In one sentence: Phil answers listener questions about marijuana stocks and startups: first check that the business matches your values, then recognise that new industries and pre-profit companies are too unpredictable for Rule #1, though studying them now may pay off later.
Key ideas
- Values first. You are voting for what you fund. Phil thinks owning something you dislike carries "karma" and makes you tire of the research. Danielle notes that legal marijuana has worked well in Colorado, so the decision is personal. [03:00–08:00]
- A new industry lacks predictability. Rule #1 buys proven businesses when fear (an event) hits them, so you need to be sure they'll be larger in 10 years. Picking a winner in marijuana now is like picking a car company in 1910. [08:00–10:00]
- Gambling versus investing. If you want to speculate, you can, but call it that. [11:00–12:00]
- Study now, buy later. Learn the industry as it consolidates and bigger firms (such as Constellation Brands) move in. Phil bought Google only after using its ads and understanding the moat, at about $200 against a $87 IPO price. [10:00–14:00]
- Size matters. Even if you did pick the winner, the odds are thin, so you could only put in small money; Rule #1 puts about 10% of the portfolio into each business that is well understood and cheap. [13:00–14:30]
- Why Rule #1 skips startups and venture capital. It expects 10 winners from 10, not a few big winners to cover losers. Early-stage companies have no cash-flow history, so profits can be an accounting illusion, and funding comes through debt or dilution. [15:00–19:30]
- Four Ms applied to startups. You can understand the business and maybe judge the management, but the moat is hard to prove, there are no return-on-equity numbers, and above all you can't value it, so you can't buy it on sale. [18:00–21:00]
- Venture pricing is guesswork. VCs assume huge target returns (40 to 50% a year) and guess ownership. Phil cites the SoftBank/WeWork overpricing as an example. [20:00–21:30]
- Jockey or horse. Venture investors like Brad Feld back people over ideas, because the plan will change. Danielle agrees that moat and management are what VCs weigh most. [22:00–24:30]
- For entrepreneurs. Build toward the kind of business Buffett buys in distress. [24:30–25:00]
How it maps to RuleOne
- A pre-profit company will fail the screen's cash-flow and ROIC filters by design, which is the intended result.
- Use the watch list as a place to study a young industry without buying.
Buffett, Munger and Graham links
- Graham's split between investment and speculation (The Intelligent Investor, ch. 1) fits the startup discussion.
- Munger's four filters in 001 are the "Four Ms" Phil applies here.
Words to know
- Venture capital: investing in early-stage companies expecting some failures.
- Dilution: new shares issued, shrinking each existing holder's share.
Try this
List one young industry that interests you. On /stocks/, check how many of its companies pass the cash-flow history filter, and write one sentence on why you can or cannot predict it 10 years out.
Check yourself
- Why doesn't Phil buy marijuana stocks now?
Answer
The industry is new and unpredictable, so he can't be confident of the winners or a fair price. - Which of the Four Ms fail first for a startup?
Answer
Moat is hard to prove and valuation is impossible, with management only partly knowable. - What does Phil suggest instead of buying now?
Answer
Study the industry and watch for consolidation, then buy a clear winner at a good price.
Short quotes
"You're going to be gambling and speculating… just know that you're doing it." (Phil, ~11:30, auto-transcribed)