Sports & Stocks: When Winning Is Everything 

Steve Pomeranz: Dr. Bud Labitan is a physician and investor who has written books related to value investing and making smarter decisions. I’ve read a number of his books and I’ve had him on the show in the past to describe the art of investing. His latest book is Sports and Stocks, Quality Business Investing. Also, from time to time, I’ll ask Bud to analyze some companies that I’m thinking about. Welcome back to the show, Bud.

Dr. Bud Labitan: Oh, thanks for having me, Steve.

Steve Pomeranz: Today we’re going to talk about the art and science and individual investing. My first question is kind of a broader question. In a world of index investing where everybody’s going what they call passive, and there’s this sense that it’s very hard to beat the basic indexes, why would anyone try their hand at individual stock picking?

Dr. Bud Labitan: Well, I agree with you that the population of individual stock pickers is probably smaller than one would think. It takes an individual who has a passion and an interest for looking into the details, and who enjoys looking at the whole business.

Steve Pomeranz: Yeah. Some people feel more comfortable investing in singular companies that they can, in a sense, feel a tangible relationship to, as opposed to an index, which again, doesn’t seem to have this quality of tangibility. And also, I feel, though I do a lot of passive investing, index investing myself and for clients, sometimes it’s just nice to know, especially in a market decline, the name that you’re investing in. Whether it’s, and I’m just picking this out of the air, a Disney or a Proctor & Gamble. Something that feels like it’s not going to disappear in a bad recession or the like. Let’s get into this idea of investing in individual stocks. Your first tenant is to find high-quality bargains. What does that actually mean?

Dr. Bud Labitan: It means to find a business that has enduring qualities. I know in our last interview we talked about the philosophy of Warren Buffett and Charlie Munger. Your listeners can review that one. Getting back to what you said about this is not for everybody, and it does that time, training, and temperament. If a person doesn’t have the time, training, and temperament, they should leave it up to investment professionals like yourself.

Steve Pomeranz: Right, or do some passive investing, like Warren Buffett says.

Dr. Bud Labitan: Right.

Steve Pomeranz: Sure, okay. You’re trying to find high-quality bargains.

Dr. Bud Labitan: Bargains.

Steve Pomeranz: What is the definition of a high-quality stock? I mean, we hear about blue chip. We kind of know. What does it mean to you?

Dr. Bud Labitan: To me, in one of the chapters, chapter seven of Sports and Stocks, I simplified it so that it would keep the readers out of bad and mediocre businesses. I’ll just read those four points to you, Steve. One is find a business that is producing positive free cash flow, or FCF. And stay away from these start-ups that are not yet producing positive free cash flow. The second thing is find a business that’s producing a net profit margin greater than 10%. Buffett likes 15% and higher, but I think if you can at least eliminate the ones under 10% profit margin, you can filter out a lot of bad and mediocre businesses. The third one is look for a business that has a debt to equity ratio less than two to one. Now, there are some exceptions to this rule because the debt to equity ratio can be a tricky one, because young companies that are financed mainly by equity, they’re going to appear as if they have hardly any debt because no one will loan them money. On the flip side, a great company like Coca-Cola can handle a little bit more debt, because it’s got a steady stream of free cash flow. In general, you want to keep that debt to equity ration less than two to one.

Steve Pomeranz: I mean if you were a banker-

Dr. Bud Labitan: And then-

Steve Pomeranz: Hang on. Before you get to point number four.

Dr. Bud Labitan: Sure.

Steve Pomeranz: If you were a banker, and you were going to be lending a company money, you would want to see whether their earnings and cash flow were steady or they were cyclical because it would really matter. If you’ve got steady income, like a Coca-Cola or something, they can take on more debt. And as a banker, you can afford to lend them more because you feel safer with regards to the ability of getting your interest paid and getting your money back. If it’s a company that’s very cyclical and does poorly in bad economic times, I think you’re going to want to lower debt to equity ratio. Would that be accurate?

