/Episode #148: Paul Lountzis, “The Qualitative Characteristics Are Becoming Significantly More Meaningful And More Important In Company Analysis”

Episode #148: Paul Lountzis, “The Qualitative Characteristics Are Becoming Significantly More Meaningful And More Important In Company Analysis”

Episode #148: Paul Lountzis,“The Qualitative Characteristics Are Becoming Significantly More Meaningful And More Important In Company Analysis”

Guest: Paul
Lountzis is the Founder and President of Lountzis Asset Management, LLC. Prior
to forming Lountzis, he was an analyst at Royce & Associates from 1989
through 1990, where he evaluated small and mid-cap stocks. That was followed by
a stint at Ruane, Cunniff & Goldfarm Inc. as an analyst from 1990 through

Date Recorded: 3/20/19

Run-Time: 1:14:13

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Summary: In episode 148 we welcome Paul Lountzis. Paul starts with his background in consulting that led him to develop a skillset in competitive analysis that meant going out into the field to conduct research far beyond the numbers, leading to “differential insights.” He wanted to get into value investing and reached out to a number of firms including Warren Buffett’s assistant, Gladys Kaiser. He ended up interviewing with Chuck Royce’s partner, Tom Ebright, and after Chuck saw his work, he was put on research projects for Chuck. He then went to work for Ruane, Cunniff & Goldfarm before founding Lountzis Asset Management.

Paul then discusses his framework of finding outstanding
businesses that are unique, different, and special. He talks about that changes
that are taking place and how the qualitative characteristics are becoming
significantly more meaningful in company analysis. He highlights the importance
of field research primarily to prevent permanent loss of capital, and to drive
greater conviction to potentially make bigger bets on companies.

Meb then asks Paul to get into the investment
process at Lountzis. Paul emphasizes a long-term holding period, screening on
financial metrics like return on investment capital, free cash flow, revenue
growth, and covering 600-700 names across the team. Beyond that, the team digs
into further insights, from management elements like capital allocation,
shareholder friendliness, and the quality of their operating ability, to
valuation and the general level of inflation and taxation. He then dives into
some examples of how he and his team identify businesses that are unique,
different, and special in practice.

Meb then gets into questions on risk. Paul discusses
how he and his team look at position sizing and risk based on the clarity in which
they understand the business.

The conversation then shifts into a discussion
about the current and future state of Berkshire Hathaway. Paul talks about how
unique and special Warren Buffett is, how valuable the underlying businesses
are that Berkshire owns, and a couple of items that concern him about life
after Warren Buffett and Charlie Munger.

All this and more in episode 148, including a
special story about a hand he played in helping students meet Warren Buffett.

Links from
the Episode:

Transcript of
Episode 148:

Welcome Message: Welcome to
the “Meb Faber Show,” where the focus is on helping you grow and
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Disclaimer: Meb is the
Co-founder and Chief Investment Officer at Cambria Investment Management. Due
to industry regulations, he will not discuss any of Cambria’s funds on this
podcast. All opinions expressed by podcast participants are solely their own
opinions and do not reflect the opinion of Cambria Investment Management or its
affiliates. For more information, visit cambriainvestments.com.

Meb: Welcome, podcast
listeners. It’s officially the first day of spring. We’re recording this on
March 20th, a beautiful 70-degree morning in Los Angeles. We have an excellent
show for you today. We’re taking it back to the old school. Our guest is the
founder of Lountzis Asset Management. Prior to starting that, he spent time at
two the most storied value investing shops on the street, Royce and Associates,
as well as Ruane and Cunniff. Welcome to the show, Paul Lountzis.

Paul: Thank you for having
me. I appreciate the opportunity.

Meb: Paul, this is gonna be a
lot of fun. And as some of the prep for this interview was doing some research
on your background and everything else. And sometimes we skip over background,
sometimes we start with it. But seeing as you had two of the most storied
investment shops, particularly in the values sphere in history, would love to
hear a little bit about your background. And I saw somewhere that you got
inoculated with the value gene at a pretty early age. Why don’t you walk us
through your progression as a value investor?

Paul: I was born and raised
in Reading, Pennsylvania, about 60 miles northwest of Philadelphia. And about
age 12, 13 when Mr. Buffett was buying “The Post,” that’s when I
first got introduced to him. So I was around 13 years old, 1973 or so. And it
wasn’t like today where information was so available, but that was the initial
inoculation, if you will. Then I went to college, graduated with a finance
degree. And then I went to work fortuitously at a small consulting firm heading
towards Philadelphia on the east side of town. And most of the people there had
technical undergraduate degrees from the best schools, Caltech, MIT, Carnegie
Mellon, and MBAs from the best schools, and I had neither. But I really worked
diligently and worked very hard and developed the skill set.

And what that consulting firm
did was competitive analysis for Fortune 500 and Fortune 1000 companies. So
what I did is prior to joining there… I didn’t graduate from college, I was
26. It took me eight years to graduate, I worked full time. But when I started
there, I tried to really always think about value investing and how I could
apply it. Because prior to that, I’d read everything I could, sending for
mutual fund literature from Gabelli and Royce and reading the Berkshires
annuals and so forth.

I really developed the skill
set there, to get on the phone, do the primary research, secondary research,
and then the primary going out into the field and talking to competitors,
customers, former employees, vendors, etc. And I did that for about two and a
half years. And I really developed a skill set and an understanding that goes
far beyond just reading the numbers. So it was a great training ground. We
prepared slides and presentations to the companies, trying to generate what I
call, Meb, differential insight. You know, what’s unique and different? What
are you seeing that others don’t that’s not visible in the numbers? How are you
making the numbers come to life?

So I did that for two and a
half years, and then I felt I had a skill set. And I didn’t wanna stay in
consulting. I wanted to get into investor management. And so I picked up the
phone and I called Mr. Buffett, I think it was Gladys Kaiser who was his
assistant back then. This is the summer of July, right after the 4th of July of
1988. And I called Mason Hawkins and Glenn Greenberg and John Shapiro, and Bill
Ruane, and Rick Cunniff, Chuck Royce, Michael Price, George Michaelis, Tweedy Browne,
Chris Browne.

And Chuck Royce and Michael
Price were kind enough to interview me. And Michael had just moved from New
York City to Short Hills, and he just hired five analysts. He said, “You
know, Paul, if you had called me six months ago I’d hired you.” And Chuck
had a partner, a terrific gentleman named Tommy Bright. I was very fortunate
Tom actually grew up in Reading and went to the same high school as my wife.
And so I went and met with Tom, and he was interested in having me do some
marketing. And then Chuck saw my research and he said, “You’re not gonna
do any marketing, you’re gonna do research.”

And so I spent a couple years
here in New York for Chuck. It was a great experience, I really enjoyed it. I
learned an enormous amount from Tommy Bright, who’s a wonderful human being,
and same for Chuck. And Chuck’s unique in the sense that Chuck is not only a
really, really outstanding investor and stock picker, he’s a really very, very
smart businessman. And those are really… Oftentimes in this business they’re
mutually exclusive. But he had them both, and he was a terrific human being. He
was great to me and my family.

So I spent a few years there.
And while I was working for Chuck, I did a lot of work on many of his large
holdings. I was traveling a couple hundred nights a year. I learned a lot,
enjoyed it greatly, but what I really would have preferred was a firm that had
fewer stock holdings. And because Chuck was small-cap, he had a lot of
holdings. And so I called George Michaelis, the predecessor out at First
Pacific in LA and he said, “You know, Paul, you don’t wanna live in LA,
but you have to call Ruane Cunniff, call Bill Ruane, and Bob Goldfarb.”

And I did, and they were kind
enough to send me the Sequoia letter. And they owned Raspberry and Kimball, who
are both companies I’d done a lot of work for Chuck Royce and Tommy Bright. And
I guess they liked what they heard. And I got an interview there with Bob and
the rest of the team and they ended up hiring me. And I spent almost a decade
there and, I think, I was a partner for about seven years. And then I started
my own shop in 2000.

