In one sentence: A new-year conversation in which Phil and Danielle say value investing is won by patience and process rather than IQ, warn that the market looked expensive on two broad measures, and talk about the pain of the great stocks you didn't buy.
Key ideas
- Challenge the premises. Danielle, trained as a lawyer, tests Phil's arguments. Phil says you need someone to challenge your thesis or you fall into confirmation bias and ignore what disagrees with you. Aim to know a company's negatives better than the people saying "don't buy". [02:00–03:30]
- It isn't an IQ game. The winners are relentlessly careful about buying things they don't understand, and patient while a company they do understand goes on sale. Graham devised it, Buffett has used it for 50-plus years. [03:30–04:30]
- Refine the process, then actually do it. Danielle says the hard part is sticking to the process, not designing it. [04:30–05:30]
- The margin of safety is for human error. We miss things, so insist on a gap between value and price. Phil, citing Mohnish Pabrai, wants a lot of upside and little downside, and tells you to watch the downside. [05:30–06:30]
- Retail trading frenzy. Danielle reads about TikTok, Discord and Reddit crowds piling into stocks like Tesla. Phil compares the internet's effect on finance to the printing press: free information for everyone, but most fund managers and amateurs alike buy what is going up. Taxi-driver tips are an old sign of a top, though low interest rates may prolong things. [06:30–14:00]
- Two valuation gauges, as Phil states them (early January 2021). The "Buffett indicator" (total US stock market value to GDP, on FRED) at about 200%, higher than he has seen in 50 years. The Shiller cyclically adjusted P/E around 34, seen only in 1999 and 1929, against an average near 16. He says a normal crash could take the market down 60 to 70%. He adds he has no crystal ball and Mark Twain's "history rhymes". These are his readings and his opinion, not a forecast, and current values should be checked. [14:00–19:30]
- Buffett's cash again. Phil points to about $150 billion of Berkshire cash as evidence the best investor thinks the market is near its limits. See 297. [19:30–20:00]
- Go back to the letters. Danielle reread the early Berkshire and partnership letters for grounding in a chaotic year, and invites listeners to read a couple a day. Phil says they shaped his investing for 40 years. [20:00–23:00]
- What investing is. Buy an asset that will be much more valuable later, with a margin of safety so you don't lose money. "Rule #1" is what the rest of the world calls value investing. [23:00–24:00]
- Errors of omission hurt. Danielle still stews over Lululemon, which she passed on when it was small and unproven. Phil says Rule #1 investors agonise over what they skipped, not what they bought. Buffett missing Amazon is the example: he couldn't tell where it would be in 10 years, and if you can't, you aren't investing. Different smart people reach different answers, so be comfortable with your own. [30:00–34:30]
- Plans for 2021. Finish the checklist discussion, review Li Lu's 2015 speech on value investing in China (next week, 300), and walk through real company purchases made by students from start to finish. [24:00–29:30, 37:30–39:30]
- Procedural note. The show notes describe a three-circles exercise, but the audio is mostly the above. [00:00–40:00]
How it maps to RuleOne
- The screen is the process in code: a margin-of-safety filter keeps you from being moved by the crowd. The home page / shows how few names qualify when the market is high.
- Phil's market-level gauges (Buffett indicator, Shiller P/E) aren't on the site; they are external context, and the agent stack doesn't use them.
- A thesis and "what could be wrong" note in /holdings/ acts as the stand-in for a person who challenges your premises.
Buffett, Munger and Graham links
- Margin of safety: Graham, The Intelligent Investor, ch. 20; Buffett calls it the central idea of investing.
- The Buffett indicator comes from Buffett's 2001 Fortune article ("probably the best single measure of where valuations stand"), which also warned against reading too much into one measure. Check the article for his wording.
- Buffett on missing Amazon: remarks at Berkshire annual meetings (2017 onward) say he didn't see how big Bezos's business would be. See also 296 on innovation.
Words to know
- Buffett indicator: total stock market value divided by GDP.
- Shiller P/E (CAPE): price over ten-year average inflation-adjusted earnings.
- Error of omission: a missed gain from not buying.
Try this
Look up the Buffett indicator on FRED (Wilshire 5000 to GDP) and the Shiller P/E, and write down both. Then open /stocks/ and count what share of names pass the screen. Is the market's price level matching what the screen finds, name by name?
Check yourself
- Why do you want someone to challenge your thesis?
Answer
To avoid ignoring evidence that disagrees with you; know the negatives better than the sellers do. - What is Rule #1's answer to being wrong about a company?
Answer
A margin of safety, so mistakes still cost little. - Why did Buffett pass on Amazon in Phil's telling?
Answer
He couldn't tell where it would be in 10 years, so buying wouldn't have been investing by his rules.
Short quotes
"Rule One investors don't make that kind of mistake very often. So we have to agonize about the things we didn't buy." (Phil, ~32:00, auto-transcribed)