Dr. Bud Labitan: That’s very accurate. That’s exactly correct.

Steve Pomeranz: What’s number four?

Dr. Bud Labitan: Then just to add on to what you said there. During these economic times, while the interest rates are still low, I believe Coca-Cola is slightly above that two. I think it’s at about 2.3 or 2.4. But item number four on the list is you want a company that’s producing a return on equity greater than 10%, and of course, higher than that is even better.

Steve Pomeranz: Yeah. So return on equity folks, means if you look at the book value of a company. Take all the assets minus all the liabilities, and you end up with really the stockholder owns, the book value. Then you look at the earnings and you figure out the ratio. Well, what is the earnings relative to that book value? That’s what he’s talking about when he says the return on equity.

Dr. Bud Labitan: Right.

Steve Pomeranz: Because as a stockholder, that’s really what matters is what you as a stockholder are getting relative to the investment that you’ve made. Now, Bud, you have written this book, Sports and Stocks, Quality Business Investing. You’ve really used the sports as a great metaphor for investing. Let’s start with the first sport that you write about, and that’s football. Why is football a good analogy to successful investing?

Dr. Bud Labitan: Well, football, for fans of football who know that the idea of winning football is based on three major areas, offense, defense, and special teams. In this context, I’m talking about offense, defense, and special situations. In the book, I talk about some of the things that the Chicago Bears have done, and also I talk about the role of the special teams and the special situations. I just wanted to make people aware that we have, there are winning ideas in sports that can relate to winning ideas in investing. The major point there is preparation, knowledge of the game, knowing how to deal with wins and losses, the mental toughness, the emotionality of the game. And our primary goal, as you so rightly said earlier, is to find a high-quality business or an HQB.

Steve Pomeranz: Yeah. All right. So football is kind of your basic, your passing, your running play, your pass play, your kicking. The second chapter though is basketball. How is basketball related? If you love basketball and you understand how teams work, how can you then make that transfer to the idea of investing successfully?

Dr. Bud Labitan: In basketball, we can look at different aspects. We can look at it from the player’s point of view, from the coach’s point of view, and also from the organizational point of view. One of the basketball players I mention in there is the famous Laker player, Jerry West, who was mentally tough. He constantly worked on learning and improving his game. As he aged … As a young player he was more of a penetrator, but as an older player, he started to develop his outside shot. He was a great team player and he was also a very unselfish player. What I was trying to relate to the readers is that in investing, we can learn a lot on our own, but just like I have learned from you and hopefully you’ve learned a few things from me. There’s a knowledge sharing there. If you’re going to do this as an individual, you kind of have to have the passion for continuous learning.

Steve Pomeranz: I think the one thing about basketball, too, is you must have the ability to make quick decisions. I know that a great investor, once knowing all the rules, knowing how things work. And I guess in basketball, how the other team is setting up, what your strategy is. But seeing opportunity and being able to act on it very quickly. I know Warren Buffett does that from time to time, and so do other great investors.

Dr. Bud Labitan: You brought up a good point there. Yeah, that’s a great point because, in sports, they have to make instantaneous decisions whereas in value investing, you can take the time and do the preliminaries. You can go through the four filters. And then you can do that, what one book calls the second level thinking, or how do they say that? There’s another term for that second level thinking. I think Daniel Kahneman in his book about behavioral finance called Slow Thinking. You have fast thinking and then you also have slow thinking.

Steve Pomeranz: Slow thinking, yeah. My guest is Dr. Bud Labitan. The book is Sports and Stocks, Quality Business Investing. I think one of the best metaphors, and I use this all the time when I’m talking about investing, is the baseball metaphor. I’m going to steal a little bit of your thunder here. Warren Buffett always talks about the ability to stand at the plate when you’re investing and not to have it be subject to any balls or strikes, to just be able to stand there and receive pitch after pitch until you get that one pitch. He calls it the fat pitch, where you just know it’s the sweetest thing that you can hit, and that ball is going to be hit out of the park. He waits and waits, the patient investor waits for the fat pitch.

