Note: While reading a book whenever I come across something interesting, I highlight it on my Kindle. Later I turn those highlights into a blogpost. It is not a complete summary of the book. These are my notes which I intend to go back to later. Let’s start!

  • Pabrai constructed an unusually concentrated portfolio. He figured that ten stocks would give him all the diversification he needed. When you’re buying so few stocks, you can afford to be choosy. Pabrai glances at hundreds of stocks and rapidly rejects almost all of them, often in less than a minute. Buffett is a master of this practice of high-speed sifting. “What he’s looking for is a reason to say no, and as soon as he finds that, he’s done,” says Pabrai. Indeed, Buffett has said, “The difference between successful people and really successful people is that really successful people say no to almost everything.” Buffett provided Pabrai with several simple filters that helped him to streamline the sifting. First, says Pabrai, one of Buffett’s “core commandments” is that you can invest in a company only if it falls within your “circle of competence.” When Pabrai analyzes a company, he starts by asking, “Is this something I truly understand?” He pushes himself to consider whether he’s at the center of his circle of competence, approaching its edge, or outside it. Second, the company has to trade at a large enough discount to its underlying value to provide a significant margin of safety. Pabrai doesn’t bother to construct elaborate Excel spreadsheets that might give him an illusion that he can precisely predict the future. He wants an investment that’s so cheap that it’s a “no-brainer.” That usually means paying less than fifty cents for $1 worth of assets. “I have very simple criteria: if something is not going to be an obvious double in a short period of time—you know, two or three years—I have no interest.” Third, under Munger’s influence, Buffett gradually shifted away from stocks that were merely cheap toward an emphasis on buying better businesses. Among other things, this meant that a company should have a durable competitive advantage and should be run by an honest, capable CEO. Munger pointed out to Pabrai that Graham, who was fixated on buying stocks that were quantitatively cheap, scored his best returns by owning GEICO. “It didn’t make him money because it was cheap,” says Pabrai. “It made him money because it was a great business.” Fourth, the company’s financial statements should be clear and simple. As Buffett observed, “The only reason that one may not understand a financial statement is because the writer does not want you to understand it.” If it isn’t easy to figure out how the business generates cash today and roughly how much it’s likely to generate in the years to come, Buffett relegates it to what he calls the “too hard” pile. Pabrai once took a photograph of a box on Buffett’s desk that is literally labeled TOO HARD—a visual reminder to resist the lure of complexity. Enron and Valeant Pharmaceuticals, both of which blew up, were easy for Pabrai to reject on that basis alone. For Pabrai, one of the secrets of successful investing is to avoid anything that’s too hard. He automatically passes on investments in countries such as Russia and Zimbabwe, given their contempt for shareholder rights. He avoids all start-ups and initial public offerings (IPOs), since he’s unlikely to find bargains in arenas dominated by sales hype and inflated expectations. He has never sold a stock short because the maximum upside is 100 percent (if the stock falls to zero), while the downside is unlimited (if the stock soars). “Why bet with those odds?” he asks. He also largely ignores the infinite complexity of macroeconomics, focusing instead on a handful of critical microfactors that are likely to drive a specific business. In short, simplicity rules.

  • As I considered Pabrai’s life and what I should learn from him, several principles particularly resonated with me. In my memo, I wrote:
    • Rule 1: Clone like crazy.
    • Rule 2: Hang out with people who are better than you.
    • Rule 3: Treat life as a game, not as a survival contest or a battle to the death.
    • Rule 4: Be in alignment with who you are; don’t do what you don’t want to do or what’s not right for you.
    • Rule 5: Live by an inner scorecard; don’t worry about what others think of you; don’t be defined by external validation.

  • Quoting a line of Munger’s that Pabrai often cites, I wrote, “Take a simple idea and take it seriously.” Of all these lessons, that last one might just be the most important. Too often, we encounter a powerful principle or habit and we contemplate it, take it for a quick spin, and then forget about it. Pabrai becomes consumed by it. He lives by it. That’s a habit I have to clone.

  • The only way to beat the market is to diverge from the market. That’s a task best suited to people who are, quite literally, extraordinary—both intellectually and temperamentally. So perhaps it’s no surprise that this is a game that favors brilliant oddballs.

  • In the depths of the Depression, the stock market was a toxic wasteland. From October 1929 to July 1932, the Dow Jones Industrial Average plunged 89 percent. In the wake of that catastrophe, few people had the financial or emotional fortitude to pick through the rubble in search of bargains. But the fact that others were too scared to invest did nothing to diminish Templeton’s interest. Against this backdrop of widespread gloom, he asked himself a critical question: How can I buy a stock for a fraction of what it’s worth? His answer: “Absolutely nothing will make a stock go down to an extremely low price except for other people urgently trying to sell.”

  • Templeton had witnessed firsthand how financial distress had forced farmers in Tennessee to sell their land for next to nothing. The lesson was etched in his brain: “You have to buy at a time when other people are desperately trying to sell.” He later coined a marvelous phrase to describe these moments when fear and desperation go viral: “the point of maximum pessimism.”

  • Psychologically, it’s tough to love a money-losing company that has burned all of its investors. But Templeton said he bought eight hundred shares of Missouri Pacific for $100. Like Buffett and Munger, he had an unemotional appreciation for a mispriced bet that offered an asymmetry between risk and reward. “The potential on the upside was much greater than on the downside,” Templeton explained to me. “Sure, I may lose my hundred dollars. But if I don’t lose my hundred dollars, I might make a lot.” He was right. Railroads prospered during the war and the stock rebounded from twelve cents to $5 before he cashed out. His only regret was that he sold too soon. “I was so excited about having any stock I bought go up forty times that I thought that was enough,” he recalled. “It was foolishness.… Within four years thereafter, it went up to $105.” Of course, a bet like this relied on so much more than mere mathematics. Mark Mobius, an eminent investor in emerging markets who worked with Templeton for years, once told me that it required “tremendous willpower and strength of personality” for Templeton to buy at the point of maximum pessimism. As Mobius put it, “Everybody else is running out of the burning building.” What’s remarkable to me is not just that Templeton had the courage to invest in 104 reviled stocks as the world went to war. It’s that he had the courage to hold them for years even as the drumbeat of disastrous news grew more and more deafening. In December 1941, the Japanese attacked Pearl Harbor, spurring the United States to join the war. By 1942, Germany had seized control of most of Europe. Despair about the future ran so deep that the markets took a terrible pounding. In April 1942, the Dow slumped to a generational low of 92.

