just so many groups and organisations that you can become a part of and so many other investors and prospective clients, people, and friends, they all come through New York City at one time or another. The problem is that it’s also very distracting, so it’s super important that when you’re living in a huge city like Manhattan, you’re able to maintain that focus.

It’s one of the reasons why Charlie and Warren preferred building their business out of Omaha. The networks that have been most beneficial to me have come from the field of arts, Fine Arts in particular. I’ve loved art from a very early age. Both my parents were art collectors. I’ve spent a lot of time with artists over the years. I’ve spent time, so many, like countless hours in museums, and through that exposure to museums getting to know trustees of museums, getting to know other collectors. So that’s been an area that’s been a wonderful circle in which to build relationships that have worked for me. But there, there are so many different areas. When you live in a city like New York or London or Berlin where we are.

Christopher Tsai (Tsai Capital) on saying „No“

[00:18:18] Tilman Versch: What I learned from living in Berlin is that you have to learn to say no to a lot of things to stay focused. Warren and Charlie made it easy. Warren made it easy. He just focuses on being in Omaha where you can– Well, it’s easier to say no to a lot of things. How have you learned or how has it helped you to say no to a lot of things?

[00:18:40] Christopher Tsai (Tsai Capital): Well, first off, I think it was Charlie Munger who said the difference between a successful person and a really successful person is that the really successful person says no to almost everything. I did not say no to almost everything in the earlier days of my investing journey. I do say no a lot more often today simply because if I don’t, I will not have the time to dedicate to my clients.

I do say no a lot more often today simply because if I don’t, I will not have the time to dedicate to my clients.

So it’s very important that the number one priority is the clients. And that means research being able to spend time looking at businesses. But the line is sometimes grey. In other words, spending time with other investors, networking with other investors, and fellow investors who are like-minded or who might be interested in similar areas or even different areas can be hugely beneficial to be helpful to your underlying investors. It’s because you learn from them. They help you uncover potential blind spots.

Inspiring people

[00:19:56] Tilman Versch: Are there any people that inspired you in that sense?

[00:20:00] Christopher Tsai: So many. My late father, Jerry Tsai, worked for Edward Johnson Sr. at Fidelity Investments, and they had a conversation once. I was told, Edward Johnson Sr. said to my father, once you buy a company, don’t talk to management again because you’ll never be told anything other than what management wants to tell you. That was their philosophy in the very early days from what I understand. They’ve since changed. But I don’t think that’s the right approach for me and I’ve learned from people and friends like Ron Baron who has just instilled in me this idea of understanding culture, understanding that a business is not an entity that exists on its own. It’s made of people.

Understanding the people, understanding culture, understanding what makes the business tick, what makes management tick, I think is super important. So we try to align our client capital with businesses that are innovative. With businesses that are run by skilled allocators and with companies that are always trying to push themselves further and trying to understand what the competition is doing and doing a bit more than that.

Good Investing Plus – A warm invite to apply

Hey, Tilman here. You seem to have passion investing. That is great!

If you want to dive deeper and go further down the rabbit hole, you are kindly invited to apply to my community Good Investing Plus. It’s a place that’s very helpful to people who are ambitious about investing and is helpful to investment talent and experienced fund managers. So if you’re interested, please click on the link below.

Christopher Tsai (Tsai Capital) on competition

[00:21:54] Tilman Versch: You mentioned competition. What is your framework for competition for your business? Who are you competing with as a fund?

[00:22:04] Christopher Tsai (Tsai Capital): I’m competing primarily with myself. That’s how I feel. That this is a journey. That it’s an ongoing journey. And I’m just trying to get better at what I’m doing each day.

I’m competing primarily with myself. That’s how I feel. That this is a journey. That it’s an ongoing journey. And I’m just trying to get better at what I’m doing each day.

I’m trying to learn something new each day. I’m trying to implement some sort of process or idea that you know something new each day that is beneficial to the Tsai Capital ecosystem. There’s this Japanese concept called kaizen, which roughly translates to that continuous improvement over time leads to large change. So everything that we do is based on this idea of kaizen.

So I think about competition first and foremost with myself, but of course, also I’m competing against my benchmark, which has been the S&P 500 and I’m competing against other investors. If other investors can add more value to underlying clients, then those underlying clients should be with those investors. So there’s this constant and that’s what I love about the investing business. It’s hugely competitive. It constantly pushed me to try to be a better investor, a better person, more thoughtful person. It’s a constant like yin and yang. It’s a constant struggle and I like that.

Closing thoughts

[00:23:50] Tilman Versch: Chris, thank you for your insights and I want to make a cut at this point because like, not only competition brings you forward, but also role models. We have two role models embedded in this picture, but in the next video we’re showing, soon, we will talk about other role models that played a role in forming you as an investor. Thank you for coming for this first episode, and if you’re interested in learning more about Chris, we recently had in our community Good Investing Plus for an in-depth interview with a lot of cool questions. It’s not only me asking questions here and you can find the link to apply for Good Investing Plus below. Feel free to apply and thank you very much for your attention. Looking forward to seeing you again in the second video.

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Tilman is a very enthusiastic, long-term investor. Over the last years he has taught himself important investing concepts autodidactically. He tries to combine a positive climate and environmental impact with his investments.
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