(Published: March 16, 2017 at 11.00 A.M. EDT)
Hello, my fellow value investors! We are pleased to have with us today, Sean Iddings, co-founder of Intelligent Fanatics Project and founder of Unconventional Capital Wisdom, LLC, an investment management firm based in Newfield, New York, USA. His unconventional investment philosophy blends ideas from investing Gurus Warren Buffett, Charlie Munger, Howard Marks, Seth Klarman, Joel Greenblatt and Benjamin Graham, focusing on generating long-term wealth.
The interview is in podcast and transcript formats.
Podcast of Interview with Sean Iddings
Transcript of Interview with Sean Iddings
Hi Sean, nice to have you with us today. How are you doing?
Sean Iddings: Doing well, Nitiin. Thanks for having me here today.
1. Could you please discuss your firm’s unconventional investment philosophy? Have you attempted to “tweak” or “customize” the investment philosophies of the aforementioned Gurus, robust as they may be in their original form?
Sean: Yes, I’ll start off with your second question first. I’ve got a background as a musician and any musician worth their salt has their own unique voice. Their unique voice is their brand. It fits their personality. They etch a mental footprint in the minds of their listeners, much like Coke and other well-known brands have done in their customers’ minds. You just need to listen to a few notes of any famous artist’s song and the recognition is almost instantaneous. I’ll let you in on a little secret. All musicians, and all artists for that matter, start off by copying the greats that preceded them. Our time on earth is the most precious commodity we all have at our disposal, and this form of learning is the shortest path to achieving mastery.
So, stealing the best ideas of others is the foundation for new ideas and a unique voice to develop. When I got started in investing, it was a natural extension for me to go out, and stand on the shoulder of giants, and shamelessly steal as many ideas as I could from the successful investors that you mentioned.
And from what I’ve learned from all of the value investors, I’ve come to settle upon my own unique voice. You need an edge and what has worked for all the aforementioned Gurus won’t necessarily work in today’s market environment. To give you an example, Benjamin Graham’s Geiger Counter net-net bargain hunting isn’t the fertile of a ground as it once used to be in the 1930s and so on.
The investment philosophy that I have landed on is simple: I prefer to find a few high-quality operators, otherwise known as “intelligent fanatics”, early in their business’ evolution and hold. All I need is to be right a few times and let the company compound over the long-term, and you’ll do quite well.
2. All right, Sean. You believe in taking a long-term business like approach while utilizing your understanding of human psychology, and its limitations, to achieve exceptional investment results. Could you please elaborate on this?
Sean: So, the game of investing is one of making better predictions about the future than other people. The future cash flows that a company produces will determine how valuable a company should be. The only problem is that the stock market and business in general are inherently unpredictable phenomena. How do we predict the future? Computers are faster, and honestly, I’m a dunce with math, so it’s hard for me to have an edge in the quantitative realm. One thing that I have found to be more predictable is the human element. Humans are complex but react in common ways. I can never know what obstacles or successes a business will face in the future, but I can kind of size up the type of leader running the business. Are they ultra-ethical, are they intelligent, are they driven? Those are qualities that you can observe in the here and now. Since a business is an embodiment of its leader, I can trust that the leader will attract similar people and infect them with the same vision, and adapt to future obstacles. Thus, when obstacles and opportunities arise, I have trust that the leader will do the right thing.
3. Sean, you seem to be quite in favor of MicroCap investing. Now, I am fairly sure you’ve been asked this question a million times. But MicroCap investing may involve sifting through as many as a few hundred companies, before finding a potential superstock with moderate risk. How exactly do you tackle this arduous task – is it via some proprietary database, or screeners, or via notes exchanged within your circles?
Sean: Good question! I used to spend hundreds of hours going through all companies from A to Z, under the $200-250 million market cap. To be honest it was quite depressing seeing so many unprofitable companies. Anyway, having done that already has provided a good number of interesting companies to watch.
Now, I get ideas from other high quality investors through places like MicroCapClub and spending my time researching the failures and successes of companies in the past. I think studying the great leaders of the past and present is a great exercise in deferred gratification, similar to what I mentioned before – stealing great ideas of the investment gurus. I’m leveraging compounding, the most powerful force in nature, to prepare me for opportunities. It also is a much better activity than listening to all of the financial noise that surrounds us. I can talk more about that process, which is tied with the intelligent fanatics project later.