  • We sat down in his living room. Templeton sipped tea out of a mug emblazoned with the FBI’s motto: Fidelity, Bravery, Integrity. He then shared with me what he saw as the most important lessons of his investment career. During this conversation and a follow-up phone interview, he mentioned six guiding principles that he believed would help any investor. This wisdom was the fruit of more than sixty years of practical experience and contemplation by one of the greatest minds of the investment world. It’s worth noting that none of these principles was cloned. When I asked Templeton if anyone had influenced him either as an investor or in other areas of life, he replied, “Absolutely no one.… I didn’t find anyone that I wanted to rely on.” What about his parents? “Not that either.” First of all, said Templeton, beware of emotion: “Most people get led astray by emotions in investing. They get led astray by being excessively careless and optimistic when they have big profits, and by getting excessively pessimistic and too cautious when they have big losses.” One of the primary services he provided as a money manager was to help his clients “get away from that emotionalism. It was a major element in my success.” But he didn’t just avoid the pitfalls of emotion. He exploited the wayward emotions of other investors, buying from them when they were irrationally bearish and selling to them when they were irrationally bullish. “To buy when others are despondently selling and to sell when others are enthusiastically buying is the most difficult,” he said. “But it pays the greatest rewards.” It came naturally for Templeton to approach every decision analytically, whether it was choosing a profession, picking a stock, or deciding where to live. Before moving to Lyford Cay, he took several sheets of paper, wrote a different place name at the top of each sheet, then listed every advantage of that place. Describing this process, he said emphatically, “It was not emotional.” Second, said Templeton, beware of your own ignorance, which is “probably an even bigger problem than emotion.… So many people buy something with the tiniest amount of information. They don’t really understand what it is that they’re buying.” It pays to remember the simple fact that there are two sides in every investment transaction: “The one with the greatest information is likely to come out ahead. It takes a huge amount of work and study and investigation.” Templeton claimed that diligence had played a much greater role in his success than innate talent. He often spoke of his determination to “give the extra ounce”—to make the extra call, to schedule the extra meeting, to take the extra research trip. He was similarly dedicated to his lifelong program of continuous self-education. As a young man, he said, “I searched for anything available in writing on the subject of investing, and I still do.” Even in his eighties, he said, “I try to be more knowledgeable each year as an investor.” Templeton argued that amateurs and professionals alike must avoid fooling themselves into believing that it’s easy to build a strong investment record: “Even with the professionals, not many of them turn out to produce superior results. So the way to invest is to say to yourself, ‘Do I have more experience and wisdom than the professionals?’ And if you don’t, then don’t do it. Hire a professional.… Don’t be so egotistical that you think you’ll do better than the experts.” Third, said Templeton, you should diversify broadly to protect yourself from your own fallibility. By his calculation, he had made at least half a million investment decisions in his career. For many years, he kept a detailed record of the advice he’d given to clients on which stocks to buy or sell. This revealed an uncomfortable truth: about a third of his advice was “the opposite of wisdom.” Investing is so difficult, he concluded, that even the best investors should assume that they’ll be right no more than two-thirds of the time, however hard they work. The moral? Get your ego—and your risk exposure—under control. “Don’t put all your money with any one expert. Don’t put all your money in any one industry or any one nation. Nobody is that smart. So the wise thing is to diversify.” Templeton recommended that the average investor should own a minimum of five mutual funds, each focused on a different area of the financial markets. It’s helpful to study a fund manager’s long-term record, he added, but this is hardly a guarantee of continued success. Again, we need to be honest about the limits of our knowledge: “Don’t be so egotistical that you think you know who is the right expert.” Fourth, said Templeton, successful investing requires patience. When he bought US stocks at the outbreak of World War II, he knew how cheap they were, but he couldn’t predict how long it would take for the market to agree with him. His edge lay not just in his superior insight, but in his willingness to wait year after painful year for the situation to play out as he’d predicted. Templeton’s affection for math reinforced his conviction that patience pays. To illustrate this, he mentioned the tale of Dutch immigrants buying Manhattan for $24 in 1626.III If the Native American sellers had invested this derisory sum at 8 percent a year, he said, they would have “enormously more than the total value of Manhattan today, including all the buildings.” Templeton regarded this as an extreme example of a fundamental financial principle: “In order to have a really good investment result, all you need is patience.” He warned that “almost all” investors are “too impatient,” adding, “People who change from one fund to another as often as once a year are basing it more on emotion than investigation.” Fifth, said Templeton, the best way to find bargains is to study whichever assets have performed most dismally in the past five years, then to assess whether the cause of those woes is temporary or permanent. Most people are naturally drawn to investments that are already successful and popular with the herd, whether it’s a high-flying stock or fund or a rapidly growing country. But if a sunny future is already reflected in the price of the asset, then it’s probably a bet for suckers. Templeton, the least tribal of investors, took the opposite approach. He wanted to know “Where is the outlook worst?” These pockets of gloom were likely to yield the most enticing bargains, since asset prices would reflect the tribe’s pessimism. His contrarian strategy involved scrutinizing stocks in beleaguered industries and markets around the world, constantly asking himself, “Which one is the lowest priced compared to what I believe it’s worth?” At the time of our discussions, the Asian financial crisis of 1997 had left a trail of destruction in countries such as Thailand, Indonesia, and South Korea. If you wanted to identify the most battered investment vehicle on earth, one clear contender was the Matthews Korea Fund, which lost about 65 percent in 1997. The fund had the misfortune of investing solely in a nation traumatized by a lending freeze, a collapsing currency, and deadly levels of corporate leverage. Templeton decided in late 1997 that South Korean stocks were the cheapest in the world relative to future corporate earnings. The price/earnings ratio of Korean stocks had crashed from more than 20 in June 1997 to 10 in December—a rough but revealing measure of investors’ fear and loathing. Still, it was reasonable to assume that the country’s history of powerful economic growth would eventually resume, once this vicious liquidity crisis had passed. So Templeton poured $10 million into the Matthews Korea Fund, becoming its single largest shareholder. He told me, “It could hardly get any worse from a psychological and public relations standpoint.” To the typical investor, that might not sound like a rousing endorsement. But just think for a moment about the simple elegance of his logic and the independence of mind required to wade into the South Korean market while everyone else flooded out. Sure enough, the crisis proved to be fleeting, just as he’d surmised. In June 1999, Bloomberg News reported that the Matthews Korea Fund had risen 266 percent in the past year, making it the single best performer in its ranking of 5,307 stock funds. As the Bible says, “The last shall be first, and the first last.” Sixth, said Templeton, “One of the most important things as an investor is not to chase fads.” In the 1980s, the Templeton Foundation Press republished a timeless book with a magnificent title: Extraordinary Popular Delusions and the Madness of Crowds. Written in 1841 by Charles Mackay, it tells the history of crazes such as tulip mania and the South Sea Bubble. Templeton wrote a foreword that offered a rational antidote to financial insanity: “The best way for an investor to avoid popular delusions is to focus not on outlook but on value.” He suggested that we ground ourselves in reality by investigating an array of specific valuation measures, including a company’s market price in relation to its sales volume per share, its net asset value per share, and its average earnings per share for the last five years. This “critical analysis” of an “investment’s fundamental value” acts as a safeguard against “crowd madness.” At the time of our meeting, US stocks had enjoyed an eight-year bull run and euphoric investors were betting blindly on technology and internet stocks. It seemed clear to me that we were in the midst of a mania, but I wanted Templeton to confirm what I suspected. He didn’t make it easy. Early in our conversation, he had told me, “The point of maximum optimism is the time to take your profits.” But when I asked him repeatedly if we’d reached that point, he evaded the question. Finally, he snapped, “Anybody is stupid to ask that question. Is that clear? Nobody ever knows when the point comes.… Some experts are right a little more often than you might be. But still, it’s a human failing to even put your mind on a question of which stock market is going to go up or down. There’s never been anybody who knew that.”

  • Templeton hatched an inspired scheme to profit when the dot-com bubble burst. Here’s how it worked. Back then, unscrupulous investment banks were making a killing by taking internet companies public. The Wall Street sales machine moved into overdrive, hyping and hawking any half-credible rubbish that naive, greedy, or reckless investors might be willing to buy. It was a classic outbreak of investment insanity—loads of fun until someone loses an eye. Templeton knew that this tragicomedy would end in tears. After all, he had often cautioned that the four most expensive words in the English language are “This time is different.” His response was to target eighty-four of the most egregiously overvalued internet stocks, all of which had tripled since their initial public offering. After the IPO, a “lockup” period followed in which company employees weren’t allowed to sell their shares, typically for six months. Templeton reasoned that these insiders would race to dump their stock at the first opportunity since they’d be anxious to cash out before the euphoria faded. This stampede of insider selling would cause the stocks to crash. So Templeton “sold short” each of those eighty-four stocks, betting that they’d nose-dive as soon as the lockup period expired. Lauren Templeton, a money manager who is his great-niece, has said that he placed a $2.2 million bet against each stock—a total of about $185 million. Templeton’s short-selling strategy worked like a dream. When the dot-com bubble burst in March 2000, he earned a profit of more than $90 million in months. Years later, when the Economist ran an article about the greatest financial trades of all time, it declared that his “ingenious” scheme “wins the ‘Wish I’d thought of that’ prize by a mile.”

  • In a world where nothing is stable or dependable and almost anything can happen, the first rule of the road is to be honest with ourselves about our limitations and vulnerabilities.

  • Marks drew a simple but life-changing lesson from these academic debates: if he wanted to add value as an investor, he should avoid the most efficient markets and focus exclusively on less efficient ones. “The more a market is studied and followed and embraced and popularized, the less there should be bargains around for the asking,” he says. For example, it’s hard to find outlandish bargains among large US companies, a mainstream market where swarms of intelligent, highly motivated money managers tend to “drive out mispricings.” If you want to invest in large-cap stocks, it makes sense to buy and hold an index fund that tracks the S&P 500, accepting that your odds of gaining a long-term edge in this efficient market are poor.

