#3 Sanjay Bakshi: Why Mental Models

In this episode, I chat with professor and value investing genius Sanjay Bakshi about the power of mental models, multidisciplinary thinking, reading, and acquiring worldly wisdom. Go Premium: Members get early access, ad-free episodes, hand-edited transcripts, searchable transcripts, member-only episodes, and more. Sign up at: https://fs.blog/membership/ Every Sunday our newsletter shares timeless insights and ideas that you can use at work and home. Add it to your inbox: https://fs.blog/newsletter/ Follow Shane on Twitter at: https://twitter.com/ShaneAParrish Learn more about your ad choices. Visit megaphone.fm/adchoices

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:09Shane Parrish?

  Welcome to The Knowledge Project. I'm your host Shane Parrish. I'm the author of the Farnham Street Blog, a website with over 65,000 readers that's dedicated to mastering the best of what other people have already figured out. In The Knowledge Project, I interview people from around the world so we can learn from them, expand our minds, and challenge our thinking.

• 0:30Shane Parrish?

  In this episode, which was recorded live in New York, I have on the show one of my favorite people, Sanjay Bhakshin. Sanjay is one of India's best-recognized finance professors. He teaches a course entitled Behavioral Finance and Business Valuation at the Management Development Institute. And while he probably doesn't want me to mention this, not only is he a teacher, but he's also a practitioner. He's one of the most successful investors you'll ever come across. In this interview, we talk about a host of things, including why he prefers to read on a Kindle, how he incorporates multidisciplinary thinking and mental models into both his investment decisions and life decisions, and how his approach to investing has changed over time. That's it, so without further ado, I hope you enjoy the conversation with Sanjay.

• 1:14Shane Parrish?

  If you enjoy it, please let me know your feedback. I'm @FarnhamStreet, F-A-R-N-A-M, Street, S-T-R-E-E-T, on Twitter. And thank you for listening.

• 1:31Shane Parrish?

  I'm here with Sanjay Bhakshin, who's been described, self-described, as an opinionated professor of value investing at the Management Development Institute in India. Welcome.

• 1:45Speaker 01

  Thank you, Shane.

• 1:45Shane Parrish?

  How are you?

• 1:46Speaker 01

  I'm very well. Thank you for coming all the way from Canada to meet me here in this lovely hotel in New York. It's such a pleasure to meet you. I've known you for so many years and I'm so glad that I'm meeting you now.

• 1:57Shane Parrish?

  It's a pleasure to meet you as well. So Sanjay and I have been emailing back and forth for years now.

• 2:03Speaker 01

  True.

• 2:03Shane Parrish?

  And being here in person and meeting him, it's an amazing experience. He's everything that I had thought he would be soon. Happy to meet you.

• 2:12Speaker 01

  Yeah, I have to say that I uh I'm envious of you for many reasons. One of them, of course, being that uh you have a library much bigger than mine. And uh I have a very large anti-library thanks to you because I end up buying virtually all the books that you recommend. And the list keeps on growing and in order to find time, I have to, you know, compromise many things, but uh it's really worth it.

• 2:34Shane Parrish?

  I appreciate that. I uh I definitely uh my bookshelves are starting to overflow, so it's getting to be a bit of a problem, but uh.

• 2:42Speaker 01

  So you I have to persuade you to get into Kindle then.

• 2:45Shane Parrish?

  I well, let's let's actually let's dive into that, like talk about the the Kindle versus the um the physical book. What is it? The what do you prefer? Why? How do you use that?

• 2:57Speaker 01

  Well, I used to prefer the written one, of course, because you can underline and um you you feel you love the smell of the paper. And you you have a nostalgic uh associations with the with the physical book, uh what it looks like and where you read it, which you kind of lose when you do it on a Kindle. But over time, I realized that uh these are um prejudices that should be let go off because there are other things that are possible with the Kindle which are not possible with the physical book. And for me, um as a professor, it really helps me to be able to know that I've read this somewhere. Um you know, the kind of associations that occur in memory when you're experiencing something. You know that you have read about this particular uh aspect in some book, but you don't know which one.

• 3:41Speaker 01

  And if it was all physical book, you would go crazy looking for that book. Uh but if you just do a search for a term across all your books in your Kindle library, it comes up in in a flash. And the interesting thing is that uh you sometimes discover things that you didn't know existed. The serendipitous um uh discovery of wonderful uh words of wisdom about a certain topic uh in your Kindle library are amazing and that happens uh I I I have my Yoricka moments. And um the other reason why I love Kindle is because you can underline stuff uh and write your own notes and they get synced to the cloud. And once they're in the cloud, you can um copy paste. Uh you can use it for your lectures and it's very helpful. So I'm very grateful to Amazon.

• 4:26Speaker 01

  And of course, it's environmental friendly. You don't have to waste paper.

• 4:29Shane Parrish?

  Do you uh read exclusively on the Kindle now?

• 4:32Speaker 01

  Uh, yes, I like to, but only for books. Of course, there are annual reports and there's a lot of wisdom in annual reports of businesses that I like to uh study and that you don't get on Kindle. I I don't like reading on computer monitors. It's very strenuous to the eye. Kindle therefore is much better because it doesn't have any eye strain. Then of course, there are um letters written by other investors which are not available on Kindle usually. So I look at, I read on Kindle any book that is available on Kindle. Some books are not, then you have to buy the physical ones.

• 5:04Shane Parrish?

  And you're you're a prolific reader, so do you notice?

• 5:07Speaker 01

  Well, about five percent of what you are.

• 5:09Shane Parrish?

  Do you notice a difference in what you retain when you're reading on the Kindle? Or uh I guess in the your your, not your physical, your takeaways from the book, but in terms of how your brain is storing or organizing. I mean, there's been a lot of studies that say that reading on a screen and reading a physical book impacts your memory and how you make connections and associations.