4. All right, Sean. MicroCaps may be a tad riskier than other stocks. Do you screen MicroCaps on quantitative filters first, or qualitative? Are MicroCaps from certain sectors usually better/less risky than those from other sectors? And do you prefer to build in a certain risk premium, into your return expectations from MicroCaps?
Sean: My main filter is: do I or can I, in a short amount of time, understand the business/industry better than most. Risk, I believe, is not understanding the business or industry appropriately. Then it comes down to my qualitative measures of the management, what type of organization are they trying to create, do they and their team have the ability to grow the company, are they market leaders and is the overall market growing?
I’ll pay up for modestly for those types of opportunities. Traditional GAAP accounting misstates growing companies’ current earnings. Many costs in the P&L could be considered capital investments, such as human capital, and there are many other intangibles that cannot be counted. Some projects that might be considered costs now, could also be a portfolio of bets with one that could be a homerun years and years ahead. There are many things that we can’t tell today, but are still very valuable.
5. Alright, Sean. So you are kind of restating reported earnings of different companies and that’s how you’re better able to arrive at investment calls, I guess.
6. All right, great. Nice to hear that. As I often request my interviewees, I would request you too, Sean, to share a couple of cases of your successes and failures in MicroCaps, without naming the companies if you so desire. I am quite sure my audience will learn valuable lessons from both.
Sean: Sure, I’ve found many of my personal mistakes have been when I got too lax in my focus on leadership. I remember being slightly apprehensive with one of my companies after meeting their CEO. Something was just off about him. I couldn’t verbally tell you why… I just felt that way. Nonetheless, the business was at, what I believed to be, an inflection point. Then I uncovered some data on the CEO that showed this individual is not as ethical as I prefer and I started to hear about some boardroom shenanigans. Fortunately, I got out without losing too much money, but the experience enforced the lesson that quality of management really matters to me. Any cracks or indications that leadership lacks integrity should be an immediate pass or sell. As Buffett said, if you find someone who lacks integrity, but has the intelligence and energy, you better watch out.
Any of my multi-bagger successes have come from investing in businesses with a strong leader along with a unique and highly effective corporate culture. I’ve also made some stupidly lucky calls. I learned not to make those types of bets again.
7. All right. I guess it happens with all of us, from time to time. Could you please describe in brief the Intelligent Fanatics Project and the book of the same name?
Ian Cassel, my co-founder, and I wanted to compound as much knowledge as we can from the successes in businesses and leaders of now and the past. I’d argue with Charlie Munger that this is a more fruitful activity than just studying the failures of the past and avoiding them. Not only does it help us become better business operators and human beings ourselves, but it also helps prepare us to be worthy of partnering with the intelligent fanatics of tomorrow. Our vision is to help investors and entrepreneurs see further by stepping on the shoulders of giants.
We published our first book that uncovers eight exceptional leaders of the past. They compounded shareholder returns at rates well beyond the market, respective of industries and peers. We focused on the common traits between the leaders and their organizations. Our second book has many more unknown examples from across the world, that we are really excited about and we have gone straight to the sources for their stories.
I’ll quickly talk about our website, intelligentfanatics.com, which has blog posts and a research portal that we are adding to daily with our notes and learnings. The site is an extension of our book, and future books. If you want to keep updated with all that information, sign up to get our weekly update sent out on Fridays.
8. As you said, Sean, the Intelligent Fanatics Project book covers eight exceptional leaders. That would be 8-10 companies out of like, 4,000 US-listed companies? How did you go about the task of identifying these companies, and leaders?
Sean: It’s a good question. Well, we don’t really restrict our universe to public companies in North America, but also look abroad and with private companies. That pool is much bigger than 4,000 U.S. listed companies. We also look throughout history so our universe is not constrained. Our belief is that business lessons can learned from everyone, at any time frame. It just means we have to look at every lead. If any listeners know of any superb company past or present, regardless of the location, let us know.