Meb: Fortuitous timing there,
an interesting start to go out on your own as a value investor. You know, it’s
funny a lot of the younger listeners may or may not know some of the shops that
you’ve mentioned, but it’s honestly some of the names, it’s kind of a Hall of
Fame roster of value investors. And they have a little bit different styles,
you mentioned Royce, it’s pretty famous name in the small-cap brand area. Talk
to me a little bit about… I assume you would call yourself a value investor,
but maybe your evolution and, you know, philosophy of value investing. It means
a lot of different things too, kind of different people, different colors,
different flavors. Talk to us a little bit about how you think about your

Paul: My framework was really
impacted by Bill Ruane, Rick Cunniff, Bob Goldfarb, Carley Cunniff, and Greg
Alexander. And it’s really trying to find outstanding businesses that are
unique, different, and special. And what they do is not easily replicated. And
historically, you know, Meb, years ago when I would do that work for Chuck or
Ruane, years ago, companies had a lot of barriers. It could be government
regulation. You know, the cable business, for example, with cable charters, or
the broadcast industry with broadcast licenses, radio licenses, pharmaceutical companies
with FDA approval, it was a lot of those things.

But what’s really occurred
now, it’s really changing, and that’s a real benefit for our team at Lountzis.
And the reason I say that, the qualitative characteristics are becoming
significantly more meaningful and more important in company analysis. And what
I mean by that is, historically, many, many years ago, you could do
spreadsheets and ratios, and all kinds of searches, databases, and screenings,
and find really outstanding companies. And today, there’s so many talented and
smart people out there doing that. It’s really leveled the playing field
computers have, and so forth.

So now what it’s coming down
to, a lot of those traditional barriers, cable charters, charter licenses,
broadcast licenses, FDA approval, etc. And many of those barriers are falling
by the wayside or are becoming less important because of the rapidity and
magnitude of change in industries and within individual businesses within those
industries. It’s really coming down to organisations that are really able to
rapidly and continuously evolve. And that comes down to having the best people.

And there’s lots of examples
of that where there’s commodity businesses. Auto Insurance and Progressive is a
great example, banking is another one. These are commodity…the traditional
banking, and traditional PNC insurance, especially auto, they’re commodity
businesses. Well, why Progressive over all those years…and Geico. Geico has
gone from a million policies 30 years ago to 13 million or something today, and
they’re number two in the country behind State Farm. And Progressive is number
three, 30 billion in revenue roughly for both. A little bit different,
Progressive is direct as well as…through independent agents, whereas Geico is
all direct.

But my point is, why is it
that they’re able to achieve that? And the answer is they have better people.
They have better people doing the underwriting and better people doing the
claims. And that’s what that business is all about. It’s about underwriting and
learning how to price the risk, and then claims. And so the way the business
has changed is really a positive for us. Because what we think differentiates
us is really going out into the field. We don’t hire consultants, we don’t do
phone interviews, we do the secondary.

And then when we do the primary
research, we’ve done all the numbers, we try to understand the industry
dynamics, the competitive dynamics, the industry size, the industry structure.
And then we also do the financial analysis on each of the competitors
horizontally, the companies in that space. And we often will even look at
private companies and go talk to them. But after we do all that we say to
ourselves, what one, two, three, four or five people on the planet can really
shed insight and give us unique differential insights on the industry, on the
key players, on the dynamics, the competitive dynamics, what’s changing?

And I can give you many, many
examples of that. And one, sadly, one of the finest gentlemen I ever had the
privilege of meeting and interviewing was Karl Eller, who recently passed away
sadly, on Sunday, he was 90. And it’s a great example of how we operate. I was
taking a look at the newspaper business. And I had done several projects for
Alan Spoon and Don Graham at “The Post” because Bill Ruane was on the
board of “The Post.” And I would do work for them, Bill would loan me
to them to do work.

And I was looking at the
newspaper industry and I came across the billboard space. And I noticed that it
only had at that time, this was 2005 or so, they only had 2 down years in like
30, 1970, ’71, I think, and then ’01. And so I thought, “Wow, this is a
stable, predictable business let me delve into it.” So I called the
Outdoor Advertising Association in Washington, got all the specific industry
literature, got the list of the top 10 players. There were a couple of private
companies in the top 10. I went and met with them. And then the big guys were
Clear Channel Outdoor first, and then CBS Outdoor two, and then Lamar number
three. And so we started doing the work.

After we did all the
financial industry analysis and financial analysis of all the public players
and some of the private players, I said, “Who can really add value?”
And I was out in LA interviewing ad agencies and a gentleman there said, “You
ought to go meet this gentleman here in LA.” He was working for JCDecaux,
I did, he had just left Eller because Eller Media had sold the Clear Channel.
And so he was working for JCDecaux in LA now and he said, “You should go
meet Karl.” But he gave me a number of insights himself, and then he said,
“Go meet, Karl.”

So I flew into Phoenix and I
spent half a day with Karl Eller. Now, why is that important? Well, Karl
graduated from the University of Arizona in ’52 and started selling billboards
in ’52. So I got 60 years of billboard insights, he knew everybody. And he was
still doing some of the buying for Coca Cola. So he knew all the players, he
knew the dynamics, he gave me a historical perspective. He knew the father of
the two gentlemen running Lamar, now the sons. And so that’s kind of what we

And why is that important,
because he really made the numbers come to life, historically, day to day, he
was able to share his insights on the quality of the people. And because we
have such a long term horizon, we’re really not interested on next month
earnings or next quarter, we could care less. I mean, we’re just not that
focused. We wanna know what’s gonna happen, or what’s leading us down the road
in this industry, and with this company? We look out 5 or 10 years.

So we spent a lot of time in
the field. And there’s many, many, many examples that I could give you, but
that’s one of them. You know, there’s United Health is another one,
Progressive, but that’s kind of what we do. And we feel it’s really, really
augmentive to go out into the field. And the reason we do it is twofold. The
primary reason is to prevent permanent capital loss. The secondary reason is it
gives us greater conviction to make a bigger bet on the company.

Now, I don’t have the courage
of Bill Ruane, who would make 10 and 15 and 20% bets. We have a little bit of a
different business, we’re all separate accounts, we have enormous amounts of
each of our client’s wealth, in many cases, 100% of their liquid net worth, and
probably 90, 95% of the cases, that is the case. So we do fixed income as well.
But for us, we will allow positions to grow to 10, even as high as 12 or 15.
But at initial purchase, we’re typically in the 5% or so range. Whereas Bill
might make it 10 or 15, or 20, at initial. We’ll let it grow to a high point,
but we just don’t want that concentration.

And combine that with the
fact that we might only be 60% in equity, we can’t have one stock be 25% of the
portfolio at 15%. So it’s a little different, but it’s the same principle in our
mind in terms of prudent concentration, but not as deep as Bill. So those are
the two primary reasons we do all the field research.

Meb: There’s a lot packed in
there. I mean, I think what you described is a lot of the old school boots on
the ground value-added research. You know, it’s interesting talking about
chatting with kind of experts. You know, a lot of investors and younger people,
in general, are often…just kind of throw up their hands and say, “Well,
I don’t have access to that sort of people,” or often kind of too scared
to even make those calls, or make those efforts. But a lot of that is what ends
up giving you that value-added insight that other people may not have.

And one of the parts you
touched on that I think is particularly instructive is it’s not just about
chatting with a company boots on the ground, but chatting with people outside
of the company, whether it’s competitors, or suppliers, or experts in the industry,
to give you some sort of insight or commentary on that business.

Because we all know that
almost every CIO or CEO thinks their business is amazing. So the ability to
chat with other people I think is hugely important. So talk to me a little bit
about… You mentioned a few different techniques. When you examine a company.
Some of these were qualitative, but what sort of traditional metrics are you
looking at? Are you combing through annual reports? Are you reading value line?
Are you looking at any traditional fundamental valuation, cash flows? What’s
kind of the research process look like for you? And talk to me a little bit
about timeframe too, you know, is it something you spend weeks or months on?
And how long do you traditionally hold these positions, all that good stuff?

