337- Checklist Inversion

[Music] Hey everybody, this is Joe Tome. This is Daniel Tome. Welcome to the Invested Podcast. We have been diving in for five years on the process of unfolding war and buffering Charlie Munger's investing strategies. And we're just going to continue right on. We've been doing a kind of a checklist thing. Kind of. What? Major. Major checklist thing. Yes. Who's a checklist? This has got to be really brutal if you're driving. If you're listening to this podcast, commuting. And we're going through this checklist, which naturally you would want to write down, right? Well, all the more reason to listen to it twice. Yeah, I guess. Maybe three times just to make sure you don't miss anything. And then you want to put in your own stuff too. Well, anyway, get it written down, type down, print it out, some place, and build your own checklist. So, by the way, one of the great ways to start this is to read. All right, this is a major project, you guys, but it's super worth it. What's the major project? Read all of Warren Buffett's letters. Oh, well, everybody doing that with me for the invested practice has done that. Right on. And while you're doing that, write down every mistake Buffett talks to you about. Yeah. Which is huge and it will create a pretty hefty checklist. And you'll discover there's a lot of things in common between is and mine. Because I did that. And that's where I got mine to start with. Yeah, it's a really good point. And it's something that as we've been going through this checklist, I've been noting like what this is what I talked about last time. Like what how I would change it a little bit so that it works for me and the way my brain thinks because this is clearly like so many of these work for you because you understand exactly what it's asking for. And it's a mental jog that for whatever reason makes a lot of sense to you. And for me, it's going to be a little bit different for somebody else. It's going to be a little bit different again. And so it's so interesting to like notice these differences between us and. And how putting something a certain way or even in a certain order creates a different mental process. Okay point being point being that to make each of our own checklists that works really well for each of us as individual investors. Having this as an example to start is amazing. It's just amazing and then to make sure that for me anyway to not necessarily treat it as gospel and to make sure that I have my own thought processes covered in a way. So like the stuff that I tend to miss, I need to have on my checklist. And that might be different stuff than you tend to miss. I would say that's the way to think about it. I think you should think of this as gospel, absolutely 100% gospel and then add your own extras to it. And you will not be, you will not be criticized for that. You can add extras, but don't. Take a point of view that if you don't understand something, it's okay to just forget about it. This checklist was earned with blood and tears and you you ignore something on this list to your to your own detriment and you interpret things differently. That's not a great idea either. It's very straightforward. It's important actually, I think it's important. It is very straightforward, but I think changing it so that it so that the intention is clear for as I go through it. To make sure that I know exactly what that checkpoint is getting at. I need to do that. Maybe make some notes. I mean, or something, but this isn't, I mean, I don't think Buffett uses this. It's gospel. It's gospel for you. Now it's gospel period. Oh, it's gospel. It's rule one gospel. Great. And the reason that there's such a thing as gospel is that when all of you little people, all you, all of your little bunnies out there, when everybody's making up their own mind about what something means, you take something that works and you turn it into a mush. And I don't want you to do that. I really don't want you to do that, Danielle. I think that that it's fine for you to interpret something however you want, but make that another checklist point. Don't reinterpret it. Well, the problem then. The point of the checklist. The problem with adding another checklist point is it gets too long. It becomes un-wieldy. It becomes unuseful. Then don't do it. Just use the checklist as it is. And do your very best to just do what it says. That would be a good thing. It'd be like you're flying a plane. The whole point of a, like I have checklists is like you're flying a plane. And you're going down this checklist. It's not for the pilots interpretation. It's do that thing. Flip that button. Flip that switch. Right. It makes it totally. Totally. It's the same every time in every airplane. But the checklists are different for the different kinds of airplanes. And so I think for me in a way it's like different kinds of airplanes. Oh, you are. Okay. I could just see this going off the rails for you by just changing it a little bit. Right. So don't. And that's why it's been so good to talk each one through because frankly a lot of these I have not even understood. Because