  • Marks himself is a staunch member of what he calls the “I Don’t Know” school of thought. As he sees it, the future is influenced by an almost infinite number of factors, and so much randomness is involved that it’s impossible to predict future events with any consistency. Recognizing that we can’t forecast the future might sound like a disheartening admission of weakness. In reality, it’s a tremendous advantage to acknowledge our limitations and operate within the boundaries of what’s possible. Out of weakness comes strength.

  • When analyzing any asset, what Marks wants to know, above all, is “the amount of optimism that’s in the price.” With the FANGs, “there’s a lot of optimism. Too much? Who knows? Will one of them become the world’s first perpetual motion machine, the first company that (a) doesn’t stumble and (b) is not subject to disruption? I don’t know.” This combustible mixture of unknowability and rampant optimism is enough to scare him off—not because he knows precisely what will happen but because the probability of disappointment is too high.

  • Marks has a rare gift for identifying cyclical patterns that have occurred again and again in financial markets. Once we understand these patterns, we can avoid being blindsided by them and can even profit from them. “It’s very helpful,” Marks tells me, “to view the world as behaving cyclically and oscillating, rather than going in some straight line.” He believes that almost everything is cyclical. For example, the economy expands and contracts; consumer spending waxes and wanes; corporate profitability rises and falls; the availability of credit eases and tightens; asset valuations soar and sink. Instead of continuing unabated in one direction, all of these phenomena eventually reverse course. He compares these patterns to the swinging of a pendulum from one extreme to the other.

  • Marks operates on the assumption that the cycle will eventually self-correct and the pendulum will swing back in the opposite direction. The future may be unpredictable, but this recurring process of boom and bust is remarkably predictable. Once we recognize this underlying pattern, we’re no longer flying blind. The problem is, most investors act as if the latest market trend will continue indefinitely. Behavioral economists use the term recency bias to describe the cognitive glitch that leads us to overweight the importance of our recent experiences. Marks notes that the human mind also has a treacherous tendency to suppress painful memories. If this weren’t the case, I’m guessing that my wife wouldn’t have been willing to endure more than one pregnancy, and I’m not sure how many writers could muster the strength to keep returning to the blank screen. In our financial lives, this life-enhancing ability to forget unpleasant experiences is less helpful because the woes and mishaps of the past tend to provide the most valuable lessons. One way to combat this costly tendency to forget is through intensive study of market history. “You can’t know the future,” says Marks, but “it helps to know the past.”

  • We can’t demand a more favorable set of market conditions. But we can control our response, turning more defensive or aggressive depending on the climate.

  • Five critical ideas from Marks:
    • The importance of admitting that we can’t predict or control the future.
    • The benefits of studying the patterns of the past and using them as a rough guide to what could happen next.
    • The inevitability that cycles will reverse and reckless excess will be punished.
    • The possibility of turning cyclicality to our advantage by behaving countercyclically.
    • The need for humility, skepticism, and prudence in order to achieve long-term financial success in an uncertain world.

  • The inevitability of change has important implications. For a start, we need to acknowledge that the current economic climate and market trajectory are temporary phenomena, just like everything else. So we should avoid positioning ourselves in such a way that we’re dependent on their continuing along the same path. As Marks notes, investors repeatedly make the mistake of overestimating the longevity of the market’s upswings and downturns; they forget that nothing lasts forever. Likewise, many home buyers ruined themselves during the financial crisis by taking on too much debt in the belief that house prices would continue to rise from here to eternity. The moral? Never bet the farm against the inexorable forces of change.

  • Both in markets and life, the goal isn’t to embrace risk or eschew it, but to bear it intelligently while never forgetting the possibility of an unpleasant outcome.

  • His new investment strategy was built on one all-important insight that he drew from The Intelligent Investor. “Because the future is uncertain, you want to minimize your risk,” says Eveillard

  • The mutual fund business can be marvelously profitable. It’s not capital intensive, and it boasts unusually high operating margins. The late Marty Whitman, a renowned investor with a gift for tactless truth-telling, once told me that fund managers are competitive in every way—except when it comes to lowering their fees. The executives who run mutual fund companies have strong incentives to keep gathering assets. They’re not fools or villains. They’re pragmatic businesspeople who focus heavily on sales and marketing. An outperformer such as Eveillard was a prized asset in good times. But in bad times, it was easy to cast him as a zealot whose extremism placed everyone’s bonuses at risk. If credulous investors wanted to buy dot-com stocks, why not give them what they wanted? Why not feed the ducks while they were quacking?

  • Following Buffett’s lead, we should always keep enough cash in reserve so we’ll never be forced to sell stocks (or any other beleaguered asset) in a downturn. We should never borrow to excess because, as Eveillard warns, debt erodes our “staying power.” Like him, we should avoid the temptation to speculate on hot stocks with supposedly glorious growth prospects but no margin of safety. And we should bypass businesses with weak balance sheets or a looming need for external funding, which is liable to disappear in times of distress. None of this is brain surgery. But it requires us to take seriously that oft-forgotten commandment Thou shalt not depend on the kindness of strangers.

  • Kahn became Graham’s teaching assistant at Columbia in the 1920s, and they remained friends for decades. I wanted to know what he’d learned from Graham that had helped him to prosper during his eighty-six years in the financial markets. Kahn’s answer: “Investing is about preserving more than anything. That must be your first thought, not looking for large gains. If you achieve only reasonable returns and suffer minimal losses, you will become a wealthy man and will surpass any gambler friends you may have. This is also a good way to cure your sleeping problems.” As Kahn put it, the secret of investing could be expressed in one word: “safety.” And the key to making intelligent investment decisions was always to begin by asking, “How much can I lose?” He explained, “Considering the downside is the single most important thing an investor must do. This task must be dealt with before any consideration can be made for gains. The problem is that people nowadays think they’re pretty smart because they can do something quite rapidly. You can make the horse gallop. But are you on the right path? Can you see where you’re going?”

  • McLennan’s voracious reading led him to the same wary conclusion that Graham and Eveillard had reached: The future is so “intrinsically uncertain” that investors should focus heavily on avoiding permanent losses and building “a portfolio that can endure various states of the world.” As McLennan sees it, we should start by defining our overarching goal, which ought to guide all of our investment choices. He makes the point by quoting the Roman philosopher Seneca: “If one does not know to which port one is sailing, no wind is favorable.” For McLennan, the destination is clear: “Our goal is not to try to become rich quickly. It’s resilient wealth creation.” For almost all of us, this is a much wiser goal than trying to trounce the market.

  • Instead of assuming that successful businesses will grow in perpetuity, McLennan views them through a darker lens, which he has borrowed from science. “I happen to believe that everything is on a path to fade,” he says. “If you think of evolution, ninety-nine percent of species that have ever existed are extinct. And businesses are no exception.” He regards the economy as an ecology in which the current lords of the jungle will eventually be defeated by disruptive technology and new competitors. “Businesses that were robust today won’t be robust in the future,” says McLennan. “Uncertainty is intrinsic to the system. It’s entropy—the second law of thermodynamics. Basically, things tend toward disorder over time, and it takes a lot of energy to keep structure and quality in place. So, philosophically, we have great respect for the fact that things are not structurally permanent in nature, that things fade.” This realization has profound implications when it comes to picking stocks. Most investors want to own glamorous companies with heady growth prospects. McLennan focuses instead on a more negative mission of “avoiding fade.” How? By identifying “persistent businesses” that are less vulnerable to “complex competitive forces.” Think of it as an anti-entropy strategy.