Paul: The typical whole
period for us is clearly way above five years. But when we think about it, at
inception, we wanna hold a minimum five, you know, barring any fundamental
changes or, you know, having made a mistake and miscalculating something or
misjudging something. But we’d like to hold things 5, 10, 15 years, and we have
in many cases. And Berkshire is a quasi-permanent holding. We’ve
essentially…you know, with rare exception of passing or something, we never
sold that. And then that’s our largest holding.

So we typically…I like to
say 5 to 10 years, and oftentimes even longer. We’ve owned many holdings since
inception, and our firm’s almost 20 years old. So that’s one. The other thing I
would say is with regard to metrics, I try to spend…I spend very little time
marketing. Our team does…it’s all research-based, which is how Ruane was and
Chuck was very similar. It’s research-based. I try to spend anywhere from 7 to
10 hours every day, I get up around 4 in the morning.

Meb: Oh, my god.

Paul: Read the papers. I’m
old now though, Meb, so I go to bed a lot earlier than I used to. I can’t go to
bed midnight anymore and do that. But I get up early I, you know, go through my
emails, do all the reading, “The Financial Times,” “The Wall
Street Journal,” “Barron’s,” “New York Times,” you
know, the standard stuff. I try to read, like I said, 7 to 10 hours a day. And
every time when I’m reading, I’m always thinking what’s unique, what’s
different. What am I seeing here that’s not common?

And with regard to financial
metrics, we’re very financially oriented. We do lots of screenings of
companies. And metrics, we like return on invested capital, free cash flow,
load debt levels, predictability, and certainty in the business, which a lot of
times comes from qualitative factors. We really try to pour over the proxies.
Because when we look at a company, if we look out three, four, or five years,
and really don’t have a reasonably good idea where the business will be. Now,
that doesn’t mean we know, you know, everything about what will happen in five

But if we look at the moat,
and the barriers to entry, and their competitive advantages, and we’re not
really comfortable that they’re strong, we just put it in the too hard pile. So
that’s the first thing we do. The second thing we do is we screen based on
financial metrics that I mentioned, return on invested capital, free cash flow,
revenue growth, which leads to earnings growth. We look at valuation levels.
But oftentimes, valuation is way down the list for us, at least initially. We
just wanna identify great businesses, irrespective of the valuation.

And so we do all those
financial metrics. We’ve created lists, we probably have 600, 700 companies
that we’ve looked at for the last 30 years. And what varies is…we’re familiar
with all of them, what varies is the breadth and depth of knowledge. I don’t
know each one of those, our team doesn’t know every one of those the way I knew
Progressive, where I spent half my life. And Ruane, when I was there, we made
well over 2 billion in gains for our clients there. But having said that, we
spend a lot of time doing the financial analysis.

And then beyond that, we say,
where can we go from here to gain some further insights? Why are the margins
different in this company? Why are they in that? And so we do a lot of the
primary research there. But one of the things…and it relates the quantitative
and qualitative, they’re all enmeshed in one. When you do these financial
metrics, and you see higher operating margins in a company within an industry,
or higher returns on invested capital, higher growth rates, and revenues and
perhaps operating earnings, we say to ourselves, “Well, we really need to
look at management.”

So we read the proxy, but we
really say to ourselves…we look at management for three things. First, how
good are they as operators? Secondly, how good are they as capital allocators?
And it’s hard to find companies with leadership that’s great at both. And the
third is, how shareholder oriented are they? And a lot that you can generate a
lot of it, not all, but a lot of it from the proxy. So those are the three
things we do after we feel that we’ve got a company that we can understand. And
that three, four, five years from now, it’s not gonna get blown out of the
water competitively. Then we look at the financial metrics, and then we look at
management on those three areas, operating, capital allocation, and are they
real shareholder oriented? Are they real stewards for shareholders?

And then the fourth thing we
look at is the valuation. And the fifth is, you know, we say to ourselves, you
know, what’s the general level of taxation and inflation over that time period
that will impact our return? So those are the key points that we look at. And,
you know, I think it’s important to just give you a couple of examples. United
Healthcare is a great one. There are frustrations with that because I did the
work in the early-mid ’90s. And we spent time with Bill McGuire and the team at
United. But before we did that, we went out into the field, and I worked in a
hospital for eight years, pay my way through college every weekend, holiday,
and during the week. So I really knew healthcare and had a good perspective.

And we met with virtually all
the major HMOs, and some foundation in Sacramento, U.S. Healthcare and Lenny
Abramson in Philadelphia, Cigna, Aetna, Wellpoint, and Len Schaeffer in LA,
etc. And in addition, we met with various payers, providers at high levels to
get a perspective. We met with George Halverson, who ran a company in
Minneapolis that was private. He later ended up running Kaiser, the largest
staff-model HMO in the country. And he ran Health Partners, wrote a terrific
book on the industry. And so what happened was…and I wasn’t smart enough at
the time to recognize the differences.

But virtually every player in
the industry at that time was treating healthcare as an insurance company, you
would expect as a loss ratio business, as an actuary would look at it. What’s
our medical loss ratio, the percentage of costs to provide health care for
every dollar of revenue? And virtually everyone was in the high 70s, low 80s.
U.S. Healthcare was in the high 60s. And we wanted to understand why. And the
reason was, they were able to dominate the Philadelphia market. And they
capitated people in that model per member per month. And by dominating their
revenues without really owning the hospital or the doctor practice, they were
able to really get some efficiencies there. And that’s why their medical loss
ratio was lower.

Now that model wasn’t really
successful, when they came to New York and competed with Steve Wiggins and
Oxford Health, which later United bought, because they had a PPO, which was
broader, much more expensive. But Goldman Sachs and other firms here, they
didn’t want, you know, very low priced product for their employees, they could
afford the better product. But the point is, that’s the kind of work we did.
And when we met with United, it’s all in my interview with him and with the
team there. I wasn’t able to discern clearly enough the insights there. And
what were those insights? The insights were everyone else was focused
actuarially on medical loss ratios.

Bill, who was a creative
genius, was focused on creating and building businesses out of healthcare
needs. So things that he was doing and the team was doing back in the early
’90s, they are today the Optum businesses. They have Optum Health, OptumInsight,
which is the old Ingenix, the data analytics firm, and OptumRx, the PBM. Well,
now everybody’s doing what they did. Well, they were doing this 25, 30 years

And why is that important?
It’s important because when you look at United today, those three businesses
are the most rapidly growing, and the least regulated. Everyone thinks of them
and they’re very dominant in traditional commercial, Medicare, Medicaid, all
the businesses, employer plans, etc. They’re number one or number two in

However, because of their
foresight, many years ago, they created these three Optum businesses. And to
give me an example, OptumInsight is the best healthcare data analytics company
perhaps in the world, 6-plus billion in revenue, 20% operating margins. OptumRx
is the third PBM in the country and it’s owned by an HMO. Well, you saw the
merger, CVS bought Caremark years ago, Express Scripts, merging Aetna, Cigna.
They’re all trying to do what United was doing 25 or 30 years ago.

Now that frustration was, I
didn’t see all these insights as clearly as I should have in the early ’90s or
we would have made an enormous amount of money. But we corrected it, and
several years later, when I started my firm, we did buy some United, and I’ve
done extremely, extremely well with it.

And another example, I did a
report on it, because I think I sent…I think it was January of ’13 under
Obamacare, and the stock was at 52, and they had a billion shares out. So you
could have bought the entire stock market capitalization for 52 billion. And
because of the work I’d done earlier and owned it in some accounts, we felt
that they were grossly misvaluing the three Optum businesses. And fortunately,
we were lucky and right, and the stock is probably 250 to 260 today.

And those Optum businesses,
they have the optionality, I’m not saying they will. But if they ever spun any
of those businesses out, they’re just worth an enormous amount of money. Their
PBM, if you look at comps at other businesses that were sold, Anthem sold their
PBM to Express Scripts, I believe, and others. And then OptumInsight, which I
mentioned Ingenix, the old Ingenix, it’s just worth an…that’s worth revenue,
multiples of revenues. And so that’s one example of going out in the field and
seeing things and trying to identify things that are different, unique, and

And another one was
Progressive. Progressive was founded in 1937 by Peter Lewis, and Peter Lewis’s
father, and his Case Western Reserve law school classmate. And Peter joined in
the late ’50s, early ’60s out of Princeton. And in 1977, Peter had a vision to
really build a great, great auto business for many, many years. And he hired
his first three MBAs in 1977. I was doing the work in the early ’90s, ’91, and
one of them was the current CFO so I didn’t interview him. And I never go
interview management until I’ve done all this work. I would never just go
interview management reading the numbers, I don’t find that helpful.

