How the Greatest Economist Defied Convention and Got Rich

(Image:  Zen Buddha Silence by Marilyn Barbone.)

April 3, 2022

John Maynard Keynes is one of the greatest economists of all time.  But when he tried to invest on the basis of macroeconomic predictions, he failed.  Twice.  When he embraced focused value investing, he was wildly successful.

It is well known that Warren Buffett and Charlie Munger are two of the greatest value investors, and that they both favor a focused approach.  What is not as well known is that the world’s most famous economist, John Maynard Keynes, independently embraced a value investing approach similar to that used by Buffett and Munger.

The story of Keynes’ evolution as an investor has been told many times.  One book in particular – Justyn Walsh’s Keynes and the Market (Wiley, 2008) – does a great job.

Keynes did very well over decades as a focused value investor.  His best advice:

  • Buy shares when they are cheap in relation to probable intrinsic value;
  • Ignore macro and market predictions, and stay focused on a few individual businesses that you understand and whose management you believe in;
  • Hold those businesses for many years as long as the investment theses are intact;
  • Try to have negatively correlated investments (for example, the stock of a gold miner, says Keynes).

Now for a brief summary of the book.



Keynes was born in 1883 in the university town of Cambridge, where his father was an economics fellow and his mother was one of its first female graduates.  After attending Eton, in 1902 Keynes won a scholarship to King’s College at Cambridge.  There, he became a member of a secret society known as “the Apostles,” which included E. M. Forster, Bertrand Russell, and Wittgenstein.  The group was based on principles expressed in G. E. Moore’s Principia Ethica.  Moore believed the following:

By far the most valuable things, which we know or can imagine, are certain states of consciousness, which may be roughly described as the pleasures of human intercourse and the enjoyment of beautiful objects.

Upon graduation, Keynes decided to become a Civil Servant, and ended up as a junior clerk in the India Office in 1906.  Keynes was also part of the Bloomsbury group, which included artists, writers, and philosophers who met at the house of Virginia Woolf and her siblings.  Walsh quotes a Bloomsbury:

We found ourselves living in the springtime of a conscious revolt against the social, political, moral, intellectual, and artistic institutions, beliefs, and standards of our fathers and grandfathers.



Keynes strongly disagreed with the proposed peace terms following the conclusion of World War I.  He wrote The Economic Consequences of the Peace, which was translated into eleven languages.  Keynes predicted that the vengeful demands of France (and others) against their enemies would inevitably lead to another world war far worse than the first one.  Unfortunately, Keynes was ignored and his prediction turned out to be roughly correct.



After resigning from Treasury, Keynes needed a source of income.  Given his background in economics and government, he decided that he could make money by speculating on currencies (and later commodities).  After a couple of large ups and downs, Keynes ended up losing more than 80% of his net worth in 1928 to 1929 – from 44,000 pounds to 8,000 pounds.  His speculative bets on rubber, corn, cotton, and tin declined massively in 1928.  Eventually he realized that value investing was a much better way to succeed as an investor.

Keynes made a clear distinction between speculation and value investing.  He described speculation as like the newspaper competitions where one had to pick out the faces that the average would pick as the prettiest:

It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest.  We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.  And there are some, I believe, who practice fourth, fifth and higher degrees.



Another famous economist, Irving Fisher, who had also done well in business, made his famous prediction in mid-October 1929:

Stock prices have reached what looks like a permanently high plateau…. I expect to see the stock market a good deal higher… within a few months.

After the initial crash that began in late October 1929, Fisher continued to predict a recovery.

Keynes, on the other hand, was quick to recognize both the deep problems posed by the economic downturn and the necessity for aggressive fiscal policy (contrary to the teachings of classical economics).  Keynes said:

The fact is – a fact not yet recognized by the great public – that we are now in the depths of a very severe international slump, a slump which will take its place in history amongst the most acute ever experienced.  It will require not merely passive movements of bank rates to lift us out of a depression of this order, but a very active and determined policy.

Keynes argued that the economy was at an underemployment equilibrium, with a large amount of wasted resources.  Only aggressive fiscal policy could increase aggregate demand, thereby bringing the economy back to a healthy equilibrium.  Classical economists at the time – who disagreed forcefully with Keynes – thought that the economy was like a household: when income declines, one must spend less until the situation corrects itself.  Keynes referred to the classical economists as “liquidationists,” because their position implied that everything should be liquidated (at severely depressed and irrational prices) until the economy corrected itself.

Franklin Delano Roosevelt seemed to agree with Keynes.  Roosevelt said “this Nation asks for action, and action now.”  Roosevelt argued that, if necessary, he would seek “broad Executive power… as great as the power that would be given to me if we were in fact invaded by a foreign foe.”

In The General Theory of Employment, Interest and Money, Keynes disagreed with the conventional doctrine that free markets always produce optimal results.  Much later, even Keynes’ opponents agreed with him and admitted that “we are all Keynesians now.”

In the 1970’s, however, when stagflation (slow growth and rising prices) reared its ugly head, neoclassical economics was revived and Keynesian economics became less popular.  But by the late 1970’s, another part of Keynes’ views – “animal spirits” – became important in the new field of behavioral economics.



Keynes held that there is an irreducible uncertainty regarding most of the future.  In the face of great uncertainty, “animals spirits” – or “the spontaneous urge to action rather than inaction” – leads people to make decisions and move forward.

Because the future is so uncertain, many investors extrapolate the recent past into the future, which often causes them to make investment mistakes.  Moreover, many investors overweight the near term, leading to stock price volatility far in excess of the long-term earnings and dividends produced by the underlying companies.  Keynes remarked:

Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market.

Keynes lamented the largely random daily price fluctuations upon which so many investors uselessly focus.  Of these fluctuating daily prices, Keynes said that they gave:

… a frequent opportunity to the individual… to revise his commitments.  It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week.

Warren Buffett has often quoted this statement by Keynes.  Indeed, in discussing speculators as opposed to long-term value investors, Keynes sounds a lot like Ben Graham and Warren Buffett.  Keynes:

It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself.  It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise.  For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.

Keynes also noted:

… it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks.  For it is in the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion.  If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.

Because many fund managers are judged over shorter periods of time – even a few months – they typically worry more about not underperforming than they do about outperforming.  With so many investors – both professional and non-professional – focused on short-term price performance, it’s no surprise that the stock market often overreacts to new information – especially if it’s negative.  (The stock market can often underreact to positive information.)  Nor is it a surprise that the typical stock price moves around far more than the company’s underlying intrinsic value – asset value or earnings power.

In a nutshell, investor psychology can cause a stock to be priced almost anywhere in the short term, regardless of the intrinsic value of the underlying company.  Keynes held that value investors should usually simply ignore these random fluctuations and stay focused on the individual businesses in which they have invested.  As Ben Graham, the father of value investing, said in The Intelligent Investor:

Basically, price fluctuations have only one significant meaning for the true investor.  They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.  At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

Graham also wrote:

The market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks.  Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels.  Thus we have what appear to be two major sources of undervaluation:  (1) currently disappointing results and (2) protracted neglect or unpopularity.

Or as Buffett said:

Fear is the foe of the faddist, but the friend of the fundamentalist.

Buffett later observed that Keynes “began as a market-timer… and converted, after much thought, to value investing.”  Whereas the speculator attempts to predict price swings, the value investor patiently waits until irrational price swings have made a stock unusually cheap with respect to probable future earnings.  Keynes:

… I am generally trying to look a long way ahead and am prepared to ignore immediate fluctuations, if I am satisfied that the assets and earnings power are there.



Ben Graham, the father of value investing and Warren Buffett’s teacher and mentor, wrote the following in Chapter 20 of The Intelligent Investor:

In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, ‘This too will pass.’  Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.

Keynes used the phrase “safety first” instead of “margin of safety.”  Moreover, he had a similar definition of intrinsic value: an estimate based on the probable earnings power of the assets.  Keynes realized that a lower price paid relative to intrinsic value simultaneously reduces risk and increases probable profit.  The notion that a larger margin of safety means larger profits in general is directly opposed to what is still taught in modern finance: higher investment returns are only achievable through higher risk.

Moreover, Keynes emphasized the importance of non-quantitative factors relevant to investing.  Keynes is similar to Graham, Buffett, and Munger in this regard.  Munger:

… practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical techniques they’re taught in academia, and (2) doesn’t mix in the hard-to-measure stuff that may be more important.

Or as Ben Graham stated:

… the combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes… in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom.



The value investor often gains an advantage by having a 3- to 5-year investment time horizon.  Because the future is always uncertain, and because so many investors are focused on the next 6 months, numerous bargains become available for long-term investors.  As Keynes mentioned:

Very few American investors buy any stock for the sake of something which is going to happen more than six months hence, even though its probability is exceedingly high; and it is out of taking advantage of this psychological peculiarity that most money is made.

Pessimism also creates bargains.  During the 1973-1974 bear market, many stocks became ridiculously cheap relative to asset value or earnings power.  Buffett has explained the case of The Washington Post Company:

In ’74 you could have bought The Washington Post when the whole company was valued at $80 million.  Now at that time the company was debt free, it owned The Washington Post newspaper, it owned Newsweek, it owned the CBS stations in Washington, D.C. and Jacksonville, Florida, the ABC station in Miami, the CBS station in Hartford/New Haven, a half interest in 800,000 acres of timberland in Canada, plus a 200,000-ton-a-year mill up there, a third of the International Herald Tribune, and probably some other things I forgot.  If you asked any one of thousands of investment analysts or media specialists about how much those properties were worth, they would have said, if they added them up, they would have come up with $400, $500, $600 million.



Keynes had a policy of buying the best within each chosen investment category:

It is generally a good rule for an investor, having settled on the class of security he prefers – … bank shares or oil shares, or investment trusts, or industrials, or debentures, preferred or ordinary, whatever it may be – to buy only the best within that category.

Buffett, partly through the influence of Charlie Munger, evolved from an investor in quantitatively cheap stocks to an investor in higher quality companies.  Munger explains the logic:

Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.  If the business earns 6 percent on capital over 40 years and you hold if for… 40 years, you’re not going to make much different than 6 percent return – even if you originally buy it at a huge discount.  Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.



Keynes was a “focused” value investor in the sense of believing in a highly concentrated portfolio.  This is similar to Buffett and Munger (especially when they were managing smaller amounts of money).

Keynes was criticized for taking large positions in his best ideas.  Here is one of his responses:

Sorry to have gone too large in Elder Dempster… I was… suffering from my chronic delusion that one good share is safer than ten bad ones, and I am always forgetting that hardly anyone else shares this particular delusion.

If you can understand specific businesses – which is easier to do if you focus on tiny microcap companies – Keynes, Buffett, and Munger all believed that you should take large positions in your best ideas.  Keynes called these opportunities “ultra favourites” or “stunners,” while Buffett called them “superstars” and “grand-slam home runs.”  As Keynes concluded late in his career:

… it is out of these big units of the small number of securities about which one feels absolutely happy that all one’s profits are made… Out of the ordinary mixed bag of investments nobody ever makes anything.

One way that the best ideas of Keynes, Buffett, and Munger become even larger positions in their portfolios over time is if the investment theses are essentially correct, which eventually leads the stocks to move much higher.  Many investors ask: if your best idea becomes an even larger part of the portfolio, shouldn’t you rebalance?  Here is Buffett’s response:

To suggest that this investor should sell off portions of his most successful investments simply because they have come to dominate his portfolio is akin to suggesting that the Bulls trade Michael Jordan because he has become so important to the team.

The decision about whether to hold a stock should depend only upon your current investment thesis about the company.  It doesn’t matter what you paid for it, or whether the stock has increased or decreased recently.  What matters is how much free cash flow you think the company will produce over time, and how cheap the stock is now relative to that future free cash flow.  What also matters is how cheap the stock is relative to your other ideas.

Keynes again on concentration:

To suppose that safety-first consists in having a small gamble in a large number of different directions…, as compared with a substantial stake in a company where one’s information is adequate, strikes me as a travesty of investment policy.

As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes.  It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.

Conducting research on a relatively short list of candidates and then concentrating your portfolio on the best ideas, is a form of specialization.  Often the stocks in a specific sector will get very cheap when that sector is out of favor.  If you’re willing to invest the time to understand the stocks in that sector, you may be able to gain an edge.

Moreover, if you’re an individual investor, it makes sense to focus on tiny microcap companies, which are generally easier to understand and can get extremely cheap because most investors completely ignore them.

Ben Graham often pointed out that patience and courage are essential for contrarian value investing.  Cheap stocks are usually neglected or hated because they have terrible short-term problems affecting their earnings and cash flows.  Similarly, Keynes held that huge short-term price fluctuations are often irrational with respect to long-term earnings and dividends.  Keynes:

… the modern organization of the capital market requires for the holder of quoted equities much more nerve, patience, and fortitude than from the holder of wealth in other forms.



Keynes’ experiences on the stock market read like some sort of morality play – an ambitious young man, laboring under the ancient sin of hubris, loses almost everything in his furious pursuit of wealth; suitably humbled, our protagonist, now wiser for the experience, applies his considerable intellect to the situation and discovers what he believes to be the one true path to stock market success.

Keynes realized that focused value investing is the best way to compound wealth over time.  Ignore market and macro predictions, and focus on a few businesses that you can understand and in whose management you believe.

In 1938, in a memorandum written for King’s College Estates Committee, Keynes gave a concise summary of his investment philosophy:

  • A careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;
  • A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake;
  • A balanced investment position, i.e., a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g., a holding of gold shares amongst other equities, since they are likely to move in opposite directions when there are general fluctuations).

Walsh writes that Keynes followed six key investment rules:

  1. Focus on the estimated intrinsic value of a stock – as represented by the projected earnings of the particular security – rather than attempt to divine market trends.
  2. Ensure that a sufficiently large margin of safety – the difference between a stock’s assessed intrinsic value and price – exists in respect of purchased stocks.
  3. Apply independent judgment in valuing stocks, which may often imply a contrarian investment policy.
  4. Limit transaction costs and ignore the distractions of constant price quotation by maintaining a steadfast holding of stocks.
  5. Practice a policy of portfolio concentration by committing relatively large sums of capital to stock market “stunners.”
  6. Maintain the appropriate temperament by balancing “equanimity and patience” with the ability to act decisively.

The importance of temperament and the ability to maintain inner peace should not be overlooked.  As Buffett points out:

Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Walsh summarizes Keynes’ performance as a value investor:

Taking 1931 as the base year – admittedly a relatively low point in the Fund’s fortunes, but also on the assumption that Keynes’ value investment style began around this time – the Chest Fund recorded a roughly tenfold increase in value in the fifteen years to 1945, compared with a virtual nil return for the Standard & Poor’s 500 Average and a mere doubling of the London industrial index over the same period.

What’s even more impressive is that this performance does not include the income generated by the Chest Fund, all of which was spent on college building works and repayment of loans.

One small mistake Keynes made was holding his “stunners” even when they were overvalued.  Keynes made this mistake because he was an optimist.  (Buffett made a similar mistake in the late 1990’s.)  Here is Keynes (sounding like Buffett) on the future:

There is nothing to be afraid of.  On the contrary.  The future holds in store for us far more wealth and economic freedom and possibilities of personal life than the past has ever offered.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

The Superinvestors of Graham-and-Doddsville

(Image:  Zen Buddha Silence by Marilyn Barbone.)

March 27, 2022

According to the Efficient Market Hypothesis (EMH), stock prices reflect all available information and are thus fairly valued.  It’s impossible to get investment results better than the market except by luck.

However, Warren Buffett, arguably the greatest investor of all time and a value investor, has argued that he knows a group of value investors, all of whom have done better than the market over time.  Buffett argues that there’s no way every investor in this group could have gotten lucky at the same time.  Also, Buffett didn’t pick this group of investors after they already had produced superior performance.  Rather, he identified them ahead of time.  The only thing these investors had in common was that they believed in the value investing framework, according to which sometimes the price of a stock can be far below the intrinsic value of the business in question.

Buffett presented his argument in 1984.  But the logic still holds today.  The title of Buffett’s speech was The Superinvestors of Graham-and-Doddsville.  The speech is still available as an essay here:

Despite the unassailable logic and evidence of Buffett’s argument, still today many academic economists and theorists continue to argue that the stock market is efficient and therefore impossible to beat except by luck.  These academics therefore argue that investors such as Warren Buffett just got lucky.

Let’s examine Buffett’s essay.

Buffett first says to imagine a national coin-flipping contest.  225 million Americans (the population in 1984) get up at sunrise and bet one dollar on the flip of a coin.  If they call correctly, they win a dollar from those who called incorrectly.  Each day the losers drop out.  And the winners bet again the following morning, putting cumulative winnings on the line.

After ten straight days, there will be approximately 220,000 Americans who correctly called ten coin tosses in a row.  Each of these participants will have a little more than $1,000.

Buffett writes hilariously:

Now this group will probably start getting a little puffed up about this, human nature being what it is.  They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping.

After another ten days of this daily contest, there will be approximately 215 flippers left who correctly called twenty coin tosses in a row.  Each of these contestants will have turned a dollar into $1 million.

Buffett continues:

By then, this group will really lose their heads. They will probably write books on “How I turned a Dollar into a Million in Twenty Days Working Thirty Seconds a Morning.” Worse yet, they’ll probably start jetting around the country attending seminars on efficient coin-flipping and tackling skeptical professors with, “If it can’t be done, why are there 215 of us?”

By then some business school professor will probably be rude enough to bring up the fact that if 225 million orangutans had engaged in a similar exercise, the results would be much the same — 215 egotistical orangutans with 20 straight winning flips.

But then Buffett says:

I would argue, however, that there are some important differences in the examples I am going to present.  For one thing, if (a) you had taken 225 million orangutans distributed roughly as the U.S. population is; if (b) 215 winners were left after 20 days; and if (c) you found that 40 came from a particular zoo in Omaha, you would be pretty sure you were on to something.  So you would probably go out and ask the zookeeper about what he’s feeding them, whether they had special exercises, what books they read, and who knows what else.  That is, if you found any really extraordinary concentrations of success, you might want to see if you could identify concentrations of unusual characteristics that might be causal factors.

Scientific inquiry naturally follows such a pattern.  If you were trying to analyze possible causes of a rare type of cancer — with, say, 1,500 cases a year in the United States — and you found that 400 of them occurred in some little mining town in Montana, you would get very interested in the water there, or the occupation of those afflicted, or other variables.  You know it’s not random chance that 400 come from a small area.  You would not necessarily know the causal factors, but you would know where to search.

Buffett adds:

I submit to you that there are ways of defining an origin other than geography.  In addition to geographical origins, there can be what I call an intellectual origin.  I think you will find that a disproportionate number of successful coin-flippers in the investment world came from a very small intellectual village that could be called Graham-and-Doddsville.  A concentration of winners that simply cannot be explained by chance can be traced to this particular intellectual village.

Buffett then argues:

In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham.  But the children who left the house of this intellectual patriarch have called their “flips” in very different ways.  They have gone to different places and bought and sold different stocks and companies, yet they have had a combined record that simply cannot be explained by random chance…

The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market… Our Graham & Dodd investors, needless to say, do not discuss beta, the capital asset pricing model, or covariance in returns among securities.  These are not subjects of any interest to them.  In fact, most of them would have difficulty defining those terms. The investors simply focus on two variables: price and value.

As Ben Graham said:

Price is what you pay.  Value is what you get.

The Efficient Market Hypothesis argues that the current value of any stock is already reflected in the price.  Value investors, however, don’t believe that.  Value investors believe that stock prices are usually correct – the market is usually efficient – but not always.

Buffett speculates on why there have been so many academic studies of stock prices:

I always find it extraordinary that so many studies are made of price and volume behavior, the stuff of chartists.  Can you imagine buying an entire business simply because the price of the business had been marked up substantially last week and the week before?  Of course, the reason a lot of studies are made of these price and volume variables is that now, in the age of computers, there are almost endless data available about them.  It isn’t necessarily because such studies have any utility; it’s simply that the data are there and academicians have worked hard to learn the mathematical skills needed to manipulate them.  Once these skills are acquired, it seems sinful not to use them, even if the usage has no utility or negative utility.  As a friend said, to a man with a hammer, everything looks like a nail.

Buffett then proceeds to discuss the group of value investors that he had selected decades before 1984.  Why is it that the value investors whom Buffett had identified decades ago before ended up far outperforming the market?  The one thing they had in common was that they distinguished between price and value, and they only bought when price was far below value.  Other than that, these investors had very little in common.  They bought very different stocks from one another and they also had different methods of portfolio construction, with some like Charlie Munger having very concentrated portfolios and others like Walter Schloss having very diversified portfolios.

Buffett shows the records for Walter Schloss, Tom Knapp, Warren Buffett (himself), Bill Ruane, Charlie Munger, Rick Guerin, Stan Perlmeter, and two others.  For details on the track records of the value investors Buffett had previously identified, see here:

While discussing Rick Guerin, Buffett offered the following interesting comments:

One sidelight here: it is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately to people or it doesn’t take at all.  It’s like an inoculation.  If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference.  They just don’t seem able to grasp the concept, simple as it is.  A fellow like Rick Guerin, who had no formal education in business, understands immediately the value approach to investing and he’s applying it five minutes later.  I’ve never seen anyone who became a gradual convert over a ten-year period to this approach.  It doesn’t seem to be a matter of IQ or academic training.  It’s instant recognition, or it is nothing.

And when discussing Stan Perlmeter, Buffett says:

Perlmeter does not own what Walter Schloss owns.  He does not own what Bill Ruane owns.  These are records made independently.  But every time Perlmeter buys a stock it’s because he’s getting more for his money than he’s paying.  That’s the only thing he’s thinking about.  He’s not looking at quarterly earnings projections, he’s not looking at next year’s earnings, he’s not thinking about what day of the week it is, he doesn’t care what investment research from any place says, he’s not interested in price momentum, volume, or anything.  He’s simply asking: What is the business worth?

Buffett then comments on the nine track records he mentioned:

So these are nine records of “coin-flippers” from Graham-and-Doddsville.  I haven’t selected them with hindsight from among thousands.  It’s not like I am reciting to you the names of a bunch of lottery winners — people I had never heard of before they won the lottery.  I selected these men years ago based upon their framework for investment decision-making.  I knew what they had been taught and additionally I had some personal knowledge of their intellect, character, and temperament.  It’s very important to understand that this group has assumed far less risk than average; note their record in years when the general market was weak.  While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock.  A few of them sometimes buy whole businesses far more often they simply buy small pieces of businesses.  Their attitude, whether buying all or a tiny piece of a business, is the same.  Some of them hold portfolios with dozens of stocks; others concentrate on a handful.  But all exploit the difference between the market price of a business and its intrinsic value.

I’m convinced that there is much inefficiency in the market.  These Graham-and-Doddsville investors have successfully exploited gaps between price and value.  When the price of a stock can be influenced by a “herd” on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally.  In fact, market prices are frequently nonsensical.

Buffett then discusses risk versus reward.  When you are practicing value investing, the lower the price is relative to probable intrinsic value, the less risk there is but simultaneously the greater upside there is.  As Buffett puts it, if you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expected reward is greater in the latter case.

Speaking of risk versus reward, Buffett gives an example:

The Washington Post Company in 1973 was selling for $80 million in the market.  At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more.  The company owned the PostNewsweek, plus several television stations in major markets.  Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy.

Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater.  And to people that think beta measures risk, the cheaper price would have made it look riskier.  This is truly Alice in Wonderland. I have never been able to figure out why it’s riskier to buy $400 million worth of properties for $40 million than $80 million.

Buffett adds that you also want to be sure that the managers of the business are reasonably competent.  But this is a very doable task.

Buffett concludes his essay by saying that people may wonder why he is writing it in the first place, given that it may create more competitors using value investing.  Buffett observes that the secret has been out since 1934, when Ben Graham and David Dodd published Security Analysis, and yet there has been no trend towards value investing.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

More Than You Know

(Image: Zen Buddha Silence, by Marilyn Barbone)

March 13, 2022

To boost our productivity—including our ability to think and make decisions—nothing beats continuous learning.  Broad study makes us better people.  See:

Michael Mauboussin is a leading expert in the multidisciplinary study of businesses and markets.  His book—More Than You Know: Finding Financial Wisdom in Unconventional Places—has been translated into eight languages.

Each chapter in Mauboussin’s book is meant to stand on its own.  I’ve summarized most of the chapters below.

Here’s an outline:

  • Process and Outcome in Investing
  • Risky Business
  • Are You an Expert?
  • The Hot Hand in Investing
  • Time is on my Side
  • The Low Down on the Top Brass
  • Six Psychological Tendencies
  • Emotion and Intuition in Decision Making
  • Beware of Behavioral Finance
  • Importance of a Decision Journal
  • Right from the Gut
  • Weighted Watcher
  • Why Innovation is Inevitable
  • Accelerating Rate of Industry Change
  • How to Balance the Long Term with the Short Term
  • Fitness Landscapes and Competitive Advantage
  • The Folly of Using Average P/E’s
  • Mean Reversion and Turnarounds
  • Considering Cooperation and Competition Through Game Theory
  • The Wisdom and Whim of the Collective
  • Vox Populi
  • Complex Adaptive Systems
  • The Future of Consilience in Investing

(Photo: Statue of Leonardo da Vinci in Italy, by Raluca Tudor)



(Image by Amir Zukanovic)

Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs.  But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.

Robert Rubin made this remark in his Harvard Commencement Address in 2001.  Mauboussin points out that the best long-term performers in any probabilistic field—such as investing, bridge, sports-team management, and pari-mutuel betting—all emphasize process over outcome.

Mauboussin also writes:

Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.

If you don’t understand why your view differs from the consensus, and why the consensus is likely to be wrong, then you cannot reasonably expect to beat the market.  Mauboussin quotes horse-race handicapper Steven Crist:

The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory… This may sound elementary, and many players may think that they are following this principle, but few actually do.  Under this mindset, everything but the odds fades from view.  There is no such thing as “liking” a horse to win a race, only an attractive discrepancy between his chances and his price.

Robert Rubin’s four rules for probabilistic decision-making:

  • The only certainty is that there is no certainty.  It’s crucial not to be overconfident, because inevitably that leads to big mistakes.  Many of the biggest hedge fund blowups resulted when people were overconfident about particular bets.
  • Decisions are a matter of weighing probabilities.  Moreover, you also have to consider payoffs.  Probabilities alone are not enough if the payoffs are skewed.  A high probability of winning does not guarantee that it’s a positive expected value bet if the potential loss is far greater than the potential gain.
  • Despite uncertainty, we must act.  Often in investing and in life, we have to make decisions based in imperfect or incomplete information.
  • Judge decisions not only on results, but also on how they were made.  If you’re making decisions under uncertainty—probabilistic decisions—you have to focus on developing the best process you can.  Also, you must accept that some good decisions will have bad outcomes, while some bad decisions will have good outcomes.

Rubin again:

It’s not that results don’t matter.  They do.  But judging solely on results is a serious deterrent to taking risks that may be necessary to making the right decision.  Simply put, the way decisions are evaluated affects the way decisions are made.



(Photo by Shawn Hempel)


So how should we think about risk and uncertainty?  A logical starting place is Frank Knight’s distinction: Risk has an unknown outcome, but we know what the underlying outcome distribution looks like.  Uncertainty also implies an unknown outcome, but we don’t know what the underlying distribution looks like.  So games of chance like roulette or blackjack are risky, while the outcome of a war is uncertain.  Knight said that objective probability is the basis for risk, while subjective probability underlies uncertainty.

Mauboussin highlights three ways to get a probability, as suggested by Gerd Gigerenzer in Calculated Risks:

  • Degrees of belief.  Degrees of belief are subjective probabilities and are the most liberal means to translate uncertainty into a probability.  The point here is that investors can translate even onetime events into probabilities provided they satisfy the laws of probability—the exhaustive and exclusive set of alternatives adds up to one.  Also, investors can frequently update probabilities based on degrees of belief when new, relevant information becomes available.
  • Propensities.  Propensity-based probabilities reflect the properties of the object or system.  For example, if a die is symmetrical and balanced, then you have a one-in-six probability of rolling any particular side… This method of probability assessment does not always consider all the factors that may shape an outcome (such as human error).
  • Frequencies.  Here the probability is based on a large number of observations in an appropriate reference class.  Without an appropriate reference class, there can be no frequency-based probability assessment.  So frequency users would not care what someone believes the outcome of a die roll will be, nor would they care about the design of the die.  They would focus only on the yield of repeated die rolls.

When investing in a stock, we try to figure out the expected value by delineating possible scenarios along with a probability for each scenario.  This is the essence of what top value investors like Warren Buffett strive to do.



In 1996, Lars Edenbrandt, a Lund University researcher, set up a contest between an expert cardiologist and a computer.  The task was to sort a large number of electrocardiograms (EKGs) into two piles—heart attack and no heart attack.

(Image by Johannes Gerhardus Swanepoel)

The human expert was Dr. Hans Ohlin, a leading Swedish cardiologist who regularly evaluated as many as 10,000 EKGs per year.  Edenbrandt, an artificial intelligence expert, trained his computer by feeding it thousands of EKGs.  Mauboussin describes:

Edenbrandt chose a sample of over 10,000 EKGs, exactly half of which showed confirmed heart attacks, and gave them to machine and man.  Ohlin took his time evaluating the charts, spending a week carefully separating the stack into heart-attack and no-heart-attack piles.  The battle was reminiscent of Garry Kasparov versus Deep Blue, and Ohlin was fully aware of the stakes.

As Edenbrandt tallied the results, a clear-cut winner emerged: the computer correctly identified the heart attacks in 66 percent of the cases, Ohlin only in 55 percent.  The computer proved 20 percent more accurate than a leading cardiologist in a routine task that can mean the difference between life and death.

Mauboussin presents a table illustrating that expert performance depends on the problem type:

Domain Description (Column) Expert Performance Expert Agreement Examples
Rules based: Limited Degrees of Freedom Worse than computers High (70-90%)
  • Credit scoring
  • Simple medical diagnosis
Rules based: High Degrees of Freedom Generally better than computers Moderate (50-60%)
  • Chess
  • Go
Probabilistic: Limited Degrees of Freedom Equal to or worse than collectives Moderate/ Low (30-40%)
  • Admissions officers
  • Poker
Probabilistic: High Degrees of Freedom Collectives outperform experts Low (<20%)
  • Stock market
  • Economy

For rules-based systems with limited degrees of freedom, computers consistently outperform individual humans; humans perform well, but computers are better and often cheaper, says Mauboussin.  Humans underperform computers because humans are influenced by suggestion, recent experience, and how information is framed.  Also, humans fail to weigh variables well.  Thus, while experts tend to agree in this domain, computers outperform experts, as illustrated by the EKG-reading example.

In the next domain—rules-based systems with high degrees of freedom—experts tend to add the most value.  However, as computing power continues to increase, eventually computers will outperform experts even here, as illustrated by Chess and Go.  Eventually, games like Chess and Go are “solvable.”  Once the computer can check every single possible move within a reasonable amount of time—which is inevitable as long as computing power continues to increase—no human will be able to match such a computer.

In probabilistic domains with limited degrees of freedom, experts are equal to or worse than collectives.  Overall, the value of experts declines compared to rules-based domains.

(Image by Marrishuanna)

In probabilistic domains with high degrees of freedom, experts do worse than collectives.  For instance, stock market prices aggregate many guesses from individual investors.  Stock market prices typically are more accurate than experts.



Sports fans and athletes believe in the hot hand in basketball.  A player on a streak is thought to be “hot,” or more likely to make his or her shots.  However, statistical analysis of streaks shows that the hot hand does not exist.

(Illustration by lbreakstock)

Long success streaks happen to the most skillful players in basketball, baseball, and other sports.  To illustrate this, Mauboussin asks us to consider two basketball players, Sally Swish and Allen Airball.  Sally makes 60 percent of her shot attempts, while Allen only makes 30 percent of his shot attempts.

What are the probabilities that Sally and Allen make five shots in a row?  For Sally, the likelihood is (0.6)^5, or 7.8 percent.  Sally will hit five in a row about every thirteen sequences.  For Allen, the likelihood is (0.3)^5, or 0.24 percent.  Allen will hit five straight once every 412 sequences.  Sally will have far more streaks than Allen.

In sum, long streaks in sports or in money management indicate extraordinary luck imposed on great skill.



The longer you’re willing to hold a stock, the more attractive the investment.  For the average stock, the chance that it will be higher is (almost) 100 percent for one decade, 72 percent for one year, 56 percent for one month, and 51 percent for one day.

(Illustration by Marek)

The problem is loss aversion.  We feel the pain of a loss 2 to 2.5 times more than the pleasure of an equivalent gain.  If we check a stock price daily, there’s nearly a 50 percent chance of seeing a loss.  So checking stock prices daily is a losing proposition.  By contrast, if we only check the price once a year or once every few years, then investing in a stock is much more attractive.

A fund with a high turnover ratio is much more short-term oriented than a fund with a low turnover ratio.  Unfortunately, most institutional investors have a much shorter time horizon than what is needed for the typical good strategy to pay off.  If portfolio managers lag over shorter periods of time, they may lose their jobs even if their strategy works quite well over the long term.



(Illustration by Travelling-light)

It’s difficult to judge leadership, but Mauboussin identifies four things worth considering:

  • Learning
  • Teaching
  • Self-awareness
  • Capital allocation

Mauboussin asserts:

A consistent thirst to learn marks a great leader.  On one level, this is about intellectual curiosity—a constant desire to build mental models that can help in decision making.  A quality manager can absorb and weigh contradictory ideas and information as well as think probabilistically…

Another critical facet of learning is a true desire to understand what’s going on in the organization and to confront the facts with brutal honesty.  The only way to understand what’s going on is to get out there, visit employees and customers, and ask questions and listen to responses.  In almost all organizations, there is much more information at the edge of the network—the employees in the trenches dealing with the day-to-day issues—than in the middle of the network, where the CEO sits.  CEOs who surround themselves with managers seeking to please, rather than prod, are unlikely to make great decisions.

A final dimension of learning is creating an environment where everyone in the organization feels they can voice their thoughts and opinions without the risk of being rebuffed, ignored, or humiliated.  The idea here is not that management should entertain all half-baked ideas but rather that management should encourage and reward intellectual risk taking.

Teaching involves communicating a clear vision to the organization.  Mauboussin points out that teaching comes most naturally to those leaders who are passionate.  Passion is a key driver of success.

Self-awareness implies a balance between confidence and humility.  We all have strengths and weaknesses.  Self-aware leaders know their weaknesses and find colleagues who are strong in those areas.

Finally, capital allocation is a vital leadership skill.  Regrettably, many consultants and investment bankers give poor advice on this topic.  Most acquisitions destroy value for the acquirer, regardless of whether they are guided by professional advice.

Mauboussin quotes Warren Buffett:

The heads of many companies are not skilled in capital allocation.  Their inadequacy is not surprising.  Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics.

Once they become CEOs, they face new responsibilities.  They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered.  To stretch the point, it’s as if the final step for a highly talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve.

The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.  CEOs who recognize their lack of capital-allocation skills (which not all do) will often try to compensate by turning to their staffs, management consultants, or investment bankers.  Charlie and I have frequently observed the consequences of such “help.”  On balance, we feel it is more likely to accentuate the capital-allocation problem than to solve it.

In the end, plenty of unintelligent capital allocation takes place in corporate America.  (That’s why you hear so much about “restructuring.”)



(Image by Andreykuzmin)

The psychologist Robert Cialdini, in his book Influence: The Psychology of Persuasion, mentions six psychological tendencies that cause people to comply with requests:

  • Reciprocation.  There is no human society where people do not feel the obligation to reciprocate favors or gifts.  That’s why charitable organizations send free address labels and why real estate companies offer free house appraisals.  Sam Walton was smart to forbid all of his employees from accepting gifts from suppliers, etc.
  • Commitment and consistency.  Once we’ve made a decision, and especially if we’ve publicly committed to that decision, we’re highly unlikely to change.  Consistency allows us to stop thinking and also to avoid further action.
  • Social validation.  One of the chief ways we make decisions is by observing the decisions of others.  In an experiment by Solomon Asch, eight people in a room are shown three lines of clearly unequal lengths.  Then they are shown a fourth line that has the same length as one of the three lines.  They are asked to match the fourth line to the one with equal length.  The catch is that only one of the eight people in the room is the actual subject of the experiment.  The other seven people are shills who have been instructed to choose an obviously incorrect answer.  About 33 percent of the time, the subject of the experiment ignores the obviously right answer and goes along with the group instead.
  • Liking.  We all prefer to say yes to people we like—people who are similar to us, who compliment us, who cooperate with us, and who we find attractive.
  • Authority.  Stanley Milgram wanted to understand why many seemingly decent people—including believing Lutherans and Catholics—went along with the great evils perpetrated by the Nazis.  Milgram did a famous experiment.  A person in a white lab coat stands behind the subject of the experiment.  The subject is asked to give increasingly severe electric shocks to a “learner” in another room whenever the learner gives an incorrect answer to a question.  (Unknown to the subject, the learner in the other room is an actor and the electric shocks are not really given.)  Roughly 60 percent of the time, the subject of the experiment gives a fatal shock of 450 volts to the learner.  This is a terrifying result.  See:
  • Scarcity.  Items or data that are scarce or perceived to be scarce automatically are viewed as more attractive.  That’s why companies frequently offer services or products for a limited time only.

These innate psychological tendencies are especially powerful when they operate in combination.  Charlie Munger calls this lollapalooza effects.

Mauboussin writes that investors are often influenced by commitment and consistency, social validation, and scarcity.

Psychologists discovered that after bettors at a racetrack put down their money, they are more confident in the prospects of their horses winning than immediately before they placed their bets.  After making a decision, we feel both internal and external pressure to remain consistent to that view even if subsequent evidence questions the validity of the initial decision.

So an investor who has taken a position in a particular stock, recommended it publicly, or encouraged colleagues to participate, will feel the need to stick with the call.  Related to this tendency is the confirmation trap: postdecision openness to confirming data coupled with disavowal or denial of disconfirming data.  One useful technique to mitigate consistency is to think about the world in ranges of values with associated probabilities instead of as a series of single points.  Acknowledging multiple scenarios provides psychological shelter to change views when appropriate.

There is a large body of work about the role of social validation in investing.  Investing is an inherently social activity, and investors periodically act in concert…

Finally, scarcity has an important role in investing (and certainly plays a large role in the minds of corporate executives).  Investors in particular seek informational scarcity.  The challenge is to distinguish between what is truly scarce information and what is not.  One means to do this is to reverse-engineer market expectations—in other words, figure out what the market already thinks.



(Photo by Marek Uliasz)

Humans need to be able to experience emotions in order to make good decisions.  Mauboussin writes about an experiment conducted by Antonio Damasio:

…In one experiment, he harnessed subjects to a skin-conductance-response machine and asked them to flip over cards from one of four decks; two of the decks generated gains (in play money) and the other two were losers.  As the subjects turned cards, Damasio asked them what they thought was going on.  After about ten turns, the subjects started showing physical reactions when they reached for a losing deck.  About fifty cards into the experiment, the subjects articulated a hunch that two of the four decks were riskier.  And it took another thirty cards for the subjects to explain why their hunch was right.

This experiment provided two remarkable decision-making lessons.  First, the unconscious knew what was going on before the conscious did.  Second, even the subjects who never articulated what was going on had unconscious physical reactions that guided their decisions.



Individual agents can behave irrationally but the market can still be rational.

…Collective behavior addresses the potentially irrational actions of groups.  Individual behavior dwells on the fact that we all consistently fall into psychological traps, including overconfidence, anchoring and adjustment, improper framing, irrational commitment escalation, and the confirmation trap.

Here’s my main point: markets can still be rational when investors are individually irrational.  Sufficient investor diversity is the essential feature in efficient price formation.  Provided the decision rules of investors are diverse—even if they are suboptimal—errors tend to cancel out and markets arrive at appropriate prices.  Similarly, if these decision rules lose diversity, markets become fragile and susceptible to inefficiency.

Mauboussin continues:

In case after case, the collective outperforms the individual.  A full ecology of investors is generally sufficient to assure that there is no systematic way to beat the market.  Diversity is the default assumption, and diversity breakdowns are the notable (and potentially profitable) exceptions.

(Illustration by Trueffelpix)

Mauboussin writes about an interesting example of how the collective can outperform individuals (including experts).

On January 17, 1966, a B-52 bomber and a refueling plane collided in midair while crossing the Spanish coastline.  The bomber was carrying four nuclear bombs.  Three were immediately recovered.  But the fourth was lost and its recovery became a national security priority.

Assistant Security of Defense Jack Howard called a young naval officer, John Craven, to find the bomb.  Craven assembled a diverse group of experts and asked them to place bets on where the bomb was.  Shortly thereafter, using the probabilities that resulted from all the bets, the bomb was located.  The collective intelligence in this example was superior to the intelligence of any individual expert.



In investing and in general, it’s wise to keep a journal of our decisions and the reasoning behind them.

(Photo by Leerobin)

We all suffer from hindsight bias.  We are unable to recall what we actually thought before making a decision or judgment.

  • If we decide to do something and it works out, we tend to underestimate the uncertainty that was present when we made the decision.  “I knew I made the right decision.”
  • If we decide to do something and it doesn’t work, we tend to overestimate the uncertainty that was present when we made the decision.  “I suspected that it wouldn’t work.”
  • If we judge that event X will happen, and then it does, we underestimate the uncertainty that was present when we made the judgment.  “I knew that would happen.”
  • If we judge that event X will happen, and it doesn’t, we overestimate the uncertainty that was present when we made the judgment.  “I was fully aware that it was unlikely.”


As Mauboussin notes, keeping a decision journal gives us a valuable source of objective feedback.  Otherwise, we won’t recall with any accuracy the uncertainty we faced or the reasoning we used.



Robert Olsen has singled out five conditions that are present in the context of naturalistic decision making.

  • Ill-structured and complex problems.  No obvious best procedure exists to solve a problem.
  • Information is incomplete, ambiguous, and changing.  Because stock picking relates to future financial performance, there is no way to consider all information.
  • Ill-defined, shifting, and competing goals.  Although long-term goals may be clearer, goals can change over shorter horizons.
  • Stress because of time constraints, high stakes, or both.  Stress is clearly a feature of investing.
  • Decisions may involve multiple participants.  

Mauboussin describes three key characteristics of naturalistic decision makers.  First, they rely heavily on mental imagery and simulation in order to assess a situation and possible alternatives.  Second, they excel at pattern matching.  (For instance, chess masters can glance at a board and quickly recognize a pattern.)

(Photo by lbreakstock)

Third, naturalistic decision makers reason through analogy.  They can see how seemingly different situations are in fact similar.



Mauboussin describes how we develop a “degree of belief” in a specific hypothesis:

Our degree of belief in a particular hypothesis typically integrates two kinds of evidence: the strength, or extremeness, of the evidence and the weight, or predictive validity.  For instance, say you want to test the hypothesis that a coin in biased in favor of heads.  The proportion of heads in the sample reflects the strength, while the sample size determines the weight.

Probability theory describes rules for how to combine strength and weight correctly.  But substantial experimental data show that people do not follow the theory.  Specifically, the strength of evidence seems to dominate the weight of evidence in people’s minds.

This bias leads to a distinctive pattern of over- and underconfidence.  When the strength of evidence is high and the weight is low—which accurately describes the outcome of many Wall Street-sponsored surveys—people tend to be overconfident.  In contrast, when the strength is low and the evidence is high, people tend to be underconfident.

(Photo by Michele Lombardo)

Does survey-based research lead to superior stock selection?  Mauboussin responds that the answer is ambiguous.  First, the market adjusts to new information rapidly.  It’s difficult to gain an informational edge, especially when it comes to what is happening now or what will happen in the near future.  In contrast, it’s possible to gain an informational edge if you focus on the longer term.  That’s because many investors don’t focus there.

The second issue is that understanding the fundamentals about a company or industry is very different from understanding the expectations built into a stock price.  The question is not just whether the information is new to you, but whether the information is also new to the market.  In the vast majority of cases, the information is already reflected in the current stock price.

Mauboussin sums it up:

Seeking new information is a worthy goal for an investor.  My fear is that much of what passes as incremental information adds little or no value, because investors don’t properly weight new information, rely on unsound samples, and fail to recognize what the market already knows.  In contrast, I find that thoughtful discussions about a firm’s or an industry’s medium- to long-term competitive outlook extremely rare.



(Image: Innovation concept, by Daniil Peshkov)

Mauboussin quotes Andrew Hargadon’s How Breakthroughs Happen:

All innovations represent some break from the past—the lightbulb replaced the gas lamp, the automobile replaced the horse and cart, the steamship replaced the sailing ship.  By the same token, however, all innovations are built from pieces of the past—Edison’s system drew its organizing principles from the gas industry, the early automobiles were built by cart makers, and the first steam ships added steam engines to existing sailing ships.

Mauboussin adds:

Investors need to appreciate the innovation process for a couple of reasons.  First, our overall level of material well-being relies heavily on innovation.  Second, innovation lies at the root of creative destruction—the process by which new technologies and businesses supersede others.  More rapid innovation means more rapid success and failure for companies.

Mauboussin draws attention to three interrelated factors that continue to drive innovation at an accelerating rate:

  • Scientific advances
  • Information storage capacity
  • Gains in computing power



(Photo: Drosophila Melanogaster, by Tomatito26)

Mauboussin mentions the common fruit fly, Drosophila melanogaster, which geneticists and other scientists like to study because its life cycle is only two weeks.

Why should businesspeople care about Drosophila?  A sound body of evidence now suggests that the average speed of evolution is accelerating in the business world.  Just as scientists have learned a great deal about evolutionary change from fruit flies, investors can benefit from understanding the sources and implications of accelerated business evolution.

The most direct consequence of more rapid business evolution is that the time an average company can sustain a competitive advantage—that is, generate an economic return in excess of its cost of capital—is shorter than it was in the past.  This trend has potentially important implications for investors in areas such as valuation, portfolio turnover, and diversification.

Mauboussin refers to research by Robert Wiggins and Timothy Ruefli on the sustainability of economic returns.  They put forth four hypotheses.  The first three were supported by the data, while the fourth one was not:

  • Periods of persistent superior economic performance are decreasing in duration over time.
  • Hypercompetition is not limited to high-technology industries but will occur through most industries.
  • Over time, firms increasingly seek to sustain competitive advantage by concatenating a series of short-term competitive advantages.
  • Industry concentration, large market share, or both are negatively correlated with chance of loss of persistent superior economic performance in an industry.