  • One example of a business that he expects to “persist” is FANUC Corp., a Japanese firm that has maintained a remarkably stable position as the world’s leading seller of robotics products such as servomotors. Whatever car you buy in the United States, says McLennan, it’s likely that it was painted by a FANUC robot. The company has an entrenched customer base that’s used to its products. It gathers real-time data from those clients and harnesses this superior knowledge of the market to keep expanding its lead over competitors. FANUC also benefits from the trend of automation within manufacturing, instead of being a victim of technological change. Its finances are strong, with net cash on the balance sheet, and it’s run by a farsighted management team that speaks explicitly about the priority of positioning the company to “survive forever.” None of this guarantees that FANUC is immune to entropy, but McLennan believes it’s “difficult to displace.” Another example of a dominant business that he regards as “built for resilience” is the consumer goods firm Colgate-Palmolive. The company has been selling toothpaste since the 1870s and controls more than 40 percent of the worldwide market. It’s an inexpensive and habitual product that’s resistant to disruption—except in the unlikely event that, say, an active ingredient turns out to be carcinogenic. Even in times of economic mayhem, such as 2008 or 2020, it’s a business that “just tends to grind on,” says McLennan. And, as with FANUC, “that combination of scale and customer captivity tends to produce better margins and therefore more cash flow.” This is a company with no novelty or sex appeal. Yet its business model would be so hard to replicate that it possesses what McLennan calls “mundane scarcity.” There’s a counterintuitive elegance to this idea that, when it comes to investing, beauty often lies in mundanity, not glamour. Over the years, he’s detected the hidden allure of countless ugly ducklings—from a timberland company acquired during a cyclical downturn to a firm that rents uniforms. Not exactly Tesla.

  • Similarly, as stocks tumbled in March 2020, McLennan added to his stake in a Japanese firm, Hoshizaki—another exquisitely mundane and persistent business that he describes as “the world leader in ice machines for restaurants.” He explains, “Restaurants always come and go, but they need the same equipment. So the equipment maker is a far safer bet than betting on a restaurant.” McLennan also insists that any stock he buys should be “priced for fade.” In other words, the valuation must be low enough to compensate for his assumption that the company, like every business, is ultimately on “a path to irrelevance.” He typically seeks to invest at a 30 percent discount to his estimate of the company’s intrinsic value. If the business doesn’t fade but instead continues to grow, “then we get the growth for free.” What remains after McLennan’s painstaking process of elimination? A “resilient core” of unusually persistent, conservatively managed, well-capitalized, undervalued businesses that are likely to thrive even in a Darwinian ecosystem where nothing lives forever. On average, he holds these positions for the best part of a decade, trimming or adding to them as their valuations fluctuate. McLennan recognizes that all of these businesses are imperfect and some will disappoint. So he adds another layer of resilience by owning about 140 of them. Like Graham and Eveillard, he sees diversification as a vital component of an “error-tolerant” strategy that can survive his own mistakes, bad luck, and inability to see the future.VII Opportunities to buy “good businesses at good prices” tend to arise erratically, often amid outbreaks of volatility. But McLennan is perfectly happy to wait five or ten years for a desirable company on his watch list to meet his valuation hurdles. In the meantime, he has the discipline to let cash pile up, instead of feeling obliged to invest when prices are too high for comfort. Indeed, the most critical idea he tries to instill in his analysts is the importance of saying no.

  • In markets, as in life, so much hinges on our ability to survive the dips.

  • Let’s step back for a moment and try to distill a few practical lessons from Graham, Kahn, Buffett, Eveillard, and McLennan on how to strengthen our resilience as investors. For me, there are five fundamental ideas that I can’t afford to forget. First, we need to respect uncertainty. Just think of all the turmoil that Graham and Kahn witnessed over the last century or so and you begin to realize that disorder, chaos, volatility, and surprise are not bugs in the system, but features. We can’t predict the timing, triggers, or precise nature of these disruptions. But we need to expect them and prepare for them, so we can soften their sting. How? By identifying and consciously removing (or reducing) our vulnerabilities. As Nassim Nicholas Taleb writes in Antifragile: Things That Gain from Disorder, “It is far easier to figure out if something is fragile than to predict the occurrence of an event that may harm it.” Second, to achieve resilience, it’s imperative to reduce or eliminate debt, avoid leverage, and beware of excessive expenses, all of which can make us dependent on the kindness of strangers. There are two critical questions to ask: “Where am I fragile? And how can I reduce my fragility?” If, say, all of your money is in one bank, one brokerage, one country, one currency, one asset class, or one fund, you may be playing with a loaded gun. With luck, you can get away with anything in the short term. With time, the odds rise that your vulnerability will be exposed by unforeseen events. Third, instead of fixating on short-term gains or beating benchmarks, we should place greater emphasis on becoming shock resistant, avoiding ruin, and staying in the game. To some degree, the upside will take care of itself as economies grow, productivity improves, populations expand, and compounding works its magic. But as Kahn warned, we can’t afford to ignore the downside. Fourth, beware of overconfidence and complacency. Aristotle observed, “The character which results from wealth is that of a prosperous fool.” Personally, if there’s anything I’m sure of, it’s that I’m irrational, ignorant, self-deluding, and prone to all of the behavioral mistakes I laugh at in others—including the perilous habit of trusting that the future will resemble the recent past. Fifth, as informed realists, we should be keenly aware of our exposure to risk and should always require a margin of safety. But there’s an important caveat. We cannot allow our awareness of risk to make us fearful, pessimistic, or paranoid. Nietzsche warned, “Stare too long into the abyss and you become the abyss.” As McLennan demonstrated during the pandemic, the resilient investor has the strength, confidence, and faith in the future to seize opportunities when unresilient investors are reeling. Defense suddenly turns into offense. Disruption brings profit.

  • Buffett himself is a grand master of simplification. Writing to his shareholders in 1977, he laid out his four criteria for selecting any stock: “We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price.” These may not strike you as earth-shattering secrets. But it’s hard to beat this distillation of eternal truths about what makes a stock desirable. More than forty years have passed, yet Buffett’s four filters remain as relevant and useful as ever.

  • Danoff had the remarkable distinction of having whipped the S&P 500 over one, three, five, ten, and twenty-seven years. I was eager to uncover the subtle ingredients of his secret sauce. But he managed to sum up his entire investment philosophy in three words: “Stocks follow earnings.” With that principle in mind, he searches with relentless drive for “best-of-breed businesses” that he thinks will “grow to be bigger in five years.” Why? Because if a company doubles its earnings per share in the next five years, he believes the stock price is also likely to double (more or less). This generalization is easy to dismiss because it sounds suspiciously simplistic. But remember: investing isn’t like Olympic diving, where the judges award extra points for difficulty. Danoff is unapologetic about his single-minded focus on predicting earnings growth. Unlike most of the investors in this book, he doesn’t even worry that much about valuation levels, except when they get “ridiculous.” He asks, “Do you want to win the game for shareholders and own great companies? Sometimes, to own a great company, you’ve got to pay a fair price.” This mindset has led him to amass enormous, long-held positions in dominant, well-managed businesses such as Berkshire Hathaway (a major holding since 1996), Microsoft, Alphabet (he was one of the largest investors in Google’s 2004 IPO and has held it ever since), Amazon (his biggest position), and Facebook (he was among the biggest buyers in the IPO). “This is pretty basic stuff,” he says. “My attitude with investing is, Why not invest with the best?”

  • Looking over his notes from that meeting, Danoff tells me, “Everything you needed to know was laid out here. There was a huge opportunity.” For example, Schultz pointed out that Italy alone had at least 200,000 coffee bars. By comparison, Starbucks had 139. But the Seattle-based company was aggressively expanding into other cities, opening new cafés at a modest cost of about $250,000 apiece. In its third year, a café could generate $150,000 in profits—a 60 percent return on the initial investment. “The key,” says Danoff, “is that the return on each store was quite high,” so the company “could grow at a fast pace without needing external financing.” Danoff says he didn’t appreciate Schultz when they first met. But Starbucks would ultimately become one of the Contrafund’s largest holdings. Along the way, the company would provide the perfect illustration of why it’s so valuable to invest for the long run in great businesses that sustain an unusually high growth rate. Danoff points to a chart that tracks the company’s stupendous performance over two decades: its earnings per share grew by 27.45 percent annually for twenty years, while the stock soared by 21.32 percent a year. Over the same period, the S&P 500’s earnings grew by 8.4 percent a year, while the index rose just 7.9 percent a year. Danoff runs a finger along the fever lines on his chart and asks me what lesson they demonstrate. I reply, “The stock price is eventually going to follow the earnings.” His eyes open wide and he flashes me a joyous smile: “Exactly! Bingo! That’s what I’ve learned. Stocks follow earnings!”

