In one sentence: Jake Taylor, CEO of Farnam Street Investments, explains how to judge a management team by where it puts the money, why professional fund managers are pushed toward short-term thinking, and why buybacks should be judged by price against value.
Key ideas
- Why a novel. Taylor wrote the lessons as a story, since a dry business book would be forgotten. The mentor figure is modelled loosely on Buffett and Munger. [05:00–08:00]
- What capital allocation is. Whatever a business does with its money, from supplies to buybacks and acquisitions. He also calls it a CEO's main job. [08:00–09:30]
- Read the cash flow statement as a story. Taylor looks at what management spent money on in each period, puts himself in their position and asks what he'd have done. Did they explain their thinking clearly? [10:00–12:00]
- Think for yourself. The Outsiders (Thorndike) shows that great allocators are independent of the herd, and he sees the same edge for individual investors. [11:30–13:00]
- Price is the herd test. Taylor says buying an index fund in 2009 made sense, while buying heavily after ten years of a bull market means paying for a very rosy future. He cautions against drawing straight lines up. [13:00–16:00]
- Efficient, but not completely. Markets are mostly efficient and more so than decades ago, but not completely, so it's worth hunting for bargains. Patience over years is one of the last edges, since beating others on data is expensive. [16:00–20:00]
- The fund manager's incentives. Danielle's point: a manager who lags peers for a year can lose the job, so the incentive is to keep up, not to be right. Taylor agrees it's a principal-agent problem. [19:00–23:00]
- Investors lose even in great funds. He recalls a top fund of the 2000s whose investors earned far less than the fund itself, because money arrived after gains and left after losses. He cited a figure of roughly -10% for investors against +17% for the fund; treat the numbers as his recollection. A second story concerned a fund that lost most of its assets in one bad year and then recovered. [23:00–27:00]
- Judging allocators. Best use of cash is usually reinvesting in the business, so check return on invested capital, ideally on incremental capital. Compare See's Candy (very high returns, little room to reinvest) with BNSF (roughly 10% regulated-type returns, can absorb huge capital). [35:00–39:00]
- Buybacks and fairness. Buybacks at deeply cheap prices help remaining holders but treat sellers poorly. Taylor argues a steward should want price near intrinsic value so both leave fairly. This is a minority view, and Phil questions it. [38:00–43:00]
How it maps to RuleOne
- The management and capital-allocation checks on /stock/TICKER/ (ROIC history, buyback and share count trend, cash flow) match Taylor's approach of reading the cash flow statement.
- Share count over time shows whether buybacks were done at sensible prices relative to your own value estimate.
- Principal-agent thinking matters for the ownership and insider data: management who own stock behave more like partners.
Buffett, Munger and Graham links
- Buffett's letters (for example 1984, on the repurchase of shares) say buybacks make sense only below intrinsic value.
- The Outsiders by William Thorndike covers Henry Singleton of Teledyne, the buyback example here.
- Buffett and Munger on institutional imperative: Buffett's 1989 letter describes it, and the same herd pull is at work here.
Words to know
- Capital allocation: how a company spends its cash (reinvestment, buybacks, dividends, acquisitions, debt paydown).
- Principal-agent problem: when the person managing money has different incentives from the owner of it.
- Incremental ROIC: the return earned on newly added capital, not on the old base.
Try this
Pick a company you know on /stocks/, open its page and check the share count over ten years and the ROIC trend. Write one paragraph on what management seems to have done with the cash, as Taylor does.
Check yourself
- Why does Taylor say reinvestment in the business is usually the best use of cash?
Answer
Management knows that business best and it can earn high returns while widening the moat, if it can absorb the capital. - Why do fund managers tend to follow the crowd?
Answer
Lagging peers for a year can cost them clients or the job, so keeping up is safer than being right. - What is the contrast between See's Candy and BNSF?
Answer
See's has very high returns but can't take new capital; BNSF earns a lower return but can absorb a lot.
Short quotes
"Thinking for yourself is your biggest advantage." (Taylor, ~12:30, auto-transcribed)