So anyway, the other two MBAs
they hired were gone and had left in the late ’80s, but I didn’t care because
we have a long term horizon. And I found both of them and spent several hours
half a day with each of them. And they just gave us enormous insights into why
Progressive was unique. Their data analytics back then, Peter Lewis’s vision,
he sat them down and said, “You’re the first three MBAs we’ve ever hired.
We’re doing close to 50 million in premium now, we wanna get to a billion by
1990.” I believe they beat that by a couple of years.

But they just gave me
enormous insights, how they priced, how they hired, how they did claims. They
were just ahead of virtually everyone in the business. And that’s something
that goes on today. That’s the kind of work we did. I found other people, I met
with competitors, like in Integon that was run by couple key former Progressive
people, Steve Andrews, and another gentleman running claims, had been at
Progressive, they were down in Winston-Salem. So that’s the kind of work we

And we just felt, we had the
insight that Progressive was really gonna be able to differentiate themselves
going forward. And as we did the work, they were primarily a non-standard or
high-risk auto insurer selling through independent agents. So that was the
model all those years, high risk auto insurance, no homeowners, no umbrella, no
other products, all through independent agents.

And there were a couple of
issues we wanted to resolve that aren’t really visible in the financials. The
first was Progressive was lowering their commissions to agents from 15 to 10.
So that pissed agents off. Second, they didn’t offer homeowners, or umbrella,
or other product that agents wanted because it increases your revenue and
increases your stickiness with a customer because higher retention rates with
higher products, higher volume of products per household.

The third was they made
companies spend a lot of money, because they were really at the forefront of
technology, lock boxes, getting a deck page right away. And all this is kind of
silly now but this is a long time ago, this is 25 years ago. And so, you know,
a lot of agents didn’t wanna spend the money. And so one of the questions we
had was, because of these negatives that Progressive has and because they’re
are exclusive to independent agents, can the agents…because that business
moves quickly.

You know, most of us don’t
even look at our policies and what we pay every year for a standard auto. But
when you’re paying 4 or 5, 6, 7 grand a year, the moment you can get out of
that high-risk policy into a standard policy, you’re shopping it. And so people
would frequently move their business. So we were concerned that they were gonna
alienate their agents because of the points I just raised. And so we went and
interviewed agents all over the country, a lot of it was in Florida, their
biggest state, which is their incubator state where they were practicing a
bunch of other things that I’ll talk about.

And so in doing so, we found
they had an advisory board in Florida, we found some of those agents, and then
we went around Florida and interviewed independent agents, just walked in the
door. Then we went to Ohio, their home state, we went to California, we went to
Pennsylvania, we went to Virginia, we went to Chicago. And the conclusion was a
couple-fold, really profound. First, agents didn’t like them, they were
arrogant, all the points I made, they were cutting their commissions, they
didn’t offer additional product for higher retention, they made you spend a lot
more money than others, etc.

However, based on the work we
did, we concluded they couldn’t get rid of them. And the reasons were
Progressive’s price in high price non-standard auto was always 10 to 15% less
than everyone else. Now, why? They were better underwriters, one, and, two, they
were better at claims. And they would take that savings and claims and reinvest
it in lower pricing. And so as a result in a very high priced product, they
were always 10 to 15% less. So because they were in 40,000, 50,000 agents at
the time, they basically leveraged the agents against themselves. So if I’m an
agent, and I didn’t wanna write Progressive insurance, I wouldn’t quote it to a
caller. However, the gentlemen across the street might say, “Well, I’d
rather get 10% of 5,000 than not get anything at all.”

So they still maintained
their business, despite some of the points I made. The second point was they
were really great at claims, and agents recognised even though it wasn’t a big
deal, because there weren’t a lot of accidents, when there were, Progressive
really did a great job, which was less of a headache for them.

Third, there were many risks
that no one else would ensure other than Progressive. Fourth, when they did the
analysis, which many didn’t wanna do, they could really have fewer employees or
fewer FTEs, or full-time equivalents, because the technology Progressive was
offering enabled them to be more efficient, more systematised, and have less
employees. So all those factors put together, we concluded that they can’t
really get rid of Progressive as one of their premier, non-standard auto
insurer underwriters. That was the first question. And so we were very
concerned about that because that’s where their whole business was.

Then there were two other
questions that were really important. The first was, they were going into the
standard market, which was 6, 7, 8 times the size of the $15 billion
non-standard market, and then we’re gonna compete against a lot of companies
like Nationwide, Allstate, and State Farm, which were captive agencies with
their own captive distribution, as well as other solid underwriters, CNA,
Cigna, Aetna, etc. So could they succeed in a space that they had never really
focused on standard, which was much larger.

And then the final question
was, could they succeed going direct? What about the channel conflict with
their independent agents? They wanted to go direct and compete with Geico. And
so those other two questions, we were very concerned, but we didn’t focus on
those until the first one was answered. Once we answered the first one, that
companies non-standard, agencies couldn’t really move the book, their cash flow
wasn’t gonna be impacted, they could keep growing, we were ready to tackle the
other two.

And then doing the other two,
we interviewed agents, we concluded from the work we did, one, they’re gonna
succeed in standard, they’re gonna figure out the pricing, they’ve got the
smartest people in the country and the best systems. Claims is virtually the
same and they’ll figure that out. We were concerned, though, because they were
a math-oriented firm, an analytical firm, we were concerned about advertising.
And that even was a bigger concern with the second question in this area, and
that was going direct.

We were very concerned going
direct, how good they would be on the marketing side because, again, it was an
analytical firm. But we found some agents from their advisory board down
there…and again, this is 25 years ago, 27 years ago, 28 years ago. And they
said, “Look, Paul, they’re arrogant, they’re this, they’re that.”
They’ve been experimenting in Florida now for many years, and I believe one of
the top people that was experimenting for them was Glenn Renwick, who ended up
becoming the CEO and retired a couple of summers ago.

And so he said, “Look,
they’re arrogant, they’re this, they’re that. They’re gonna succeed in
standard, they’ll figure out pricing, and they will be able to compete against
the big guys, the captive guys, State Farm, Nationwide. And Allstate. And
they’re gonna succeed in going direct, because they’ll build their capability
and marketing, they’ll have great pricing, they’re phenomenal in technology,
and they’ve got great people.”

Unfortunately, what happened
was, they announced in the ’91, ’92 timeframe that they were gonna reduce their
profitability by two-thirds. They were gonna take their combined ratio from 82
to 83, which was creating a huge pricing umbrella for lots of competitors to
come in. The combined ratio is your expense ratio plus your loss ratio. And if
it’s 100, you’re even, if it’s above 100, you’re losing money. If it’s below
100, you’re making money. Well, they were making 18 cents on the dollar
pre-investment income, which is unheard of.

But they figured we wanna
grow, we don’t wanna keep this pricing umbrella and let others come into the
non-standard market. So what we’re gonna do is we’re gonna take our combined to
96 and reduce our operating profitability by two-thirds, but we’re gonna grow
20%, 30% a year, which is an enormous undertaking in terms of the claims people
you have to hire, it’s just a big challenge. But fortunately, they did it. When
they announced they were gonna cut profitability by two-thirds, short term
oriented Wall Street sold off the stock. And I think it went from 46, 47, 48,
down into the high 20s.

And we stepped in and bought
some, lots of it. And over the ensuing 10, 15 years, I think it went up 10, 12,
14 times. And so that’s the kind of example that I give, and people ask all the
time, “Why doesn’t Wall Street do more of this?” And there’s four
real reasons, and there may be others, but four that I think of. The first is
most firms don’t concentrate enough for that to matter. The second is most
firms don’t keep their holdings long enough for it to matter, to do that amount
of work.