• 5:33Speaker 01

  Sure, that's true. Uh but I think there's a trade off here. Uh you might retain more when you read a physical book and you might retain a bit less, but that kind of gets offset by the fact that you are creating an a document on the cloud which contains the best things that you have read in a book, the ones which influenced you the most because you have underlined them. Sometimes the underlying portions of a book span many pages. And all of that gets um, you know, sent to the cloud. And when you work on that particular passage again in the context of something that you're trying to evaluate, then all of that comes back. Uh so in a sense, I think there is a trade off here. While reading on a book, you get to underline physically and you may have a moment of reflection and you may write things on the side.

• 6:18Speaker 01

  You can do that in a Kindle as well. So I, net net, I think uh I don't feel the the loss of uh memory uh if I am uh using a physical book.

• 6:28Shane Parrish?

  So what's your process for reading? So you you you purchase a Kindle book, you get it to your Kindle. Uh take me through how you how you read in terms of are you reading one book at a time? Are you reading multiple? Do you put it aside at the end and then go back to it? Or do you immediately take your notes out?

• 6:44Speaker 01

  Well, I I don't like to read one book. Um, I mean, I maybe read about three or four books uh at any given point of time and I finish them. Then I'll pick up another three or three books uh to read. Um, one reason is um uh you get kind of bored by reading the same thing, uh same subject. Uh and you know, based on what Charlie say that you should have multidisciplinary mindset. So it's good to have different books from different disciplines and read them. And then some one of the amazing things that I discovered is that you kind of associate one for the with the other ones. Uh and that really is helpful to me. Um, so far as note taking is concerned, I underline stuff on the fly as I read it.

• 7:23Speaker 01

  And uh once the book is over, I go back on the cloud and uh take out whatever I've under underlined in that particular book. Whatever notes I have, whatever annotations that are there. And I would um put them in a different document. Uh and then uh I'll I'll let that be, uh because I've already studied on the underlying text the second time. So I've done in a sense a second reading of the things that I like the most in that particular book. And I let that be uh kind of reside in my memory for some time. And then when I'm uh experiencing the world out there and uh there is a moment when I would remember that there is, this is something which relates to something that I've read somewhere, then I can always go back to the document and uh

• 8:07Speaker 01

  uh be able to pull out whatever is useful. So you have a different document for each book? Not always, uh but I have a master document because once you have it on the cloud, you can always copy and paste it uh any any annotation, any uh underline text for that particular book in a different document. I do that for some books, though not all of them. That's awesome. That's a really good way to do it. Do you use Evernote or anything or is it all? I do, I do. I use Evernote, uh that's been helpful to me. I use uh um other tools like the Brain, uh which is a wonderful piece of software available. What is that? Um, it's a, it's it's kind of replicates what your human brain does. Uh it it helps you create thoughts, uh and it helps you connect different kinds of thoughts.

• 8:51Speaker 01

  And you can put your emails in it and you can put your um sound files in it and you can put any kind of document in it. And uh then you can uh look at any particular topic from the perspective of a thought. So you have all these thoughts which are connected and uh this is exactly how the human brain works and new associations are created. So when you're looking at that brain screen, you see and your actual brain is thinking about those associations, new associations get created. So in a sense, it's an external brain which is working for you and the size of that thing keeps on going and it's virtually infinite, you know, you can keep on adding stuff in it.

• 9:28Shane Parrish?

  So how do you go about teaching that to your students about multidisciplinary thinking and connecting and associating and synthesizing and distilling and is that?

• 9:40Speaker 01

  Well, Charlie's already taught us how to do that. We just follow what he says, you know, we try to look at a problem from multiple perspectives and that's, I think, the correct way of doing it. When you are trying to evaluate something, you're trying to ask the question, why? Why did this happen? And when you reflect upon it, you find that the answer sometimes comes from multiple disciplines and you get down to that and try to figure it out. It is very enjoyable to do it in that way. The process for me has always been to ask the question why and wait because the mind will tend to jump to a certain answer and that's not the only answer. So, you know, the way I think about it is whenever there is a complex question which I'm trying to answer, I always start with the words, part of the reason

• 10:25Speaker 01

  is this, and which means that there must be other parts too. And I like to think about what those parts could be. And they don't have to be 20 of them. Even if there are three or four of them, that's better than one. So it helps me ask the question why and then look for answers.

• 10:39Shane Parrish?

  That's an awesome. Do you think that's like a mental trick as well, where when you respond saying that's part of the answer, you remain uncommitted in a sense to a firm and definite answer and then therefore you're more willing to be open-minded at the end?

• 10:54Speaker 01

  Absolutely, absolutely. And the way to do that is to always answer a question why by the phrase, part of the reason, because that removes the availability heuristic, the first conclusion bias. Because there are, in a world which is full of complexity, there are multiple answers. There are second order effects and third order effects. And you can think of those, I think, especially well if you start your answers with the phrase, part of the reason.

• 11:21Shane Parrish?

  So multidisciplinary thinking is incredibly popular in the value investing kind of community in the sense that people look up to Charlie Munger, Warren Buffett and yourself and they try to Bring that approach on their problems. Do you know anybody outside of value investing who's taking that sort of approach? And how they're applying it to broader policies or anything? Or is it just, do you think that it resonates with people in this particular context?

• 11:50Speaker 01

  I think it's wrong to assume that the idea of multidisciplinary thinking that Charlie Munger talks about should be applied only to investing. In fact, you should use investing mainly as an excuse to be able to illustrate the idea that you can use multidisciplinary thinking in pretty much everything that you do. And I think that's a very useful skill to acquire and Charlie offers you a way to do that. And of course, the way he has done that is to be, you know, invest successfully. But if you read through his letters and his talks, he is very rarely actually only talking about things which have to do with investing. There are other applications. And if you look around the world, the really good thinkers, they do think in terms of

• 12:34Speaker 01

  multidisciplinary applications. I do think that there is, there are a lot of Charlie Munger fans out there, even though they don't know of Charlie. And I think there is an important role that people like you are playing in bringing that kind of knowledge to the world out there. It's not just about investing. You have to be able to apply it in, in, in, in other disciplines as well.