the way that you think about it and say it is a way that makes sense to you. But it doesn't make sense to me. Okay. You'll have to come and show me one of those at some point. But right now let's finish the checklist. What do you say? Let's finish the checklist. Okay. So where we are is we just finished events two episodes ago event singular. Yeah. In system one. Yeah. And I think we're. So the last one that I have is in spite of this event or perhaps because of it. I can specify three reasons. Why this would be the only company I'd buy for the rest of my life. It really is. We talked about that a high bar. That's a high bar. Yeah. And I really enjoy how a lot of these most of them, maybe even all of them require extremely succinct answers. You need to know what the answer is. It can't be three pages and 10 minutes of talking or however it is that you process your investing research. It's like give me three reasons or like there's like give me one sentence or you know tell me quickly how this thing works. And I think that really requires a lot of understanding and I really like that. So let's go to the next one. Okay. So to put this in context, we use an acronym are you LES that kind of encompasses the that encompasses the whole checklist. So R is radar. No where the where you find in this thing and why. You is understand the business. That's the four M's meaning mode management margin of safety. L is love the business is where you attach values. Your personal values to what product this business produces. The way it does it the way it treats employees the way it's operating in the world. That's all under love the business. And your values and then E is event that we just did. And now we're on S which is story inversion. So we've created a story here with our ULE we've created this great story. This is business you know Warren Buffett's buying it. And it's easy to understand business and an easy to understand industry. It's got a big margin of safety a huge moat great management team. I totally understand the business. It matches my values and there's this major event that has knocked the price down by 50% or more. It will definitely resolve itself in under three years and I'm going to double my money in this thing. And I would love to own this business. If this is the only business I could buy I'd be okay with that. We would be sitting on a great franchise. And you see it's so you're right. And like that's a point where I feel like a lot of people would just be like we're done here. Like this is enough. It's met every possible insane requirement. And yet there's more. There's one more. And this one is the hardest one of all. And it's the absolutely most important one of all. Because this is the one where you challenge your own confirmation bias that has now been created. Yeah. I have been built this wonderful story. Totally. Are you L. E. thing builds a conf builds a bias you now really want to buy this thing. Like today I want to get out there and get it. The last thing I want to do is blow holes in this story. I'm already done all this work. I think I know what's going on here. But the last thing is just for Charlie Munger quote to understand why we're doing this. And so what I want to do is as he said, if you want to really be a great investor, then quote, invert. Always invert. Now that's a little bit thick. So we're going to unpack that a little bit. by he's basically coming from a mathematical perspective here, that if you want to solve a mathematical equation, you flip it around and you can start to, I'm not a mathematician, so I'm almost, I just sort of understand what that means. You sort of flip it around. Anyway, that's what Charlie says. When it applies to a business, I fully understand it. And by flip it around, what I understand it to mean is these four things, there we go. Okay. Number one, I have a serious inversion for every key reason to own this business. Oh, wow, okay. I have a question for you. So as I've gone through, for every key reason to own the business. So I've gone through RUL. So I have a bunch of great reasons to own the business right there, right? Which one of those is a great reason? Warren Buffett owns it. That's a great reason. I fully understand the business. That's a great reason on it. It's got a great mode. Management team, great reason, margin of safety. It's on sale, great reason. Had an event, great reason. It matches my values, great reason. All right. So RULE creates a series of great reasons to own the business. At the top three at a minimum, the ones that are the greatest reasons to own it. Maybe it's got a gigantic moat. Maybe it's a really easy business for you to understand, totally effortless business to understand with fabulous management team. Whatever are the major three reasons you've got there. Okay. And then you invert them. Okay. You invert them. So let me give you an example, all right? Yeah. Okay. So one of the great reasons to own, let's say Chipotle, Mexican grill, our eternal, great example, is that it has a huge moat by having created the niche that it's in, which is organic, natural, gourmet