Mauboussin points out that faster product and process life cycles means that historical multiples are less useful for comparison.  Also, the terminal valuation in discounted cash-flow models in many cases has to be adjusted to reflect shorter periods of sustainable competitive advantage.

(Image by Marek Uliasz)

Furthermore, while portfolio turnover on average is too high, portfolio turnover could be increased for those investors who have historically had a portfolio turnover of 20 percent (implying a holding period of 5 years).  Similarly, shorter periods of competitive advantage imply that some portfolios should be more diversified.  Lastly, faster business evolution means that investors must spend more time understanding the dynamics of organizational change.



(Photo by Michael Maggs, via Wikimedia Commons)

Mauboussin notes the lessons emphasized by chess master Bruce Pandolfini:

  • Don’t look too far ahead.  Most people believe that great players strategize by thinking far into the future, by thinking 10 or 15 moves ahead.  That’s just not true.  Chess players look only as far into the future as they need to, and that usually means looking just a few moves ahead.  Thinking too far ahead is a waste of time: The information is uncertain.
  • Develop options and continuously revise them based on the changing conditions: Great players consider their next move without playing it.  You should never play the first good move that comes into your head.  Put that move on your list, and then ask yourself if there’s an even better move.  If you see a good idea, look for a better one—that’s my motto.  Good thinking is a matter of making comparisons.
  • Know your competition: Being good at chess also requires being good at reading people.  Few people think of chess as an intimate, personal game.  But that’s what it is.  Players learn a lot about their opponents, and exceptional chess players learn to interpret every gesture that their opponents make.
  • Seek small advantages: You play for seemingly insignificant advantages—advantages that your opponent doesn’t notice or that he dismisses, thinking, “Big deal, you can have that.”  It could be slightly better development, or a slightly safer king’s position.  Slightly, slightly, slightly.  None of those “slightlys” mean anything on their own, but add up seven or eight of them, and you have control.

Mauboussin argues that companies should adopt simple, flexible long-term decision rules.  This is the “strategy as simple rules” approach, which helps us from getting caught in the short term versus long term debate.

Moreover, simple decision rules help us to be consistent.  Otherwise we will often reach different conclusions from the same data based on moods, suggestion, recency bias, availability bias, framing effects, etc.



(Image: Fitness Landscape, by Randy Olsen, via Wikimedia Commons)


What does a fitness landscape look like?  Envision a large grid, with each point representing a different strategy that a species (or a company) can pursue.  Further imagine that the height of each point depicts fitness.  Peaks represent high fitness, and valleys represent low fitness.  From a company’s perspective, fitness equals value-creation potential.  Each company operates in a landscape full of high-return peaks and value-destructive valleys.  The topology of the landscape depends on the industry characteristics.

As Darwin noted, improving fitness is not about strength or smarts, but rather about becoming more and more suited to your environment—in a word, adaptability.  Better fitness requires generating options and “choosing” the “best” ones.  In nature, recombination and mutation generate species diversity, and natural selection assures that the most suitable options survive.  For companies, adaptability is about formulating and executing value-creating strategies with a goal of generating the highest possible long-term returns.

Since a fitness landscape can have lots of peaks and valleys, even if a species reaches a peak (a local optimum), it may not be at the highest peak (a global optimum).  To get a higher altitude, a species may have to reduce its fitness in the near term to improve its fitness in the long term.  We can say the same about companies…

Mauboussin remarks that there are three types of fitness landscape:

  • Stable.  These are industries where the fitness landscape is reasonably stable.  In many cases, the landscape is relatively flat, and companies generate excess economic returns only when cyclical forces are favorable.  Examples include electric and telephone utilities, commodity producers (energy, paper, metals), capital goods, consumer nondurables, and real estate investment trusts.  Companies within these sectors primarily improve their fitness at the expense of their competitors.  These are businesses that tend to have structural predictability (i.e., you’ll know what they look like in the future) at the expense of limited opportunities for growth and new businesses.
  • Coarse.  The fitness landscape is in flux for these industries, but the changes are not so rapid as to lack predictability.  The landscape here is rougher.  Some companies deliver much better economic performance than do others.  Financial services, retail, health care, and more established parts of technology are illustrations.  These industries run a clear risk of being unseated (losing fitness) by a disruptive technology.
  • Roiling.  This group contains businesses that are very dynamic, with evolving business models, substantial uncertainty, and ever-changing product offerings.  The peaks and valleys are constantly changing, ever spastic.  Included in this type are many software companies, the genomics industry, fashion-related sectors, and most start-ups.  Economic returns in this group can be (or can promise to be) significant but are generally fleeting.

Mauboussin indicates that innovation, deregulation, and globalization are probably causing the global fitness landscape to become even more contorted.

Companies can make short, incremental jumps towards a local maximum.  Or they can make long, discontinuous jumps that may lead to a higher peak or a lower valley.  Long jumps include investing in new potential products or making meaningful acquisitions in unrelated fields.  The proper balance between short jumps and long jumps depends on a company’s fitness landscape.

Mauboussin adds that the financial tool for valuing a given business depends on the fitness landscape that the business is in.  A business in a stable landscape can be valued using discounted cash-flow (DCF).  A business in a course landscape can be valued using DCF plus strategic options.  A business in a roiling landscape can be valued using strategic options.



Bradford Cornell:

For past averages to be meaningful, the data being averaged have to be drawn from the same population.  If this is not the case—if the data come from populations that are different—the data are said to be nonstationary.  When data are nonstationary, projecting past averages typically produces nonsensical results.

Nonstationarity is a key concept in time-series analysis, such as the study of past data in business and finance.  If the underlying population changes, then the data are nonstationary and you can’t compare past averages to today’s population.

(Image: Time Series, by Mike Toews via Wikimedia Commons)

Mauboussin gives three reasons why past P/E data are nonstationary:

  • Inflation and taxes
  • Changes in the composition of the economy
  • Shifts in the equity-risk premium

Higher taxes mean lower multiples, all else equal.  And higher inflation also means lower multiples.  Similarly, low taxes and low inflation both cause P/E ratios to be higher.

The more companies rely on intangible capital rather than tangible capital, the higher the cash-flow-to-net-income ratio.  Overall, the economy is relying increasingly on intangible capital.  Higher cash-flow-to-net-income ratios, and higher returns on capital, mean higher P/E ratios.



Growth alone does not create value.  Growth creates value only if the return on invested capital exceeds the cost of capital.  Growth actually destroys value if the return on invested capital is less than the cost of capital.

(Illustration by Teguh Jati Prasetyo)

Over time, a company’s return on capital moves towards its cost of capital.  High returns bring competition and new capital, which drives the return on capital toward the cost of capital.  Similarly, capital exits low-return industries, which lifts the return on capital toward the cost of capital.

Mauboussin reminds us that a good business is not necessarily a good investment, just as a bad business is not necessarily a bad investment.  What matters is the expectations embedded in the current price.  If expectations are overly low for a bad business, it can represent a good investment.  If expectations are too high for a good business, it may be a poor investment.

On the other hand, some cheap stocks deserve to be cheap and aren’t good investments.  And some expensive-looking stocks trading at high multiples may still be good investments if high growth and high return on capital can persist long enough into the future.



(Illustration: Concept of Prisoner’s Dilemma, by CXJ Jensen via Wikimedia Commons)

Mauboussin quotes Robert Axelrod’s The Complexity of Cooperation:

What the Prisoner’s Dilemma captures so well is the tension between the advantages of selfishness in the short run versus the need to elicit cooperation from the other player to be successful over the longer run.  The very simplicity of the Prisoner’s Dilemma is highly valuable in helping us to discover and appreciate the deep consequences of the fundamental processes involved in dealing with this tension.

The Prisoner’s Dilemma shows that the rational response for an individual company  is not necessarily optimal for the industry as a whole.

If the Prisoner’s Dilemma game is going to be repeated many times, then the best strategy is tit-for-tat.  Whatever your competitor’s latest move was, copy that for your next move.  So if your competitor deviates one time and then cooperates, you deviate one time and then cooperate.  Tit-for-tat is both the simplest strategy and also the most effective.

When it comes to market pricing and capacity decisions, competitive markets need not be zero sum.  A tit-for-tat strategy is often optimal, and by definition it includes a policing component if your competitor deviates.



Mauboussin quotes Robert D. Hanson’s Decision Markets:

[Decision markets] pool the information that is known to diverse individuals into a common resource, and have many advantages over standard institutions for information aggregation, such as news media, peer review, trials, and opinion polls.  Speculative markets are decentralized and relatively egalitarian, and can offer direct, concise, timely, and precise estimates in answer to questions we pose.

Mauboussin then writes about bees and ants, ending with this comment:

What makes the behavior of social insects like bees and ants so amazing is that there is no central authority, no one directing traffic.  Yet the aggregation of simple individuals generates complex, adaptive, and robust results.  Colonies forage efficiently, have life cycles, and change behavior as circumstances warrant.  These decentralized individuals collectively solve very hard problems, and they do it in a way that is very counterintuitive to the human predilection to command-and-control solutions.

(Illustration: Swarm Intelligence, by Farbentek)

Mauboussin again:

Why do decision markets work so well?  First, individuals in these markets think they have some edge, so they self-select to participate.  Second, traders have an incentive to be right—they can take money from less insightful traders.  Third, these markets provide continuous, real-time forecasts—a valuable form of feedback.  The result is that decision markets aggregate information across traders, allowing them to solve hard problems more effectively than any individual can.



(Painting: Sir Francis Galton, by Charles Wellington Furse, via Wikimedia Commons)

Mauboussin tells of an experiment by Francis Galton:

Victorian polymath Francis Galton was one of the first to thoroughly document this group-aggregation ability.  In a 1907 Nature article, “Vox Populi,” Galton describes a contest to guess the weight of an ox at the West of England Fat Stock and Poultry Exhibition in Plymouth.  He collected 787 participants who each paid a sixpenny fee to participate.  (A small cost to deter practical joking.)  According to Galton, some of the competitors were butchers and farmers, likely expert at guessing the weight.  He surmised that many others, though, were guided by “such information as they might pick up” or “by their own fancies.”

Galton calculated the median estimate—the vox populi—as well as the mean.  He found that the median guess was within 0.8 percent of the correct weight, and that the mean of the guesses was within 0.01 percent.  To give a sense of how the answer emerged, Galton showed the full distribution of answers.  Simply stated, the errors cancel out and the result is distilled information.

Subsequently, we have seen the vox populi results replicated over and over.  Examples include solving a complicated maze, guessing the number of jellybeans in a jar, and finding missing bombs.  In each case, the necessary conditions for information aggregation to work include an aggregation mechanism, an incentive to answer correctly, and group heterogeneity.



(Illustration by Acadac, via Wikimedia Commons)

Complex adaptive systems exhibit a number of essential properties and mechanisms, writes Mauboussin:

  • Aggregation.  Aggregation is the emergence of complex, large-scale behavior from the collective interactions of many less-complex agents.
  • Adaptive decision rules.  Agents within a complex adaptive system take information from the environment, combine it with their own interaction with the environment, and derive decision rules.  In turn, various decision rules compete with one another based on their fitness, with the most effective rules surviving.
  • Nonlinearity.  In a linear model, the whole equals the sum of the parts.  In nonlinear systems, the aggregate behavior is more complicated than would be predicted by totaling the parts.
  • Feedback loops.  A feedback system is one in which the output of one iteration becomes the input of the next iteration.  Feedback loops can amplify or dampen an effect.

Governments, many corporations, and capital markets are all examples of complex adaptive systems.

Humans have a strong drive to invent a cause for every effect.  This has been biologically advantageous for the vast majority of human history.  In the past, if we heard a rustling in the grass, we immediately sought safety.  There was always some cause for the noise.  It virtually never made sense to wait around to see if it was a predator or not.

However, in complex adaptive systems like the stock market, typically there is no simple cause and effect relationship that explains what happens.

For many big moves in the stock market, there is no identifiable cause.  But people have such a strong need identify a cause that they make up causes.  The press delivers to people what they want: explanations for big moves in the stock market.  Usually these explanations are simply made up.  They’re false.



(Painting: Galileo Galilei, by Justus Sustermans, via Wikimedia Commons)

Mauboussin, following Charlie Munger, argues that cross-disciplinary research is likely to produce the deepest insights into the workings of companies and markets.  Here are some examples:

  • Decision making and neuroscience.  Prospect theory—invented by Daniel Kahneman and Amos Tversky—describes how people suffer from cognitive biases when they make decisions under uncertainty.  Prospect theory is extremely well-supported by countless experiments.  But prospect theory still doesn’t explain why people make the decisions they do.  Neuroscience will help with this.
  • Statistical properties of markets—from description to prediction?  Stock price changes are not normally distributed—along a bell-shaped curve—but rather follow a power law.  The statistical distribution has fat tails, which means there are more extreme moves than would occur under a normal distribution.  Once again, a more accurate description is progress.  But the next step involves a greater ability to explain and predict the phenomena in question.
  • Agent-based models.  Individual differences are important in market outcomes.  Feedback mechanisms are also central.
  • Network theory and information flows.  Network research involves epidemiology, psychology, sociology, diffusion theory, and competitive strategy.  Much progress can be made.
  • Growth and size distribution.  There are very few large firms and many small ones.  And all large firms experience significantly slower growth once they reach a certain size.
  • Flight simulator for the mind?  One of the biggest challenges in investing is that long-term investors don’t get nearly enough feedback.  Statistically meaningful feedback for investors typically takes decades to produce.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Volatility Is the Friend of the Long-Term Value Investor

(Image:  Zen Buddha Silence by Marilyn Barbone.)

February 27, 2022

The stock market has been volatile so far this year.  The Federal Reserve plans to raise rates.  This is likely to cause stock prices (which are elevated) to continue declining.

Update May 2022:  China has shutdown part of its economy to deal with the Omicron variant of the coronavirus.  This will impact the global economy.

Russia’s war against Ukraine drags on.

Finally, oil prices have been over $100 per barrel (WTI).  Every time oil prices have been this high historically, a recession has ensued.

Continued stock market volatility is highly likely.

When stocks drop in value, many people want to stop investing, or even sell what they own, out of fear that stock prices will continue dropping.  But the wisest thing to do for a long-term value investor is to take advantage of lower stock prices by buying more shares than you otherwise could.

Consider a hypothetical Stock HQ, which is a high-quality company that you want to buy and hold.  Stock HQ will grow in value over time.

You are going to invest $2,000 into Stock HQ each year in for ten years.  Which of the following three scenarios would you prefer?  Each scenario shows a different path the stock price could take over the next ten years.

Most people prefer Scenario (1) because the stock steadily rises.  However, Scenario (3) is by far the best market scenario to invest in.  Scenario (1) is actually the worst of the three.



A steadily rising market

In Scenario (1), you invest $2,000 each year for ten years in a steadily rising market.  The following table shows the number of shares you will end up with and their value.

Because the stock price keeps increasing steadily, you are buying less shares each year than the year before.  The net result is that you end up with 465.51 shares with a value of $46,550.98.

An increasing but volatile market

In Scenario (2), you invest $2,000 each year for ten years in a rising but volatile market.  The following table shows the number of shares you will end up with and their value.

Because there is more volatility, some years you can buy more shares than the year before.  The net result is that you end up with 484.20 shares with a value of $48,419.51.  So you are better off in this scenario than in the previous scenario due to market volatility.

A decreasing market

In Scenario (3), you invest $2,000 each year for ten years in a decreasing market.  The following table shows the number of shares you will end up with and their value.

Because the stock price steadily declines, each year you are able to buy more shares than the year before.  The net result is that you end up with 1,357.54 shares worth $135,754.28.



The bottom line is that if you are a long-term value investor, you are far better off over the long term if an already undervalued stock keeps declining so that you can keep buying more shares than you otherwise could.

This is also true for the stock market in general.  The next 3 to 10 years are likely to be flat or down.  If so, this will be a wonderful opportunity if you’re a long-term value investor because many good individual stocks will decline in value.  This will allow you to buy more shares than you otherwise could, which will translate into a greater amount of money in 10 to 20 years.

If your investment time horizon is at least 10 years or 20 years, then all that matters is what your portfolio is worth in 10 years or 20 years.  If prices decline in the interim, that is a great opportunity to buy more shares than you otherwise could. 

All that you need to believe is that, over the very long term, the economy grows and the stock market increases.  As Warren Buffett said:

In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president.  Yet the Dow rose from 66 to 11,497.



    • Opportunities to purchase what we deem to be attractively undervalued companies occur more frequently when stock prices are volatile. – Chuck Royce
    • We steer clear of the foolhardy academic definition of risk and volatility, recognizing, instead, that volatility is a welcome creator of opportunity. – Seth Klarman
    • Investors should treat volatility as a friend. High volatility permits an investor to purchase stocks that are particularly depressed and to sell stocks when they are selling at particularly high prices.  The greater the volatility, the greater the opportunity to purchase stocks at very low prices and then sell stocks at very high prices. – Ed Wachenheim
    • We are willing to endure a high degree of stock price and portfolio volatility because we believe it allows us to achieve a greater degree of investment performance over the long term. – Bill Ackman
    • Volatility actually is the opposite of risk.  It’s opportunity.  But you need to think through and fight some basic human weaknesses. – Jeff Ubben
    • Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it. – Warren Buffett
    • One of the great lessons on the crisis was learning the difference between volatility, which most people perceive as risk, and a permanent impairment of capital, which is what we believe is risk. – Matt McLennon
    • Basically, price fluctuations have only one significant meaning for the true investor.  They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. – Benjamin Graham

This blog post was inspired by the following post by Andy Rachleff:



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

The Growth Trap

(Image:  Zen Buddha Silence by Marilyn Barbone.)

February 20, 2022

Jeremy Siegel is the author of The Future for Investors (Crown Business, 2005).  Warren Buffett commented:  “Jeremy Siegel’s new facts and ideas should be studied by investors.”  (Although the book was published in 2005, most of the facts and ideas still hold.)



Siegel summarizes the main lesson from his previous book, Stocks for the Long Run:

My research showed that over extended periods of time, stock returns not only dominate the returns on fixed-income assets, but they do so with lower risk when inflation is taken into account.  These findings established that stocks should be the cornerstone of all long-term investors’ portfolios.

As you extend forward in time, especially to three or four decades, the real return from stocks is roughly 6.5 to 7 percent, which will nearly always be better than any other investment, such as fixed-income or gold.  Siegel has given many talks on Stocks for the Long Run, and he reports that two questions always come up:

  • Which stocks should I hold for the long run?
  • What will happen to my portfolio when the baby boomers retire and begin liquidating their portfolios?

Siegel says he wrote The Future for Investors in order to answer these questions.  He studied all 500 firms that constituted the S&P 500 Index when it was first formulated in 1957.  His conclusions – that the original firms in the index outperformed the newcomers (those added later to the index) – were surprising:

These results confirmed my feeling that investors overprice new stocks, many of which are in high technology industries, and ignore firms in less exciting industries that often provide investors superior returns.  I coined the term the growth trap to describe the incorrect belief that the companies that lead in technological innovation and spearhead economic growth bring investors superior returns.

The more I investigated returns, the more I determined that the growth trap affected not just individual stocks, but also entire sectors of the market and even countries.  The fastest-growing new firms, industries, and even foreign countries often suffered the worst return.  I formulated the basic principle of investor return, which specifies that growth alone does not yield good returns, but only growth in excess of the often overly optimistic estimates that investors have built into the price of stock.  It was clear that the growth trap was one of the most important barriers between investors and investment success.

As regards the aging of the baby-boom generation, Siegel argues that growth in developing countries (like China and India) will keep the global economy moving forward.  Also, as citizens in developing countries become wealthier, they will buy assets that baby-boomers are selling.  Siegel also holds that information technology will be central to global economic growth.

I am not going to discuss baby-boomer retirement any further in this blog post.  I would only note that there is a good chance that economically significant innovation could surprise on the upside in the next few decades.  See, for instance, The Second Machine Age, by Erik Brynjolfsson and Andrew McAfee (W. W. Norton, 2016).  As Warren Buffett has frequently observed, the luckiest people in history are those being born now.  Life in the future for most people is going to be far better than at any previous time in history.



Siegel opens the first chapter by noting the potential impact of improving technology:

The future for investors is bright.  Our world today stands at the brink of the greatest burst of invention, discovery, and economic growth ever known.

Yet investors must be careful to avoid the growth trap:

The growth trap seduces investors into overpaying for the very firms and industries that drive innovation and spearhead economic expansion.  This relentless pursuit of growth – through buying hot stocks, seeking exciting new technologies, or investing in the fastest-growing countries – dooms investors to poor returns.  In fact, history shows that many of the best-performing investments are instead found in shrinking industries and in slower-growing countries.

Although technology has created amazing wealth and well-being, investing in new technologies is generally a poor investment strategy.  Siegel explains:

How can this happen?  How can these enormous economic gains made possible through the proper application of new technology translate into substantial investment losses?  There’s one simple reason:  in their enthusiasm to embrace the new, investors invariably pay too high a price for a piece of the action.  The concept of growth is so avidly sought after that it lures investors into overpriced stocks in fast-changing and overly competitive industries, where the few big winners cannot begin to compensate for the myriad of losers.

To illustrate his point, Siegel compares Standard Oil of New Jersey (now ExxonMobil) with the new-economy juggernaut, IBM.  Consider the growth rates of these companies from 1950 to 2003:

Growth Measures IBM Standard Oil Advantage
Revenue/Share 12.19% 8.04% IBM
Dividends/Share 9.19% 7.11% IBM
Earnings/Share 10.94% 7.47% IBM
Sector Growth 14.65% -14.22% IBM

IBM performed much better fundamentally than Standard Oil of New Jersey.  Moreover, from 1950 to 2003, the technology sector rose from 3 percent of the market to almost 18 percent, while oil stocks shrank from 20 percent of the market to 5 percent.  Therefore, it seems clear that an investor who had to choose between IBM and Standard Oil in 1950 should have chosen IBM.  But this would have been the wrong decision.

Over the entire period, Standard Oil of New Jersey had an average P/E of 12.97, while IBM had an average P/E of 26.76.  Also, Standard Oil had an average dividend yield of 5.19%, while IBM had an average dividend yield of 2.18%.  As a result, the total returns for the two stocks were as follows:

Return  Measures IBM Standard Oil Advantage
Price Appreciation 11.41% 8.77% IBM
Dividend Return 2.18% 5.19% Standard Oil
Total Return 13.83% 14.42% Standard Oil

Siegel explains:

IBM did very well, but investors expected it to do well, and its stock price was consistently high.  Investors in Standard Oil had very modest expectations for earnings growth and kept the price of its shares low, allowing investors to accumulate more shares through the reinvestment of dividends.  The extra shares proved to be Standard Oil’s margin of victory.