• 12:56Shane Parrish?

  So not only are you a professor, you're a prolific, world-renowned investor. You started in ninety-six. Did you, I think, investing?

• 13:05Speaker 01

  Ninety-four.

• 13:05Shane Parrish?

  Ninety-four. Did you originally take the multidisciplinary approach?

• 13:09Speaker 01

  Oh, not at all. I had no idea about all of that, not until two thousand and four. So I, I was a one-trick pony at that time. I was only, I was an accountant. I knew how, how financial statements get created from, from transactions. I knew all of that, but I had no idea what a good business and what is a bad business and what is a mediocre business and why. And I was studying at the London School of Economics in nineteen ninety when I chanced upon an article on an obscure guy operates out of Omaha, has a wonderful track record. Says the markets are quite inefficient, which is quite the opposite of what I was being taught at the LSE. So I found that very interesting.

• 13:51Speaker 01

  And that particular article also said that he writes wonderful letters and you can, you can get them for free if you write to him. So I wrote to Mr. Buffett and within four days I got the, I got those annual reports. Debbie, his secretary, sent, wrote a letter to me that you have to send the postage money, which was probably the best investment I ever made. So I, I got those annual reports, letters of Berkshire Hathaway. As I read through them, I discovered Graham. And I picked up on Graham because I was an accountant, as I mentioned earlier, and I could relate to what Graham was saying. Up until now, I knew that there is, how financial statements get prepared, what is book value and

• 14:35Speaker 01

  what is profit and what are margins and I knew all of those things, but I had no idea whether this was cheap or expensive. And Graham provides a very good framework for people who are good in accounting to be able to figure out fairly quickly whether this is cheap or expensive. So I found that very interesting and I started practicing Graham style investing from then onwards. It's only much, much later that I chanced upon the idea that there could be different kinds of businesses and some businesses could be remarkably having remarkably good quality and one should ask why do they have this good quality and then of course, once you start talking about that, you end up discovering Charlie Bunker.

• 15:15Speaker 01

  And once you pick up Charlie Bunker, you ultimately discovered the power of multidisciplinary thinking. So all of that happened. It took me about 10 years to get there. So I started practicing value investing in ninety four. But I, when I discovered Charlie's talk on multidisciplinary thinking only in two thousand and four. And that was a very significant event in my life because as it happens, that was the year when my family was coming to the United States for a holiday. And I came across this talk and my course was to commence in September and this was in June or July. And I told my family, I'm not coming with you. Please leave. And they were supportive.

• 15:54Speaker 01

  And they left me alone and that's how I decided to change my course and turn it into what is now called as behavioral finance and business valuation. So that particular idea of the psychology of human misjudgment and the mental model talks, they helped me a lot.

• 16:10Shane Parrish?

  Was it as simple as um coming across that talk and then being inoculated and changed forever or was there something else going on?

• 16:18Speaker 01

  Absolutely. There's nothing else going on. I was alone. Uh I think it was uh um. It was stupendous to be able to read it over and over again, make notes, try to relate to the the power of the ideas that he has laid out in those couple of talks. Was so powerful for me and I had the conviction to teach it and and learn it through teaching. And um it's been very helpful for my students and for me. And my journey as a value minister is not complete unless I bring up uh my discussion on mental models.

• 16:51Shane Parrish?

  So what was the course before? Were you still, were you, you were teaching?

• 16:54Speaker 01

  It was pure Graham style.

• 16:56Shane Parrish?

  Okay.

• 16:56Speaker 01

  Investing. It was called security analysis and I would mostly talk about risk arbitrage, about. Uh bankruptcy investing, about investing in cash bargains and statistical screens that Graham used to create. Um and talk about in his books. Uh it was purely that. Uh the idea that there could be a great business out there and the idea there could be a a competitive advantage out there was not even known to me at that time. And um most of the discussion was revolving around financial statement analysis. Instead of going to the reason as to why is this business successful? And when you go into the question why? The answers come from many sources. Uh why, why does a customer buy this product?

• 17:37Speaker 01

  What is it um that the customer likes? Why does he not buy somebody else's product? Uh why would a competitor not enter this market? Why, why, why would they, um why wouldn't they even try? Those are very profound questions and you won't know the answers to those questions unless you ask them and the answer comes from different disciplines.

• 17:55Shane Parrish?

  So the role of mental models and multidisciplinary thinking has played an incredible role through investing for you. And changed the way that you teach. Has it changed the way you live outside of those domains? How so?

• 18:10Speaker 01

  It has, uh, in, in many ways. And um, when you look at the world out there, you can't think about it without thinking about incentives. And that's one of the most important lessons of, uh, that Charlie has given. That you must have a two-tiered system in, in trying to understand the world out there. And, uh, you know, we talk about economics and economics is incomplete without psychology. Uh, and you know, we have all these notions about the rational man, models in economics. And most of economics is based on the idea that human beings are rational, but most of social psychology actually tells you that we are quite dumb. Very often we make, uh, very foolish mistakes. And I think, um, both the, the disciplines of economics and psychology are kind of connected.

• 18:54Speaker 01

  Uh, and, uh, if you, if you put that in the context, let me give an example. You know, as an accountant, I learned about the idea of shutdown point. That there is a point in a business's life when you should shut it down. Uh, but if you study Charlie and if you study Warren Buffett's life, you'll find out that actually you should shut it down well before. When it makes sense for you to shut it down because you have to think about opportunity costs. And, uh, a lot of people will not shut down, even if it makes sense to shut down because they figure that the other guy is going to blink first. So they operate in a competitive market and we're seeing that right now in many industries. Look at what is happening to shale and oil production in, in even in Canada or in the US. Uh, compared to what is happening in the Middle East.

• 19:36Speaker 01

  People will keep on producing things even though it doesn't make sense for them to produce it because they think that somebody else will shut down before they would. And, uh, sometimes they are right and often they're wrong. And when they're right, often they're right because they have a backing of some, somebody who is going to fund them. And in today's world, you have these markets which will fund you. And, and we're seeing that in India, we have an e-commerce bubble going on. There are three or four players. And they are essentially giving huge discounts to to consumers.