But the biggest reasons are
three and four. One, most firms don’t concentrate enough for it to matter. And,
two, most firms, again, they don’t hold things long enough for it to matter.
They have 500 stock portfolios, so just wouldn’t behoove you to do that. So
those are the primary reasons in my mind. In addition, it’s difficult to go out
into the field, you need the skill sets. And then the final point is, it’s
expensive, but most firms could afford it. But those four reasons, it’s the
concentration, holding stocks for long periods, developing the skill set and
time to go do that, and then force the expense to go do that. A lot of firms
aren’t structured to do that.

Meb: I think that’s an
important point because you look at a lot of firms… I heard Bill Miller was
on a podcast where people talk about indexing, and he’s like, “Look, yeah,
indexing is growing, but if you account for all of the closet indexers, meaning
the people that end up holding 100, 200, 500 stocks that essentially give you
S&P exposure, you end up paying too high of a fee for just getting the
S&P.” And so one of the biggest challenges that people…one of the
reasons people don’t do the concentration, of course, is career risk, because
by the time you get to be a $10, $50, $100 billion firm, it’s much easier to
diversify away a lot of blame and just say, “Hey, you know, U.S. stocks
were down, U.S. stocks were up,” because you can always collect the fee.

And we often say this to
people. We say, “Look, if you’re gonna move away from market cap-weighted
index, you gotta be weird, concentrated, and different.” The problem with
that is it’s hard for a lot of people. It’s a really uncomfortable thing to be
concentrated and different.

Paul: Those are great, great
points, Meb. And I would also add to that, I was asked in an interview a while
back about what I would look for in a money manager. And I thought about it,
you know, what would Mr. Ruane say, what would Mr. Buffett say? And I certainly
can’t speak for them. But in my mind, there are five things, and one of them,
you know, really applies to what you just said. The first is impeccable
integrity. The second, which almost no client asks about, and that is tell me
about your research process. They just don’t ask, because the business is all
about marketing.

The third is, and it’s a
little controversial, but this is how I feel, there are exceptions, as there
always are. But the third thing is I would rarely…or I think our team, and I
would advise people, I would rarely give money to firms that aren’t owned by
the principals. And so we own the firm here. So we have no outside pressure,
we’re not public to make earnings. We don’t have a vice president coming down
and saying, “Why didn’t you raise more money? Why didn’t you sell that
product?” We have a simple model, separate accounts. We’re not constrained
by market cap, by geography. The limitation is our insights. That’s the only
limitation we have, and so we like that.

And then the fourth thing is,
where’s your money? We created a partnership where a preponderance of my liquid
net worth is. So I eat my own cooking, our team eats our own cooking. And then
the fifth everyone asks about, and that’s your performance and your fees. And
we’re a flat 1%, 25 basis points paid in advance every quarter. The only other
fee they incur is $4.95 portrayed at Schwab. And so we have some sizable
accounts. So it’s almost meaningless because we just don’t trade that much.

And we’re not trying to sell
you any other product. We don’t buy mutual funds, we don’t take the money and
send it elsewhere so you’re paying double fees, we don’t do any of that. But I
think the passive thing, Meb, is really an interesting area. And one of the
challenges is you take a company like Vanguard, and Mr. Bogle, a true legend, a
real, real, real supporter of the individual investor. But take, for example,
at the end of January, you know, they owned seven and a half percent of
Microsoft, that’s 60.3 billion, they own 50.9 billion, 6% of Amazon, they own
7.2% of Apple 56.3 billion, and 6.2% of Alphabet Google, 48.3.

Well, the reality is, as ETFs
and index funds, the decision is not based at all on any fundamentals, on any
quantitative or qualitative factors. The money flows in, they buy. That has had
an enormous effect on the market. And these indexes, as the money flows in, the
prices go up. And what’s scary for me…and there is a place for passive
investing. I’m not saying it’s totally bad or wrong, not at all. But I think
it’s getting to the point where it’s really impacting things greatly on the
upside because we’re in the 10th year of a bull market.

There will come a time when
that will reverse itself, and fund shareholders will say, “We want
liquidity now, sell.” And I think when that happens, especially in ETFs,
industry-specific ETFs, levered ETFs, I think it’s gonna be a really volatile
and wonderful time for active investors. Now I have no idea when this will
happen, etc. But I just think it’s a dynamic that’s playing. And that relates
to a final point, Meb, that’s really profound in our firm.

One of the reasons Mr.
Buffett…he’s a million times smarter than I’ll ever be. But one of the
reasons he’s been so successful, he’s really had permanent capital or
quasi-permanent capital. And I can’t emphasize, if you’re running a mutual fund
or a hedge fund, you simply can’t do what he has done or what we try to do. We
try to really get quasi-permanent capital, we’ve tried to build deep embedded
intimate relationships with our clients, we wanna be an advisor to them if
they’re looking…a lot of them are small business owners, probably 60%, 70%.
If they’re looking to sell their business, if we know things about it, we’ll

We wanna be a true advisor to
them, and we want them to look out 5 or 10 years. And by doing so, if you have
quasi-permanent capital, it enables you to be patient far beyond what you ever
could do in mutual funds or hedge funds, especially in the mutual fund space
because the money comes from intermediaries. And so the money managers today
have been disintermediated and clients are paying double fees. But more than
that, as a money manager, you can’t always do what you always prefer. You might
wanna be in cash or some short term liquid stuff, you can’t do it because
they’ll take the money.

We’re in a position where we
can do that. And a great example of that was back in…and it was much harder
then, now we own some certain fixed income securities, that we’re getting 4%,
and 5%, and 6%, and 7% on yields to call. They’re wonderful securities. But
prior to that it in ’06, ’07, we got a large account. I think it was $3 million
and it was the only account we ever got that he wanted all equity. He’s
executive that I’d met in the early ’90s, very talented fellow. And he said,
“I want all equity, Paul.”

So we got the account December
23rd of ’05, and he called me a year later…and we charged a full 1% on that
account. However, a year later, it might have been 40%, 50%, or 60% cash still.
Now rates were higher than we were…more than earning the fee. But again to
him…so he called me in December of ’06 and said, “You know, Paul, half
of portfolio is in cash.” And I told him, I said, “Look, if you wanna
take the money, you’re more than welcome to. We’re not gonna invest because we
can’t find compelling ideas.”

So another year goes by, and
he called again, December of ’07. And he said, “You know…” and I
don’t remember the numbers, there’s probably a little more invested. But he
said, “You still have an enormous cash business.” And I said,
“Well, I just can’t find things that are compelling.” And so, don’t
misunderstand me, I was not intelligent enough to forecast ’08, ’09. But what I
knew was things were expensive. Because of his trust in us, his patients, his
discipline, his confidence in us, when the fall of ’08 came, and the spring of
’09 came, we filled the portfolio. And because of his patience, and discipline,
and trust in us, it enabled us to really build a high-quality portfolio for him
that has done really, really well.

And my point is, unless you
have that type of client, they’re so many smart, talented people today out
there in the public markets, and now in the private, and venture capital as
well, it’s very hard to outperform. And contrast that you go to a big endowment
or pension fund, or life insurance company, they give you… First they wanna
segment, you which they can’t do with me, because we have small-cap, large-cap,
we’re not segment at all, we don’t have a product, we have separate accounts.

They segment you small cap
gross, small cap value. And after they do that, they then say, “Okay, we
like your approach. You’re small-cap value 1 to 5 billion market cap all U.S.
And then here’s $50 million or $100 million and you have two weeks to invest

Now, given those parameters,
it really makes it challenging to outperform your benchmarks, because
everyone’s so focused on the benchmarks. And so those are some of the points, I
think, that are really coming to the fore today. And a lot of them aren’t
clearly visible at this point, because we’re in a 10-year bull market. But over
time, a lot of these issues that I’m raising, I think, are gonna become far
more important going forward.

Meb: Oh, it’s funny, a few of
the things you touched on. I mean, we often give mutual funds a lot of crap on
the show, not just the closet indexing structure and being taxed inefficient,
but also the structure and historically has been built…mutual funds have been
sold, not bought. Meaning all the intermediaries you talk about, and all the
additional fees embedded in that, but also the conflicts of interest.