9. All right, Sean, I’ll keep that in mind myself. What is the secret sauce of the intelligent fanatics? Were they the sole driving force behind the companies they set up, or were they able to put in place great management teams, to which the companies owe their successes?
Sean: There isn’t a magic formula that makes all intelligent fanatics. With my background in music, I can say that like musicians, they have their own unique voices, but they generally have certain characteristics that allow them to dominate the market. And not every leader or system is perfect, so we focus on the positive qualitative characteristics that should be stolen. So if you want to think of an analogy, think of the banana – we want the banana inside, and don’t care about the peel, so we throw the peel and let somebody slip on it.
Businesses are the embodiment of their founders. That means a business really takes on the characteristics of the founder. If they are highly ethical individuals, driven, they can infect their employees to be mini-founders, and they attract the same type of people. Of course, the opposite can be true.
10. A review of these eight leaders shows that companies set up by just two of them, remain private till date, indicating no requirement of external capital. Some of these companies stuck to their core competencies even after decades, for instance, National Cash Register, incorporated 1884, is now NCR Corporation ($NCR), which is into ATMs with approx. 27% global market share. Southwest Airlines ($LUV) is a major success story within the Aviation sector, which has mostly been a thorn in the side for investors. Of the two companies set up by Sol Price, FedMart went out of business within less than 3 decades, in 1982, while Price Club eventually got merged into Costco ($COST). What are the broad lessons we can learn from these intelligent fanatics and their companies?
Sean: I took away a few broad lessons. It takes luck to be in the right place at the right time and every fanatic has the humility to admit that. And sustaining a business success is hard. What separates these leaders from other, once successful, entrepreneurs, is that they sustain their operations significantly longer than competent leaders. The culture is generally the differentiating factor.
You mention Sol Price, he built FedMart but was kicked out when Hugo Mann took control of that business. A friendly takeover turned sour. Mann lacked the integrity in maintaining the quality operation Sol Price started, employees lost morale and Mann did not sufficiently adapt to the changing market. Price would develop Price Club what today is known as Costco and instilled, through his mentee Jim Sinegal, the intelligent fanatic culture to help the company succeed even to this day. It doesn’t matter who’s leading Costco, in my opinion, it would be hard for the company to lose its culture. And that is the key, the best cultures are extremely strong and can maintain well after the founder leaves.
11. Great insights, Sean, on the intelligent fanatics and their successes. It is said that a team is only as good as its weakest member. How do exceptional leaders ensure that team performance and morale is not affected by a few below-average team members? Do exceptional leaders believe in supporting their entire team, and standing firmly behind it, or do they have to adapt to the changing environment and ruthlessly expel the below-average team members? To quote an examples, a few decades ago, Cricket Australia (formerly, the Australian Cricket Board) decided to stick to the same team members for its national cricket squad, regardless of the success ratio, and for quite a while, this strategy worked, and the Australian cricket team rose to the top of the ICC Cricket Rankings back then.
Sean: Good point and thanks for the example. Most intelligent fanatics that I have studied so far – and this is an ongoing project for me – eventually learn that it is necessary to voluntarily or involuntarily weed out the average and below-average members. There have only been a few cases that I can think of where a culture has been turnaround without cutting any employees – that’s is a rare occurrence. There are certain ways that have been utilized to keep the below-average team members to a minimum. First, intelligent fanatics build a cult-like culture and so those that can fit within their culture want to stay. No one has perfect hiring capabilities – so mistakes will be made, but the cultures are often set up so the mistaken hires voluntarily leave on their own.
Take for instance QuikTrip, the convenience store chain located in the South Central part of the US. Most of their turnover happens in the first few months. The reason? The culture of performance and service is so strong, almost like a cult, that those who don’t fit in the high-performance culture, will voluntarily leave. They just can’t handle it. The rest that do stay, often stay for decades, leading to overall turnover rates in the low single digits, while the industry has rates at or above 100%. It’s hard to have an edge turning over your entire staff every year while some competitors can invest heavily into the long-term development of their team.
12. Sure, makes sense. Most of these have been established companies for decades. But some day in the past, they all probably started as MicroCaps. It might be easy to call them great now, but how does one figure out the complex task of identifying exceptional future leaders and companies?