• 20:07Shane Parrish?

  Hmm.

• 20:07Speaker 01

  To to purchase their products and to not go to bricks and mortar stores and people are doing that. But all of these e-commerce companies, they are bleeding cash, but they have rich investors who are willing to give them money to uh to gain market share. And as long as that money keeps on coming, it's going to be very difficult for the bricks and mortar players to be able to effectively compete. So we see a kind of a situation where if you want to understand this situation, you cannot understand without thinking about psychology. What gets a business to continue to operate even though it doesn't make economic sense? Why does that happen? That helps.

• 20:43Shane Parrish?

  And do you think like you mentioned the shutdown point? Do you think that that transfers to relationships and friendships and books? And a whole bunch of other things in the concept of there's a point at which you should stop reading. There's a point at which a relationship becomes unhealthy. There's a point at which, do you think about it in those ways? Or do you approach outside relationships differently? Or do you always have that kind of multidisciplinary mental model filter on?

• 21:10Speaker 01

  I think there's something to be uh learned on that from the experience of Charlie and Warren. Uh I think we all know this, that they really sell out of a business, even though it's not doing well. Even though economically it should be close, but the why do they, why don't they shut it down? Why don't they get out of a business? Usually they don't. And I think the reason is that they they've created a culture when they want to be a natural partner for a for a business to be owned by Berkshire. And you don't get to that kind of a state if you start treating businesses as a game of rummy.

• 21:48Shane Parrish?

  Hmm.

• 21:48Speaker 01

  Uh you don't discard your least performing businesses. And I think they've done that and and and they've done done that over decades. And have created a position in the minds of the owners of admirable businesses out there that here is a place where I can give my business to somebody and that's not going to be sold off to a private equity investor or to be liquidated because it doesn't make sense. Even though in the short term. It might cost Berkshire some money in the long run. It has created a huge reputational advantage for them. Uh. And of course, uh, that has helped Berkshire. Uh. I think there is something to be learned from that. Um. But, um, you know, when you're running a fund, uh, when you have investors who can, uh, pull the money out at a short notice.

• 22:32Speaker 01

  You probably cannot think on those lines and which is something which Buffett and Charlie are familiar with. And they don't have their structural disadvantages. So you have to be very careful about these notions because you have to have the structural advantages that some people have. To be able to have the privilege of thinking along those lines.

• 22:51Shane Parrish?

  How conscious are you about setting up your, your environment to allow for that in the sense of?

• 22:57Speaker 01

  It's a journey. It's a journey and, um, there were times, uh, in my, in my life and I did not have that privilege as I, um. As I evolved over the years, uh, I am, I think I'm closer to that utopian kind of a situation where I can say that. I can truly think long term. I'm not fully there yet though. Uh. But I think, uh, it's important, uh, to, to think really long term and you can't do that unless you are financially independent. That's one of the big lessons that I have for my students is that the first thing that they need to get is financial independence. Once they have that, then they can look at the world the way it really is and they can perhaps think much longer term. Um. But, um, things could be a lot better. I have to, you know, admit.

• 23:38Shane Parrish?

  So outside of the structural reasons, is it, how do you set up your actual physical environment to encourage? Uh. Rationality or better decisions or so, I mean, um, Buffett is the one who moved from New York to Omaha in part. Because he felt like somebody was always whispering in his ear. And the assumption or, you know, reading between the lines there is that I think they're more conscious about how they set up. Not only their, um, structure of the company, like when him and Munger owned almost forty percent of Berkshire. But also their physical environment to maximize their personal, um, ability to make rational decisions. And I, I'm wondering what yours looks like.

• 24:19Speaker 01

  Yes, I think that's absolutely, uh, the right way of thinking about it and I, um. I completely agree with you that you have to have a physical environment. And one way I've done that is to, uh, to give up on television. Uh. So I don't have a television. The other thing which I did recently was shut out, uh, take away, uh, um, Yahoo Finance uh, as a bookmark on my, on my, uh, on my browser. So I don't get to see stock prices as often as I used to. And it, it does look, uh, it does look a bit odd in the beginning, but if you do this long enough, uh, I, I am, I'm more at peace. Uh, I apparently there is a lot of volatility in the markets as we speak right now, but I have no idea as to what has happened to a specific business because I'm not looked at the stock price.

• 25:04Speaker 01

  I think that's very helpful to me. Um, Guy Spear has written, you know, the marvelous passage in his book, where he wrote about creating a physical space, uh, where you have, uh, shut out a lot of the distractions of life. So he writes in his book that there is a room where he has no electronics, uh, and he cannot be disturbed when he is in that room. And I think that's a very useful way of doing things. And I'm not there yet, but that's one of my aspirations to have a room where there is no electronics and no distraction. And there's a big do not disturb sign outside and where you can just sit and think, which is exactly what I think Buffett does or what Warren does and what I think most successful investors do.

• 25:48Speaker 01

  And it's not just about investing, it's about everything in life. You know, if you want to make decisions, you need to shut out a lot of the noise. You have to really focus on things that really matter. And sometimes the things that really matter are far fewer than what it appears.

• 26:01Shane Parrish?

  How do you go about determining what matters and what doesn't? I mean, we live in a, in a world where everybody, including Farnham Street, I mean, it competes for eyeballs and it competes for attention. And those are scarce resources on behalf of people. And it seems like the pace or the, the velocity of that information coming at you is increasing. Um, people feel overwhelmed, they feel like they can't separate the signal from the noise. Is there anything that you do that helps you eliminate, reduce, filter, sift?