And there’s a stat we had
tweeted out a while back where the average financial advisor that’s been in the
business 20 years on something like 200 mutual funds, which is sort of an
insane number. Because what happens, the wholesaler shows up, they sell a fund,
the advisor buys it, they forget about it. And then another wholesaler shows
up, they buy a fund, forget about it, and all of a sudden they have this huge
mess, but that’s not something that really aligns with the fiduciary process.

There’s a bunch of other
stuff I wanna talk about. One of the things you mentioned was this concept, you
know, as you think about risk, and some would say it’s a potential macro
influence. We had Steve Romick on the podcast who probably has a similar
philosophy. Talk to us a little bit about how you think about fully investing a
portfolio with equities versus times when you may have a higher cash balance.
It sounds like it’s a bottom-up process where you’re just not finding names or
opportunity. And then walking forward, what does that mean for your portfolios
here at the beginning of 2019?

Paul: What we’ve done, Meb,
over the last couple of years some of our major holdings, Martin Marietta,
Brown & Brown, United Health Group, BBNT, Berkshire, U.S. Bank Corp, Bank
of New York, Zoetis, Progressive, Mohawk, PepsiCo, Lab Corp, Wells Fargo, and
those companies, the retailers, those are it in terms of major holdings.

What we’ve done over the last
several years, but particularly the last 18 months or 2 years, many of those
holdings, not all, but several of those, United Health, Martin Marietta, Lowes,
Mohawk, several of those, we felt were getting expensive relative to their long
term prospects. And we’re very slow, careful sellers. But over the last 18
months to 2 years, we began selling many of those.

So Mohawk, for example, which
went from 286, now it might be 125, 130. We sold the preponderance of Mohawk at
much, much higher prices over the last couple of years. We just thought it was
getting ahead of itself. So today, it’s probably 0.9 of our holdings, and we’re
reevaluating, again, because it’s way, way down.

But the point is, we look at
position sizing and risk based on the clarity with which we understand the
business and the industry in which it competes first, and then secondarily, the
valuation. So you know, we really wanna find impregnable businesses and then
buy them at a reasonable price. And we’re not averse to paying a little more
for them. And we’re not gonna pay 35 times earnings for something.

But the point is, we look at
risk and portfolio based on do we understand the business? Is management
outstanding? You know, the issues I raised earlier. Can we look out three to
five years and have a good sense of where the business will be? How good is
management and leadership at operating the business, capital allocating? And
are they good, shareholder-oriented? And then the valuation comes into play.

And so preparing for 2019,
we’ve been really fortunate, though, Meb, in 2012, 2013, we came across these
really interesting fixed income securities called fixed adjustable preferreds.
And what happened was, I was reading the U.S. Bank annual report, great bank,
First Bank system years ago, I’ve been following it, or its predecessor for
almost 30 years. And I was reading the annual and I saw the issue of preferred
stock. And I never bought a preferred stock in my life for several reasons.

But, one, when I was reading
it, it was non-cumulative, which I did like, no dividends and arrears. Two, it
was perpetual, there was no maturity date, which I didn’t like, so it was off
for two. But then I saw the coupon was six and a half percent. And owning U.S.
Bank, in my mind, is not dissimilar from owning the U.S. Treasury, diverse
revenues, credible credit culture, Richard Davies…it was just a great bank,
and we own the stock so I’d known it. So I saw those things and I said,
“Well, maybe I’ll dig a little deeper.”

Then I saw that the dividends
were qualified tax at cap gains rates, not ordinary income. And then I saw it
had an adjustable component, so that resolved the perpetual issue. Meaning,
when the call date comes, June of ’21 or ’22, it was 10-year paper at the time.
When the call date comes, if they don’t call it we’re protected a great deal.
They have to pay me three months LIBOR, which is now 262 plus 448. So they’re
gonna pay me six and a half, 7% if it doesn’t get called in the current
environment, that’s fine. I hope they never call it.

So we did further work. And
we, today, as we’ve sold many of the holdings we’re describing or portions of
many of the holdings I mentioned, we’ve been buying these, and we have them
laddered from 2019 all the way to 2026. The price fluctuates, but we don’t care
about the price. All we care about is the cash flows that they’re bringing in
for our clients. And many of our clients are retired, sold their businesses. So
for the last three, four, or five years, we have been getting many clients on a
yield to call basis two to three times or four times depending on comparable
maturity treasuries. And so that’s what we’ve been doing.

Meb: And so for the
individual out here who’s listening to this, how investable is that for your
just kind of standard listeners? This institutional only sort of investment you
could find, you gotta go through a bond desk? How challenging is that to find
these securities?

Paul: That’s a great
question. There’s two types, Meb. The first is the $25 ones that you can buy on
Schwab. So, for retail investors, they can buy those. They typically come out
of $25 when they’re offered at the IPO price. And those you can buy and pay the
standard Schwab fee. The great majority, though, that we own, you do have to
call bond desks. Now you can do it through Schwab or you can call any of the
major houses to buy those. And those are more liquid and they’re larger. But
the important point to point out is, it’s not a huge market. It’s been
estimated at 500 to 700 billion, some have even given lower rates.

But the bigger issue is, the
great majority of these preferreds are fixed only. So the universe…and we
don’t own any of the fixed only because when the call date comes, if rates are
going up and you go to redeem it, you’re gonna really get hurt when you try to
redeem it and get liquidity. While with us, we own 17 that all have the
adjustable component. Now the adjustable component, we obviously have some
risk, it ranges from 248 to 448. So it’s three months LIBOR plus 248, all the
way to 448 and several in between. But a good example is we have two securities
now that are floating and they’re wonderful.

One of them we’re getting six
and a half percent on because of the three-month LIBOR and the floating rate.
And the other one we’re getting, I think, five and a half, almost six on. And
the beauty is they’re comparable… Look, it’s not fully equivalent to a
treasury, but in our mind, the banks we own are. And we try to mitigate some of
the risks. Another thing you should know, Meb, is the majority are financial
institutions. But to try to limit that risk, we didn’t buy any J.P. Morgan
until we did work for over four years. We don’t own the stock.

We finally bought J.P.
Morgan, a few of their fixed adjustable. But the core of what we own are Wells,
Bank of New York, and State Street, which are really custodians, not true
banks. PNC, those are the preponderance of what we own. We will not buy on the fixed
income side, let alone the stock side, any Barclays, City Group, Morgan
Stanley, or Goldman. Even though they’re all probably fine, we’re just not
comfortable because these are all for us primarily concentrated in financial
institutions. There’s a few industrials that are out there, Berkshire, BNSF,
the Burlington Northern is out there, but it’s really expensive. There’s a few
industrial. But the great preponderance, especially the fixed adjustable, but
even the fixed only are all financial.

So we try to mitigate some of
that risk by not owning what we think are higher risk financials. But that has
served to really protect us and really buffer us with the cash flows coming in
at much, much higher yields than what you could get in comparable maturity treasuries.
So it’s really been a blessing for us, Meb, to be able to do that. Furthermore,
the floating rate ones now, which are a large amount of our capital, 10, 15,
20, 25 million of our investors own these, and it’s a large chunk of our
capital, we’ve used that, rightly or wrongly, as quasi liquidity. We could sell
those tomorrow.

And certainly, there could be
liquidity issues someday if we go into ’08 timeframe. But the point is, they’re
all investment grade-rated, the yields are phenomenal, we’re getting paid
wonderfully. But if we could find really compelling opportunities, we’d be
happy to sell them.

Meb: It’s interesting, I love
chatting with my discretionary fundamental managers, we wrote a book on 13F
investing, and the managers that I really am drawn to are the ones that have
holdings that are not your traditional kind of hedge fund hotel holdings. But
the ones that I look at, and I’m often like, I’ve never heard of that, or
they’re slightly different, you know, hearing you talk about this reminds me of
the old green-black book, “You Too Can Be a Stock Market Genius.” It
talked about spin-offs and all sorts of different investment styles. And it’s
fun to listen to you talk about those.