  • Danoff’s edge lies partly in his consistent refusal to overcomplicate. His friend Bill Miller, one of the most insightful thinkers in investing, says Danoff consciously focuses on the questions that matter most, instead of getting tangled up in distracting details: “Will once said to me, falsely, ‘Look, I’m not that smart and there’s a lot of information out there. So when I look at a company, I just ask myself: “Are things getting better or are they getting worse?” If they’re getting better, then I want to understand what’s going on.’ ” Miller, too, has learned to simplify his investment process. “I’m trying to get rid of the unnecessary parts of what I used to do,” he says. For example, he used to build elaborate financial models in an attempt to grasp the complexities of each company he was analyzing. “I don’t build models anymore. It’s just stupid. It doesn’t make any sense.” Instead, he concentrates on three or four critical issues that he believes will drive the business. “For every company, there are a few key investment variables,” he says, “and the rest of the stuff is noise.” The pattern is clear. In their own ways, Greenblatt, Buffett, Bogle, Danoff, and Miller have all been seekers of simplicity. The rest of us should follow suit. We each need a simple and consistent investment strategy that works well over time—one that we understand and believe in strongly enough that we’ll adhere to it faithfully through good times and bad.

  • Once you realize that your entire mission is to value businesses and pay much less for them than they’re worth, it’s incredibly liberating. “If you see it that simply and can keep that simplicity in your mind, it’s very compelling and almost makes a lot of what else you see look silly,” says Greenblatt. “It kind of gets rid of ninety-nine percent of everything else that anyone had ever told me about how to look at the world and the market.” Many investors get rattled when they read the latest news about, say, a Greek debt crisis that threatens the European economy. But Greenblatt says, “The way I look at it is, if I own a chain store in the Midwest, am I all of a sudden going to sell it for half of what it’s worth because something bad happened in Greece? I don’t think so! But that’s what you read in the newspaper, and that’s what everyone is looking at. If you have a context to say, ‘Well, does it matter or doesn’t it matter?’—it’s just very helpful.”

  • Depending on the business, Greenblatt uses some combination of four standard valuation techniques. Method 1: he performs a discounted cash flow analysis, calculating the net present value of the company’s estimated future earnings. Method 2: he assesses the company’s relative value, comparing it to the price of similar businesses. Method 3: he estimates the company’s acquisition value, figuring out what an informed buyer might pay for it. Method 4: he calculates the company’s liquidation value, analyzing what it would be worth if it closed and sold its assets. None of these methods is precise, and each has its limitations. But Greenblatt works on the basis that, if a stock is sufficiently cheap, the upside potential significantly outweighs the downside. The underlying concept of buying bargains is simplicity itself. But the execution process isn’t that simple because it involves such complexities as (roughly) predicting a company’s future earnings and cash flows. This reminds me of an acerbic comment about investing that Charlie Munger once made at the end of a lunch with Howard Marks: “It’s not supposed to be easy. Anyone who thinks it’s easy is stupid.” Greenblatt insists that his own valuation skills are merely “average.” Rather, his advantage stems chiefly from his ability to “contextualize” everything he sees in the market, fitting it all into a coherent framework. His faith in this framework is so strong that he issues a guarantee to his Columbia students: if they do a decent job of valuing businesses, buy them at a steep discount to their intrinsic value, and wait patiently for the gap to close between the current price and their appraisal of the value, the market will eventually reward them.

  • The hitch is that you can never tell how long the process of convergence between price and value will take. Still, he says, “I’m a firm believer that, in 90 percent of the cases, the market will recognize that value within two or three years.” This points to a fundamental truth that is one of the most dependable laws of the financial universe. In the short term, the market is irrational and frequently misprices stocks—but in the long term, it’s surprisingly rational. “Eventually,” says Greenblatt, “Mr. Market gets it right.”

  • Greenblatt had always been fascinated by gambling. At fifteen, he’d discovered the furtive joy of sneaking into a dog track and wagering a couple of bucks on a greyhound. His brain was built for betting. “I like calculating the odds,” he says. “Consciously or unconsciously, I’m calculating the odds on every investment. What’s the upside? What’s the downside?” When I mention that all of the best investors seem to think probabilistically, carefully weighing the odds of different outcomes, he replies, “I don’t think you can be a good investor without thinking in that way.” Greenblatt spent the next three years as an analyst at a start-up investment firm, making “risk arbitrage” bets on companies involved in mergers. It didn’t take him long to realize that this was a game with odious odds. If a merger went ahead as planned, “you could make a dollar or two,” he says. But if the deal unexpectedly fell apart, “you could lose ten or twenty.” This was “the exact opposite” of Graham’s strategy of buying dirt cheap stocks, “where you can lose a dollar or two and make ten or twenty. That’s a good risk/reward.”

  • When I think about everything that I’ve learned from Greenblatt, I’m struck above all by four simple lessons. First, you don’t need the optimal strategy. You need a sensible strategy that’s good enough to achieve your financial goals. As the Prussian military strategist General Carl von Clausewitz said, “The greatest enemy of a good plan is the dream of a perfect plan.” Second, your strategy should be so simple and logical that you understand it, believe in it to your core, and can stick with it even in the difficult times when it no longer seems to work. The strategy must also suit your tolerance for pain, volatility, and loss. It helps to write down the strategy, the principles upon which it stands, and why you expect it to work over time. Think of this as a policy statement or a financial code of conduct. In times of stress and confusion, you can review this document to restore your equilibrium and regain your sense of direction. Third, you need to ask yourself whether you truly have the skills and temperament to beat the market. Greenblatt possesses an unusual combination of characteristics that give him a significant edge. He has the analytical brilliance to deconstruct a complex game, breaking it down into the most fundamental principles: value a business, buy it at a discount, then wait. He knows how to value businesses. He isn’t influenced by conventional opinion or authority figures such as the Wharton professors who claimed that the market is efficient. On the contrary, he delights in proving them wrong again and again. He’s also patient, even-tempered, self-assured, competitive, rational, and disciplined. Fourth, it’s important to remember that you can be a rich and successful investor without attempting to beat the market. Over several decades, Jack Bogle watched thousands of active fund managers try and fail to prove their long-term superiority over index funds. “All these stars proved to be comets,” he told me. “They light up the firmament for a moment in time. They burn out, and their ashes float gently down to earth. Believe me, it happens almost all the time.” Bogle often argued that “the ultimate in simplicity” is to buy and hold a single balanced index fund that owns a fixed percentage of US and foreign stocks and bonds. And that’s it. No self-destructive attempts to time the market. No fantasies of picking the next hot stock or fund.

  • Wall Street tends to fixate on short-term outputs, favoring questions such as What will this company’s profits be over the next three months? and What is our twelve-month price target for this stock? Sleep and Zakaria focused instead on the inputs required for a business to fulfill its potential. For example, they wanted to know, Is this company strengthening its relationship with customers by providing superior products, low prices, and efficient service? Is the CEO allocating capital in a rational way that will enhance the company’s long-term value? Is the company underpaying its employees, mistreating its suppliers, violating its customers’ trust, or engaging in any other shortsighted behavior that could jeopardize its eventual greatness? It’s worth noting that destination analysis is an equally handy tool in other areas of life. If, say, your goal is to be healthy in old age, you might ask yourself what inputs (in terms of nutrition, exercise, stress reduction, medical checkups, and the like) are required now to boost your odds of reaching that destination. If you want to be remembered lovingly by your family and friends, you might picture them at your funeral and ask how you need to behave today so they will cherish the memory of you. This emphasis on destinations had a profound impact on Sleep and Zakaria. “You want to look back at eighty,” says Sleep, “and think that you treated your clients equitably, did your job properly, gave money away properly—not that you had four houses and a jet.”

  • Nomad rejected all of the get-rich-quick tactics that hedge funds routinely use to pump up their short-term performance—high-testosterone strategies that Sleep dubbed “investment Viagras.” For example, Nomad never used leverage, never shorted a stock, never speculated with options or futures, never made a macroeconomic bet, never traded hyperactively in response to the latest news, never dabbled in exotic financial instruments with macho names such as LYONs and PRIDEs. Instead, Sleep and Zakaria played what they viewed as “a long, simple game,” which involved buying a few intensively researched stocks and holding them for years.

  • In 2006, Sleep wrote to shareholders that Nomad’s average holding period for stocks was seven years, whereas other investors held the US stocks in Nomad’s portfolio (excluding Berkshire Hathaway) for an average of only fifty-one days. Sleep and Zakaria were appalled by this cultural shift toward short-termism. “We cannot for the life of us figure out why society at large is served by having company owners swap seats every few months,” wrote Sleep. “This basic building block of society is broken when those with their hands on the permanent capital change their minds with their underwear.” Nomad would succeed by taking the opposite approach. “The Bible would say that you want to build your house on rock rather than sand,” says Sleep. “You want to build something that has permanence.”