• 26:36Speaker 01

  Yes. So, um, depends on what context you're speaking about. Let me pick up the context of, uh, analyzing businesses. You have all this data. I mean, there's real time information out there. There's Bloomberg and I don't have Bloomberg and there's CNBC and I don't have a television. So there are all these uh sources of so-called information. Most of it is, in my view, noise. So if you shut out all of it, you have um uh filtered out a lot of the noise. But there's more. Um as you go through analyzing a business, you come across um data, for example, quarterly results. You you start thinking about C's Candy. If you think about C's Candy, C's Candy loses money as as if I recall correctly about eight

• 27:17Speaker 01

  eight months in a year. It loses money. Four months in a year, it makes money and it's a fabulous business. We all know that. So here is a business which is a fabulous business, which has created a wonderful uh cash flow, which has helped uh Berkshire become what it is today. But it loses money eight months in a year, which means there are several quarters when it is loss-making. And there is one one there is one big quarter when they make a lot of money. I think that's a very powerful way of thinking, that there are these businesses out there which are not going to do well. And therefore, if you put a lot of emphasis on short-term quarterly results, you are really looking at noise. And therefore, you should focus on what really matters and

• 27:57Speaker 01

  if you focus on the idea of competitive advantage, the idea of what Buffett likes to call as a moat out there, then it's by definition, a moat is not going to get eroded in a day. It's not going to get eroded in a quarter. So in effect, if you are focused on investing in a business which you think has a durable competitive advantage, then quarterly results are going to be almost insignificant. What really matters over there is the durability of that advantage over a long period of time and how how the business can scale. I think those are two or three things you have to focus on. I mean, you do that, a lot of things which are irrelevant, uh which are available to you. You you don't have to focus on them at all. You can remove them from the from the from your screen.

• 28:42Shane Parrish?

  There's different types of modes. I think you you teach that there's, I I forget how many that you distinguish, right? Between low cost and differentiation and um do you find that any are more sustainable in general? If all things are considered, like which would be the best mode to have if you could have one one mode? Would it be a product differentiator? Would it be a a low-cost provider? Would it be?

• 29:06Speaker 01

  It would be a low-cost provider, if you think about it. The reason why brands are successful is because they give you scale and they give you a cost advantage. Um, I think the low-cost model is a far more sustainable model. It's actually a very admirable model in capitalism because there's less wastage. If you, if you look at a Costco, which we both know is a very admirable business model, then why is it an admirable business model? Because it deals with the paradox of choice. You don't need fifty ketchups. And why, why do you need fifty different kinds of ketchups? It's not good for civilization, if you think of, from a Charlie Munger perspective,

• 29:44Shane Parrish?

  Mm-hmm.

• 29:45Speaker 01

  to have consumers get fifty different kinds of ketchup. Three or four are good enough.

• 29:49Shane Parrish?

  Hmm.

• 29:49Speaker 01

  And when you have only three or four in a business which has scale, then you can offer them at a lower price because you're, you're buying them in large quantities, much larger than other vendors who have fifty ketchups. So I think that's very admirable from a civilization's point of view. But if you could have something that will, will be good for civilization, which means enough choice, but not, not so much that creates a paradox of choice. At the same time, you can earn a high return on capital and also pay your employees well, which is what Costco does. I think that's an extremely admirable combination of things that are happening over there. And when you combine that with the fact that customers are funding a lot of that business because they pay upfront a fee to get the privilege of shopping with you and that gives you um float,

• 30:35Speaker 01

  uh which I think is another aspect of, of a wonderful business. I think all of that combines together to produce something which I think is absolutely fabulous. So in a sense, when you have scale, you have a low-cost advantage. You pass on most of the benefits to your customers that creates loyalty. They want to come back to you again and again and they don't mind paying you an annual fee to get a chance to shop with you. And and with the cash flow that you generate, you have a system where you are keeping your employees very happy. You pay them more than your competitors pay their employees. And that creates a wonderful culture of meritocracy. Um. It's a nice karmic feeling about it, that you're doing good, you're doing something pro-social for civilization.

• 31:17Speaker 01

  And in this, in the process, you're not compromising on on creating wealth for your for your owners. I think even if you make slightly less money, uh net-net, I think civilization is better off having businesses where you have low-cost advantage. Now, you know, we are not very far from Fifth Avenue, which is a place where you go to buy all those wonderful overpriced brands. But if you think about it, really speaking, the consumers who buy those five thousand dollar bags are really paying a price which is way more than the cost of manufacturing that bag. Uh. So you have huge gross margins in those businesses and they use their extra gross margin to to advertise,

• 31:57Speaker 01

  to create a perception that you really do need that bag because you if you don't have that bag, then your life is not full. It's not complete. You're not, you're incomplete without that bag. I don't think of that as a very admirable business model. I'm not being very judgmental here. I'm just saying things from my own perspective. That i- if you had a business where you have a low-cost advantage, where you're selling something that is really good and cheap, and it has got a brand and it is creating a a brand loyalty, uh and you're selling it at a price which is um uh a really low price and in the process you can still earn a high return on capital. I think of that as far more admirable business model than where you are selling at ridiculous prices

• 32:39Speaker 01

  because you're creating a perception in the minds of the consumer that this is worth a lot more than what it really is. Do you think that that's a short-term strategy, doing that?

• 32:49Shane Parrish?

  And then, because long term, that's not a win-win relationship in the sense that, as you said that, it struck me that if you're creating unhappiness in my life, because I don't own your product, and I buy your product, and I'm still unhappy, and you're still creating that unhappiness, how can that take advantage of compounding on a long time scale? Whereas Costco, for instance, much better kind of model in terms of consumer wins, the employee wins, the shareholders win. It seems pretty win-win for everybody involved. The suppliers win. I don't know if I get the same feeling as you were talking about like the high-end brands on Fifth or somewhere else.