There’s a couple of the
things I wanna talk about otherwise, I could just talks stocks all day. And we
might just have to do that again sometime. But for a quant like me, I could
listen to chats about this for endless amount of time. You mentioned Buffett
being an early influence, as well as Berkshire being a long time holding. You
know, as the crew gets on in their years, I think Charlie’s in his mid-90s, we
go to the… Listeners, if you haven’t been to Omaha, but even more intimate
would be the daily journal meeting here in Los Angeles, which I think just recently
happened. So gotta wait till next year, highly recommended. But what’s your
current opinion about the State of Berkshire as well as opinion on the company
and the stock in this day and age?

Paul: The holding is 15% plus
in virtually every account, and so…and we’re not budging. And that’s a great
question. Charlie just turned 95 January 1st, and Warren, Mr. Buffett’s going
to turn 89 on August 30th. So certainly those are issues. I think he’s done as
much as humanly possible to prepare it for the future. The business is very
different than what it was when he was the driver with the public equity
portfolio and the look through earnings valuation model. The reason, Meb, we
haven’t sold it, even though certainly there’s no one on the planet… I mean,
Mr. Buffett is unique.

There’s icons in different
industries, Wilt Chamberlain in basketball, Bill Russell, Michael Jordan,
Gretzky in hockey he’s got, you know, more assists than anybody else has total
points, not even counting his goals. You can go on and on and on. Bill Walton
in college basketball, and Bay Bruce in baseball, Mickey Mantle. The irony is,
I think, Mr. Buffett is not an icon in just one sport. He’s an amalgamation of
all the people I just mentioned. So there’s no one gonna come around, again,
like him. He’s unique, he’s special, he’s totally irreplaceable. He’s tried to
help the firm solve for some of that by buying many businesses, Burlington,
Northern, etc.

So the wholly owned companies
today, MidAmerican, which is almost totally owned, but all the companies today
are really the driving force in Berkshire. And I wish he didn’t even have much
of an equity portfolio or stock portfolio, but he hasn’t been able to find

But the reason we haven’t
sold is, one, I think there’s incredible…and I think that’s obvious today,
there’s enormous underlying value in the businesses that Berkshire owns. And I
know he would never want it broken apart. And certainly, we’re not proposing
that. But I just think if you look at each of the individual businesses,
they’re just worth enormous amounts of money. I think it’d be complex to do
anything because, you know, the ownership and different insurance subsidiaries
and so forth. But we just think the underlying value is enormous.

The second thing is, which we
try not to think about a lot, but we have to for our clients, when he passes,
there’s gonna be a multitude of changes that do concern us. Several members of
the board are in their late 80s, 90s, Sandy Gottesman, Tom Murphy, I think when
he passes and so forth, they’ll be gone, you’ll have to replace them. There
won’t be a problem replacing them as great as they’ve been, there’s plenty of
great people out there. But that concerns me.

Another area that concerns
me, Meb, is a lot of the people that sold to him are basically not as active,
they’re a lot older. And I worry about the second generation. Will they be as
loyal as committed to the new people? Greg Able, probably, as the old ones were
to Mr. Buffett? Secondly, I don’t know a lot about it, I know he’s very
generous with his top people. But what about the levels below the top people,
the second and third generation? They’re not as wealthy as the people that sold
to Mr. Buffett. So I worry a little bit about that.

But having said that, I just
think one of the first things they will do when he’s gone is, I think…because
of the amount of capital they have, unless something really changes, they’re
gonna pay a dividend. And there’s so much… I mean, this is an institutional
imperative kind of thing. But there’s so many institutions out there with
enormous capital, that they would love to own Berkshire, but they can’t,
because they don’t pay a dividend. It used to be a liquidity issue, but the B
shares really have solved a lot of that. So I think they’ll pay a dividend and
should they pay a dividend, it’s a Rock Gibraltar [SP] balance sheet, I think
that would really make the stock even more attractive.

Now, if you go out, I think
Mr. Buffett said when the stock is all transferred to Gates, and the four other
foundations, his late wife and his three kids, I do worry that 10 years after
he’s gone, he said he wants it all spent. So you’re not gonna have a relative
control in shareholder anymore. And so I wonder what would happen, would the activists
go after it? Would it be a private equity feeding frenzy? I just don’t know.
But we just think they built such a great organization with such embedded
value. And especially as long as Mr. Buffett’s alive, and Mr. Munger, I don’t
even worry about it.

And I don’t worry a whole
lot, even when they’re both gone, because those underlying values are really,
really substantial. I do think Ted and Todd as talented as they are, if he
can’t find where to invest that 100 plus billion, it’s gonna be really hard for
them. I mean, they’re in a tough spot, replacing a legend, and then trying to
find, you know, great opportunities, because, you know, they’ve got the anchor
of size. They’re not running 1 billion or 500 million or 3 billion, it’s an
enormous…it’s a real challenge.

Meb: Well, they can call me
up anytime they want. We got some liquid ETFs they can invest in. But it’s
funny you mentioned the dividend because I think, you know, Warren talked about
in the early days, Berkshire paid a dividend, but he always jokes that they
must have been in the bathroom at the time when they decided to do so. I think
you also got involved with sending some students to go hang out with Buffet. Do
you mind telling our listeners that story?

Paul: Yeah, the thing, Meb,
and I put together a piece with many of Mr. Buffett’s quotes over the years,
and I share that with students. I lecture… I just came back from the Ivy
School of Business at Western University in London, Ontario, 45, West of
Toronto. And I also spoke at the London Business School, but I typically speak
at Villanova once a year, and University of Arizona, which I’m going to this
week, University of Kentucky and Lexington University of Alabama. And they all
have terrific programs, and there’s great people there.

Wendy Lee at University of
Kentucky is really helping the students there. C.T. Fitzpatrick chairs, a
couple of…has endowed a couple chairs and incredibly generous and a brilliant
investor at Vulcan Value at Alabama, his alma mater. Arizona and the team there
have done a great job. And I just enjoy helping the students in a small way, I
don’t put myself in comparison to them. But University of Arizona, our oldest
son who just joined our firm, March 1st, after nine years here in New York, on
the sell side, it was back in ’07, ’08.

And there was a gentleman
named Max Burke in London. He’s with a private equity firm in London now, he
wanted to set up a meeting with Berkshire. And he called me and we called
Debbie Bosanek, and she put us through to the young lady that was handling it
at the time. And Zachary and 75 students at the University of Arizona, and I
think it was the Haas Business School at Berkeley sent 150 students went out
and spent time with them. I’ve helped kids at Villanova do the same thing. I
just have found…and this is really profound for me, all the investing lessons
I’ve learned from him have been enormously helpful. And I’m grateful. He’s a
phenomenal teacher. And that’s how you live on when you’re gone.

But even more than that, he’s
impacted me personally. And I’ll send it to you, I’ll send it to Justin, I put
together a list, it’s four pages. And the first three pages are quotes on
investing for Mr. Buffett. The last page are quotes that really impacted my
life. And ironically, he’s actually impacted my life a lot more than he’s
impacted me on the investing side. Which I know sounds kind of silly, given how
much he’s impacted my investment life. But it’s lots of things he talks about,
you know, they’re just etched in my memory. About wanting to work for yourself,
controlling your time, what you look for in an employer, habits or first
cobwebs and cables. You know, all those personal things, he’s just taught me to
become a better person.

So I just think it’s so imperative
to find the best possible teacher that you can, and there’s nobody better in my
mind than him. I think he can really impact your life in a multitude of ways,
far beyond just investing. And so that’s why, Meb, I try to start spend time, I
never turn away a student. I meet with them on Saturdays, over near my place
here in the city at the Greek Kitchen, because I’m on the west side, and I try
to have phone calls often on Sunday evenings to speak with kids because I just
don’t have time during the week.

But I just think it’s so
important to really find people that really will share their insights and
knowledge, and will take the time and effort to do that for you. Because I’ve
had so many people, Chuck Royce, Tommy Bright, Carley Cunniff, Rick Cunniff,
Bill Ruane, Mr. Buffett. I wouldn’t be anywhere near where I am without all
their insights, guidance and help

Meb: You talk a little bit
about students. So let’s say you have some aspiring young investors listening
to this podcast in their 20s or 30s. And they really want to learn the craft of
investing. Talk to me a little bit about kind of modern…you know, some of
these mentors you’re talking about are getting up there in years. But as far as
resources and a path to becoming a world class investor, what are some
resources directly you could recommend? It could be anything from books, to
conferences, to ideas to anything.