Here are Siegel’s broad conclusions on the S&P 500 Index:

  • The more than 900 new firms that have been added to the index since it was formulated in 1957 have, on average, underperformed the original 500 firms in the index.
  • Long-term investors would have been better off had they bought the original S&P 500 firms in 1957 and never bought any new firms added to the index. By following this buy-and-never-sell approach, investors would have outperformed almost all mutual funds and money managers over the last half century.
  • Dividends matter a lot. Reinvesting dividends is the critical factor giving the edge to most winning stocks in the long run… Portfolios invested in the highest-yielding stocks returned 3 percent per year more than the S&P 500 Index, while those in the lowest-yielding stocks lagged the market by almost 2 percent per year.
  • The return on stocks depends not on earnings growth but solely on whether this earnings growth exceeds what investors expected, and those growth expectations are embodied in the price-to-earnings, or P/E ratio. Portfolios invested in the lowest-P/E stocks in the S&P 500 Index returned almost 3 percent per year more than the S&P 500 Index, while those invested in the high-P/E stocks fell 2 percent per year behind the index.
  • The growth trap holds for industry sectors as well as individual firms. The fastest-growing sector, the financials, has underperformed the benchmark S&P 500 Index, while the energy sector, which has shrunk almost 80 percent since 1957, beat this benchmark index.  The lowly railroads, despite shrinking from 21 percent to less than 5 percent of the industrial sector, outperformed the S&P 500 Index over the last half century.
  • The growth trap holds for countries as well. The fastest-growing country over the last decade has rewarded investors with the worst returns.  China, the economic powerhouse of the 1990s, has painfully disappointed investors with its overpriced shares and falling stock prices.



But how, you will ask, does one decide what [stocks are] ‘attractive’?  Most analysts feel they must choose between two approaches customarily thought to be in opposition: ‘value’ and ‘growth.’… We view that as fuzzy thinking… Growth is always a component of value [and] the very term ‘value investing’ is redundant.

– Warren Buffett, Berkshire Hathaway annual report, 1992

What was the best-performing stock from 1957 to 2003?  Siegel answers that it was Philip Morris.  Siegel observes:

The superb returns in Philip Morris illustrate an extremely important principle of investing:  what counts is not just the growth rate of earnings but the growth of earnings relative to the market’s expectation.  One reason investors had low expectations for Philip Morris’s growth was because of its potential liabilities.  But its growth has continued apace.  The low expectations combined with high growth and a high dividend yield provide the perfect environment for superb investor returns.

What were the top-performing S&P 500 Survivors from 1957 to 2003?

Rank 2003 Name Accumulation of $1,000 Annual Return
1 Philip Morris $4,626,402 19.75%
2 Abbott Labs $1,281,335 16.51%
3 Bristol-Myers Squibb $1,209,445 16.36%
4 Tootsie Roll Industries $1,090,955 16.11%
5 Pfizer $1,054,823 16.03%
6 Coca-Cola $1,051,646 16.02%
7 Merck $1,003,410 15.90%
8 PepsiCo $866,068 15.54%
9 Colgate-Palmolive $761,163 15.22%
10 Crane $736,796 15.14%
11 H. J. Heinz $635,988 14.78%
12 Wrigley $603,877 14.65%
13 Fortune Brands $580,025 14.55%
14 Kroger $546,793 14.41%
15 Schering-Plough $537,050 14.36%
16 Proctor & Gamble $513,752 14.26%
17 Hershey Foods $507,001 14.22%
18 Wyeth $461,186 13.99%
19 Royal Dutch Petroleum $398,837 13.64%
20 General Mills $388,425 13.58%
S&P 500 $124,486 10.85%

Siegel points out that most of the top twenty performers have strong brands, but are not technology companies per se.  Siegel discusses some of these great companies:

Number four on this list is a most unlikely winner – a small manufacturer originally named the Sweets Company of America.  This company has outperformed the market by 5 percent a year since the index was formulated.  The founder of this firm, an Austrian immigrant, named its product after his five-year-old daughter’s nickname, Tootsie….

The surviving company with the sixth highest return produces a product today with the exact same formula as it did over 100 years ago, much like Tootsie Roll…. Although the company keeps the formula for its drinks secret, it is no secret that Coca-Cola has been one of the best companies you could have owned over the last half century.

…Pepsi also delivered superb returns to its shareholders, coming in at number eight and beating the market by over 4 percent per year.

Two others of the twenty best-performing stocks also manufacture products virtually unchanged over the past 100 years:  the William Wrigley Jr. Company and Hershey Foods.  Wrigley came in at number twelve, beating the market by almost 4 percent per year, whereas Hershey came in at seventeen, beating the market by 3 percent a year.

Wrigley is the largest gum manufacturer in the world, commanding an almost 50 percent share in the global market and selling in approximately 100 countries.  Hershey is currently the number-one U.S.-based publicly traded candy maker (Mars, a private firm, is number one, followed by Swiss-based Nestle).

…Heinz is another strong brand name, one that is virtually synonymous with ketchup.  Each year, Heinz sells 650 million bottles of ketchup and makes 11 billion packets of ketchup and salad dressings – almost two packets for every person on earth.  But Heinz is just not a ketchup producer, and it does not restrict its focus to the United States.  It has the number-one or –two branded business in fifty different countries, with products such as Indonesia’s ABC soy sauce (the second-largest-selling soy sauce in the world) and Honig dry soup, the best-selling soup brand in the Netherlands.

Colgate-Palmolive also makes the list, coming in at number nine.  Colgate’s products include Colgate toothpastes, Speed Stick deoderant, Irish Spring soaps, antibacterial Softsoap, and household cleaning products such as Palmolive and Ajax.

No surprise that Colgate’s rival, Procter & Gamble, makes this list as well, at number sixteen.  Procter & Gamble began as a small, family-operated soap and candle company in Cincinnati, Ohio, in 1837.  Today, P&G sells three hundred products, including Crest, Mr. Clean, Tide, and Tampax, to more than five billion consumers in 140 countries.

…Number twenty on the list is General Mills, another company with strong brands, which include Betty Crocker, introduced in 1921, Wheaties (the ‘Breakfast of Champions’), Cheerios, Lucky Charms, Cinnamon Toast Crunch, Hamburger Helper, and Yoplait yogurt.

What is true about all these firms is that their success came through developing strong brands not only in the United States but all over the world.  A well-respected brand name gives the firm the ability to price its product above the competition and deliver more profits to investors.

…Besides the strong consumer brand firms, the pharmaceuticals had a prominent place on the list of best-performing companies.  It is noteworthy that there were only six health care companies in the original S&P 500 that survive to today in their original corporate form, and all six made it onto the list of best performers.  All of these firms not only sold prescription drugs but also were very successful in marketing brand-name over-the-counter treatments to consumers, very much like the brand-name consumer staples stocks that we have reviewed.

…When these six pharmaceuticals are added to the eleven name-brand consumer firms, seventeen, or 85 percent, of the twenty top-performing firms from the original S&P 500 Index, feature well-known consumer brand names.



What really matters for investors is the price paid today compared to all future free cash flows.  But investors very regularly overvalue high-growth companies and undervalue low-growth or no-growth companies.  This is the key reason value investing works.  As Siegel writes:

Expectations are so important that without even knowing how fast a firm’s earnings actually grow, the data confirm that investors are too optimistic about fast-growing companies and too pessimistic about slow-growing companies.  This is just one more confirmation of the growth trap.

Thus, if you want to do well as an investor, it is best to stick with companies trading at low multiples (low P/E, low P/B, low P/S, etc.).  All of the studies have confirmed this.  See:

Siegel did his own study, dividing S&P 500 Index companies into P/E quintiles.  From 1957 to 2003, the lowest P/E quintile – bought at the beginning of each year – produced an average annual return of 14.07% (with a risk of 15.92%), while the highest P/E quintile produced an average annual return of 9.17% (with a risk of 19.39%).  The S&P 500 Index averaged 11.18% (with a risk of 17.02%)

If you’re doing buy-and-hold value investing – as Warren Buffett does today – then you can pay a higher price as long as it is still reasonable and as long as the brand is strong enough to persist over time.  Buffett has made it clear, however, that if he were managing a small amount of money, he would focus on microcap companies available at cheap prices.  That would generate the highest returns, with 50% per year being possible in micro caps for someone like Buffett.  See:

Siegel discusses GARP, or growth at a reasonable price:

Advocates here compute a very similar statistic called the PEG ratio, or price-to-earnings ratio divided by the growth rate of earnings.  The PEG ratio is essentially the inverse of the ratio that Peter Lynch recommended in his book, assuming you add the dividend yield to the growth rate.  The lower the PEG ratio, the more attractively priced a firm is with respect to its projected earnings growth.  According to Lynch’s criteria, you would be looking for firms with lower PEG ratios, preferably 0.5 or less, but certainly less than 1.

It’s important to note that earnings growth is very mean-reverting.  In other words, most companies that have been growing fast do NOT continue to do so, but tend to slow down quite a bit.  That’s why deep value investing – simply buying the cheapest companies (based on low P/E or low EV/EBIT), which usually have low- or no-growth – tends to produce better returns over time than GARP investing does.  This is most true, on average, when you invest in cheap microcap companies.

Deep value microcap investing tends to work quite well, especially if you also use the Piotroski F-Score to screen for cheap microcap companies that also have improving fundamentals.  This is the approach used by the Boole Microcap Fund.  See:

One other way to do very well investing in micro caps is to try to find the ones that will grow for a long time.  It’s much more difficult to use this approach successfully than it is to buy cheap microcap companies with improving fundamentals.  But it is doable with enough patience and discipline.  See if you want to learn about some microcap investors who use this approach.



Most investors seem to believe that the fastest-growing industries will yield the best returns.  But this is simply not true.  Siegel compares financials to energy companies:

Of the ten major industries, the financial sector has gained the largest share of market value since the S&P 500 Index was founded in 1957.  Financial firms went from less than 1 percent of the index to over 20 percent in 2003, while the energy sector has shrunk from over 21 percent to less than 6 percent over the same period.  Had you been looking for the fastest-growing sector, you would have sunk your money in financial stocks and sold your oil stocks.

But if you did so, you would have fallen into the growth trap.  Since 1957, the returns on financial stocks have actually fallen behind the S&P 500 Index, while energy stocks have outperformed over the same period.  For the long-term investor, the strategy of seeking out the fastest-growing sector is misguided.

Siegel continues by noting that the GICS (Global Industrial Classification Standard) breaks the U.S. and world economy down into ten sectors:  materials, industrials, energy, utilities, telecommunication services, consumer discretionary, consumer staples, health care, financial, and information technology.  (Recently real estate has been added as an eleventh sector.)

Just as the fastest-growing companies, as a group, underperform the slower growers in terms of investment returns, so new companies underperform the tried and true.  Siegel explains what his data show:

These data confirm my basic thesis:  the underperformance of new firms is not confined to one industry, such as technology, but extends to the entire market.  New firms are overvalued by investors in virtually every sector of the market.

Siegel also answers the question of why energy did so well, despite shrinking from over 21 percent to less than 6 percent of the market:

Why did the energy sector perform so well?  The oil firms concentrated on what they did best:  extracting oil at the cheapest possible price and returning the profits to the shareholders in the form of dividends.  Furthermore investors had low expectations for the growth of energy firms, so these stocks were priced modestly.  The low valuations combined with the high dividends contributed to superior investor returns.

Technology firms have experienced high earnings growth.  Yet investors have tended to expect even higher growth going forward than what subsequently occurs.  Thus we see again that investors systematically overvalue high-growth companies, which leads to returns that trail the S&P 500 Index.  Technology may be the best example of this phenomenon.  Technology companies have grown very fast, but investors have generally expected too much going forward.

The financial sector is another case of high growth but disappointing (or average) returns.  Much of the growth in financials has come from new companies joining the sector and being added to the index.  Siegel:

The tremendous growth in financial products has spurred the growth of many new firms.  This has caused a steady increase in the market share of the financial sector, but competition has kept the returns on financial stocks close to average over the whole period.

To conclude his discussion of the various sectors, Siegel writes:

The data show that three sectors emerge as long-term winners.  They are health care, consumer staples, and energy.  Health care and consumer staples comprise 90 percent of the twenty best-performing surviving firms of the S&P 500 Index.  These two sectors have the highest proportion of firms where management is focused on bringing quality products to the market and expanding brand-name recognition on a global basis.

The energy sector has delivered above-average returns despite experiencing a significant contraction of its market share.  The excellent returns in this sector are a result of two factors:  the relatively low growth expectations of investors (excepting the oil and gas extractors during the late 1970s) and the high level of dividends.



Siegel opens the chapter by remarking:

Economic growth is not the same as profit growth.  In fact, productivity growth can destroy profits and with it stock values.

Siegel continues:

Any individual or firm through its own effort can rise above the average, but every individual and firm, by definition, cannot.  Similarly, if a single firm implements a productivity-improving strategy that is unavailable to its competition, its profits will rise.  But if all firms have access to the same technology and implement it, then costs and prices will fall and the gains of productivity will go to the consumer.

Siegel notes that Buffett had to deal with this type of issue when he was managing Berkshire Hathaway, a textile manufacturer.  Buffett discussed plans presented to him that would improve workers’ productivity and lower costs:

Each proposal to do so looked like an immediate winner.  Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable investments in our highly profitable candy and newspaper businesses.

Yet Buffett realized that the proposed improvements were available to all textile companies.  Buffett commented in his 1985 annual report:

[T]he promised benefits from these textile investments were illusory.  Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide.  Viewed individually, each company’s investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes).  After each round of investment, all the players had more money in the game and returns remained anemic.

Eventually, after a decade, Buffett realized he had to close the company.  (He had kept it open for a decade out of concern for the employees, and because management was doing an excellent job with the hand it was dealt.)  Siegel comments:

Buffett contrasts his decision to close up shop with that of another textile company that opted to take a different path, Burlington Industries.  Burlington Industries spent approximately $3 billion on capital expenditures to modernize its plants and equipment and improve its productivity in the twenty years following Buffett’s purchase of Berkshire.  Nevertheless, Burlington’s stock returns badly trailed the market.  As Buffett states, ‘This devastating outcome for the shareholders indicates what can happen when much brain power and energy are applied to a faulty premise.’

Siegel then draws a broader conclusion about technology:

Historical economic data indicate that the fruits of technological change, no matter how great, have ultimately benefited consumers, not the owners of firms.  Productivity lowers the price of goods and raises the real wages of workers.  That is, productivity allows us to buy more with less.

Certainly, technological change has transitory effects on profits.  There is usually a ‘first mover’ advantage.  When one firm incorporates a new technology that has not yet been implemented by others, profits will increase.  But as others avail themselves of this technology, competition ensures that prices will fall and profits will revert to normal.



Siegel quotes Peter Lynch:

As a place to invest, I’ll take a lousy industry over a great industry anytime.  In a lousy industry, one that’s growing slowly if at all, the weak drop out and the survivors get a bigger share of the market.  A company that can capture an ever-increasing share of a stagnant market is a lot better off than one that has to struggle to protect a dwindling share of an exciting market.

Many investors try to look for an industry with a bright future, and then select a company that will benefit from this growth.  As we’ve already seen, this doesn’t work in general because investors systematically overvalue high-growth companies.

A deep value investment strategy looks for companies at low multiples, with terrible performance.  These companies, as a group, have done much better than the market over time.

Although a deep value approach works well even if it is entirely quantitative – which is what Ben Graham, the father of value investing, often did – it can work even better if you can identify a winning management.  Siegel explains:

… some of the most successful investments of the last thirty years have come from industries whose performances have been utterly horrendous.

These companies have bucked the trend.  They all rose above their competitors by following a simple approach:  maximize productivity and keep costs as low as possible.

Siegel gives Southwest Airlines as an example.  Investors have lost more money in the airline industry than in any other.  But Southwest Airlines established itself as ‘the low-fare airline.’  It accomplished this by being the low-cost airline.  It offered only single-class service, with no assigned seats and no meals.  It only operated city-to-city where demand was high enough.  And it only used Boeing 737’s.  As a result of being the low-cost and low-fare airline, the business performed well and the stock followed.

Siegel also mentions the example of Nucor, which pioneered the use of ‘minimill’ technology and the recycling of scrap steel.  While the steel industry as a whole underperformed the market by close to 4 percent a year for thirty years, Nucor outperformed the market by over 5 percent a year over the same time period.  According to Jim Collins and others, at least 80 percent of Nucor’s success had to do with the leadership and culture of the company.  At Nucor, executives actually received fewer benefits than regular workers:

  • All workers were eligible to receive $2,000 per year for each child for up to four years of postsecondary education, while the executives received no such benefit.
  • Nucor lists all of its employees – more than 9,800 – in its annual report, sorted alphabetically with no distinctions for officer titles.
  • There are no assigned parking spots and no company cars, boats, or planes.
  • All employees of the company receive the same insurance coverage and amount of vacation time.
  • Everybody wears the same green spark-proof jackets and hard hats on the floor (in most integrated mills, different colors designate authority).

Siegel quotes Buffett:

It is the classic example of an incentive program that works.  If I were a blue-collar worker, I would like to work for Nucor.

In stark contrast, Bethlehem Steel had executives using the corporate fleet for personal reasons, like taking children to college or weekend vacations.  Bethlehem also renovated a country club with corporate funds, at which shower priority was determined by executive rank, notes Siegel.

Siegel concludes his discussion of Southwest Airlines and Nucor (and Wal-Mart):

The success of these firms must make investors stop and think.  The best-performing stocks are not in industries that are at the cutting edge of the technological revolution; rather, they are often in industries that are stagnant or in decline.  These firms are headed by managements that find and pursue efficiencies and develop competitive niches that enable them to reach commanding positions no matter what industry they are in.  Firms with these characteristics, which are often undervalued by the market, are the ones that investors should want to buy.

Another great example of a company implementing a low-cost business strategy is 3G Capital, a Brazilian investment firm.  (3G was founded in 2004 by Jorge Paulo Lemann, Carlos Alberto Sicupira, and Marcel Herrmann Telles.)  3G is best known for partnering with Buffett’s Berkshire Hathaway for its acquisitions, including Burger King, Tim Hortons, and Kraft Foods.  When 3G acquires a company, they typically implement deep cost cuts.



Siegel explains what can happen to a dividend-paying stock during a bear market:  If the stock price falls more than the dividend, then the higher dividend yield can then be used to reinvest, leading to a higher share count than otherwise.  The Great Depression led to a 25-year period – October 1929 to November 1954 – during which stocks plunged and then took a long time to recover.  Most investors did not do well, often because they could not or did not hold on to their shares.  But investors with dividend-paying stocks who reinvested those dividends did quite well, as Siegel notes:

Instead of just getting back to even in November 1954, stockholders who reinvested their dividends (indicated as ‘total return’) realized an annual rate of return of 6 percent per year, far outstripping those who invested in either long- or short-term government bonds.  In fact, $1,000 invested in stocks at the market peak turned into $4,440 when the Dow finally recovered to its old high on that November day a quarter century later.  Although the price appreciation was zero, the $4,400 that resulted solely from reinvesting dividends was almost twice the accumulation in bonds and four times the accumulation in short-term treasury bills.

Siegel concludes:

There is an important lesson to be taken from this analysis.  Market cycles, although difficult on investors’ psyches, generate wealth for long-term stockholders.  These gains come not through timing the market but through the reinvestment of dividends.

Bear markets are not only painful episodes that investors must endure; they are also an integral reason why investors who reinvest dividends experience sharply higher returns.  Stock returns are generated not by earnings and dividends alone but by the prices that investors pay for these cash flows.  When pessimism grips shareholders, those who stay with dividend-paying stocks are the big winners.

The same logic applies to individual stocks.  If a company is a long-term survivor (or leader), then short-term bad news causing the stock to drop will enhance your long-term returns if you’re reinvesting dividends.  This is also true if you’re dollar-cost averaging.

In theory, share repurchases when the stock is low can work even better than dividends because share repurchases create tax-deferred gains.  In practice, Siegel observes, management is often not as committed to a policy of share repurchases as it is to paying dividends.  Once a dividend is being paid, the market usually views a reduced dividend unfavorably.  Also, shareholders can track dividends more easily than share repurchases.  In sum, when a stock is low, it is usually better for shareholders if they can reinvest dividends instead of relying on management to repurchase shares.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

One Up On Wall Street

(Image:  Zen Buddha Silence by Marilyn Barbone.)

January 30, 2022

Peter Lynch is one of the great investors.  When Lynch managed Fidelity Magellan from 1977 to 1990, the fund averaged 29.2% per year—more than doubling the annual return of the S&P 500 Index—making it the best performing mutual fund in the world.

In One Up On Wall Street: How to Use What You Already Know to Make Money in the Market (Fireside, 1989 and 2000), Lynch offers his best advice to individual investors.

Lynch explains how to find tenbaggers—stocks that increase by 10x—by looking among stocks that are too small for most professionals.  Lynch also suggests that you pay attention to small businesses you may come across in your daily life.  If you notice a company that seems to be doing well, then you should research its earnings prospects, financial condition, competitive position, and so forth, in order to determine if the stock is a bargain.

Moreover, Lynch notes that his biggest winners—tenbaggers, twentybaggers, and even a few hundredbaggers—typically have taken at least three to ten years to play out.

The main idea is that a stock tracks the earnings of the underlying company over time.  If you can pay a cheap price relative to earnings, and if those earnings increase over subsequent years, then you can get some fivebaggers, tenbaggers, and even better as long as you hold the stock while the story is playing out.

Lynch also writes that being right six out of ten times on average works well over time.  A few big winners will overwhelm the losses from stocks that don’t work out.

Don’t try to time the market.  Focus on finding cheap stocks.  Some cheap stocks do well even when the market is flat or down.  But over the course of many years, the economy grows and the market goes higher.  If you try to dance in and out of stocks, eventually you’ll miss big chunks of the upside.

Here are the sections in this blog post:

  • Introduction: The Advantages of Dumb Money
  • The Making of a Stockpicker
  • The Wall Street Oxymorons
  • Is This Gambling, or What?
  • Personal Qualities It Takes to Succeed
  • Is This a Good Market? Please Don’t Ask
  • Stalking the Tenbagger
  • I’ve Got It, I’ve Got It—What Is It?
  • The Perfect Stock, What a Deal!
  • Stocks I’d Avoid
  • Earnings, Earnings, Earnings
  • The Two-Minute Drill
  • Getting the Facts
  • Some Famous Numbers
  • Rechecking the Story
  • The Final Checklist
  • Designing a Portfolio
  • The Best Time to Buy and Sell



Lynch writes that two decades as a professional investor have convinced him that the ordinary individual investor can do just as well as—if not better than—than the average Wall Street expert.

Dumb money is only dumb when it listens to the smart money.

Lynch makes it clear that if you’ve already invested in a mutual fund with good long-term performance, then sticking with it makes sense.  His point is that if you’ve decided to invest in stocks directly, then it’s possible to do as well as—if not better than—the average professional investor.  This means ignoring hot tips and doing your own research on companies.

There are at least three good reasons to ignore what Peter Lynch is buying:  (1) he might be wrong!  (A long list of losers from my own portfolio constantly reminds me that the so-called smart money is exceedingly dumb about 40 percent of the time);  (2) even if he’s right, you’ll never know when he’s changed his mind about a stock and sold;  and (3) you’ve got better sources, and they’re all around you…

If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall, and long before Wall Street discovers them… and if you work in the industry, so much the better.  This is where you’ll find the tenbaggers.  I’ve seen it happen again and again from my perch at Fidelity.

You can find tenbaggers even in weak markets, writes Lynch.  If you have ten positions at 10% each, then one tenbagger will cause your total portfolio to increase 90% if the other nine positions are flat.  If the other nine positions collectively lose 50% (perhaps in weak market), then your overall portfolio will still be up 45% if you have one tenbagger.