food at a fast food pace and a fast food price. It's a total niche, all right? No other company in the entire world is able to replicate what Chipotle does at any sort of scale. There are a few competitors, but they don't amount to a hill of beans. I like that. All right. All right. So. Okay. So there's your reason. So that's not an inverted reason. Right. Okay. All right. Here's the. And obsessively, nobody comes close. Okay. Huge moat, huge moat. Okay. Here's the inversion. The moat's broken. So if the reason to own it is it's great moat, then the inversion is no moat. You see what I'm doing? I'm flipping it on its head, making it be more to it than that. Sure. Okay. Absolutely. But you, I want you to get it that this is really pretty simple. It's you take the great thing, wonderful management team with great experience and integrity. What's the inversion management team isn't trustfully stealing from the company. Yeah. They're passing employees. Good. There you go. Okay. And we just don't know about it. Right. Now you're going to try to dig in and see if this is true. Is it true that the moat is broken on Chipotle? All right. So now that you're inversion, now you've got to decide it's true. Now one of the ways to do that is our second point, our second point on the checklist, which is I know every reason not to buy this company better than the short sellers. Short sellers. So the short sellers are people who have determined to try to make money by shortening the company. So let's take the game stop, for example, since that's a classic recent example of short sellers getting their short-handed doing. This company is struggling to have a moat. It used to be a big moat company doing its business. The only one of its kind, kind of retail games and turning over games to people. And that is going away with the cloud. You just don't need that anymore. So their moat is terribly broken. And so short sellers would say, oh, the moat's terribly broken. That's one of the reasons we're going to short the company. And they're going to try to make money when it goes to zero and goes bankrupt. All right. So a whole group of investors from Reddit got together and said, no, this company is getting new management. It's going to figure this out. We love this company. This is a legacy company to us. It'd be like somebody who loves McDonald's burgers so much that they can't stand the idea of the company going out of business. They want to keep being around McDonald's. And if it isn't the same burger, it's just connected to it by a brand. That's kind of a bad example. But you get the idea. Oh, OK. Yeah, because I think specifically they didn't band together. And I think it's just important to say that because the SEC doesn't approve of people banding together. So they individually decided and shared information, which influenced each other. And then individually decided to individually buy the company for their own individual reasons. Apparently arose by any other name does matter to the SEC. So yeah, you know, I mean, it's true. These people don't know each other. They don't have each other's phone numbers, you know, they don't know each other. It was mass collusion. Now, it was really something to some extent. And you know, the reasons were interesting. And I don't remember all of them, but the idea was that this company is going to make a comeback. And it was very much a lot of the people were doing it just because it was on the internet. But a number of them in the beginning were truly investing in GameStop because they think that it's going to essentially have a turnaround and become I'm not sure what exactly. Some kind of purveyor of games in a new way that's going to be profitable. Yeah, I don't want to go too much on GameStop here because it's really sort of trying to get through inversions and inversions are hard. So yeah. So the short sellers have very good reasons to short this company. And I have to know what they are. All right. And that helps me create my inversions, right? So I can do my own inversions by listing out the reasons I want to buy the company. And I'm going to go read what the short sellers are publishing and make sure that I've covered every inversion on my list that they're using. And if they're using others, I'm going to put those on my list. If they're out there promoting the ultimate demise of GameStop for reason A, B, C, I've got A and B, but I don't have C, I'm going to add C and make sure I understand that inversion completely. Yeah. I'm intrigued by the GameStop example because that's one, you know, a great company. It's hard to find people who are against it. You're not going to, like, maybe back a few years ago, you would have found people short-selling Chipotle in a major way. Oh, huge. Not so much these days. Whereas GameStop, different situation. So if it's a company where, let's say it's a more controversial situation, which it generally is in an event situation, like we're not talking about companies that everybody thinks are amazing. We're talking about companies if it's in an event that a lot of people think are going down. So. Most