• 33:28Speaker 01

  You're right, but I don't think we can say this is short term or long term, because clearly many of those brands have been around for a long time, and they're very successful businesses. It's just that if you notice that you don't usually find a Berkshire Hathaway owning them, why? You know, why don't they own any of that? Why do they have something which gives genuine happiness? Why do they own businesses which provide something which is genuinely useful

• 33:55Speaker 01

  to society? I think there is something to be thought about on that. But I don't think, you know, there's a saying that there's a sucker born every minute, and there are all these people who believe that if they have become wealthy, then they need to have certain product, even though it is indistinguishable from something else which is far cheaper. And the supply of those people is actually going to increase over time. So I don't think we can say that those businesses are not going to thrive in the long run. They probably will. But to me, that doesn't matter, because I am much more in awe of businesses which which do something pro-social for society and also make money for the stockholder. So there is no trade-off there. You're not really doing charity. You're doing something good.

• 34:40Speaker 01

  And still make money. I think that's far better than a business where you're making a fool of somebody.

• 34:45Shane Parrish?

  Yeah.

• 34:46Speaker 01

  Uh, and a business model which essentially involves making a fool of somebody, in in this case, your customer, I I don't think it's as admirable as a business model where uh, everybody goes home happy.

• 34:57Shane Parrish?

  As you were talking about Costco, uh, it sounded a lot like Amazon up until you got to your company culture. But the other thing that I think that Costco does, which is, which plays to psychology a little bit, is when I go in there and buy my ketchup, I have no idea what, you know, eight liters of ketchup should cost, because I have no reference point, whereas when you're.

• 35:15Speaker 01

  You have a reference point. It's called trust.

• 35:17Shane Parrish?

  Yeah.

• 35:18Speaker 01

  It's a business, it's a business model which is, Charlie keeps on saying, a a seamless web of deserved trust.

• 35:24Shane Parrish?

  Which I completely understand. Like, I know if I go to Walmart and I go to a grocery store, they're selling the exact same bottle of ketchup. So I have a general sense of how much that should cost when you get into Costco. And I've looked at the financial statements, so I know they're not making, you know, a ton on this stuff. They make enough to pay their employees, basically, and then they they try to make their money, if I understand it correctly, through the memberships.

• 35:47Speaker 01

  Well, Costco, I think, makes about twenty percent return on equity, which is actually quite healthy, if you look at uh, interest rates over this part of the world. And it has a a PAT margin of less than two percent. So it has very high capital turns. Uh, and it can do that only because it has scale, and it can get scale only because it has fewer SKUs. Uh, so I think it's a nice virtuous circle. It's a nice positive feedback loop and player out out there.

• 36:12Shane Parrish?

  And do you think that that's more resistant to some of the the types of?

• 36:16Speaker 01

  Yes.

• 36:16Shane Parrish?

  E-commerce stuff that you were talking about before, in terms of not only the physical kind of bricks and mortar stores, but uh, against the online sort of efficiencies that Amazon? I mean, it seems like they're not really impacting Costco as much as other other stores like Walmart or?

• 36:33Speaker 01

  Yes, that's true. You know, in a sense, Amazon has picked up some of the best ideas of Costco. Uh, if you look at Amazon Prime, that takes money from customers upfront to give you certain privileges. That's an idea that they, I think they copied from Costco, but it has. Certain other advantages, it offers you amazing amount of availability, which Costco doesn't. So it kind of uh gives you, and it has one shop, it doesn't have a lot of the costs which uh which uh which Costco has. So clearly, I think there is in capitalism, you'll keep on finding all kinds of businesses that are evolving over time. And I think the Amazon business model is very misunderstood, particularly people who think that they don't make any money. I don't think that, I think Costco, uh Amazon makes money.

• 37:17Speaker 01

  Uh you can't just go by uh reported earnings, the true economic earnings of Amazon are significantly higher than reported earnings. Uh I I think it's a superior business model over time, but that doesn't have to mean that Costco is going to go out of business.

• 37:30Shane Parrish?

  So let's switch gears just a little bit here from um investing specific to acquiring, organizing and synthesizing kind of knowledge. Um as a prolific reader, you read a lot, you you integrate that into the Word documents afterwards. Do you also integrate it into your courses? And how do you go about connecting the different ideas other than um you mentioned the Kindle search earlier? But how do you go about adding or refining, I guess, the mental models that you have in your head? And adding new mental models and how do you know you've come across a new model?

• 38:04Speaker 01

  Well, um I over over a period of time and you experience something and you find answers to that. Questions that keep on occurring uh in in a manner which uh provides you with answers which are different from what you thought earlier. Then you might have chanced upon a new model. Uh you never know for sure, of course, and it's just a way of organizing your thoughts. So you're trying to evaluate a situation and maybe five years ago you had looked at it differently. Today you look at it differently because you read so many things and you have a better understanding of the world. And uh maybe some answer to that question will help you figure out the problem better than five years earlier. Then I think there's a good reason to give a name to that. And that's how I do go about doing that.

• 38:48Speaker 01

  And Charlie has provided you with a with a framework. There are all these disciplines and there are all these names. He uses uh things like the boiling frog syndrome, which is a model which deals with the. Low contrast effect, which talks about the idea that slow changes tend to go unnoticed. That's a very powerful notion if you think about it because if you look at a business, hugely value creating business or a value destroying business and if you look at their financial statements over a quarterly period, you will miss a lot of the change. But if you put gaps in between, if you look at data five years ago and today, you will see huge change. Uh, and that tells you why you noticed change because you removed a lot of the columns. You removed a lot of the quarterly information.

• 39:31Speaker 01

  Charlie likes to give a name to, to models like this, a boiling frog syndrome. And I think we already know that, that there is this myth that if you put a frog in boiling hot water, it'll jump out and escape. But if you put a frog in lukewarm water and boil it slowly, it'll stay there. And it's absolutely a myth. But I think the, the human equivalent of boiling frog is there in all of us. Uh, and therefore, if you can notice change over a period of time by removing periods where change was not likely to be noticed, it's going to be very, very helpful. So I use that a lot. So in a sense, uh, I, I, I like to look at a business twenty years ago, fifteen years ago, ten years ago, five years ago and today.