  • In the Philippines, they invested in Union Cement, the nation’s largest cement producer, after its stock had plunged from thirty cents to less than two cents. Pessimism was so pervasive that the market valued the business at one-quarter of the replacement cost of its assets. In Thailand, they invested in Matichon, a newspaper publisher whose stock had crashed from $12 to $1. It traded at 0.75 times revenues and was worth about three times what they paid for it. In the United States, they bought preferred shares of Lucent Technologies, a fallen telecom star that had lost 98 percent of its value. These were classic “cigar butts”—not the best businesses, but fantastically cheap. By the end of 2003, Nomad’s net asset value had doubled as opportunistic bets like these paid off. The supply of bargains dwindled as fears receded and markets revived. So Sleep and Zakaria ventured to one of the few remaining pockets of despair. In 2004, they crossed the border from South Africa into Zimbabwe. Under Robert Mugabe’s despotic rule, Zimbabwe’s economy was paralyzed by corruption, a currency collapse, the nationalization of many privately owned farms, and mobs of looters. Undaunted, Sleep and Zakaria bought a basket of four Zimbabwean stocks—virtual monopolies that traded as if they were almost worthless. Zimcem, a cement producer, sold on the stock exchange in Harare for one-seventieth of the replacement cost of its assets. Writing to Nomad’s investors about the perverse appeal of this detested market, Sleep remarked, “The clients will hate it. Compliance will hate it. The consultants will hate it. Marketing will hate it. The size of the investment opportunity is tiny. It is not part of the benchmark.… It’s perfect.”

  • For a while, Nomad valued its basket of bargains at zero because trading on Zimbabwe’s stock exchange ceased entirely. The economy remained a catastrophe. Still, by the time Nomad sold the last of its Zimbabwean stocks in 2013, they’d risen between threefold and eightfold. As a souvenir, Sleep and Zakaria gave each Nomad shareholder a worthless banknote for 100 trillion Zimbabwean dollars, which the government had issued at the height of hyperinflation. Nomad’s appetite for reasonable businesses selling at unreasonably low prices made sense, given the opportunities available at the time. But this strategy had one drawback. When stocks like these rebounded and were no longer that cheap, they had to sell them and hunt for new bargains. But what if nothing particularly attractive was on sale when they sought to redeploy those winnings? An obvious solution to this reinvestment risk was to buy and hold higher-quality businesses that were more likely to continue compounding for many years. This second strategy grew out of a costly mistake. In 2002, Nomad made its biggest wager to date, investing in Stagecoach, a debt-ridden British bus operator that had overreached disastrously while expanding overseas. The stock had crashed from £2.85 to 14p, but Sleep and Zakaria figured it could easily be worth 60p. In part, they were betting on a turnaround led by the founder, a former bus conductor who’d run the firm so adroitly in the past that he’d become one of Britain’s richest people. He came out of semiretirement to streamline the business and refocus on its neglected cash cow: the UK bus operation. His strategy worked. Sleep and Zakaria cashed out at around 90p and congratulated themselves on a sixfold gain. But Stagecoach was a better business than they’d realized. In late 2007, the stock hit £3.68. “We felt like a bit of a horse’s arse,” says Sleep. “We had framed it in our own minds as only ever being a cigar butt.” Sleep and Zakaria started searching for other businesses run by farsighted managers whom they could trust to keep building wealth over time. “If they’re thinking rationally and thinking about the long term,” says Sleep, “you can subcontract the capital allocation decisions to them. You don’t have to be buying and selling shares.” They also began to wonder what characteristics account for the success of companies with unusually long shelf lives, and they would reach the revelatory conclusion that one business model may be more powerful than all the rest. Their term for it is scale economies shared.

  • In retirement, Zakaria kept half a dozen or so of his favorite stocks from Nomad’s portfolio. His biggest holding, Amazon, surpassed $3,000 per share in 2020, giving it a market value of $1.5 trillion and making Bezos the world’s richest person. Zakaria, who has never sold a share of Amazon in his personal portfolio, has about 70 percent of his money riding on that one stock. The rest is almost entirely invested in Costco, Berkshire Hathaway, and an online retailer named Boohoo.com. Zakaria says he occasionally glances at his portfolio and wonders, “What would Nick do? And I think, ‘Nick wouldn’t do anything.’ And I go, ‘Okay, that’s done for another six months.’ ” As for Sleep, he invested almost all of his money in just three stocks: Amazon, Costco, and Berkshire. “There are very few businesses that are investing in the future the way they are,” he says. “They don’t care about Wall Street. They don’t care about the trends and the fads. They’re just doing the right thing long term.” The volatility of a three-stock portfolio didn’t bother him, given the high probability that all three businesses would reach a desirable destination. However, by 2018, Amazon had risen so meteorically that it accounted for more than 70 percent of his net worth. Sleep began to worry. Could its market value grow to $3 trillion or $4 trillion, or were there limits even to Amazon’s greatness? He wasn’t sure. So, after thirteen years, he sold half of his stake in a single day for $1,500 a share. How did it feel? “I hated it,” he says. “I felt horribly conflicted, and I’m not sure it’s a good decision.” For a while, Sleep sat patiently on tens of millions of dollars in cash, not sure how to invest his windfall from selling those shares in Amazon. But when we spoke in 2020, he had invested the money in a fourth stock, ASOS—an online retailer that he’d previously owned at Nomad. Since he repurchased it, the stock had already doubled. In short, life is still sweet.

  • There are five key lessons to be learned from Sleep and Zakaria. First, they provide a compelling example of what it means to pursue quality as a guiding principle in business, investing, and life—a moral and intellectual commitment inspired by Zen and the Art of Motorcycle Maintenance. It’s easy to dismiss quality as a vague and subjective notion, but it offers a surprisingly useful filter for many decisions. For example, it was obvious to Sleep and Zakaria that a low annual management fee that merely covered Nomad’s operating costs was a higher-quality option than a fatter fee that would enrich them regardless of how they performed. Second, there is the idea of focusing on whatever has the longest shelf life, while always downplaying the ephemeral. This principle applied not only to the information they weighed most heavily, but also to the long-lasting companies they favored. Third, there is the realization that one particular business model—scale economies shared—creates a virtuous cycle that can generate sustainable wealth over long periods. Sleep and Zakaria took this one great insight and profited massively from it by focusing on a few high-quality businesses that followed a similar path. Paradoxically, they also argued that it was less risky for them to own a small number of stocks (usually about ten) than to own hundreds—a standard strategy that would inevitably have produced less dazzling returns. “We knew that we didn’t know many things,” says Sleep. “So it made sense to us only to have a few shares because those were the only things we ever understood and ever really knew.” It was no surprise to them that the businesses they knew the best and loved the most—Amazon, Costco, and Berkshire—proved remarkably resilient even when the world was turned upside down by COVID-19. After all, their economies of scale enabled them to provide customers with exceptional value for money. “With Amazon and Costco, in particular, what you’ve seen is their businesses being enhanced by the crisis,” says Zakaria. “The worse the environment gets for the economy in general, the better it gets for these cost-advantaged businesses.” Fourth, it’s not necessary to behave unethically or unscrupulously to achieve spectacular success, even in a voraciously capitalistic business where self-serving behavior is the norm. During the financial crisis, Sleep wrote about the destruction caused by a culture in which “the players just have to win” and “are not too squeamish about the means.” He and Zakaria wanted Nomad to embody a more enlightened form of capitalism. This explains why they adopted a fee scheme that favored their shareholders over themselves. They were generous to each other, too. For example, Zakaria insisted that Sleep should own 51 percent of their investment firm, instead of an equal share; if a disagreement were ever to arise, Zakaria trusted Sleep to make the final decision. Sleep says it was unthinkable to abuse a partner who had “loaded a revolver, passed it across the table, and said, ‘Go on, then, you can shoot me if you like!’ ” He adds, “There’s a kindness to the relationship, which I think is important to our success.” It’s telling that they still share an office several years after winding up their fund. As Sleep puts it, Good behavior has a longer shelf life.” A strong emphasis on charity is also a distinguishing feature of their gentle version of capitalism. “Once we had proved what we wanted to do running Nomad, it was very obvious to both of us that the job at hand was to give the money back to society,” says Sleep. “It lowers the risk of us being bent out of shape by having too much money.” Plus, “you have the joy of giving it away.”