people think it's going down. Absolutely. So in that situation, short sellers and people who think it's going down tend to have quite good arguments. So here I am going, like, well, retail is dying and GameStop hasn't been doing well. That's why I don't want to get too deep into GameStop. I'm almost sorry. I brought it up because it is a very good short. It's a real good short. You can't defend GameStop's price at all. So I don't want to keep going on the GameStop because it's a bad example. But I guess what I'm getting at is somebody has a good argument. Something has a good argument. Your company, company A. The reason I brought up GameStop is because the arguments to short GameStop, the arguments that GameStop is going to fail are really good arguments. Yeah. And those guys who are going long on GameStop either don't know those arguments, which I think is mostly the case, right? They're not looking at the company fundamentally. They're not looking. at the quality of its earnings or where it's going to go. They're just emotional investors who are hoping for this thing to go up and that it will recover and it'll become something great. But if you looked at the reasons why the short sellers are shorting the company is you would have a list of very good reasons to short the company. And that is often the case. Yeah. As you just said. In fact, it's almost always the case. It's almost always the case. Yeah. Right. Now the difference between Chipotle and GameStop is that the next step, this is number three. Okay. For every inversion, I know a solid rebuttal that erases the inversion. Sounds like a merry-go-round. For every inversion, I know a solid rebuttal for that inversion. Yep. So somebody, it's like lacomal. Well, you hope it's not like lacomal. You have an inversion that comes up and you need to knock it down. If you can't knock it down, then you are probably in a position where you can't buy that company. I think this is where I get stuck with inversions. Or maybe not stuck, but start to feel like it's a little bit of a mental exercise waste of time. Because, because, because once I've got my inversion, my multiple inversions, and then I think, okay, I have an answer for each of these. Then it's like, it's really just a matter of opinion at that point. And so it's like, yeah, I have an answer for each of these, but I also don't have a crystal ball and I don't know which way this is going to go. That's the truth. No, no, no, no, no, no, no. I can say like, I think if I'm confident, it'll go the other way. No. But as soon as I start getting into like rebuttals of the inversions, that's where it starts to feel like, like I said, like this merry-go-round. So you don't feel like that. Oh, man, no. If you feel like, A, you're just sort of going through an exercise, then you're in a either in a, then you're in a serious state of confirmation bias. You've already made up your mind, and you're not really seriously looking at the reasons why you're wrong. No, no, no, no, no, it's the opposite. Oh, okay. So you look at these things and you can see, wow, I'm not 100% sure that these short sellers are wrong. No, I can see that it could go the way that they think it's going to go. Okay, then that's a very dangerous place to be. It is. That's my point. Yeah. Or don't invest in that. That's my point. Don't invest. Why would you invest if you're going into a very dangerous place to be? Well, because every single company has inversions and every single company has possibilities like the one they would only use a set. Every single company has inversions, but every single company, but there's some companies where there's rebuttals to those inversions that are correct. The inversion is wrong. And that's point number four. Oh, okay. The short sellers are wrong. In other words, everyone who's selling it off and everyone who's shorting it are all wrong. They're all wrong. Not, I hope they're wrong or maybe they're wrong, but they're wrong. Charlie would say it like this. You're, he would say it like this, I'm right and you're smart. And pretty soon you'll realize I'm right. There's no place for you might realize I might be right. That's very dangerous for investing. And that's that's sloppy sort of way of going into things is the way most people do it. And as a result, they can fill up their dance card of 20 companies for their whole life in a year because they're sloppy. They're not willing to be patient and demand that high level of certainty that long-term investing requires. So for example, let's take these two examples. Game stop in Chipotle. Chipotle investors said the moats broken. How could it not be broken because they've got E. coli and they're a health food company essentially with E. coli, broken moat, damaged brand, nobody's going to come back in if people are puking in the Chipotle restaurants. That was just wrong. 100% wrong and wrong at the time. And the reason that anyone rational would know it's wrong is because multiple other restaurants have had E. coli in their past and all of them overcane it. It's not something you can't overcome. Right? That is they overcame the damage to the brand. The brand wasn't broken. The moat wasn't broken. Right. Right. 