Paul: What I do, Meb, several
people have put together book lists. I mean, a lot of people have put together
just terrific book lists. And I basically send those booklets… one of them I
think has like 350 books on it, but I…

Meb: That’s not an easy

Paul: That’s not an easy
answer. I have… Jason’s Waig [SP] has like a top 10 list. And I have a couple
others that list like the top 20 or 30 books that I found helpful. And so I’ll
email them all and then they have the option to go as far as they want. But you
know, the standard stuff, the “Intelligent Investor,” that really
changed my life, Graham-Dodd in “Security Analysis.” But I even
prefer the “Intelligent Investor,” Seth Klarman’s book, “Margin
of Safety.” The standard great books that are out there in investing. Read
everything you can from Berkshire.

I have a database of his
interviews over the last 20 years, anything he said, any interviews that I
could get my hands on. Just read voraciously and learn, and learn, and then
keep working hard to find ways to apply what you’re learning. Because
ultimately, that’s how you really learn, is by applying it. And so that would
be my advice.

But, you know, at the end of
the day, Meb, they have to have a deep drive, they have to be almost fanatical
on loving the learning process. See, that’s the key. People are drawn to it
because of the financial rewards, and that’s fully understandable. But that has
never been the case with me. I love and our team loves figuring things out. And
you know, you could give me an enormous amount of money tomorrow, it wouldn’t
really change anything for me, you know, I don’t really care about things a
whole lot. I certainly wanna live well and take care of my four kids, and my
wife, my family. But at the end of the day, it’s an incidental byproduct of
doing something you love. And I just really enjoy trying to figure things out.

Meb: It’s not like you’re
gonna spend your time playing golf. When we were chatting before the interview
you said you’ve never played golf. Does that include miniature golf, you’ve
never even played pickup?

Paul: No, that’s not true. I
have played miniature golf probably a handful of times in my life.

Meb: Awesome. I wish I
haven’t played golf because I think the hundreds of times I probably played
golf could be…considering my handicap of about 20. I probably…that time
would be better spent. Although I frame it kind of is just a going on a long hike
with a couple beers with friends. So not too bad. Paul, we gotta start winding
down. We got a couple more questions, I think, I’d love to ask you and then
we’ll eventually let you go. This has been a lot of fun.

We’re moving on from
resources, a couple quick questions. So your firm…you mentioned you’ve owned
a few all the way to firm inception in 2000. And this, I guess, could
transition over from Ruane or your time with Royce. What stock do you think
you’ve hold the longest. Has it been Berkshire?

Paul: Yeah, it’s Berkshire.

Meb: What has been your most
memorable investment? Now this could be good, it can be bad, it could be
anything. Just the thing that comes to mind that just sticks out is the…?

Paul: I think one that really
jumps out, I was really interested always interested in animal health. I never
really understood it clearly as I should have IDEXX Labs in the diagnostics
animal health space, which was a stock I missed, and my mistakes of omission
are just enormous and that’s one of them. But in the process, I really delved
into the animal health business. And I noticed that a lot of the pharma
companies and I love healthcare, owned a lot of the animal health companies,
you know, Merck, Pfizer, Elanco just spun out of Eli Lilly. They bought Novartis’s
business and so forth.

And so I began really delving
into that space, probably in 2013, 2014. And I did a 130-page report in July of
2014 shortly after we had bought a company called Zoetis. It was owned by
Pfizer and spun out a couple years earlier, a year and a half earlier. So there
were 500 million shares out and I delved into it. They had about 18% operating
margins, and 64%, of their business was livestock, and the remainder, 36% was
companion, which is much more profitable.

And so I delved into it and
clearly with a spin-off as Joe Greenback would say. You know, there’s a lot you
can discern, but there’s a lot you don’t know. You don’t know how good they’d
be as capital allocators. There’s a lot of things you don’t know, because
they’re embedded within Pfizer. But the thesis was, they could really grow the
companion business to make up more of the business and it’s a lot more
profitable. Their margins were 17%, 18%, within Pfizer. We thought they could
get into the high 20s, like some of their competitors.

And then we did further work
and we noticed that in the animal pharmaceutical space, there’s an animal
organization comparable to the FDA. They had accounted on the prior 10 years
for about 25% of all new drugs. And then in the vaccine space again with
another regulator they had accounted for 20 or 25%, in the prior 10 years of
all the vaccines. So they had a really productive and powerful R&D space we

Second, they had a huge sales
force in livestock that could service all these farms and ranches around the
world, which was a huge competitive advantage. It’d be hard to replicate that.
So that was another thing we really liked. Third, they were gonna be able to
significantly reduce expenses, we felt coming out of Pfizer, they were going to
SAP network spending 320 million over three year period. You know, and once
that was over, I thought that would really be beneficial for them from expense
leverage and improving the margins.

Fourth, in the pharmaceutical
space and the vaccine space, because most countries don’t have animal and
livestock government regulatory agencies. In many cases, if you get approval in
the U.S., you have free reign around the world, in many cases. So you don’t
have to go through the regulatory hassle in other countries. Another issue was,
once you develop a pharmaceutical in one area, cats, dogs in companion animal
and sometimes there’s a crossover even with livestock, once you develop the
drug, you can develop a pill, a liquid, an injection. Any kind of creation you
make, it’s extendable. So you can take that drug, and then apply it on a much
broader scale across other animals and so forth than you could with human

And then one final point I
would make is there’s essentially no Mylan or Teva, major generic player in
that space, very few drugs or a billion or more. It’s typically a lot of small
drugs that are very profitable. You can keep raising prices because there’s
almost no generics. And you’ll find drugs that might have done 50 million, and
then they go off patent. And today, 10 years, 15 years later, they’re doing 150
and 200 million. So all those factors led me to Zoetis and it was really
rewarding. I think we paid 28, 29, 30, 31 in that area. It’s right around 100
today, and again, it’s expensive now.

So as it has grown whatever,
you know, the portfolio had if it was a small equity allocation portfolio, 30%
equity, we might have made it 3%. If it was a bigger allocation portfolio we
might have made it five or six. Well, we haven’t let it go up three, three and
a half, four times, we’ve sold portions of it because we’re just not
comfortable at the multiple that it’s at. But that’s one where, you know, I’m
pretty happy about.

And then there’s a lot, Meb.
You know, O’Reilly that I missed twice. You know, I mentioned a bunch of
others, United Health when I could have bought that in the early ’90s. Most of
our mistakes, and we’re not proud of this, but fortunately, they haven’t been
mistakes of commission. But it’s equally painful, it’s just not visible to
others the mistakes of omission that we’ve made, which have been many.

Meb: Paul, this has been
super fun today. Where can people find more information about you if they want
to get in touch?

Paul: They can call our
office number, 610-375-2585, and they can go to our website, www.lountzis.com,
which has just some basic information on our firm. We don’t post our letters or
haven’t…but at some point, we will update it.

Meb: Well, you have an old
school website, it looks like, the old Berkshire website, it’s pleasantly
sparse, I appreciate it. We’ll add a bunch of the show notes and things you
mentioned today to the mebfaber.com/podcast links. You’re bold putting your
phone number on there. You’re gonna get some inquiries, I’m certain. Again
thanks so much for joining us.

Paul: It’s my pleasure, and
thank you for having me, I really enjoyed it. Thank you both very much. Thank
you, Justin, as well.

Meb: Great, listeners, again,
we’ll post the show notes. You can find the archives at mebfaber.com/podcast.
Please reach out, leave us a review on iTunes as well as send us feedback at
the mebfabershow.com, we read them all we’d love to respond. Thanks for
listening, friends, and good investing.

Listeners, we got a lot of
show notes and links for this episode. We’ll post those to mebfaber.com/podcast
where you can also find the other 150 odd episodes in the archives. Listen to
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