Most often, tenbaggers are in companies like Dunkin’ Donuts rather than in penny stocks that depend on a scientific breakthrough.  Lynch also mentions La Quinta Motor Inns—a tenbagger from 1973 to 1983.  (La Quinta modeled itself on Holiday Inn, but with 30% lower costs and 30% lower prices.  If you’ve attended a Berkshire Hathaway Annual Shareholders meeting in the past decade, you may have stayed at La Quinta along with a bunch of other frugal Berkshire shareholders.)

  • Note: When considering examples Lynch gives in his book, keep in mind that he first wrote the book in 1989.  The examples are from that time period.

Lynch says he came across many of his best investment ideas while he was out and about:

Taco Bell, I was impressed with the burrito on a trip to California;  La Quinta Motor Inns, somebody at the rival Holiday Inn told me about it;  Volvo, my family and friends drive this car;  Apple Computer, my kids had one at home and then the systems manager bought several for the office;  Service Corporation International, a Fidelity electronics analyst… found on a trip to Texas;  Dunkin’ Donuts, I loved the coffee…

Many individual investors think the big winners must be technology companies, but very often that’s not the case:

Among amateur investors, for some reason it’s not considered sophisticated practice to equate driving around town eating donuts with the initial phase of an investigation into equities.  People seem more comfortable investing in something about which they are entirely ignorant.  There seems to be an unwritten rule on Wall Street:  If you don’t understand it, then put your life savings into it.  Shun the enterprise around the corner, which can at least be observed, and seek out the one that manufactures an incomprehensible product.

Lynch is quick to point out that finding a promising company is only the first step.  You then must conduct the research.



Lynch describes his experience at Boston College:

As I look back on it now, it’s obvious that studying history and philosophy was much better preparation for the stock market than, say, studying statistics.  Investing in stocks is an art, not a science, and people who’ve been trained to rigidly quantify everything have a big disadvantage.

Granted, since Lynch first wrote this book in 1989, more quantitative investors—using computer-based models—have come along.  But when it comes to picking stocks that can do well if held for many years, the majority of successful investors still follow a much more traditional process:  gathering information through observation, massive reading, and scuttlebutt, and then making investment decisions that are often partly qualitative in nature.  Here is a partial list of successful stockpickers:

  • Bill Ackman, David Abrams, Lee Ainslie, Chuck Akre, Bruce Berkowitz, Christopher Browne, Warren Buffett, Michael Burry, Leon Cooperman, Christopher Davis, David Einhorn, Jean-Marie Eveillard, Thomas Gayner, Glenn Greenberg, Joel Greenblatt, Mason Hawkins, Carl Icahn, Seth Klarman, Stephen Mandel, Charlie Munger, Bill Nygren, Mohnish Pabrai, Michael Price, Richard Pzena, Robert Rodriguez, Stephen Romick, Thomas Russo, Walter Schloss, Lou Simpson, Guy Spier, Arnold Van Den Berg, Prem Watsa, Wallace Weitz, and Donald Yacktman.



Lynch observes that professional investors are typically not able to invest in most stocks that become tenbaggers.  Perhaps the most important reason is that most professional investors never invest in microcap stocks, stocks with market caps below $500 million.  Assets under management (AUM) for many professional investors are just too large to be able to invest in microcap companies.  Moreover, even smaller funds usually focus on small caps instead of micro caps.  Often that’s a function of AUM, but sometimes it’s a function of microcap companies being viewed as inherently riskier.

There are thousands of microcap companies.  And many micro caps are good businesses with solid revenues and earnings, and with healthy balance sheets.  These are the companies you should focus on as an investor.  (There are some microcap companies without good earnings or without healthy balance sheets.  Simply avoid these.)

If you invest in a portfolio of solid microcap companies, and hold for at least 10 years, then the expected returns are far higher than would you get from a portfolio of larger companies.  There is more volatility along the way, but if you can just focus on the long-term business results, then shorter term volatility is generally irrelevant.  Real risk for value investors is not volatility, or a stock that goes down temporarily.  Real risk is the chance of suffering a permanent loss—when the whole portfolio declines and is unable to bounce back.

Fear of volatility causes many professional investors only to look at stocks that have already risen a great deal, so that they’re no longer micro caps.  You’ll miss a lot of tenbaggers and twentybaggers if you can’t even look at micro caps.  That’s a major reason why individual investors have an advantage over professional investors.  Individual investors can look at thousands of microcap companies, many of which are in very good shape.

Furthermore, even if a professional investor could look at microcap stocks, there are still strong incentives not to do so.  Lynch explains:

…between the chance of making an unusually large profit on an unknown company and the assurance of losing only a small amount on an established company, the normal mutual-fund manager, pension-fund manager, or corporate-portfolio manager would jump at the latter.  Success is one thing, but it’s more important not to look bad if you fail.

As Lynch says, if you’re a professional investor and you invest in a blue chip like General Electric which doesn’t work, clients and bosses will ask, ‘What is wrong with GE?’  But if you invest in an unknown microcap company and it doesn’t work, they’ll ask, ‘What is wrong with you?’

Lynch sums it up the advantages of the individual investor:

You don’t have to spend a quarter of your waking hours explaining to a colleague why you are buying what you are buying.  [Also, you can invest in unknown microcap companies…]  There’s nobody to chide you for buying back a stock at $19 that you earlier sold at $11—which may be a perfectly sensible move.



In general, stocks have done better than bonds over long periods of time.

Historically, investing in stocks is undeniably more profitable than investing in debt.  In fact, since 1927, common stocks have recorded gains of 9.8 percent a year on average, as compared to 5 percent for corporate bonds, 4.4 percent for government bonds, and 3.4 percent for Treasury bills.

The long-term inflation rate, as measured by the Consumer Price Index, is 3 percent a year, which gives common stocks a real return of 6.8 percent a year.  The real return on Treasury bills, known as the most conservative and sensible of all places to put money, has been nil.  That’s right.  Zippo.

Many people get scared out of stocks whenever there is a large drop of 20-40% (or more).  But both the U.S. economy and U.S. stocks are very resilient and have always bounced back quickly.  This is especially true since the Great Depression, which was a prolonged period of deep economic stagnation caused in large part by policy errors.  A large fiscal stimulus and/or a huge program of money-printing (monetary stimulus) would have significantly shortened the Great Depression.

Lynch defines good investing as a system of making bets when the odds are in your favor.  If you’re right 60% of the time and you have a good system, then you should do fine over time.  Lynch compares investing to stud poker:

You can never be certain what will happen, but each new occurrence—a jump in earnings, the sale of an unprofitable subsidiary, the expansion into new markets—is like turning up another card.  As long as the cards suggest favorable odds of success, you stay in the hand.

…Consistent winners raise their bets as their position strengthens, and they exit the game when the odds are against them…

Consistent winners also resign themselves to the fact that they’ll occasionally be dealt three aces and bet the limit, only to lose to a hidden royal flush.  They accept their fate and go on to the next hand, confident that their basic method will reward them over time.  People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences.  Calamitous drops do not scare them out of the game… They realize the stock market is not pure science, and not like chess, where the superior position always wins.  If seven out of ten of my stocks perform as expected, then I’m delighted.  If six out of ten of my stocks perform as expected, then I’m thankful.  Six out of ten is all it takes to produce on enviable record on Wall Street.

Lynch concludes the chapter by saying that investing is more like 70-card poker than 7-card poker.  If you have ten positions, it’s like playing ten 70-card hands at once.



Lynch writes:

It seems to me the list of qualities ought to include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic…

It’s also important to be able to make decisions without complete or perfect information.  Things are almost never clear on Wall Street, or when they are, then it’s too late to profit from them.  The scientific mind that needs to know all the data will be thwarted here.

And finally, it’s crucial to be able to resist your human nature and your ‘gut feelings.’  It’s the rare investor who doesn’t secretly harbor the conviction that he or she has a knack for divining stock prices or gold prices or interest rates, in spite of the fact that most of us have been proven wrong again and again.  It’s uncanny how often people feel most strongly that stocks are going to go up or the economy is going to improve just when the opposite occurs.  This is borne out by the popular investment-advisory newsletter services, which themselves tend to turn bullish and bearish at inopportune moments.

According to information published by Investor’s Intelligence, which tracks investor sentiment via the newsletters, at the end of 1972, when stocks were about to tumble, optimism was at an all-time high, with only 15 percent of the advisors bearish.  At the beginning of the stock market rebound in 1974, investor sentiment was at an all-time low, with 65 percent of the advisors fearing the worst was yet to come…. At the start of the 1982 sendoff into a great bull market, 55 percent of the advisors were bears, and just prior to the big gulp of October 19, 1987, 80 percent of the advisors were bulls again.

…Does the success of Ravi Batra’s book The Great Depression of 1990 almost guarantee a great national prosperity?

Lynch summarizes:

…The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them.  Stand by your stocks as long as the fundamental story of the company hasn’t changed.




There’s another theory that we have recessions every five years, but it hasn’t happened that way so far… Of course, I’d love to be warned before we do go into a recession, so I could adjust my portfolio.  But the odds of my figuring it out are nil.  Some people wait for these bells to go off, to signal the end of a recession or the beginning of an exciting new bull market.  The trouble is the bells never go off.  Remember, things are never clear until it’s too late.

… No matter how we arrive at the latest financial conclusion, we always seem to be preparing ourselves for the last thing that’s happened, as opposed to what’s going to happen next.  This penultimate preparedness is our way of making up for the fact that we didn’t see the last thing coming along in the first place.

Lynch continues:

I don’t believe in predicting markets.  I believe in buying great companies—especially companies that are undervalued and/or underappreciated.

Lynch explains that the stock market itself is irrelevant.  What matters is the current and future earnings of the individual business you’re considering.  Lynch:

Several of my favorite tenbaggers made their biggest moves during bad markets.  Taco Bell soared through the last two recessions.

Focus on specific companies rather than the market as a whole.  Because you’re not restricted as an individual investor—you can look at microcap companies and you can look internationally—there are virtually always bargains somewhere.

A few good quotes from Warren Buffett on forecasting:

Market forecasters will fill your ear but never fill your wallet.

We will continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen.

Charlie and I never have an opinion on the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.



If you work in a particular industry, this can give you an edge:

If you work in the chemical industry, then you’ll be among the first to realize that demand…is going up, prices are going up, and excess inventories are going down.  You’ll be in a position to know that no new competitors have entered the market and no new plants are under construction, and that it takes two to three years to build one.

Lynch also argues that if you’re a consumer of particular products, then you may be able to gain insight into companies that sell those products.  Again, you still need to study the financial statements in order to understand earnings and the balance sheet.  But noticing products that are doing well is a good start.



Most of the biggest moves—from tenbaggers to hundredbaggers—occur in smaller companies.  Microcap companies are the best place to look for these multi-baggers, while small-cap companies are the second best place to look.

Lynch identifies six general categories:  slow growers, stalwarts, fast growers, cyclicals, asset plays, and turnarounds.  (Slow growers and stalwarts tend to be larger companies.)

Slow Growers

Many large companies grow slowly, but are relatively dependable and may pay dividends.  A conservative investor may consider this category.


These companies tend to grow annual earnings at 10 to 12 percent a year.  If you buy the stock when it’s a bargain, you can make 30 to 50 percent, then sell and repeat the process.  This is Lynch’s approach to Stalwarts.  Also, Stalwarts can offer decent protection during weak markets.

Fast Growers

Some small, aggressive new companies can grow at 20 to 25 percent a year:

If you choose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers.

Of course, you have to be careful to identify the risks.  Many younger companies may grow too quickly or be underfinanced.  So look for the fast growers with good balance sheets and good underlying profitability.


A cyclical is a company whose sales and profits rise and fall regularly.  If you can buy when the company and the industry are out of favor—near the bottom of the cycle—then you can do well with a cyclical.  (You also need to sell when the company and the industry are doing well again unless you think it’s a good enough company to hold for a decade or longer.)

Some cyclical stocks—like oil stocks—tend to have a low level of correlation with the broader stock market.  This can help a portfolio, especially when the broader stock market offers few bargains.



Turnaround stocks make up lost ground very quickly… The best thing about investing in successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market.

Again, a low correlation with the broader market is especially an advantage when the broader market is overvalued.  You do have to be careful with turnarounds, though.  As Buffett has said, ‘Turnarounds seldom turn.’

Asset Plays

A company may have something valuable that the market has overlooked.  It may be as simple as a pile of cash.  Sometimes it’s real estate.  It may be unrecognized intellectual property.  Or it could be resources in the ground.



Similar to Warren Buffett, Lynch prefers simple businesses:

Getting the story on a company is a lot easier if you understand the basic business.  That’s why I’d rather invest in panty hose than in communications satellites, or in motel chains than in fiber optics.  The simpler it is, the better I like it.  When somebody says, ‘Any idiot could run this joint,’ that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it.

… For one thing, it’s easier to follow.  During a lifetime of eating donuts or buying tires, I’ve developed a feel for the product line that I’ll never have with laser beams or microprocessors.

Lynch then names thirteen attributes that are important to look for:

It Sounds Dull—Or, Even Better, Ridiculous

Lynch says a boring name is a plus, because that helps a company to stay neglected and overlooked, often causing the stock to be cheap.  Bob Evans Farms is an example of a perfect name.

It Does Something Dull

Crown, Cork, and Seal makes cans and bottle caps, says Lynch.  The more boring the business, the better.  Again, this will help keep the stock neglected, often causing the stock to be cheap.

It Does Something Disagreeable

Safety-Kleen provides gas stations with a machine that washes greasy auto parts.  Gas stations love it.  But it’s a bit disgusting, which can cause the stock to be neglected and thus possibly cheap.

It’s a Spinoff

Large companies tend to make sure that divisions they spin off are in good shape.  Generally spinoffs are neglected by most professional investors, often because the market cap of the spinoff is too small for them to consider.

The Institutions Don’t Own It, and the Analysts Don’t Follow It

With no institutional ownership, the stock may be neglected and possibly cheap.  With no analyst coverage, the chance of neglect and cheapness is even higher.  It’s not only microcap companies that are neglected.  When popular stocks fall deeply out of favor, they, too, can become neglected.

Rumors Abound: It’s Involved with Toxic Waste

Waste Management, Inc. was a hundredbagger.  People are so disturbed by sewage and waste that they tend to neglect such stocks.

There’s Something Depressing About It

Funeral home companies tend to be neglected and the stocks can get very cheap at times.

It’s a No-Growth Industry

In a no-growth industry, there’s much less competition.  This gives companies in the industry room to grow.

It’s Got a Niche

The local rock pit has a niche.  Lynch writes that if you have the only rock pit in Brooklyn, you have a virtual monopoly.  A rival two towns away is not going to transport rocks into your territory because the mixed rocks only sell for $3 a ton.

People Have to Keep Buying It

Drugs, soft drinks, razor blades, etc., are products that people need to keep buying.

It’s a User of Technology

A company may be in a position to benefit from ongoing technological improvements.

The Insiders Are Buyers

Insider buying usually means the insiders think the stock is cheap.

Also, you want insiders to own as much stock as possible so that they are incentivized to maximize shareholder value over time.  If executive salaries are large compared to stock ownership, then executives will focus on growth instead of on maximizing shareholder value (i.e., profitability).

The Company Is Buying Back Shares

If the shares are cheap, then the company can create much value through buybacks.



Lynch advises avoiding the hottest stock in the hottest industry.  Usually a stock like that will be trading at an extremely high valuation, which requires a great deal of future growth for the investor just to break even.  When future growth is not able to meet lofty expectations, typically the stock will plummet.

Similarly, avoid the next something.  If a stock is touted as the next IBM, the next Intel, or the next Disney, avoid it because very probably it will not be the next thing.

Avoid diworseifications:  Avoid the stock of companies that are making foolish acquisitions of businesses in totally different industries.  Such diworseifications rarely work out for shareholders.  Two-thirds of all acquisitions do not create value.  This is even more true when acquisitions are diworseifications.

Beware whisper stocks, which are often technological long shots or whiz-bang stories such as miracle drugs.  Lynch notes that he’s lost money on every single whisper stock he’s ever bought.

One trick to avoiding whisper stocks is to wait until they have earnings.  You can still get plenty of tenbaggers from companies that have already proven themselves.  Buying long shots before they have earnings rarely works.  This is a good rule for buying microcap stocks in general:  Wait until the company has solid earnings and a healthy balance sheet.



Lynch writes that a stock eventually will track the earnings of the business:

Analyzing a company’s stock on the basis of earnings and assets is no different from analyzing a local Laundromat, drugstore, or apartment building that you might want to buy.  Although it’s easy to forget sometimes, a share of stock is not a lottery ticket.  It’s part ownership of a business.

Lynch gives an example:

And how about Masco Corporation, which developed the single-handle ball faucet, and as a result enjoyed thirty consecutive years of up earnings through war and peace, inflation and recession, with the earnings rising 800-fold and the stock rising 1,300-fold between 1958 and 1987?  What would you expect from a company that started out with the wonderfully ridiculous name of Masco Screw Products?

Lynch advises not to invest in companies with high price-to-earnings (p/e) ratios:

If you remember nothing else about p/e ratios, remember to avoid stocks with excessively high ones.  You’ll save yourself a lot of grief and a lot of money if you do.  With few exceptions, an extremely high p/e ratio is a handicap to a stock, in the same way that extra weight in the saddle is a handicap to a racehorse.

Future earnings may not be predictable, but you can at least check how the company plans to increase future earnings.  Lynch:

There are five basic ways a company can increase earnings:  reduce costs;  raise prices;  expand into new markets;  sell more of its product in the old markets;  or revitalize, close, or otherwise dispose of a losing operation.  These are the factors to investigate as you develop the story.  If you have an edge, this is where it’s going to be most helpful.



Warren Buffett has said that he would have been a journalist if he were not an investor.  Buffett says his job as an investor is to write the story for the company in question.  Lynch has a similar view.  He explains:

Before buying a stock, I like to be able to give a two-minute monologue that covers the reasons I’m interested in it, what has to happen for the company to succeed, and the pitfalls that stand in its path.  The two-minute monologue can be muttered under your breath or repeated out loud to colleagues who happen to be standing within earshot.  Once you’re able to tell the story of a stock to your family, your friends, or the dog… and so that even a child could understand it, then you have a proper grasp of the situation.

Usually there are just a few key variables for a given investment idea.  As value investor Bruce Berkowitz has said:

We’ve always done very well when we can use sixth-grade math on the back of a postcard to show how inexpensive something is relative to its free cash.

One good way to gain insight is to ask the executive of a company what he or she thinks the competition is doing right.  Lynch discovered La Quinta Motor Inns while he was talking to the vice president of United Inns, a competitor.

Lynch later learned that La Quinta’s strategy was simple:  to have both costs and prices that are 30% lower than Holiday Inn.  La Quinta had everything exactly the same as at a Holiday Inn—same size rooms, same size beds, etc.  However:

La Quinta had eliminated the wedding area, the conference rooms, the large reception area, the kitchen area, and the restaurant—all excess space that contributed nothing to the profits but added substantially to the costs.  La Quinta’s idea was to install a Denny’s or some similar 24-hour place next door to every one of its motels.  La Quinta didn’t even have to own the Denny’s.  Somebody else could worry about the food.  Holiday Inn isn’t famous for its cuisine, so it’s not as if La Quinta was giving up a major selling point…  It turns out that most hotels and motels lose money on their restaurants, and the restaurants cause 95 percent of the complaints.



If it’s a microcap business, then you may be able to speak with a top executive simply by calling the company.  For larger companies, often you will only reach investor relations.  Either way, you want to check the story you’ve developed—your investment thesis—against the facts you’re able to glean through conversation (and through reading the financial statements, etc.).

If you don’t have a story developed enough to check, there are two general questions you can always ask, notes Lynch:

  • What are the positives this year?
  • What are the negatives?

Often your ideas will not be contradicted.  But occasionally you’ll learn something unexpected, that things are either better or worse than they appear.  Such unexpected information can be very profitable because it is often not yet reflected in the stock price.  Lynch says he comes across something unexpected in about one out of every ten phone calls he makes.

Lynch also often will visit headquarters.  The goal, he says, is to get a feel for the place.  What Lynch really appreciates is when headquarters is obviously shabby, indicating that the executives are keeping costs as low as possible.  When headquarters is very nice and fancy, that’s generally a bad signal about management.

Kicking the tires can help.  It’s not a substitute for studying the financial statements or for asking good questions.  But it can help you check out the practical side of the investment thesis.  Lynch used to make a point of checking out as many companies as possible this way.

Finally, in addition to reading the financial statements, Lynch recommends Value Line.



If you’re looking at a particular product, then you need to know what percent of sales that particular product represents.

Lynch then notes that you can compare the p/e and the growth rate:

If the p/e of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year, etc.  But if the p/e ratio is less than the growth rate, you may have found yourself a bargain.  A company, say, with a growth rate of 12 percent a year… and a p/e of 6 is a very attractive prospect.  On the other hand, a company with a growth rate of 6 percent a year and a p/e ratio of 12 is an unattractive prospect and headed for a comedown.

In general, a p/e that’s half the growth rate is very positive, and one that’s twice the growth rate is very negative.

You can do a similar calculation by taking earnings, adding dividends, and comparing that sum to the growth rate.

High debt-to-equity is something to avoid.  Turnarounds with high debt tend to work far less often than turnarounds with low debt.

Free cash flow is important.  Free cash flow equals net income plus depreciation, depletion, and amortization, minus capital expenditures.  (There may also be adjustments for changes in working capital.)

The important point is that some companies and some industries—such as steel or autos—are far more capital-intensive than others.  Some companies have to spend most of their incoming cash on capital expenditures just to maintain the business at current levels.  Other companies have far lower reinvestment requirements; this means a much higher return on invested capital.  The value that any given company creates over time is the cumulative difference between the return on invested capital and the cost of capital.

Another thing to track is inventories.  If inventories have been piling up recently, that’s not a good sign.  When inventories are growing faster than sales, that’s a red flag.  Lynch notes that if sales are up 10 percent, but inventories are up 30 percent, then you should be suspicious.

Like Buffett, Lynch observes that a company that can raise prices year after year without losing customers can make for a terrific investment.  Such a company will tend to have high free cash flow and high return on invested capital over time.

A last point Lynch makes is about the growth rate of earnings:

All else being equal, a 20-percent grower selling as 20 times earnings (a p/e of 20) is a much better buy than a 10-percent grower selling at 10 times earnings (a p/e of 10).  This may sound like an esoteric point, but it’s important to understand what happens to the earnings of the faster growers that propels the stock price.

Lynch gives an example.  Assume Company A and Company B both start with earnings of $1.00 per share.  But assume that Company A grows at 20 percent a year while Company B grows at 10 percent a year.  (So the stock of Company A starts at $20, while the stock of Company B is at $10.)  What happens after 10 years, assuming the growth rates stay the same?  Company A will be earning $6.19 while Company B will be earning $2.59.

If the multiples haven’t changed, then the stock of Company A will be at $123.80, while the stock of Company B will only be at $26.  Even if the p/e for Company A falls to 15 instead of 20, the stock will still be at $92.  Going from $20 to $92 (or $123.80) is clearly better than going from $10 to $26.