• 40:12Speaker 01

  Uh, and that helps me understand, uh, what comparative advantage could be and how, whether it is increasing or reducing over time. So it's useful to have these models, give them names, uh, which are very useful for recall because you, you can give a technical name to boiling frog. Uh, but, uh, I think it's very important to have these notions in your head because you can retrieve them very quickly. Once you have, uh, names which, uh, to, to specific models, which, uh, which you can recall immediately, it will be very helpful. So I like that particular point that Charlie makes that you can give them your own name. And he uses things like deprival superreaction. He doesn't use the word loss aversion because loss aversion is a technical word, technical phrase to illustrate a very powerful point that he makes.

• 40:57Speaker 01

  Uh, deprival superreaction, I think when you read through his letters, uh, and whenever he's talked about deprival superreaction, it immediately hits you. And of course, Charlie has filed them away in his head by giving these descriptive names. And I find they're very useful.

• 41:12Shane Parrish?

  So the names are great and for Charlie and for you, you can probably just mentally go through this this list. How do you feel about checklists? Or how do you make sure that you've thought about things from it? It seems like ever since Atul Gawande's book, The Checklist Manifesto, there's been a movement, not only in the value investing community, but a movement in hospitals and a movement to go back to maybe the airlines are doing something right. Maybe the low fatalities and the very methodical approach to things has an advantage. How do you make sure that you're capturing all the mental models that you have and bringing them to bear on a particular problem?

• 41:49Speaker 01

  So when you think about checklists, I think what you're trying to do is to reduce your rate of error. And there's a trade off here. I think what Atul Gawande has done is done a marvelous, you know, service to civilization by giving us a framework of how to reduce error. And it could be domain, it has to be domain specific. It could be, you know, flying a plane, as he talks about in chapter one in that book. It could be about running a hospital operation. It could also be about running an investment operation. But all of that is focusing on how to reduce error. But that's just one aspect of it. Because reducing error is not always the most optimal thing to do. You also have to be creative. If you're going to be creative, you're going to make mistakes.

• 42:30Speaker 01

  If you look at any business which has been innovative, you'll find that they have made mistakes. So there are two things here. You need to have the framework to create insights, which means you need to have a creative mindset, which means that you should be willing to experiment and sometimes make mistakes. At the same time, when you're actually making big decisions, you need to also have a framework to reduce error. And I think Atul Gawande's work and the movement that he's created that you're referring to deals very well with that aspect. It doesn't deal at all with the idea that you want to be creative. So you need both. You need to have the ability to have unique insights, and you also need to have the ability to reduce your error rate.

• 43:12Shane Parrish?

  So there's a tension between those two. But when you go inside an organization and you're, say, a mid mid level manager, your job is almost effectively reducing error. Reducing variance.

• 43:23Speaker 01

  True.

• 43:24Shane Parrish?

  Uh, which, you know, um, is at odds with creativity and possible film because I, I think there was an article in the Atlantic that put it really well about creativity and I'm kind of going off the cuff here, but they basically said that, you know, creativity is connecting things that other people haven't connected before. And if it works, you're a genius. And if it doesn't, you're basically in the madhouse because people think you're crazy. So when you're trying to get promoted and the psychology of being that mid-level manager in an organization who's very career oriented and has a lot at stake in reducing the variability, how do you go about implementing creativity? How do you with, like, how do you balance that tension? And some companies do it really well, and I have no idea how they, how they do that.

• 44:10Speaker 01

  So that's a great question, and I thought about that over the years and over the years I've come across a few entrepreneurs which have, I think, been what I would describe as what Charlie would call as a learning machine. They made mistakes, um, they learned and they haven't made those mistakes again. Uh, and you know, as a, as a financial analyst, I do know a few things about risk management. So, uh, what I, the way I think about it is that I'm looking for businesses that that are risk averse but not loss averse. And those two things are very different. So what you're really looking for is somebody who doesn't mind making a few small bets. Many of them will go bad, but they have potential. And if they, if, if they pay off, they'll pay big. Uh, and if none of them pay off, it's, it won't impair the company.

• 44:53Speaker 01

  It won't impair the business and that's exactly what how Buffett thinks. So when he, uh, is in a position to write, uh, an esoteric insurance policy, which will maybe pay off if he has to, to make good on his promise, he may have to pay a couple of billion dollars or even more than that. But the premium that he receives, uh, in return of that promise is several times more than the actual value of that bet. And the reason why he can do that is because nobody else is willing to make that bet. And the reason why nobody else is willing to make that bet is because of the point that you just made, that they have the people who have to make that bet have career issues. They have career risk associated, so they are, they are, they are. And they are risk averse. They don't want to take a chance, but Buffett doesn't mind doing that.

• 45:38Speaker 01

  I think that's very interesting because you can use that in analyzing a whole variety of businesses out there. And find entrepreneurs which in aggregate are not taking a significant risk. Because if all of these bets don't work out, you're still fine. And the way to think about that is to look at the quality of the balance sheet. If, for example, you're not borrowing money to expand. And if you're doing multiple expansion projects, you're introducing different products in different markets, in different geographies. And you know that each and every one of those bets have great potential, but it's a probabilistic world out there. You have no idea whether they will work or not. So you're giving a lot of respect to uncertainty. You don't know what will work. You're just being driven by data is exactly what happens in amazon.com.

• 46:21Speaker 01

  You're trying to do a lot of experiments. You don't know which ones will pay off. But if even if none of them pay off, it won't ruin the company because it has got other earnings streams. It has zero debt on the balance sheet. I think that layer of financial discipline. When you combine that with an innovative culture is a very good mix. And I think you find that in some entrepreneurs and when you find them, you should, you should look at it with a bit of admiration.

• 46:47Shane Parrish?

  That's a really good way to think about it. As you were talking, you were answering there. I was trying to think of the differences between Jeff Bezos and Steve Jobs. And one would be if you had to categorize him purely analytic. And the other would be driven by an intuitive sense of design. And yet they're both incredibly or were incredibly successful.

• 47:07Speaker 01

  Yes.

• 47:07Shane Parrish?