Dr. Bud Labitan: Oh, exactly. You’re referring to him talking about Ted Williams and his book, The Science of Hitting, where you wait just for that right pitch. That’s the beauty of value investing, is that you don’t have to swing right away. You can take your time.

Steve Pomeranz: Wow. All right. Well, baseball we’ve got. What about the coaching aspect of sports that’s incredibly important? How does that relate to being a successful investor?

Dr. Bud Labitan: Now the coaching, I sort of divided that into the external coach and the internal coach. The external coach, you can learn from reading, from listening to your podcasts, Steve. From other documentaries, and also mentors. Charlie Munger refers to them as the, what is it, the wise dead. People who have already passed on-

Steve Pomeranz: The wise dead.

Dr. Bud Labitan: But have left a legacy of useful thought. That encompasses the whole external coaching. The internal coach that I referred to is the desire and passion to do your homework and try to look at these things from different angles and try to teach yourself more things.

Steve Pomeranz: You know, listeners, if any questions come to mind, don’t forget that you can write in your questions to us at StevePomeranz.com. You can, of course, hear this interview again. You can see a transcript or a summary about this interview and find out more about Bud’s book. The book is Sports and Stocks, Quality Business Investing.
Earlier, Bud, we talked about mental toughness. I was thinking about the game of golf, in particular. A lot of great players, great technical players in the game of golf, but that particular sport seems to require a tremendous amount of mental toughness. What do you think about that?

Dr. Bud Labitan: You know, I wish I had added a chapter on golf, but I remember one of my book reviewers mentioned golf. And I agree with you that it does take discipline. There’s also, I think in golf, as well as investing, one should have a certain degree of calmness. I used to play with a fellow who was physically gifted, and he was well trained, and he had a beautiful swing. You would think that this guy could have been a professional golfer, but every hole after the first hole, he would be so critical of himself, that his game would just deteriorate. And by the time we got to the 18th hole, he had basically torn himself apart mentally. There’s a certain degree of framing and calmness. Anyone who gets into this should enjoy the process.

Steve Pomeranz: Well, you know the thing about a game, especially for amateurs is you play the game of golf. You play football. So you should play. You should have fun and play, and it shouldn’t be quite so serious. The fact with golf though is at the very end, when we’re talking about high-level professional golf, you get to the 17th hole. It’s the last round of the day, everything is at stake. I mean, that’s really where you see the real mental toughness coming out. And investing, you do need a lot of mental toughness. Investing is simple, but it’s not easy. And there’s a lot of times your thesis that you kind of feel is right and you know is right, and you’ve done all the math, and you’ve checked and checked and checked. And yet the investment is still going against you.

Dr. Bud Labitan: Let me add two things to what you’re saying there, Steve. On that mental toughness chapter, I also talk a little bit about mental flexibility and the ability to keep an open mind. Then I also talk about mental efficiency, which is sort of like time management. That chapter title’s kind of a misnomer or miss-heading. I think if folks read the book or listen to the audio book that’s coming from Audible.com, they’ll kind of get the idea that hopefully it will stimulate them to look at it from different mental aspects.

Steve Pomeranz: Yeah, so this is a book that I recommend. I think it’s a book that will take you through these first steps, and plus there’s some really good examples of individual stocks and how to think about them. And to give you a kind of a springboard to dig deeper. Dr. Labitan’s books will do just that. The Four Filters is an excellent one on how to think about and structure the idea of how to invest in stocks.
If we’ve raised more questions than we’ve answered, don’t forget that you can hear this interview again by coming to our website, which is StevePomeranz.com. And you know, if you want to get these and more informative interviews straight to your inbox, subscribe to our weekly update. Again, that’s StevePomeranz.com. Bud Labitan, thank you so much for joining us.

Dr. Bud Labitan: Thank you, Steve. I hope your listeners find this both entertaining, stimulating and profitable to them.