  • Fifth, in a world that’s increasingly geared toward short-termism and instant gratification, a tremendous advantage can be gained by those who move consistently in the opposite direction. This applies not only to business and investing, but to our relationships, health, careers, and everything else that matters. Deferring gratification is no easy task, given the environment in which we live. In wealthier nations, everything is available on demand—limitless food, information, bingeable TV shows, every flavor of porn, or whatever else tickles our fleeting fancy. Our attention spans are shortening under a high-speed bombardment of emails, text messages, Facebook posts, and Twitter notifications. Similarly, in the investment realm, we can now dart in and out of the market instantaneously by pushing a few keys on our mobile phones. We’re all struggling in our own ways to adjust to this technological and social revolution, which is both miraculous and perilous. As pleasure-seeking creatures, we tend to be drawn to whatever feels good now, despite the price that we (or others) may have to pay later. This is evident not just in our individual lives but collectively in everything from government deficits to unconstrained energy consumption. “It’s all about deferred gratification,” says Sleep. “When you look at all the mistakes you make in life, private and professional, it’s almost always because you reached for some short-term fix or some short-term high.… And that’s the overwhelming habit of people in the stock market.”

  • Gayner, who is now the co-CEO of Markel, a financial holding company with insurance and investment operations around the world, may not set any records for the 100-meter dash. But his running habit (topped off with a little yoga and some modest kettlebell lifting) helps him to handle the physical demands and daily stress of a relentless job that involves managing about $21 billion in stocks and bonds, plus a collection of nineteen fully owned companies, not to mention around seventeen thousand employees. “If you’re an executive or a money manager who has these kinds of responsibilities, you’re playing the game twenty-four hours a day, seven days a week. There’s no off-season. There are no days off,” he says. “As a consequence, I think it’s very important to be disciplined about paying attention to your wellness, your sleep, your exercise, a little work-life balance, spending time with your wife and kids and your fellow parishioners—all these sorts of things.” Such behavior “may not create the outcome that you want, but it improves your odds.” What’s distinctive is the indomitable consistency of his discipline. Most people get fired up for a few days, then flame out. I own a kettlebell and a skipping rope, neither of which I’ve used more than three times. The primary purpose of their existence is to make me feel guilty. Yet Gayner keeps plugging away, never perfect, but always directionally correct. The key, he says, is that he is “radically moderate” about everything he does. “If I make extreme changes, they’re not sustainable. But moderate, incremental changes—they’re sustainable.”

  • Resounding victories tend to be the result of small, incremental advances and improvements sustained over long stretches of time. “If you want the secret to great success, it’s just to make each day a little bit better than the day before,” says Gayner. “There are different ways you can go about doing that, but that’s the story.… Just making progress over and over again is the critical part.”

  • Many investors lurch erratically from one short-term bet or promising strategy to the next, much like yo-yo dieters who bounce between fad diets without entrenching a sustainable solution. Gayner, the patron saint of steady progress, adheres to a stock-picking strategy built on four principles that haven’t changed in thirty years. They point him in the right direction and help him to avoid “being stupid.… They’re like guardrails.” First, he seeks “profitable businesses with good returns on capital and not too much leverage.” Second, the management team must have “equal measures of talent and integrity.” Third, the company should have ample opportunity to reinvest its profits at handsome rates of return. Fourth, the stock must be available to him at a “reasonable” price. Once Gayner finds a business that passes his four-part test, he looks to invest with “a forever time horizon,” leaving the stock to compound indefinitely while deferring the tax consequences of selling. Berkshire Hathaway was the first stock he bought at Markel back in 1990, and his stake has snowballed to more than $600 million. Buffett made a mistake in 1965 when he acquired control of Berkshire, which was then a failing textile manufacturer destined for extinction. Still, the stock has since soared from about $15 to $330,000 as he’s reinvested the company’s assets in greener pastures. “What you had going for you,” says Gayner, was that the person “making the reinvestment decisions was a genius.” As Gayner sees it, Berkshire demonstrates that the most important of his four criteria is number three, “the reinvestment dynamic.” Gayner’s second-largest holding is CarMax, which he’s owned since the late 1990s. Back then, it was a small company with the novel idea of selling used cars at fixed prices, violating the tradition of haggling with and hoodwinking buyers. Gayner, a devout Episcopalian who was raised as a Quaker, recalled that the Macy’s department store was founded in the 1850s by a Quaker who sold each item at a set price, eliminating any suspicion that customers would be duped by sly salesmen. Wouldn’t CarMax enjoy a similar advantage, given its commitment to transparency and fair dealing? What’s more, the stock was cheap and CarMax had boundless opportunities to reinvest its profits by opening new dealerships. Since he first invested, it has expanded from about eight dealerships to two hundred, and the stock has risen more than sixtyfold. Gayner’s portfolio is dominated by dependable compounding machines such as Brookfield Asset Management, the Walt Disney Company, Diageo, Visa, and Home Depot—businesses that he expects to prosper for a long time, despite the threat of creative destruction. For example, it reassures him that Diageo owns Johnnie Walker, a two-hundred-year-old brand of Scotch whisky: “That seems to me to be a pretty durable thing. So I just try to find things like that in life.” He’s not looking to trade them, but to sit tight as they grow: “It’s been my experience that the richest people were those who found something good and held on to it. The people who seemed the least happy and the most frenzied and the least successful are those that are always chasing the next hot thing.” In all, Gayner owns about one hundred stocks, which may be overly defensive. But two-thirds of his assets are in his top twenty positions, which is moderately aggressive. His attitude toward tech stocks such as Amazon, Alphabet, and Facebook has been similarly measured. He was “very slow” to appreciate their sustainable competitive advantages, but belatedly recognized that they met his four investment criteria. Still, they weren’t cheap, and he couldn’t value them precisely. So he took an incremental approach. He “steadily” accumulated big (not huge) positions, dollar-cost averaging his way in to reduce the risk of overpaying. If he has blundered, it won’t be disastrous.

  • Gundlach, a brash and brilliant billionaire known as the King of Bonds, says he’s wrong about 30 percent of the time. So he asks one critical question before making any investment: “If I assume that I’m wrong on this, what’s the consequence going to be?” He then tries to structure his bet so the outcome won’t be ruinous, whatever happens. “Make your mistakes nonfatal,” Gundlach tells me. “It’s so fundamental to longevity. And ultimately, that’s what success is in this business: longevity.” Gayner’s portfolio is built to last. It would have been much more lucrative if he’d loaded up on Amazon, Google, and Facebook. But his investment decisions—much like his approach to food and exercise—are not intended to be optimal. Rather, he’s attempting to be consistently and sustainably sensible. The cumulative effect of operating this way over three decades has been extraordinary because he has harnessed the power of long-term compounding without ever galloping “at such a pace” that he would heighten “the odds of some catastrophic falloff.”

  • You cannot control the outcome,” says Gayner. “You can only control the effort and the dedication and the giving of one hundred percent of yourself to the task at hand. And then whatever happens, happens.”

  • Early in his career, Bill Miller asked Lynch for advice. Lynch told him that the investment business is so rewarding financially and intellectually that it attracts an overabundance of intelligent people. “The only way you can beat them is to outwork them,” said Lynch, “because nobody is just so much smarter than the next person.” Lynch told Miller that he stayed ahead of the pack by reading investment research while he carpooled to the office at 6:30 a.m., working after dinner and on weekends, and taking no vacations for years. When Miller asked if it was possible to slow down as you got older, Lynch replied, “No. In this business, there are only two gears: overdrive and stop.” Miller agrees: “That’s basically right. You have to be focused.”