  I think often I'm wondering if we just straddle, we try to be a little bit of both. And that that strategy is effectively ineffective. Because instead of trying to to compete or better yourself in one area, you're trying to better yourself in two areas. By which, you know, you can't be an expert at both in that sense. Or maybe you can be and we just haven't come across examples of people that I can come off the top of my head. But how do we, how do we move forward with that tension in terms of, is it better to pick one? I, I know myself and you know, you can't really make these decisions until you know yourself. And therefore I will be a data-driven person and I will make these decisions. Or I know myself and I have a more intuitive sense of design and that's the path I want to pursue.

• 47:52Shane Parrish?

  And then burn your bridges to the other one. Or do you, do you still, like, how would you approach that?

• 47:57Speaker 01

  I would do that from a data-driven perspective. Uh, you know, there are these intuitive people out there. Uh, in capitalism, we have found a Steve Jobs who can create something beautiful that people relate to and they don't, they become price insensitive. They just want what he is offering to the world out there and it is beautiful. But you can't spot these people at the beginning of their careers. You can spot them maybe in the middle of their careers. So there has to be past-track record of somebody who is intuitive and right over and over again. Once you found that, that's based on actual data. Uh, and on the other hand, you have these other kinds of entrepreneurs who are like Jeff Bezos, who are data-driven, who don't mind, who have no idea about what will happen,

• 48:40Speaker 01

  but who don't mind making a, a series of small bets on a number of hundreds of experiments and have the ability to be absolutely unbiased about where to put money. And they would bet heavily once they know that this bet is likely to pay off. And then if bets that are not paying off, they would hesitate to withdraw capital from those. I think there is in capitalism, uh, as investors, for, for us, it's, uh, it, it, we, we shouldn't have, um, at least I don't feel the need to have a preference of one or the other. If you can find both kinds of entrepreneurs, it's wonderful because you are trying to build a portfolio.

• 49:17Shane Parrish?

  That's a really good way to think about it. So there's three questions I do at the end of every interview. And so we're coming to the end, so I want to ask you these three. And the first one is, what book has influenced you the most in your life or?

• 49:32Speaker 01

  That's easy, that's Poor Jha Chali's Almanac.

• 49:34Shane Parrish?

  Portrayal's Almanac?

• 49:35Speaker 01

  Yes. It, it, it never stops influencing me. Every time I pick it up, I read it, it, it gives me something more to think about.

• 49:43Shane Parrish?

  How often do you reread it or go back and think about it or?

• 49:49Speaker 01

  I do it about three times in a year. Um, um, but some talks I end up reading more. Uh, every year I go and teach a course on, on behavioral finance and on the talk on psychology, human judgment is, is, is helpful. Because every time I read that talk, I come up with new examples. I've learned. Something else over the last one year and every time I read that book, that particular speech that he gave. Um. It helps me come up with new associations, new examples. And I think I'm a better thinker after having uh read uh what he what Charlie had said so many years ago. And related to my new experiences and be able to teach them and in the process learn more through teaching.

• 50:32Speaker 01

  Uh. So that's so some talks I would read more uh and some I would read less. But I would pretty much read that book about three times in a year.

• 50:41Shane Parrish?

  So with the talk, the psychology of human misjudgment, do you listen to it or do you read?

• 50:46Speaker 01

  I read it. I I know there there is a uh audio version of the first talk.

• 50:50Shane Parrish?

  Right.

• 50:51Speaker 01

  Uh. But uh I I prefer to read it because this it's so profound. I mean, you have to pause. If you if you are listening to it on audio, then I guess you need to constantly pause and think about it. Maybe you can do it, but I just don't find that very. Easy to do. So I'd rather read it and then let it be, uh read a passage and then think about it. May spend a few hours thinking about it.

• 51:12Shane Parrish?

  And is your copy of Poor Charlie's Almanack marked up?

• 51:15Speaker 01

  Oh, yes.

• 51:16Shane Parrish?

  Yes.

• 51:16Speaker 01

  Oh, yes.

• 51:17Shane Parrish?

  What book are you reading right now um that you're really enjoying?

• 51:21Speaker 01

  Oh, I had to pick up. I'm reading so many of them. Let me open up um. I picked up one book which you had recommended uh a few weeks ago, which I find very useful. We just pull that up. Fabulous Perception.

• 51:34Shane Parrish?

  Mm hmm.

• 51:35Speaker 01

  That's a book that you wrote about uh in in one of your posts. And uh I I picked it up and I I I'm reading that. That's a fabulous book. I've just read about thirty percent of it. I think it's a fabulous book.

• 51:47Shane Parrish?

  It's an amazing book.

• 51:48Speaker 01

  Yeah.

• 51:49Shane Parrish?

  I think my what I said was it deserves a place on everybody's shelf beside Seeking Wisdom.

• 51:54Speaker 01

  Right.

• 51:54Shane Parrish?

  Um. And uh he's an amazing person.

• 51:56Speaker 01

  Right.

• 51:57Shane Parrish?

  Um. And then the final question is who uh if you could have anybody else interviewed on The Knowledge Project, who would it be? Who would you like to see me interview?

• 52:06Speaker 01

  Charlie Munger.

• 52:07Shane Parrish?

  I'll try to make that happen. Sanjay, thank you so much for your time. I really appreciate it. It's been an amazing experience meeting you. And speaking with you.

• 52:16Speaker 01

  Thank you, Shane. It was a pleasure meeting you as well. Thank you.

• 52:22Shane Parrish?

  Hey guys, this is Shane again. Just a few more things before we wrap up. You can find show notes at farnamstreetblog.com/podcast. That's F-A-R-N-A-M-S-T-R-E-E-T-B-L-O-G.com/podcast. You can also find information there on how to get a transcript. And if you'd like to receive a weekly email from me filled with all sorts of brain food, go to farnamstreetblog.com/newsletter. This is all the good stuff I've found on the web that week that I've read and shared with close friends, books I'm reading, and so much more. Thank you for listening.