Sean: Generally, they do start off as small companies, but it all comes down to the people.
13. Alright. I believe valuable lessons can be learned by entrepreneurs and investors both, if one were to draw up a list of Intelligent Fanatics who were ahead of the curve, ethical and driven, but nevertheless did not succeed in their ventures. In other words, there’s a lot that we could learn from the failed ventures of promising, upright leaders. So, we’re not really talking about the Enrons and the Worldcoms of the world, but about the companies which showed promise, but simply disappeared off the face of the earth, like FedMart. Do you concur with this view?
Sean: Sometimes leaders have the right process, but luck is not so generous. These examples would be a good reminder that you need to set yourself up to make a few mistakes. We try to uncover as many of these examples on the Intelligent Fanatics website, but as I said earlier, while studying the failures and staying away is a good exercise, the best exercise in my opinion, is to identify and emulate those who are already standing at the end of the maze. Life is too short to do anything else.
Let me give you an example. Say your goal is to become a world class artist. Would you rather emulate DaVinci, Rafael, Picasso, etc. or to find all of artists that didn’t succeed? Time is ticking, I want to emulate the best and build on their ideas. If I found someone who was not famous but a great artist, I’d look at them too, but I wouldn’t seek them out first and ask why they didn’t get famous. I would just steal their great ideas. So, I’d start with the well-known greats that have stood the test of time and work to find the more obscure ones.
Learning any other way could work for other people, but I’ve found that our way of learning is quicker and more efficient. I subscribe to Darwin’s thought on time, “A man who dares to waste one hour of time has not discovered the value of life.”
14. While shortlisting intelligent fanatics from the past may not be impossible, how would you go about identifying the intelligent fanatics in the present day? What in your view, would separate intelligent fanatics from the intelligent but not so ethical leaders?
Sean: Simple, as Charlie Munger has stated many times, “the best way to get a good partner is to be a good partner yourself.” You attract who you are. In other words, emulate the best qualities of all the intelligent fanatics and great leaders. If you lead an organization, you’ll run it better than others, attract the right partners and employees. If you are an investor, you’ll likely attract more quality people to learn from, and, potentially, when the opportunity arises, to be prepared to invest alongside the next fanatic.
And overall, no matter what happens, the world is better off with someone striving to be highly ethical, driven, and compassionate about every relationship in their lives.
15. Great to come across a book which makes the management or leadership as its sole focus. I mean, we’ve all read so many books about investing, per se. But a book truly and solely on management – absolutely fantastic. Coming to my next question. Analyzing companies for investing requires consideration of a number of factors. How do you gauge the importance of Intelligent Fanatics, within the overall investing framework?
Sean: Business is all about trust. Partners trust their partners to do the right thing. Employees trust their employers to do the right thing, and vice versa. Suppliers, communities, investors, and customers trust companies to do the right thing. I think quality of leadership and quality of culture has a huge importance on business and thus I conduct my investment framework pretty much solely around that.
16. Sean, you have mentioned that Intelligent Fanatics Project is the first book in the series. Which topics are likely to be covered in the next in the series? And what are the timelines for publishing the same?
Sean: The first book was a launching pad, if you will. We provided the basic framework of what we have observed to be intelligent fanatics. Yet, there are many flavors of highly successful entrepreneurs. The goal of future books will be to uncover less known fanatics, share their stories and build up a library of experiences which readers can leverage. The more examples we all have in our library of both intelligent fanatics that achieved success and those that might not, will allow us to have a better model for you to emulate and compare to.
We are looking to be finished with the next book around September this year. Again, those who are interested in stealing the best ideas of intelligent fanatics, sign up at intelligentfanatics.com for weekly updates. You can also follow myself on Twitter at @iddings_sean and you can follow Ian at @iancassel. For the investors looking for great ideas in the MicroCap space then check out www.microcapclub.com.
Alright, Sean it’s been a real pleasure to have you with us today. Thanks so much for sharing so many invaluable insights from the Intelligent Fanatics Project. Needless to say, we’re all very excited and looking forward to reading the next book you have plans for. Good luck with publishing that. Have a nice day!
Sean: Thanks, Nitiin.
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