100% wrong. And that single view of the world caused that stock to go from $760 to $250. And the really classic part of that is that as it started to recover it went back up to 500 when people started to realize, oh no more E. coli, it crashed back down to 250 when they got the Naurovirus in a couple of restaurants, which you can get in any restaurant in the country. It could be on a doorknob. So Naurovirus and E. coli are two totally different things. And people are so dense and so unwilling to dig in deeper that they sold off the stock. These are fun managers who are supposed to be smarter than this. They sold the stock off based on Naurovirus, which is ridiculous. So I mean, some of these things would just come back. It's just so obvious. So yeah, you want to make sure that especially as you're beginning that you're not falling into some gray area. Where your rebuttal is there, but you're not sure. So give me an example of that. Your rebuttal is there, but you're not sure. Do you have any offhand? Yeah, you've got to rebuttal to the inverse. All right, let's go game stop. So here's like the Chipotle one is a great example because I agree with you and agreed at the time that it was very highly, highly, highly likely that Chipotle would recover from that situation. But I'm not 100% kind of investor or person ever. So there is there was at the time a possibility that Chipotle's brand would not recover from that situation by a number of ways that I could imagine. Like they would not fix their distribution of their food process, which is what originally allowed the problem to show up. Or they have so many outbreaks that people just stop going to them or the different states actually shut them down for long enough that it was a huge problem. I can imagine scenarios like that. Well, to me, that's the equivalent of imagining that man, you know, we're going to have a nuclear war tomorrow. You know, we're going to have a pandemic that wipes out all of our investing for everything. That's literally stuff I think about during my inversions. I'm going to get up in the morning. It's like, I don't know. So it's like you're getting to get in the car. And I'm going to say, I am certain that I'm driving my granddaughter down to her preschool and I will get there. I will guarantee her mother that my granddaughter will get there safely. I am certain I will. Now, if a nuclear weapon hit me, I would have failed. But if some just you don't have to be like black and white about it. Like a lot of people get hit within a mile of their own home. And that's the reason why children go in safety seats. So I think I'm a better driver than that. But you can't control other people. You talk to that. I got out of their way. I get out of their way. But we're getting away from the question. What's the point of trying to merge? Yeah. Okay. Is it you if you, I guess it's just your personality or something. But really, you you have to put aside the, you know, one and a million lightning strike events. You have to put those away and you can't walk around going, well, you're never certain about anything. I'm certain I'm going to get my granddaughter to school. Okay. And I I invest like that. Now, if you're not certain, you're going to get your your needs to school. I wouldn't put her in your car. If you were like, I don't know, when I get hit by somebody, I would not put her in your car. I'll just stick her in the passenger seat then if you have no worries. Don't use a safety belt. No, because I hit the brakes yesterday avoiding a little spike buck that just ran right out in front of the car. And man, my my cell phone went flying. Isle was like under the seat belts. Lano is into the seat belts. Stuff does happen. - Stuff happens. - But you're supposed to be a good enough driver that you don't create. - Exactly. - Exactly, which is what this process is and investing, right? It's like putting on your seat belt. That's how I see it. It's like, what's my extra bit of safety for the stuff that I don't know about? That's how I view this section. - Yeah, but you're still saying that you're gonna get run over by a meteor. - I didn't say that. - You're gonna hit by a truck. Oh, so many people are mild from their home. (laughing) - Have a wreck. - That's just a fact. - Oh, man. I don't know what to say to you. - Well, I'm trying to figure out, this is, I'm really glad that we're talking about it because I've been trying, by the way, I use so many questions about this from people. How do I deal with inversions when I can imagine 50,000 different bad outcomes here? - Well, here's what I'm worried about is that that view of the world that says, "Oh, there's 50,000 bad outcomes here." And I'm only, you know, one of them is a meteor strike and a nuclear war. What I'm concerned about is that that view of the world that I can never be certain will allow you to be sloppy. And be investing in things you shouldn't invest in because you will have kind of become immune to uncertainty. You're just in a state of uncertainty all