One last point.  In the case of a successful turnaround, the stock of a relatively low-profit margin (and perhaps also high debt) company will do much better than the stock of a relatively high-profit margin (and low debt) company.  It’s just a matter of leverage.

For a long-term stock that you’re going to hold through good times and bad, you want high profit margins and low debt.  If you’re going to invest in a successful turnaround, then you want low profit margins and high debt, all else equal.  (In practice, most turnarounds don’t work, and high debt should be avoided unless you want to specialize in equity stubs.)



Every few months, you should check in on the company.  Are they on track?  Have they made any adjustments to their plan?  How are sales?  How are the earnings?  What are industry conditions?  Are their products still attractive?  What are their chief challenges?  Et cetera.  Basically, writes Lynch, have any new cards been turned over?

In the case of a growth company, Lynch holds that there are three phases.  In the start-up phase, the company may still be working the kinks out of the business.  This is the riskiest phase because the company isn’t yet established.  The second phase is rapid expansion.  This is generally the safest phase, and also where you can make the most money as an investor.  The third phase is the mature phase, or the saturation phase, when growth has inevitably slowed down.  The third phase can be the most problematic, writes Lynch, since it gets increasingly difficult to grow earnings.



Lynch offers a brief checklist.

  • The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry.
  • The percentage of institutional ownership. The lower the better.
  • Whether insiders are buying and whether the company itself is buying back its own shares.  Both are positive signs.
  • The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.)
  • Whether the company has a strong balance sheet or a weak balance sheet (high debt-to-equity ratio) and how it’s rated for financial strength.
  • The cash position.  With $16 in net cash, I know Ford is unlikely to drop below $16 a share.

Lynch also gives a checklist for each of the six categories.  Then he gives a longer checklist summarizes all the main points (which have already been mentioned in the previous sections).



Some years you’ll make 30 percent, other years you’ll make 2 percent, and occasionally you’ll lose 20 or 30 percent.  It’s important to stick to a disciplined approach and not get impatient.  Stick with the long-term strategy through good periods and bad.  (Even great investors have periods of time when their strategy trails the market, often even several years in a row.)

Regarding the number of stocks to own, Lynch mentions a couple of stocks in which he wouldn’t mind investing his entire portfolio.  But he says you need to analyze each stock one at a time:

…The point is not to rely on any fixed number of stocks but rather to investigate how good they are, on a case-by-case basis.

In my view it’s best to own as many stocks as there are situations in which:  (a) you’ve got an edge; and (b) you’ve uncovered an exciting prospect that passes all the tests of research.  Maybe it’s a single stock, or maybe it’s a dozen stocks.  Maybe you’ve decided to specialize in turnarounds or asset plays and you buy several of those;  or perhaps you happen to know something special about a single turnaround or a single asset play.  There’s no use diversifying into unknown companies just for the sake of diversity.  A foolish diversity is the hobgoblin of small investors.

Lynch then recommends, for small portfolios, owning between 3 and 10 stocks.  It makes sense to concentrate on your best ideas and on what you understand best.  At the same time, it often happens that the tenbagger comes—unpredictably—from your 8th or 9th best idea.  The value investor Mohnish Pabrai has had this experience.

  • Important Note:  One of the best edges you can have as an individual investor—in addition to being able to focus on microcap companies—is that you can have at least a 3- to 5-year holding period.  Because so many investors focus on shorter periods of time, very often the best bargains are stocks that are cheap relative to earnings in 3 to 5 years.

Lynch advises against selling winners and holding on to losers, which is like pulling out the flowers and watering the weeds.  But Lynch’s real point is that price movements are often random.  Just because a stock has gone up or down doesn’t mean the fundamental value of the business has changed.

If business value has increased—or if fundamentals have improved—then it often makes sense to add to a stock even if it’s gone from $11 to $19.

If business value has not declined, or has improved, then it often makes sense to add to a stock that has declined.  On the other hand, if business value has decreased—or if fundamentals have deteriorated—then it often makes sense to sell, regardless of whether the stock has gone up or down.

In general, as long as the investment thesis is intact and business value is sufficiently high, you should hold a stock for at least 3 to 5 years:

If I’d believed in ‘Sell when it’s a double,’ I would never have benefited from a single big winner, and I wouldn’t have been given the opportunity to write a book.  Stick around to see what happens—as long as the original story continues to make sense, or gets better—and you’ll be amazed at the results in several years.



Often there is tax loss selling near the end of the year, which means it can be a good time to buy certain stocks.

As mentioned, you should hold for at least 3 to 5 years as long as the investment thesis is intact and normalized business value is sufficiently high.  Be careful not to listen to negative nellies who yell ‘Sell!’ way before it’s time:

Even the most thoughtful and steadfast investor is susceptible to the influence of skeptics who yell ‘Sell’ before it’s time to sell.  I ought to know.  I’ve been talked out of a few tenbaggers myself.

Lynch took a big position in Toys ‘R’ Us in 1978.  He had done his homework, and he loaded up at $1 per share:

…By 1985, when Toys ‘R’ Us hit $25, it was a 25-bagger for some.  Unfortunately, those some didn’t include me, because I sold too soon.  I sold too soon because somewhere along the line I’d read that a smart investor named Milton Petrie, one of the deans of retailing, had bought 20 percent of Toys ‘R’ Us and that his buying was making the stock go up.  The logical conclusion, I thought, was that when Petrie stopped buying, the stock would go down.  Petrie stopped buying at $5.

I got in at $1 and out at $5 for a fivebagger, so how can I complain?  We’ve all been taught the same adages:  ‘Take profits when you can,’ and ‘A sure gain is always better than a possible loss.’  But when you’ve found the right stock and bought it, all the evidence tells you it’s going higher, and everything is working in your direction, then it’s a shame if you sell.

Lynch continues by noting that individual investors are just as susceptible to selling early as are professional investors:

Maybe you’ve received the ‘Congratulations: Don’t Be Greedy’ announcement.  That’s when the broker calls to say:  ‘Congratulations, you’ve doubled your money on ToggleSwitch, but let’s not be greedy.  Let’s sell ToggleSwitch and try KinderMind.’  So you sell ToggleSwitch and it keeps going up, while KinderMind goes bankrupt, taking all of your profits with it.

One major problem for all investors is that there are so many market, economic, and political forecasts.  Market forecasts and economic forecasts can be very expensive if you follow them, as Buffett has often noted.  The only thing you can really know is the individual company in which you’ve invested, and what its long-term business value is.  Everything else is noise that can only interfere with your ability to focus on long-term business value.

I quoted Buffett earlier.  Now let’s quote the father of value investing, Buffett’s teacher and mentor, Ben Graham:

… if I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.

This has happened in recent years, too.  Ever since 2012 or 2013, some exceptionally intelligent and well-informed people have been predicting some sort of reversion to the mean or bear market.  But it just hasn’t happened.  Of course, there could be a bear market and/or recession at any time.  But even then, there will be at least a few stocks somewhere in the world that perform well if bought cheaply enough.

The main point made by Graham and Buffett is that repeatedly buying stocks at bargain levels relative to business value can work very well over time if you’re patient and disciplined.  Market forecasting can only distract you from what works.

What works is investing in businesses you can understand at sensible prices, and holding each one for at least 3 to 5 years, if not 10 years or longer, as long as the thesis is intact.  Lynch:

Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold.  I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised.  The success of a company isn’t the surprise, but what the shares bring often is.  I remember buying Stop & Shop as a conservative, dividend-paying stock, and then the fundamentals kept improving and I realized I had a fast grower on my hands.

It’s important to note that sometimes years can go by while the stock does nothing.  That, in itself, doesn’t tell you anything.  If the business continues to make progress, and long-term business value is growing (or is sufficiently high), then you should stick with it or perhaps add to the position:

Here’s something else that’s certain to occur:  If you give up on a stock because you’re tired of waiting for something wonderful to happen, then something wonderful will begin to happen the day after you get rid of it.  I call this the postdiverstiture flourish.

…Most of the money I make is in the third or fourth year that I’ve owned something… If all’s right with the company, and whatever attracted me in the first place hasn’t changed, then I’m confident that sooner or later my patience will be rewarded.

…It takes remarkable patience to hold on to a stock in a company that excites you, but which everybody else seems to ignore.  You begin to think everybody else is right and you are wrong.  But where the fundamentals are promising, patience is often rewarded…

Lynch again later:

… my biggest winners continue to be stocks I’ve held for three and even four years.

Lynch offers much commentary on a long list of macro concerns that are going to sink stocks.  (Remember he was writing in 1989.)  Here is a snipet:

I hear every day that AIDS will do us in, the drought will do us in, inflation will do us in, recession will do us in, the budget deficit will do us in, the trade deficit will do us in, and the weak dollar will do us in.  Whoops.  Make that the strong dollar will do us in.  They tell me real estate prices are going to collapse.  Last month people started worrying about that.  This month they’re worrying about the ozone layer.  If you believe the old investment adage that the stock market climbs a ‘wall of worry,’ take note that the worry wall is fairly good-sized now and growing every day.

Like Buffett, Lynch is very optimistic about America and long-term investing in general.  Given the strengths of America, and all the entrepreneurial and scientific energy creating ongoing innovation, it seems to me that Buffett and Lynch are right to be long-term optimists.  That’s not to say there won’t be setbacks, recessions, bear markets, and other problems.  But such setbacks will be temporary.  Over the long term, innovation will amaze, profits will grow, and stocks will follow profits higher.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Compound Interest Can Change Your Life

(Image:  Zen Buddha Silence by Marilyn Barbone.)

January 23, 2022

Here is our performance for 2021 and since inception (June 9, 2020):

  Boole Microcap Fund Russell Microcap Index S&P 500 Index
2021 net return  45.9% 18.3% 28.8%
2020 net return from inception (06/09/21) 21.1% 31.7% 16.3%
Compounded annual return (net) 32.9% 24.8% 22.4%
Overall gain (net) 76.7% 55.8% 49.8%

Albert Einstein is reputed to have said:

Compound interest is the eighth wonder of the world.  He who understands it, earns it; he who doesn’t, pays it.

If you invest today and stay invested, there are two factors that determine how much that investment will be worth in the future:

    • The length of time over which you invest.
    • The average annual rate of return on your investment.

The earlier you start investing, the more time you have to let the magic of compounding work for you.

Also, the higher the average annual rate of return you can get on your investment, the greater the sum you will have later.



If you earn interest on an investment and then reinvest that interest; and if you then earn interest on the new balance (the original principal plus the reinvested interest); and if you then reinvest that interest, etc., that is compound interest.

For example, say you invest $1,000 and say you can earn 4% a year consistently for thirty years.

First, let’s say that you DO NOT reinvest interest.

    • That means each year you will get $40 in interest on your principal of $1,000.
    • At the end of thirty years, you will have gotten $40 in interest thirty times for a total of $1,200 in interest.
    • Your principal plus interest after thirty years will be $2,200.

Now, let’s say you DO reinvest interest.

    • At the end of the first year, you’ll get $40 in interest.  Your principal plus interest will be $1,040.
    • Since you reinvest the $40, then in the second year, instead of getting 4% interest on $1,000, you’ll get 4% interest on $1,040.  So instead of getting another $40 in interest (4% of $1,000), you’ll get $41.60 in interest (4% of $1,040).
    • At the end of the second year, instead of $1,080 ($1,o00 in principal plus $80 in interest), you’ll have $1,081.60 ($1,o00 in principal plus $81.60 in interest).
    • Since you reinvest the new $41.60, then in the third year, instead of getting $40 in interest  (4% of $1,000), you’ll get $43.30 in interest (4% of $1,081.60).
    • At the end of the third year, instead of $1,120 ($1,000 in principal plus $120 in interest), you’ll have $1,124.90 ($1,000 in principal plus $124.90 in interest).
    • So it continues.
    • After thirty years of reinvesting the interest, instead of $1,200 in interest, you’ll have $2,243.40 in interest.  So instead of a total of $2,200 ($1,000 in principal plus $1,200 in interest), you’ll have $3,243.40 ($1,000 in principal plus $2,243.40 in interest).



The earlier you start investing—that is, the longer the period of time over which you invest—the greater the sum you will end up with.

Consider this example:

    • If you invest $50,000 at 10% a year for twenty years, you will end up with about $336,000.
    • If you invest $50,000 at 10% a year for thirty years, you will end up with about $872,000.



The higher the average annual rate of return you get, the greater the sum you will end up with.

Consider this example:

    • If you invest $50,000 at 10% a year for thirty years, we already saw that you will end up with about $872,000.
    • If you invest $50,000 at 20% a year for thirty years, you will end up with about $11,869,000.

$11.87 million vs. $872,000: This is a stunning difference.



If you invest in an S&P 500 index fund, then over the very long term, you can get approximately 9-10% a year.   That is solid.

If you invest systematically in undervalued microcap stocks with improving fundamentals, then you can get approximately 18-20% a year.  This is much better, especially if you invest over a long period of time.  See:

Please contact me if you would like to learn more.

    • My email:
    • My cell: 206.518.2519



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail:




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

How Great Leaders Build Sustainable Businesses

(Image:  Zen Buddha Silence by Marilyn Barbone.)

January 16, 2022

Ian Cassell and Sean Iddings are successful microcap investors who co-authored the book, Intelligent Fanatics Project: How Great Leaders Build Sustainable Businesses (Iddings Cassel Publishing, 2016).  Ian Cassell is the founder of

If a microcap company is led by an intelligent fanatic, then it has a good chance of becoming a much larger company over time.  So, for a long-term investor, it makes sense to look for an intelligent fanatic who is currently leading a microcap company.  Cassel:

I want to find Reed Hastings in 2002, when Netflix (NFLX) was a $150 million market cap microcap (now worth $38 billion).  I want to find Bruce Cozadd in 2009, when Jazz Pharmaceuticals (JAZZ) was a $50 million market cap microcap (now worth $9 billion).

All great companies started as small companies, and intelligent fanatics founded most great companies.  So how do we find these rare intelligent fanatics early?  We find them by studying known intelligent fanatics and their businesses.  We look for common elements and themes, to help us in our search for the next intelligent fanatic-led business.

The term intelligent fanatic is originally from Charlie Munger.  Cassel defines the term:

CEO or management team with large ideas and fanatical drive to build their moat.  Willing and able to think and act unconventionally.  A learning machine that adapts to constant change.  Focused on acquiring the best talent.  Able to create a sustainable corporate culture and incentivize their operations for continual progress.  Their time horizon is in five- or ten-year increments, not quarterly, and they invest in their business accordingly.  Regardless of the industry, they are able to create a moat [– i.e., a sustainable competitive advantage].

Cassel and Iddings give eight examples of intelligent fanatics:

  • Father of Sales and Innovation: John H. Patterson—National Cash Register
  • Retail Maverick: Simon Marks—Marks & Spencer
  • Original Warehouse Pioneer: Sol Price—Fedmart and Price Club
  • King of Clever Systems: Les Schwab—Les Schwab Tire Centers
  • Low-Cost Airline Wizard: Herb Kelleher—Southwest Airlines
  • Cult of Convenience: Chester Cadieux—QuikTrip
  • Leader of Steel: Kenneth Iverson—Nucor
  • Human Capital Allocators: 3G Partners—Garantia…

Cassel and Iddings conclude by summarizing the intelligent fanatic model.



Patterson purchased control of National Manufacturing Company, the originator of the cash register, in 1885, five years after the company had been formed.  Prospects did not appear good at all:

Everything was against a business selling cash registers at that time.  There was virtually no demand for cash registers.  Store owners could not justify the cost of the machine, which in today’s dollars would be roughly $1,000.  Patterson’s peers mocked his purchase of such a poor business, yet Patterson had a bold vision of what the cash register market could be, and he knew it would make a significant impact.

Patterson had had a great experience with the cash register.  His store in Coalton, Ohio, had immediately turned losses into profits simply by buying and installing a cash register.  It is hard to imagine now but employee theft at retail operations was common, given the primitive form of record keeping in those days.  Patterson knew the power of the cash register and needed to help merchants understand its value, too.

Patterson believed in staying ahead of what the current market was demanding:

We have made a policy to be just a short distance ahead, for the cash register has always had to make its market.  We had to educate our first customers;  we have to educate our present-day customer;  and our thought has always been to keep just so far ahead that education of the buyer will always be necessary.  Thus the market will be peculiarly our own—our customers will feel that we are their natural teachers and leaders.

…We are always working far ahead.  If the suggestions at the tryout demonstrate that the model will be much more valuable with changes or improvements, then send them out again to be tried.  And we keep up this process until every mechanical defect has been overcome and the model includes every feasible suggestion.

Few people at the time believed that the cash register would be widely adopted.  But Patterson predicted at least one cash register for every four hundred citizens in a town.  He was basically right.

Patterson started out working at the store on the family farm.  He was frustrated by the poor recordkeeping.  The employee books never reconciled.

Patterson then got a job as a toll collector at the Dayton office on the Miami and Erie Canal.  There were always arguments, with the bargemen complaining about higher tolls at certain locations.  Patterson solved the issue by developing a system of receipts, all of which would be sent to toll headquarters.

Patterson had extra time as a toll collector, so he started selling coal and wood out of his office.  He learned that he could differentiate himself by selling quality coal delivered on time and in the right quantity.  He also used the best horses, the best scales, and the best carts.  He made sure everything was quality and high-class.  His main challenge was that he never seemed to have enough cash since he was always reinvesting in the business, including advertising.

Eventually Patterson and his brother owned three coal mines, a store, and a chain of retail coal yards.  He had trouble with his mine store in Coalton, Ohio.  Revenues were high, but there were no profits and debt was growing.  He discovered that some clerks were only charging for half the coal.  Patterson bought two cash registers and hired new clerks.  Six months later, the debt was almost zero and there were profits.

Patterson then entered a venture to take one-third of the profits for operating the Southern Coal and Iron Company.  Unfortunately, this proved to be a disaster.  Patterson lost three years of his life and half his investment.

Meanwhile, Patterson had purchased stock in the cash register manufacturer National Manufacturing Company.  Patterson was also on the board of the company.  Patterson came up with a plan to increase sales, but the controlling shareholder and CEO, George Phillips, did not agree.  Patterson sold most of his stock.

But Patterson still believed in the idea of the cash register.  He was able to buy shares in National Manufacturing Company from George Phillips.  Patterson became the butt of Dayton jokes for buying such a bad business.  Patterson even tried to give his shares back to Phillips, but Phillips wouldn’t take them even as a gift.  So Patterson formed the National Cash Register Company.

Patterson started advertising directly to prospects through the mail.  He then sent highly qualified salesmen to those same prospects.  Patterson decided to pay his salesmen solely on commission and with no cap on how much they could make.  This was unconventional at the time, but it created effective incentives.  Patterson also bought expensive clothes for his salesmen, and at least one fine gown for the salesman’s wife.  As a result, the salesmen became high-quality and they also wanted a better standard of living.

Moreover, Patterson systematized the sales pitches of his salesmen.  This meant even salesmen with average ability could and did evolve into great salesmen.  Patterson also designated specific territories for the salesmen so that the salesmen wouldn’t be competing against one another.

Patterson made sure that salesmen and also manufacturing workers were treated well.  When he built new factories, he put in wall-to-wall glass windows, good ventilation systems, and dining rooms where employees could get decent meals at or below cost.  Patterson also made sure his workers had the best tools.  These were unusual innovations at the time.

Patterson also instituted a profit-sharing plan for all employees.

National Cash Register now had every worker aligned with common goals:  to increase efficiency, cut costs, and improve profitability.

Patterson was always deeply involved in the research and development of the cash register.  He often made sketches of new ideas in a memo book.  He got a few of these ideas patented.

NCR’s corporate culture and strategies were so powerful that John H. Patterson produced more successful businessmen than the best university business departments of the day.  More than a dozen NCR alumni went on to head large corporations, and many more went on to hold high corporate positions.

Cassel and Iddings sum it up:

Patterson was a perpetual beginner.  He bought NCR without knowing much of anything about manufacturing – except that he wanted to improve every business owner’s operations.  From his experiences, he took what he knew to be right and paid no attention to convention.  John Patterson not only experimented with improving the cash register machine but also believed in treating employees extremely well.  Many corporations see their employees as an expense line item;  intelligent fanatics see employees as a valuable asset.

When things failed or facts changed, Patterson showed an ability to pivot…

…He was able to get every one of his workers to think like owners, through his profit-sharing plan.  Patterson was always looking to improve production, so he made sure that every employee had a voice in improving the manufacturing operations.



Marks & Spencer was started by Michael Marks as a small outdoor stall in Leeds.  By 1923, when Michael’s son Simon was in charge, the company had grown significantly.  But Simon Marks was worried that efficient American competitors were going to wage price wars and win.

So Marks went to the U.S. to study his competitors.  (Walmart founder Sam Walton would do this four decades later.)  When Marks returned to Britain, he delivered a comprehensive report to his board:

I learned the value of more commodious and imposing premises.  I learned the value of checking lists to control stocks and sales.  I learned that new accounting machines could help to reduce the time formidably, to give the necessary information in hours instead of weeks.  I learned the value of counter footage and how in the chain store operation each foot of counter space had to pay wages, rent, overhead expenses, and profit.  There could be no blind spots insofar as goods are concerned.  This meant a much more exhaustive study of the goods we were selling and the needs of the public.  It meant that the staff who were operating with me had to be reeducated and retrained.

Cassel and Iddings:

…Simon Marks had been left a company with a deteriorating moat and a growing list of competitors.  He had the prescience and boldness to take a comfortable situation, a profitable, growing Marks & Spencer, and to take risks to build a long-term competitive edge.  From that point on, it could have been observed that Simon Marks had only one task – to widen Marks & Spencer’s moat every day for the rest of his life and to provide investors with uncommon profits.

Simon Marks convinced manufacturers that the retailer and manufacturer, by working together without the wholesale middleman, could sell at lower prices.  Marks made sure to maintain the highest quality at the lowest prices, making up for low profit margins with high volume.

Simon Marks was rare.  He was able to combine an appreciation for science and technology with an industry that had never cared to utilize it, all the while maintaining ‘a continuing regard for the individual, either as a customer or employee, and with a deep responsibility for his welfare and well-being.’  Marks & Spencer’s tradition of treating employees well stretched all the way back to Michael Marks’s Penny Bazaars in the covered stalls of Northern England… To Simon Marks, a happy and contented staff was the most valuable asset of any business.

Simon Marks established many policies to better Marks & Spencer’s labor relations, leading to increased employee efficiency and productivity…

Marks introduced dining rooms to provide free or low-cost meals to employees of stores.  Marks even put hair salons in stores so the female workforce could get their hair done during lunch.  He also provided free or reduced-cost health insurance.  Finally, he set up the Marks & Spencer Benevolent Trust to provide for the retirement of employees.  These moves were ahead of their time and led to low employee turnover and high employee satisfaction.



Sol Price founded Price Club in 1976.  The company lost $750,000 during its first year.  But by 1979, revenues reached $63 million, with $1.1 million in after-tax profits.

The strategy was to sell a limited number of items – 1,500 to 5,000 items versus 20,000+ offered by discounters – at a small markup from wholesale, to a small group of members (government workers and credit union customers).

Before founding Price Club, Sol Price founded and built FedMart from one location in 1954 into a company with $361 million in revenue by 1975.

