In one sentence: A rerun that goes through Bill Ackman's eight principles one at a time, then adds the ninth Phil says Ackman leaves out: the price.
Rerun. This is a rerun of an earlier episode in the same series; see 274 and 275 for the first two parts. Only what is new here is recorded.
Key ideas
- Never stop learning. Phil and Danielle open on Buffett and Munger as learners. Danielle says the Buffett letters show how often he admits mistakes and says what he will change. [01:00–04:00]
- Your size advantage. Buffett cannot dump a big holding quickly (he said he was "not nimble" about Coca-Cola), while a small investor can exit in seconds. Phil says his own larger positions now face the same problem. [04:00–07:00]
- What Buffett checks at year-end. Danielle cites the 2007 letter: earnings, not the share price, and whether the moat got wider. [07:00–08:00]
- The eight principles. Simple and predictable; free-cash-flow generative; dominant market position; large barriers to entry; high return on capital; limited exposure to extrinsic risks; strong balance sheet; excellent management and governance. Phil's reading: "simple and predictable" is sturdier than "capable of understanding", since hubris creeps into the second. [11:00–14:00]
- Free cash flow and ROIC are symptoms of a moat. Phil says return on capital is the first thing he looks at: double digits for ten years or more, and he now has 30 years of data in his toolbox. [19:00–22:00]
- Debt rule of thumb. Keep debt under about three years of free cash flow or earnings, with exceptions such as a finance arm (John Deere). [21:00–23:00]
- Barriers to entry are easy to misjudge. Coca-Cola's brand and distribution are a barrier; encyclopedias had one until the internet. If you can't tell what the barrier is, treat it as too hard. [16:00–20:00]
- Extrinsic risk. Things you can't control, such as new technology, legislation and regulation (the harness-maker and typewriter examples). [23:00–25:00]
- Management. Hard to judge; Danielle reads how they write, who they put on the board, and how Buffett praises named managers. [25:00–27:00]
- The missing ninth: on sale. Ackman is an activist who can change a company, so he can skip a margin of safety. Phil says an ordinary investor can't force changes and must buy cheap. The eight are a screen for what a great business is; price comes as step two. [27:00–31:00]
How it maps to RuleOne
- The screen's ROIC, free-cash-flow and debt-to-earnings columns map to principles two, five and seven.
- The stock page's sticker price and margin-of-safety price are the "ninth" principle.
- Candidates that pass go on the watch list.
Buffett, Munger and Graham links
- Ackman's list restates Munger's four filters; Phil maps "predictable" to the first two filters.
- Buffett's 2007 Berkshire letter (earnings and moat width), as Danielle recounts it. Check the exact wording before quoting.
- Graham's margin of safety (The Intelligent Investor, ch. 20) is the missing ninth principle.
Words to know
- Extrinsic risk: risk from outside the business that it cannot control.
- Activist investor: someone who buys a stake large enough to push a company to change.
Try this
On /stocks/ pick one company and score it 0 or 1 on each of Ackman's eight. Then open its /stock/TICKER/ page and note whether the price is below the margin-of-safety price.
Check yourself
- Why does Phil prefer "simple and predictable" to "capable of understanding"?
Answer
Hubris: experienced investors assume they are capable. Asking whether the business is simple is harder to fool yourself on. - What debt level does Phil use as a rule of thumb?
Answer
No more than about three years of free cash flow or earnings, with exceptions such as a finance arm. - Why is price missing from Ackman's list, in Phil's view?
Answer
Ackman is an activist who can change a company, so he can pay full price. Ordinary investors cannot, so they need a margin of safety.
Short quotes
"If you don't know what the barrier to entry is, just assume that it's too hard and move on." (Phil, ~18:30, auto-transcribed)