the time. No one can know everything. And therefore, you just have to, you know, put the money in on stuff where you feel the most certain. I think that is super, super dangerous. Think about what we're teaching you here. Buffett's teaching you 20 companies in your lifetime. Out of, I don't know how many. 100,000 or 200,000 that are gonna crop up over a 30, 40, about 300,000 public companies around the world. And you gotta get 20 of them. And if you get 20 of them not wrong, four of them will be right enough, according to Buffett, that you'll become rich. - Yeah. - But in order to get those 20, you have to be rigorous and recognize that there's a level of certainty that you need to achieve. So maybe you could be comfortable with that idea. There's a level of certainty that is a kin to that what you have driving your car to go to work. - Exactly, that's what I'm talking about. It's not 100%. But it's very high. - Okay, how high is it? Do you ride out your will and say, you know, be sure you contact all of your family members every day before you go get in your car. Before you get on an airplane, you know, do you? - I'm lost. It sounds like you're saying yes, there's a certain level of uncertainty that is inherent in any investment, but that you kind of throw that over your shoulder and decide to just look at the stuff that's right in front of you. Is that-- - No, that's what I'm afraid you're gonna do. That's exactly what I'm afraid you're going to do. I'm trying to tell you that the level of certainty you should have going into an investment is the same level of certainty you have driving your car to work. You're not thinking about a life insurance. - That's what you're trying to get there with this process, yeah? - Right. - So your rebuttals should be, it's not that just every company's got rebuttals and you're just in a gray area, game stop, there's rebuttals, but they're ridiculous. They're not, any rational investor is not going to accept the rebuttals against this game stop purchase price. It's like the purchase price is insane for a company like GameStop. GameStop would have to have a lightning strike hit it level of result in order to make the purchase price worth it. In other words, a complete opposite. - But this is a situation of a company that's not really gonna meet any of the other-- - True, you're gonna have a whole kind of-- - Point's on this checklist. - Right. - So, okay. - So, not even at the inversion level with that company. - Maybe the, maybe the thing that you're raising here, never so, I had a glimmer there for a second that you're raising an issue, say it again, what you said about game, oh yeah, that you've gone through the whole checklist. And by the time you've gone through the checklist and get to the inversion, the inversion is moot. You've already done it all. And therefore, you're making up reasons not to do it. That you've already answered. And the rebuttals are just sort of pro forma. And what's the point of doing it? You've already done it. Is that kind of what you're ending at here? - I don't know, I don't know. I'm not even sure what that means. I mean, if there's a company that I'm researching, if I were using this checklist on it, that didn't even make it through like the first couple sections I wouldn't keep going. Do you go all the way through to the end on every company? - No. No, I'm gonna get to be clear that we're not gonna go further, doesn't have a moat, for example. - Right, exactly. - Right? - Yeah. - So yeah, you can actually, I like to get done as quickly as possible, so I can just go to the spa. - Oh, I was gonna say move on, but yeah. (laughing) Well, I suggest we continue to discuss this inversion section in the next one. - We need to dig in deeper. - Yes. - 'Cause you're not comfortable with my level of certainty, and I'm not comfortable with your level of sort of softness on this issue. I wanna make it really crystal clear. So yeah, so let's go back to the next one. - So this is an interesting way to describe. - Okay. - Gray area, something. - Gray area. - Whatever you said, use your words, but I'm not liking it, so maybe you can convince me. - Well, what I'm looking for is more certainty. That's what I'm looking for. - Yes, more certainty. - Yeah. - Okay, cool. We'll dive into it more next time. - Okay. - Thanks everybody. - Bye, you guys, time to go play. - Hi guys, thanks for listening to "Invested." If you enjoyed this episode, and you want more information, or to listen to additional episodes, visit our website at investedpodcast.com. And sign up for my virtual workshop right there. Spots are definitely limited for this event. I'm not kidding, they really are, they sell out very quickly. So everything discussed on this podcast, by the way, is either my opinion or it's Daniel's opinion. And I'm really important, it's not to be taken as investing advice because I am not your financial advisor, nor have I considered your personal situation as your fiduciary. So remember that, you're on your own here. This podcast is for your entertainment and education only, and I really hope you enjoyed it. (upbeat music)