  • Lountzis is a warm and exuberant man who speaks effusively of his four adult children and his wife, Kelly, who has stayed by his side for almost forty years. But his life is built almost entirely around his compulsive craving for any knowledge that could make him a better investor. “I try to read four, five, six, seven hours a day, seven days a week,” he says. “I have no hobbies. I have never golfed in my life.… It’s just my personality—always trying to get smarter, to learn.” He regards social functions as a bothersome distraction: “I love people. But if I’m not learning and growing and being stimulated intellectually, I’d rather be elsewhere.” Part of what he cherishes about his wife is that “she places no demands on me, and I can’t tell you how important that is.… She understands me and lets me be me. Very few people could be married to me.” Lountzis makes no apologies for his extremism: “You need a maniacal focus to really be great at anything. Anyone who tells you that you can have everything all at once, you can’t. I mean, you don’t become Roger Federer by not playing tennis. It has to be consuming.”

  • Geritz’s willingness to travel extensively gives her a cumulative advantage over more parochial investors. “The more you go out into the world, the more you see the patterns,” she says, including cycles of boom and bust that recur in different countries as credit expands or contracts and optimism rises or falls. This pattern recognition helps in “avoiding the massive blowups you can get in emerging and frontier markets.” For example, she sold out of Brazil during a period of euphoria when foreign capital had flooded in, the government had overspent, and prices had gone crazy. The symptoms of excess looked ominously familiar. “The hotels were a thousand dollars a night, easily,” she recalls. “I had spent, I think, thirty-five dollars on a piece of pizza in the airport.” She saw similar warning signs in Nigeria when foreigners piled in, convinced that it was “the best investment destination in Africa.” Her wary verdict: “I’ve seen that movie before. I’ve seen it in China when valuations go high and everyone loves the market. I’ve seen it in Brazil.” Before each trip, Geritz creates a study program designed to enrich her understanding of the place she’s visiting. “I try to read at least three books for every country I go to,” she says. Typically, one book is about the economics or politics of the country or region; one is a work of literature; and one is a lighter piece of pop culture, such as a mystery or crime novel. “If we’re going for a research trip to Uganda, I probably carry a tiny suitcase full of clothes and a giant backpack full of twenty books,” she says. “It’s a big joke.” She also carries a Kindle, “but I’ve had it go down in a couple of countries, and I can’t live without books.”

  • If there is one habit that all of the investors in this chapter have in common, it’s this: They focus almost exclusively on what they’re best at and what matters most to them. Their success derives from this fierce insistence on concentrating deeply in a relatively narrow area while disregarding countless distractions that could interfere with their pursuit of excellence. Jason Zweig, an old friend who is a personal finance columnist at the Wall Street Journal and the editor of a revised edition of The Intelligent Investor, once wrote to me, “Think of Munger and Miller and Buffett: guys who just won’t spend a minute of time or an iota of mental energy doing or thinking about anything that doesn’t make them better.… Their skill is self-honesty. They don’t lie to themselves about what they are and aren’t good at. Being honest with yourself like that has to be part of the secret. It’s so hard and so painful to do, but so important.” I think this applies to any elusive skill that we hope to master, whether it’s picking stocks, healing patients, or wrestling with words. One of my heroes is the late Oliver Sacks, an eminent neurologist and a superb author, who put up a big yellow sign in his house with the word NO! written on it in block letters. In a memoir, he explained that it was his way of “reminding myself to say no to invitations, so I could preserve writing time.” Thousands of years earlier, the Taoist philosopher Lao-tzu wrote that the path to wisdom involves “subtracting” all unnecessary activities: “To attain knowledge, add things every day. To attain wisdom, subtract things every day.” The art of subtraction is incalculably important, particularly in an age of information overload when our minds can so easily become scattered.

  • Tillinghast, a shy and timid math whiz who manages more than $40 billion in assets, has developed a plethora of defensive principles and practices, which have helped him to outperform—and outlast—almost all of his competitors. For a start, he says, “Don’t pay too much. Don’t go for businesses that are prone to obsolescence and destruction. Don’t invest with crooks and idiots. Don’t invest in things you don’t understand.” Tillinghast also steers clear of businesses that are deeply cyclical, heavily indebted, or faddish. He views “promotional management” and “aggressive accounting” as “red flags.” He shuns areas where he has no special insight or skill because nothing is more critical than “staying away from your ignorance.” He also refrains from talking “too publicly or too frequently” about his holdings because that would make it harder to change his mind and admit when he was wrong. And he resists the urge to trade stocks actively, since that would generate onerous transaction costs and taxes, which would erode his returns. What’s left once he’s eliminated all of those common causes of disappointment? A portfolio packed with undervalued, understandable, financially stable, profitable, and growing businesses run by honest people.

  • Those formative experiences of market folly reinforced the lesson that Martin had learned at sea. Nothing matters more than averting obvious errors with the potential for catastrophic consequences. But in the decades that followed, he would observe the same pattern again and again: heedless risk followed by unnecessary disaster.

  • For example, during the internet and telecom craze of the late 1990s, some of his clients jumped ship and invested a major portion of their life savings with Jim Oelschlager, a gunslinging tech evangelist who, at his peak, attracted more than $30 billion in assets. Oelschlager ran narrowly focused funds filled with overpriced highfliers such as Cisco Systems. When the bubble burst in 2000, Cisco lost $400 billion in market value. As Martin had feared, gung-ho investors who were overexposed to such ultra-aggressive funds were “immolated.” Another client phoned to ask if Martin could guarantee a 12 percent return “every year without fail.” Martin told him that stocks are too volatile to promise that level of consistency: “And he said, ‘Aww, a guy in New York—a genius named Madoff—won’t tell anybody how he does it, but he does 12 percent like clockwork.” So the client entrusted his savings to Bernie Madoff, operator of the biggest Ponzi scheme in history. The lesson? “If people can’t tell you how they do it” and “you can’t understand what they do,” says Martin, “that’s probably not the best spot to be in.” His “golden rule for risk management” is simple: “Know what you own.”

  • As Martin sees it, the best defense against disaster is to “understand the core principles” of investing and then have the “basic discipline” never to violate these “financial laws of gravity.” The most essential law is always to maintain a margin of safety, which stems from buying assets for less than they are worth.

  • Martin will buy a stock only if it’s cheap enough to generate a high expected rate of return over the next seven years. For mid-cap stocks, he requires a minimum rate of return of 12 percent a year. For small caps, which have a greater risk of failure, he requires a minimum of 15 percent a year. Why does this matter? Because those standardized requirements force him systematically to buy stocks only when they are a sufficiently attractive proposition. As Martin learned in the navy, “adherence to process” is an indispensable safeguard: “Always honor it because that’s going to keep you out of trouble.”I This idea of adopting a few standard practices and unbendable rules is our fourth technique for reducing stupidity. Buffett and Munger may not need formal constraints to maintain their discipline. But you and I are not them. Martin has another rule that he observes “religiously” as a protection against calamity. He never invests more than 3 percent of his assets in a stock at the time of purchase. Typically, he owns forty-five to fifty stocks. Is that too conservative? Absolutely. But it hasn’t prevented him from beating the indexes by a wide margin over decades, and it has prevented no end of misery.

  • In 1998, I wrote a damning article about the Kaufmann Fund, which had hit the jackpot as a small fund making big bets on tiny stocks. Stellar returns and relentless advertising transformed it into a different beast. With nearly $6 billion in assets, it could no longer focus aggressively on small caps, and its results deteriorated. Still, its two managers raked in $186 million in fees over three years, despite lagging the S&P 500 by more than 50 percentage points. One even admitted to me that he had none of his own money in the fund. That’s misalignment. All these years later, I’m not shocked to see that the fund still charges an egregious expense ratio of 1.98 percent a year. With $7.5 billion in assets, it’s a fantastic fee machine. Given the economies of scale, wouldn’t it be fairer to charge less? Sure. But who would benefit? Only its shareholders.

  • By contrast, Martin accepted long ago that he’s incapable of investing large sums in small stocks without hurting his shareholders’ returns. So he closed his small-cap portfolio to new investors in 2006 when his firm’s assets in that area amounted to only $400 million. That self-restraint has cost him tens of millions in fees, but it has served his existing clients admirably. It’s always revealing to see how investors structure their incentives. As vice chairman of Berkshire, which has a market value of more than $500 billion, Munger receives a salary of $100,000. As chairman of the Daily Journal, he receives no salary. He profits from performance, not fees.

  • Munger particularly admires their unflinching determination to seek out “disconfirming evidence” that might disprove even their most cherished beliefs. This mental habit, which takes many different forms, is our fifth defense against idiocy.

  • Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.