…Thus, when Sol Price founded Price Club, other savvy retailers, familiar with this track record, were quick to pay close attention.  These retailers made it their obligation to meet Price, to learn as much as possible, and to clone Price’s concept.  They knew that the market opportunity was large and that Sol Price was an intelligent fanatic with a great idea.  An astute investor could have done the same and partnered with Price early in 1980 by buying Price Club stock.

One savvy retailer who found Sol Price early in the development of Price Club was Bernard Marcus, cofounder of Home Depot.  After getting fired from the home improvement company Handy Dan, Marcus met with Price, in the late 1970s.  Marcus was looking for some advice from Price about a potential legal battle with his former employer.  Sol Price had a similar situation at FedMart.  He told Marcus to forget about a protracted legal battle and to start his own business.

Marcus borrowed many ideas from Price Club when he cofounded Home Depot.  Later, Sam Walton copied as much as he could from Price Club when he founded Walmart.  Walton:

I guess I’ve stolen – I actually prefer the word borrowed – as many ideas from Sol Price as from anyone else in the business.

Bernie Brotman tried to set up a deal to franchise Price Clubs in the Pacific Northwest.  But Sol Price and his son, Richard Price, were reluctant to franchise Price Club.  Brotman’s son, Jeff Brotman, convinced Jim Sinegal, a long-time Price Club employee, to join him and start Costco, in 1983.

Brotman and Sinegal cloned Price Club’s business model and, in running Costco, copied many of Sol Price’s strategies.  A decade later, Price Club merged with Costco, and many Price Club stores are still in operation today under the Costco name.

Back in 1936, Sol Price graduated with a bachelor’s degree in philosophy.  He got his law degree in 1938.  Sol Price worked for Weinberger and Miller, a local law firm in San Diego.  He represented many small business owners and learned a great deal about business.

Thirteen years later, Price founded FedMart after noticing a nonprofit company, Fedco, doing huge volumes.  Price set up FedMart as a nonprofit, but created a separate for-profit company, Loma Supply, to manage the stores.  Basically, everything was marked up 5% from cost, which was the profit Loma Supply got.

FedMart simply put items on the shelves and let the customers pick out what they wanted.  This was unusual at the time, but it helped FedMart minimize costs and thus offer cheaper prices for many items.

By 1959, FedMart had grown to five stores and had $46.3 million in revenue and nearly $500,000 in profits.  FedMart went public that year and raised nearly $2 million for expansion.

In 1962, Sam Walton had opened the first Walmart, John Geisse had opened the first Target, and Harry Cunningham had opened the first Kmart, all with slight variations on Sol Price’s FedMart business model.

By the early 1970s, Sol Price wasn’t enjoying managing FedMart as much.  He remarked that they were good at founding the business, but not running it.

While traveling in Europe with his wife, Sol Price was carefully observing the operations of different European retailers.  In particular, he noticed a hypermarket retailer in Germany named Wertkauf, run by Hugo Mann.  Price sought to do a deal with Hugo Mann as a qualified partner.  But Mann saw it as a way to buy FedMart.  After Mann owned 64% of FedMart, Sol Price was fired from the company he built.  But Price didn’t let that discourage him.

Like other intelligent fanatics, Sol Price did not sit around and mourn his defeat.  At the age of 60, he formed his next venture less than a month after getting fired from FedMart.  The Price Company was the name of this venture, and even though Sol Price had yet to figure out a business plan, he was ready for the next phase of his career.

…What the Prices [Sol and his son, Robert] ended up with was a business model similar to some of the concepts Sol had observed in Europe.  The new venture would become a wholesale business selling merchandise to other businesses, with a membership system similar to that of the original FedMart but closer to the ‘passport’ system used by Makro, in the Netherlands, in a warehouse setting.  The business would attract members with its extremely low prices.

During the first 45 days, the company lost $420,000.

Instead of doing nothing or admitting defeat, however, Sol Price figured out the problem and quickly pivoted.

Price Club had incorrectly assumed that variety and hardware stores would be large customers and that the location would be ideal for business customers.  A purchasing manager, however, raised the idea of allowing members of the San Diego City Credit Union to shop at Price Club.  After finding out that Price Club could operate as a retail shop, in addition to selling to businesses, the company allowed credit union members to shop at Price Club.  The nonbusiness customers did not pay the $25 annual business membership fee but got a paper membership pass and paid an additional 5% on all goods.  Business members paid the wholesale price.  The idea worked and sales turned around, from $47,000 per week at the end of August to $151,000 for the week of November 21.  The Price Club concept was now proven.

Sol Price’s idea was to have the smallest markup from cost possible and to make money on volume.  This was unconventional.

Price also sought to treat his employees well, giving them the best wages and providing the best working environment.  By treating employees well, he created happy employees who in turn treated customers well.

Instead of selling hundreds of thousands of different items, Sol Price thought that focusing on only a few thousand items would lead to greater efficiency and lower costs.  Also, Price was able to buy in larger quantities, which helped.  This approach gave customers the best deal.  Customers would typically buy a larger quantity of each good, but would generally save over time by paying a lower price per unit of volume.

Sol Price also saved money by not advertising.  Because his customers were happy, he relied on unsolicited testimonials for advertising.  (Costco, in turn, has not only benefitted from unsolicited testimonials, but also from unsolicited media coverage.)

Jim Sinegal commented:

The thing that was most remarkable about Sol was not just that he knew what was right.  Most people know the right thing to do.  But he was able to be creative and had the courage to do what was right in the face of a lot of opposition.  It’s not easy to stick to your guns when you have a lot of investors saying that you’re not charging customers enough and you’re paying employees too much.

Over a thirty-eight year period, including FedMart and then Price Club until the Costco merger in 1993, Sol Price generated roughly a 40% CAGR in shareholder value.



Les Schwab knew how to motivate his people through clever systems and incentives.  Schwab realized that allowing his employees to become highly successful would help make Les Schwab Tire Centers successful.

Schwab split his profits with his first employees, fifty-fifty, which was unconventional in the 1950s.  Schwab would reinvest his portion back into the business.  Even early on, Schwab was already thinking about massive future growth.

As stores grew and turned into what Schwab called ‘supermarket’ tire centers, the number of employees needed to manage the operations increased, from a manager with a few helpers to six or seven individuals.  Schwab, understanding the power of incentives, asked managers to appoint their best worker as an assistant manager and give him 10% of the store’s profits.  Schwab and the manager each would give up 5%.

…Les Schwab was never satisfied with his systems, especially the employee incentives, and always strove to develop better programs.

…Early on, it was apparent that Les Schwab’s motivation was not to get rich but to provide opportunities for young people to become successful, as he had done in the beginning.  This remained his goal for decades.  Specifically, his goal was to share the wealth.  The company essentially has operated with no employees, only partners.  Even the hourly workers were treated like partners.

When Schwab was around fifteen years old, he lost his mother to pneumonia and then his father to alcohol.  Schwab started selling newspapers.  Later as a circulation manager, he devised a clever incentive scheme for the deliverers.  Schwab always wanted to help others succeed, which in turn would help the business succeed.

The desire to help others succeed can be a powerful force.  Les Schwab was a master at creating an atmosphere for others to succeed through clever programs.  Les always told his manager to make all their people successful, because he believed that the way a company treated employees would directly affect how employees would treat the customer.  Schwab also believed that the more he shared with employees, the more the business would succeed, and the more resources that would eventually be available to give others opportunities to become successful.  In effect, he was compounding his giving through expansion of the business, which was funded from half of his profits.

Once in these programs, it would be hard for employees and the company as a whole not to become successful, because the incentives were so powerful.  Schwab’s incentive system evolved as the business grew, and unlike most companies, those systems evolved for the better as he continued giving half his profits to employees.

Like other intelligent fanatics, Schwab believed in running a decentralized business.  This required good communication and ongoing education.



The airline industry has been perhaps the worst industry ever.  Since deregulation in 1978, the U.S. airline industry alone has lost $60 billion.

Southwest Airlines is nearing its forty-third consecutive year of profitability.  That means it has made a profit nearly every year of its corporate life, minus the first fifteen months of start-up losses.  Given such an incredible track record in a horrible industry, luck cannot be the only factor.  There had to be at least one intelligent fanatic behind its success.

…In 1973, the upstart Texas airline, Southwest Airlines, with only three airplanes, turned the corner and reached profitability.  This was a significant achievement, considering that the company had to overcome three and a half years of legal hurdles by two entrenched and better-financed competitors:  Braniff International Airways had sixty-nine aircraft and $256 million in revenues, and Texas International had forty-five aircraft with $32 million in revenues by 1973.

As a young man, Herb ended up living with his mother after his older siblings moved out and his father passed away.  Kelleher says he learned about how to treat people from his mother:

She used to sit up talking to me till three, four in the morning.  She talked a lot about how you should treat people with respect.  She said that positions and titles signify absolutely nothing.  They’re just adornments;  they don’t represent the substance of anybody… She taught me that every person and every job is worth as much as any other person or any other job.

Kelleher ended up applying these lessons at Southwest Airlines.  The idea of treating employees well and customers well was central.

Kelleher did not graduate with a degree in business, but with a bachelor’s degree in English and philosophy.  He was thinking of becoming a journalist.  He ended up becoming a lawyer, which helped him get into business later.

When Southwest was ready to enter the market in Texas as a discount airline, its competitors were worried.

With their large resources, competitors did everything in their power to prevent Southwest from getting off the ground, and they were successful in temporarily delaying Southwest’s first flight.  The incumbents filed a temporary restraining order that prohibited the aeronautics commission from issuing Southwest a certificate to fly.  The case went to trial in the Austin state court, which did not support another carrier entering the market.

Southwest proceeded to appeal the lower court decision that the market could not support another carrier.  The intermediate appellate court sided with the lower court and upheld the ruling.  In the meantime, Southwest had yet to make a single dollar in revenues and had already spent a vast majority of the money it had raised.

The board was understandably frustrated.  At this point, Kelleher said he would represent the company one last time and pay every cent of legal fees out of his own pocket.  Kelleher convinced the supreme court to rule in Southwest’s favor.  Meanwhile, Southwest hired Lamar Muse as CEO, who was an experienced, iconoclastic entrepreneur with an extensive network of contacts.

Herb Kelleher was appointed CEO in 1982 and ran Southwest until 2001.  He led Southwest from $270 million to $5.7 billion in revenues, every year being profitable.  This is a significant feat, and no other airline has been able to match that kind of record in the United States.  No one could match the iron discipline that Herb Kelleher instilled in Southwest Airlines from the first day and maintained so steadfastly through the years.

Before deregulation, flying was expensive.  Herb Kelleher had the idea of offering lower fares.  To achieve this, Southwest did four things.

  • First, they operated out of less-costly and less-congested airports. Smaller airports are usually closer to downtown locations, which appealed to businesspeople.
  • Second, Southwest only operated the Boeing 737. This gave the company bargaining power in new airplane purchases and the ability to make suggestions in the manufacture of those plans to improve efficiency.  Also, operating costs were lower because everyone only had to learn to operate one type of plane.
  • Third, Southwest reduced the amount of time planes were on the ground to 10 minutes (from 45 minutes to an hour).
  • Fourth, Southwest treats employees well and is thus able to retain qualified, hardworking employees. This cuts down on turnover costs.

Kelleher built an egalitarian culture at Southwest where each person is treated like everyone else.  Also, Southwest was the first airline to share profits with employees.  This makes employees think and act like owners.  As well, employees are given autonomy to make their own decisions, as an owner would.  Not every decision will be perfect, but inevitable mistakes are used as learning experiences.

Kelleher focused the company on being entrepreneurial even as the company grew.  But simplifying did not include eliminating employees.

Southwest Airlines is the only airline – and one of the few corporations in any industry – that has been able to run for decades without ever imposing a furlough.  Cost reductions are found elsewhere, and that has promoted a healthy morale within the Southwest Airlines corporate culture.  Employees have job security.  A happy, well-trained labor force that only needs to be trained on one aircraft promotes more-efficient and safer flights.  Southwest is the only airline that has a nearly perfect safety record.

Kelleher once told the following story:

What I remember is a story about Thomas Watson.  This is what we have followed at Southwest Airlines.  A vice president of IBM came in and said, ‘Mr. Watson, I’ve got a tremendous idea…. And I want to set up this little division to work on it.  And I need ten million dollars to get it started.’  Well, it turned out to be a total failure.  And the guy came back to Mr. Watson and he said that this was the original proposal, it cost ten million, and that it was a failure.  ‘Here is my letter of resignation.’  Mr. Watson said, ‘Hell, no!  I just spent ten million on your education.  I ain’t gonna let you leave.’  That is what we do at Southwest Airlines.

One example is Matt Buckley, a manager of cargo in 1985.  He thought of a service to compete with Federal Express.  Southwest let him try it.  But it turned out to be a mistake.  Buckley:

Despite my overpromising and underproducing, people showed support and continued to reiterate, ‘It’s okay to make mistakes;  that’s how you learn.’  In most companies, I’d probably have been fired, written off, and sent out to pasture.

Kelleher believed that any worthwhile endeavor entails some risk.  You have to experiment and then adjust quickly when you learn what works and what doesn’t.

Kelleher also created a culture of clear communication with employees, so that employees would understand in more depth how to minimize costs and why it was essential.

Communication with employees at Southwest is not much different from the clear communication Warren Buffett has had with shareholders and with his owned operations, through Berkshire Hathaway’s annual shareholder letters.  Intelligent fanatics are teachers to every stakeholder.



Warren Buffett:

Back when I had 10,000 bucks, I put 2,000 of it into a Sinclair service station, which I lost, so my opportunity cost on it’s about 6 billion right now.  A fairly big mistake – it makes me feel good when Berkshire goes down, because the cost of my Sinclair station goes down too.

Chester Cadieux ran into an acquaintance from school, Burt B. Holmes, who was setting up a bantam store – an early version of a convenience store.  Cadieux invested $5,000 out of the total $15,000.

At the time, in 1958, there were three thousand bantam stores open.  They were open longer hours than supermarkets, which led customers to be willing to pay higher prices.

Cadieux’s competitive advantage over larger rivals was his focus on employees and innovation.  Both characteristics were rooted in Chester’s personal values and were apparent early in QuikTrip’s history.  He would spend a large part of his time – roughly two months out of the year – in direction communication with QuikTrip employees.  Chester said, ‘Without fail, each year we learned something important from a question or comment voiced by a single employee.’  Even today, QuikTrip’s current CEO and son of Chester Cadieux, Chet Cadieux, continues to spend four months of his year meeting with employees.

Cassel and Iddings:

Treat employees well and incentivize them properly, and employees will provide exceptional service to the customers.  Amazing customer service leads to customer loyalty, and this is hard to replicate, especially by competitors who don’t value their employees.  Exceptional employees and a quality corporate culture have allowed QuikTrip to stay ahead of competition from convenience stores, gas retailers, quick service restaurants, cafes, and hypermarkets.

Other smart convenience store operators have borrowed many ideas from Chester Cadieux.  Sheetz, Inc. and Wawa, Inc. – both convenience store chains headquartered in Pennsylvania – have followed many of Cadieux’s ideas.  Cadieux, in turn, has also picked up a few ideas from Sheetz and Wawa.

Sheetz, Wawa, and QuikTrip all have similar characteristics, which can be traced back to Chester Cadieux and his leadership values at QuikTrip.  When three stores in the same industry, separated only by geography, utilize the same strategies, have similar core values, and achieve similar success, then there must be something to their business models.  All could have been identified early, when their companies were much smaller, with qualitative due diligence.

One experience that shaped Chester Cadieux was when he was promoted to first lieutenant at age twenty-four.  He was the senior intercept controller at his radar site, and he had to lead a team of 180 personnel:

…he had to deal with older, battle-hardened sergeants who did not like getting suggestions from inexperienced lieutenants.  Chester said he learned ‘how to circumvent the people who liked to be difficult and, more importantly, that the number of stripes on someone’s sleeves was irrelevant.’  The whole air force experience taught him how to deal with people, as well as the importance of getting the right people on his team and keeping them.

When Cadieux partnered with Burt Holmes on their first QuikTrip convenience store, it seemed that everything went wrong.  They hadn’t researched what the most attractive location would be.  And Cadieux stocked the store like a supermarket.  Cadieux and Holmes were slow to realize that they should have gone to Dallas and learned all they could about 7-Eleven.

QuikTrip was on the edge of bankruptcy during the first two or three years.  Then the company had a lucky break when an experienced convenience store manager, Billy Neale, asked to work for QuikTrip.  Cadieux:

You don’t know what you don’t know.  And when you figure it out, you’d better sprint to fix it, because your competitors will make it as difficult as possible in more ways than you could ever have imagined.

Cadieux was smart enough to realize that QuikTrip survived partly by luck.  But he was a learning machine, always learning as much as possible.  One idea Cadieux picked up was to sell gasoline.  He waited nine years until QuikTrip had the financial resources to do it.  Cadieux demonstrated that he was truly thinking longer term.

QuikTrip has always adapted to the changing needs of its customers, demographics, and traffic patterns, and has constantly looked to stay ahead of competition.  This meant that QuikTrip has had to reinvest large sums of capital into store updates, store closures, and new construction.  From QuikTrip’s inception, in 1958, to 2008, the company closed 418 stores;  in 2008, QuikTrip had only five hundred stores in operation.

QuikTrip shows its long-term focus by its hiring process.  Cadieux:

Leaders are not necessarily born with the highest IQs, or the most drive to succeed, or the greatest people skills.  Instead, the best leaders are adaptive – they understand the necessity of pulling bright, energetic people into their world and tapping their determination and drive.  True leaders never feel comfortable staying in the same course for too long or following conventional wisdom – they inherently understand the importance of constantly breaking out of routines in order to recognize the changing needs of their customers and employees.

QuikTrip interviews about three out of every one hundred applicants and then chooses one from among those three.  Only 70% of new hires make it out of training, and only 50% of those remaining make it past the first 6 months on the job.  But QuikTrip’s turnover rate is roughly 13% compared to the industry average of 59%.  These new hires are paid $50,000 a year.  And QuikTrip offers a generous stock ownership plan.  Employees also get medical benefits and a large amount of time off.

Cadieux’s main goal was to make employees successful, thereby making customers and eventually shareholders happy.



Ken Iverson blazed a new trail in steel production with the mini mill, thin-slab casting, and other innovations.  He also treated his employees like partners.  Both of these approaches were too unconventional and unusual for the old, slow-moving, integrated steel mills to compete with.  Ken Iverson harnessed the superpower of incentives and effective corporate culture.  He understood how to manage people and had a clear goal.

In its annual report in 1975, Nucor had all of its employees listed on the front cover, which showed who ran the company.  Every annual report since then has listed all employees on the cover.  Iverson:

I have no desire to be perfect.  In fact, none of the people I’ve seen do impressive things in life are perfect… They experiment.  And they often fail.  But they gain something significant from every failure.

Iverson studied aeronautical engineering at Cornell through the V-12 Navy College Training Program.  Iverson spent time in the Navy, and then earned a master’s degree in mechanical engineering from Purdue University.  Next he worked as an assistant to the chief research physicist at International Harvester.

Iverson’s supervisor told him you can achieve more at a small company.  So Iverson started working as the chief engineer at a small company called Illium Corp.  Taking chances was encouraged.  Iverson built a pipe machine for $5,000 and it worked, which saved the company $245,000.

Iverson had a few other jobs.  He helped Nuclear Corporation of America find a good acquisition – Vulcraft Corporation.  After the acquisition, Vulcraft made Iverson vice president.  The company tripled its sales and profits over the ensuing three years, while the rest of Nuclear was on the verge of bankruptcy.  When Nuclear’s president resigned, Iverson became president of Nuclear.

Nuclear Corporation changed its name to Nucor.  Iverson cut costs.  Although few could have predicted it, Nucor was about to take over the steel industry.  Iverson:

At minimum, pay systems should drive specific behaviors that make your business competitive.  So much of what other businesses admire in Nucor – our teamwork, extraordinary productivity, low costs, applied innovation, high morale, low turnover – is rooted in how we pay our people.  More than that, our pay and benefit programs tie each employee’s fate to the fate of our business.  What’s good for the company is good – in hard dollar terms – for the employee.

The basic incentive structure had already been in place at Vulcraft.  Iverson had the sense not to change it, but rather to improve it constantly.  Iverson:

As I remember it, the first time a production bonus was over one hundred percent, I thought that I had created a monster.  In a lot of companies, I imagine many of the managers would have said, ‘Whoops, we didn’t set that up right.  We’d better change it.’  Not us.  We’ve modified it some over the years.  But we’ve stayed with that basic concept ever since.

Nucor paid its employees much more than what competitors paid.  But Nucor’s employees produced much, much more.  As a result, net costs were lower for Nucor.  In 1996, Nucor’s total cost was less than $40 per ton of steel produced versus at least $80 per ton of steel produced for large integrated U.S. steel producers.

Nucor workers were paid a lower base salary – 65% to 70% of the average – but had opportunities to get large bonuses if they produced a great deal.

Officer bonuses (8% to 24%) were tied to the return on equity.

Nonproduction headquarter staff, engineers, secretaries, and so on, as well as department managers, could earn 25% to 82% of base pay based on their division’s return on assets employed.  So, if a division did not meet required returns, those employees received nothing, but they received a significant amount if they did.  There were a few years when all employees received no bonuses and a few years when employees maxed out their bonuses.

An egalitarian incentive structure leads all employees to feel equal, regardless of base pay grade or the layer of management an employee is part of.  Maintenance workers want producers to be successful and vice versa.

All production workers, including managers, wear hard hats of the same color.  Everyone is made to feel they are working for the common cause.  Nucor has only had one year of losses, in 2009, over a fifty-year period.  This is extraordinary for the highly cyclical steel industry.

Iverson, like Herb Kelleher, believed that experimentation – trial and error – was essential to continued innovation.  Iverson:

About fifty percent of the things we try really do not work out, but you can’t move ahead and develop new technology and develop a business unless you are willing to take risks and adopt technologies as they occur.



3G Partners refers to the team of Jorge Paulo Lemann, Carlos Alberto “Beto” Sicupira, and Marcel Hermann Telles.  They have developed the ability to buy underperforming companies and dramatically improve productivity.

When the 3G partners took control of Brahma, buying a 40% stake in 1989, it was the number two beer company in Brazil and was quickly losing ground to number one, Antarctica.  The previously complacent management and company culture generated low productivity – approximately 1,200 hectoliters of beverage produced per employee.  There was little emphasis on profitability or achieving more efficient operations.  During Marcel Telles’s tenure, productivity per employee multiplied seven times, to 8,700 hectoliters per employee.  Efficiency and profitability were top priorities of the 3G partners, and the business eventually held the title of the most efficient and profitable brewer in the world.  Through efficiency of operations and a focus on profitability, Brahma maintained a 20% return on capital, a 32% compound annual growth rate in pretax earnings, and a 17% CAGR in revenues over the decade from 1990 to 1999… Shareholder value creation stood at an astounding 42% CAGR over that period.

…Subsequent shareholder returns generated at what eventually became Anheuser-Busch InBev (AB InBev) have been spectacular, driven by operational excellence.

Jorge Paulo Lemann – who, like Sicupira and Telles, was born in Rio de Janeiro – started playing tennis when he was seven.  His goal was to become a great tennis player.  He was semi-pro for a year after college.  Lemann:

In tennis you win and lose.  I’ve learned that sometimes you lose.  And if you lose, you have to learn from the experience and ask yourself, ‘What did I do wrong?  What can I do better?  How am I going to win next time?’

Tennis was very important and gave me the discipline to train, practice, and analyze… In tennis you have to take advantage of opportunities.

So my attitude in business was always to make an effort, to train, to be present, to have focus.  Occasionally an opportunity passed and you have to grab those opportunities.

In 1967, Lemann started working for Libra, a brokerage.  Lemann owned 13% of the company and wanted to create a meritocratic culture.  But others disagreed with him.

In 1971, Lemann founded Garantia, a brokerage.  He aimed to create a meritocratic culture like the one at Goldman Sachs.  Lemann would seek out top talent and then base their compensation on performance.  Marcel Telles and Beto Sicupira joined in 1972 and 1973, respectively.

Neither Marcel Telles nor Beto Sicupira started off working in the financial markets or high up at Garantia.  Both men started at the absolute bottom of Garantia, just like any other employee…

Jorge Paulo Lemann initially had a 25% interest in Garantia, but over the first seven years increased it to 50%, slowly buying out the other initial investors.  However, Lemann also wanted to provide incentives to his best workers, so he began selling his stake to new partners.  By the time Garantia was sold, Lemann owned less than 30% of the company.

Garantia transformed itself into an investment bank.  It was producing a gusher of cash.  The partners decided to invest in underperforming companies and then introduce the successful, meritocratic culture at Garantia.  In 1982, they invested in Lojas Americanas.

Buying control of outside businesses gave Lemann the ability to promote his best talent into those businesses.  Beto Sicupira was appointed CEO and went about turning the company around.  The first and most interesting tactic Beto utilized was to reach out to the best retailers in the United States, sending them all letters and asking to meet them and learn about their companies;  neither Beto nor his partners had any retailing experience.  Most retailers did not respond to this query, but one person did:  Sam Walton of Walmart.

The 3G partners met in person with the intelligent fanatic Sam Walton and learned about his business.  Beto was utilizing one of the most important aspects of the 3G management system:  benchmarking from the best in the industry.  The 3G partners soaked up everything from Walton, and because the young Brazilians were a lot like him, Sam Walton became a mentor and friend to all of them.

In 1989, Lemann noticed an interesting pattern:

I was looking at Latin America and thinking, Who was the richest guy in Venezuela?  A brewer (the Mendoza family that owns Polar).  The richest guy in Colombia?  A brewer (the Santo Domingo Group, the owner of Bavaria).  The richest in Argentina?  A brewer (the Bembergs, owners of Quilmes).  These guys can’t all be geniuses… It’s the business that must be good.

3G always set high goals.  When they achieved one ambitious goal, then they would set the next one.  They were never satisfied.  When 3G took over Brahma, the first goal was to be the best brewer in Brazil.  The next goal was to be the best brewer in the world.

3G has always had a truly long-term vision:

Marcel Telles spent considerable time building Brahma, with a longer-term vision.  The company spent a decade improving the efficiency of its operations and infusing it with the Garantia culture.  When the culture was in place, a large talent pipeline was developed, so that the company could acquire its largest rival, Antarctica.  By taking their time in building the culture of the company, management was ensuring that the culture could sustain itself well beyond the 3G partners’ tenure.  This long-term vision remains intact and can be observed in a statement from AB InBev’s 2014 annual report:  ‘We are driven by our passion to create a company that can stand the test of time and create value for our shareholders, not only for the next ten or twenty years but for the next one hundred years.  Our mind-set is truly long term.’

3G’s philosophy of innovation was similar to a venture capitalist approach.  Ten people would be given a small amount of capital to try different things.  A few months later, two out of ten would have good ideas and so they would get more funding.

Here are the first five commandments (out of eighteen) that Lemann created at Garantia:

  • A big and challenging dream makes everyone row in the same direction.
  • A company’s biggest asset is good people working as a team, growing in proportion to their talent, and being recognized for that. Employee compensation has to be aligned with shareholders’ interests.
  • Profits are what attract investors, people, and opportunities, and keep the wheels spinning.
  • Focus is of the essence. It’s impossible to be excellent at everything, so concentrate on the few things that really matter.
  • Everything has to have an owner with authority and accountability. Debate is good, but in the end, someone has to decide.

Garantia had an incentive system similar to that created by other intelligent fanatics.  Base salary was below market average.  But high goals were set for productivity and costs.  And if those goals are achieved, bonuses can amount to many times the base salaries.

The main metric that employees are tested against is economic value added – employee performance in relation to the cost of capital.  The company’s goal is to achieve 15% economic value added, so the better the company performs as a whole, the larger is the bonus pool to be divided among employees.  And, in a meritocratic culture, the employees with the best results are awarded the highest bonuses.

Top performers also are given a chance to purchase stock in the company at a 10% discount.

The 3G partners believe that a competitive atmosphere in a business attracts high-caliber people who thrive on challenging one another.  Carlos Brito said, ‘That’s why it’s important to hire people better than you.  They push you to be better.’



Cassel and Iddings quote Warren Buffett’s 2010 Berkshire Hathaway shareholder letter:

Our final advantage is the hard-to-duplicate culture that permeates Berkshire.  And in businesses, culture counts.

One study found the following common elements among outperformers:

What elements of those cultures enabled the top companies to adapt and to sustain performance?  The common answers were the quality of the leadership, the maintenance of an entrepreneurial environment, prudent risk taking, innovation, flexibility, and open communication throughout the company hierarchy.  The top-performing companies maintained a small-company feel and had a long-term horizon.  On the other hand, the lower-performing companies were slower to adapt to change.  Interviewees described these companies as bureaucratic, with very short-term horizons.

Cassel and Iddings discuss common leadership attributes of intelligent fanatics:

Leading by Example

Intelligent fanatics create a higher cause that all employees have the chance to become invested in, and they provide an environment in which it is natural for employees to become heavily invested in the company’s mission.

…At Southwest, for example, the company created an employee-first and family-like culture where fun, love, humor, and creativity were, and continue to be, core values.  Herb Kelleher was the perfect role model for those values.  He expressed sincere appreciation for employees and remembered their names, and he showed his humor by dressing up for corporate gatherings and even by settling a dispute with another company through an arm wrestling contest.

Unblemished by Industry Dogma

Industries are full of unwritten truths and established ways of thinking.  Industry veterans often get accustomed to a certain way of doing or thinking about things and have trouble approaching problems from a different perspective.  This is the consistency and commitment bias Charlie Munger has talked about in his speech ‘The Psychology of Human Misjudgment.’  Succumbing to the old guard prevents growth and innovation.

…All of our intelligent fanatic CEOs were either absolute beginners, with no industry experience, or had minimal experience.  Their inexperience allowed them to be open to trying something new, to challenge the old guard.  The CEOs developed new ways of operating that established companies could not compete with.  Our intelligent fanatics show us that having industry experience can be a detriment.

Teaching by Example

Jim Sinegal learned from Sol Price that ‘if you’re not spending ninety percent of your time teaching, you’re not doing your job.’

Founder Ownership Creates Long-Term Focus

The only way to succeed in dominating a market for decades is to have a long-term focus.  Intelligent fanatics have what investor Tom Russo calls the capacity to suffer short-term pain for long-term gain…. As Jeff Bezos put it, ‘If we have a good quarter, it’s because of work we did three, four, five years ago.  It’s not because we did a good job this quarter.’  They build the infrastructure to support a larger business, which normally takes significant up-front investment that will lower profitability in the short term.

Keep It Simple

Jorge Paulo Lemann:

All the successful people I ever met were fanatics about focus.  Sam Walton, who built Walmart, thought only about stores day and night.  He visited store after store.  Even Warren Buffett, who today is my partner, is a man super focused on his formula.  He acquires different businesses but always within the same formula, and that’s what works.  Today our formula is to buy companies with a good name and to come up with our management system.  But we can only do this when we have people available to go to the company.  We cannot do what the American private equity firms do.  They buy any company, send someone there, and constitute a team.  We only know how to do this with our team, people within our culture.  Then, focus is also essential.

Superpower of Incentives

Intelligent fanatics are able to create systems of financial incentive that attract high-quality talent, and they provide a culture and higher cause that immerses employees in their work.  They are able to easily communicate the why and the purpose of the company so that employees themselves can own the vision.

…All of this book’s intelligent fanatic CEOs unleashed their employees’ fullest potential by getting them to think and act as owners.  They did this two ways:  they provided a financial incentive, aligning employees with the actual owners, and they gave employees intrinsic motivation to think like owners.  In every case, CEOs communicated the importance of each and every employee to the organization and provided incentives that were simple to understand.


Intelligent fanatics and their employees are unstoppable in their pursuit of staying ahead of the curve.  They test out many ideas, like a scientist experimenting to find the next breakthrough.  In the words of the head of Amazon Web Services (AWS), Andy Jassy, ‘We think of (these investments) as planting seeds for very large trees that will be fruitful over time.’

Not every idea will work out as planned.  Jeff Bezos, the founder and CEO of Amazon, said, ‘A few big successes compensate for dozens and dozens of things that did not work.’  Bezos has been experimenting for years and often has been unsuccessful…

Productive Paranoia

Jim Collins describes successful leaders as being ‘paranoid, neurotic freaks.’  Although paranoia can be debilitating for most people, intelligent fanatics use their paranoia to prepare for financial or competitive disruptions.  They also are able to promote this productive paranoia within their company culture, so the company can maintain itself by innovating and preparing for the worst.

Decentralized Organizations

Intelligent fanatics focus a lot of their mental energy on defeating bureaucracies before they form.

…Intelligent fanatics win against internal bureaucracies by maintaining the leanness that helped their companies succeed in the first place… Southwest was able to operate with 20% fewer employees per aircraft and still be faster than its competitors.  It took Nucor significantly few workers to produce a ton of steel, allowing them to significantly undercut their competitors’ prices.

Dominated a Small Market Before Expanding

Intelligent fanatics pull back on the reins in the beginning so they can learn their lessons while they are small.  Intelligent fanatic CEOs create a well-oiled machine before pushing the accelerator to the floor.

Courage and Perseverance in the Face of Adversity

Almost all successful people went through incredible hardship, obstacles, and challenges.  The power to endure is the winner’s quality.  The difference between intelligent fanatics and others is perseverance…

Take, for instance, John Patterson losing more than half his money in the Southern Coal and Iron Company, or Sol Price getting kicked out of FedMart by Hugo Mann.  Herb Kelleher had to fight four years of legal battles to get Southwest Airlines’ first plane off the ground.  Another intelligent fanatic, Sam Walton, got kicked out of his first highly successful Ben Franklin store due to a small clause in his building’s lease and had to start over.  Most people would give up, but intelligent fanatics are different.  They have the uncanny ability to quickly pick themselves up from a large mistake and move on.  They possess the courage to fight harder than ever before…



Intelligent fanatics demonstrate the qualities all employees should emulate, both within the organization and outside, with customers.  This allows employees to do their jobs effectively, by giving them autonomy.  All employees have to do is adjust their internal compass to the company’s true north to solve a problem.  Customers are happier, employees are happier, and if you make those two groups happy, then shareholders are happier.

…Over time, the best employees rise to the top and can quickly fill the holes left as other employees retire or move on.  Employees are made to feel like partners, so the success of the organization is very important to them.  Partners are more open to sharing new ideas or to offering criticism, because their net worth is tied to the long-term success of the company.

Companies with a culture of highly talented, driven people continually challenge themselves to offer best-in-class service and products.  Great companies are shape-shifters and can maneuver quickly as they grow and as the markets in which they compete change.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.


If you are interested in finding out more, please e-mail me or leave a comment.

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Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Verde AgriTech (AMHPF)

(Image: Zen Buddha Silence, by Marilyn Barbone)

January 2, 2022

Verde AgriTech (AMHPF) is an agri-tech company founded in 2005 by Cristiano Veloso.  Veloso comes from a family of farmers.  He is highly educated and intellectually curious.

Verde owns the first Brazilian potash mine in 33 years.  Brazil imports 94% of its potash.  Verde is the lowest cost potash producer—its cost is $170 per ton of potash—for two mains reasons:

    • Because Verde produces its potash in Brazil, that makes it lower cost than most potash producers who exist outside of Brazil and have to pay additional shipping costs;
    • Verde’s production process does not use any water or chemicals, and no tailings dams or waste generation is needed.  The company’s deposit is at the surface, while most potash mines are deep.

Because Verde is the lowest cost producer, it has a sustainable competitive advantage that should allow it to earn high margins—and high return on invested capital—for many years.

Furthermore, traditional potash has high salinity and is therefore bad for the biodiversity of the soil.  The world uses 61.5 million tons of potassium chloride each year, which is equivalent to 460 billion liters of bleach.

Verde’s product—K Forte—is a salinity and chloride free potassium specialty fertilizer.  Verde produces K Forte by using the naturally occurring glauconite in the Alto Paranaiba region in the state of Minas Gerais in Brazil.  Whereas traditional potash contains potassium and chlorine, K Forte contains potassium, silicon, magnesium, and manganese. As a result, K Forte is better for the soil and leads to healthier plants and ultimately healthier food.  K Forte also improves the carbon capture capacity of the soil.  The company’s mission: “Our purpose is to improve the health of people and the planet.”

Verde currently has only Plant 1 running.  It is maxed out at 400,000 tons per year (tpy).  The company has already maxed out Plant 1’s production.  Plant 2 is expected to start producing in Q3 2022 and it will be able to produce 800,000 tpy.  Plant 3 will be even larger.

Potash prices could remain high for much of 2022.  See:

More importantly, potash prices could be high for much of the next decade if it turns out to be a commodities bull market.  See:

The current market cap of AMHPF is $110.57 million, while the stock price is $2.20.  The enterprise value (EV) is $114.47 million.  Assuming that production is maxed out for Plants 1 and 2, that would be 1,200,000 tpy.  Assuming a potash price of $400, that would be $66.67 per ton ($400 for 6 tons of K Forte).  Revenue would be $80.00 million.

Operating cost per ton is $28.33 ($170 for 6 tons of K Forte).  So operating costs would be $34.00 million.  That means operating profit would be $46.00 million.  Net profit would be $41.00 million.  EBITDA would be $47.00 million.  (That puts the EBITDA margin at 58.8%.  If potash prices are higher, the EBITDA margin can reach 70-80%.)   Operating cash flow can be estimated at $47.00 million.

Using these figures, we get the following multiples:

    • EV/EBITDA = 2.44
    • P/E = 2.70
    • P/B = 1.76
    • P/CF = 2.35
    • P/S = 1.38

Also note that the NAV of the company—based on its glauconite resources and on the fact that the total Brazilian market for potash is 20 million tpy—is $49.77 per share in Canadian dollars or $38.82 per share in U.S. dollars.

The CEO Cristiana Veloso owns 20% of the shares.  Also, he has been adamant about not using shares to fund growth.  For the construction of its Plant 2, the company is using $3.75 million in debt and $1.41 million in internally generated cash flows.

On the most recent quarterly call, Veloso commented on the triple digit growth: “Blitzscaling is never an easy endeavour, but I’m confident we have built the right team to continue succeeding at this challenge.  It is still day 1 at Verde.”

The company board includes people like Alysson Paolinelli, a professor, former minister of agriculture, and a World Food Prize winner.

Verde AgriTech has a Piotroski F_Score of 7, which is good.

Net debt is low:  Cash is $2.4 million.  Debt is $2.8 million.  TL/TA is 30%, which is good.

Intrinsic value scenarios:

    • Low case: Assume $400 per ton for potash prices—the current price is over $700—and that plant 2 is delayed.  In this scenario, revenue could be $27 million and net profit $5 million.  With a P/E of 15, the stock would trade at $1.49, which is 32% below today’s $2.20.
    • Mid case: Assume $400 per ton for potash prices—the current price is over $700.  With plant 1 and plant 2 producing, production would be 1,200,000 tpy.  That translates into $80 million in revenue and $41 million in net profit.  The company should have at least a P/E of 15.  That would put the intrinsic value of the stock at $12.24, which is over 450% higher than today’s $2.20.
    • High case: Assume $400 per ton for potash prices—the current price is over $700.  With plant 1 and plant 2 producing, production would be 1,200,000 tpy.  That translates into $80 million in revenue and $41 million in net profit.  The company should have at least a P/E of 25 because of its significant growth potential.  That would put the intrinsic value of the stock at $20.39, which is over 825% higher than today’s $2.20.
    • Very high case:  NAV per share—based on the company’s glauconite resources and on the size of the Brazilian market—is $38.82.  That is over 1,660% higher than today’s $2.20.  In other words, a 16-bagger.  (Note that the company has 777.28 million tons of glauconite reserves, enough to supply most of the Brazilian market for decades.)


The biggest risks are market adoption risk, currency risk, political risk, and commodity price risk.

So far, farmers are adopting Verde’s products, as evidenced by the sold out production.

The Brazilian real seems to be fairly stable at $0.18 per U.S. dollar.  But if there is a flight to safety during a bear market or recession, the Brazilian real would decline versus the U.S. dollar.

One political risk is that their application for the license needed to start Plant 2 in Q3 2022 won’t be approved in time.  Another political risk is government corruption and the lack of growth-oriented reforms.

There is a risk that the price of potash could fall significantly.  This seems unlikely, given double digit inflation in many parts of the world.  It seems to be a commodity bull market.  It’s even possible that potash prices will remain at $600-800 per ton, which would mean huge profits for Verde Agritech as long as it can fully increase its production as planned.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Journey Energy (JRNGF)

(Image: Zen Buddha Silence, by Marilyn Barbone)

December 12, 2021

It’s usually not possible to predict oil prices.  But oil prices have been relatively low on average since early 2015.

If oil prices remain high, then Journey Energy (JRNGF) will probably be a wonderful investment.



It appears probable that oil prices will be higher in the coming years, perhaps $65 to $75 a barrel (WTI) or more.  (If there is a recession, oil prices will likely drop temporarily before snapping back.)

Here is the best article I’ve seen on oil prices:

If the demand for jet fuel normalizes over the next 12 to 18 months, that will add approximately 1.5 million bpd (barrels per day) to oil demand.  Also, continued recovery in transportation is likely to add 500,000 bpd to oil demand.

Since 2012, global oil supply has increased by 10 million bpd.  6 million bpd has come from U.S. shale oil while 4 million bpd has come from OPEC.

Currently, U.S. shale oil production is at 7.5 million bpd, about 1.5 million bpd below its peak of 9 million barrels per day.  Because investors are demanding that U.S. shale oil production return more cash to shareholders—which it hasn’t done for most of the last 8+ year—U.S. shale oil production is likely to increase only 750,000 bpd in 2022.  Thus far, capex has been much lower than cash flow from operations.  And only the Permian basin has enough frac fleets to grow production.

Recently, OPEC+ agreed to increase production by 400,000 bpd each month starting in July 2021 and going through September 2022.  But so far, instead of adding the scheduled 1.6 million bpd, OPEC+ instead has only added 900,000 bpd.  With oil prices being high, OPEC+ members have every incentive to maximize their production.  They are not doing so because they cannot.  (For example, Angola is underproducing its quota by 250,o00 bpd, while Nigeria is underproducing its quota by 390,000 bpd.)

Meanwhile, the major producers in OPEC+ are not overproducing in order to make up for the deficit.  (Russia is overproducing its quota by 100,000 bpd, but other major producers in OPEC+ are not overproducing their quotas.)  Thus, the collective supply deficit from OPEC+ will keep growing.  It may turn out that OPEC+ is not able to achieve pre-pandemic production levels.

This situation has caused oil inventories to be 200 million barrels lower than pre-COVID levels.  The lower inventories fall, the more upward pressure on oil prices there is.  If oil inventories keep falling, then eventually the oil price will hit $100 per barrel (WTI).

Since it takes five years to develop a major oil project, there won’t be any material addition to oil supply from new projects for at least five years.

Of course, if there is a recession, oil prices will fall temporarily but then snap back.

As for long-term demand for oil, it’s likely to grow at least at 1% a year on average.  It may grow more than that as a result of all the fiscal and monetary stimuli in response to the COVID pandemic.  See this recent note from Bridgewater Associates, “It’s Mostly a Demand Shock, Not a Supply Shock, and It’s Everywhere”:

Also, longer term, the per capita oil consumption in China, India, Africa, and other countries nearby is a tiny fraction of the per capita oil consumption in the United States.  The transition away from fossil fuels is likely to take decades, and oil demand is likely to increase for at least 10 to 20 years.  If per capita oil consumption increases in China, India, Africa, and other countries nearby, that may make oil demand keep increasing even as western countries are working to reduce their oil demand.

Even if car manufacturers started making only all-electric vehicles today, oil demand would keep rising for many years, as Daniel Yergin points out in The New Map.

I am, of course, in favor of the transition to a post-fossil fuel economy.  But the global economy needs a lot of oil in order to make that transition over the next several decades.

The oil and gas industry will exist in close to its current form 10 or 20 years from now, as Jeremy Grantham has noted.  (As well, most oil companies do not have more than 15-20 years of reserves.)  The fact that some investors are no longer investing in oil and gas companies means that oil and gas stocks now have even higher expected returns.



Journey Energy (JRNGF) appears very cheap because of the recent increases in oil prices.

Normalized EBITDA is at least $60 million.  Normalized net income per share is at least $0.80.  Operating cash flow per share is least $1.10.  And normalized revenue is at least $132 million.  Whether the normalized figures are higher or lower depends mostly on oil prices.

The current market cap is $85.7 million, while the current enterprise value (EV) is $134.2 million.  The stock price is $1.73.

Using the normalized figures, here are the multiples:

    • EV/EBITDA = 2.23
    • P/E = 2.16
    • P/NAV = 0.69
    • P/CF = 1.57
    • P/S = 0.64

(We use P/NAV instead of P/B.  The NAV assumes $70 WTI.)

The Piotroski F_Score is 7, which is good.

In order to pay down debt, Journey Energy spent very little on capex in 2020 and 2021.  The company has $7.6 million in cash and $67.9 million in debt.  (Debt a year ago was $124.6 million.)  JRNGF plans to end 2021 with debt at $53 to $54 million.

In 2022, the company plans to spend $36 million on capex and $20 million on debt reduction, leading to a debt level of about $34 million at the end of 2022.

Currently, TL/TA is 76.0%.  This is high, but Journey Energy continues to rapidly pay down debt.

Insider ownership is 10%.  That is worth $8.5 million.  Insiders will make a good deal of money if the company does well.

For the intrinsic value scenarios, we calculate NAV based on 2P reserves (proved plus probable).

    • Low case: If the oil price averages $50 (WTI), then the stock may be worth half the current NAV ($2.50), which is $1.25.  That is 28% lower than today’s $1.73.
    • Mid case: If the oil price averages $70 (WTI), then NAV per share is $3.75.  That is over 210% higher than today’s $1.73.
    • High case: If the oil price averages $90 (WTI), then NAV per share is $6.25.  That is over 360% higher than today’s $1.73.



An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.  See the historical chart here:

This outperformance increases significantly by focusing on cheap micro caps.  Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals.  We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio.  The size of each position is determined by its rank.  Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost).  Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods.  We also aim to outpace the Russell Microcap Index by at least 2% per year (net).  The Boole Fund has low fees.




Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.