Good morning,

Today we are welcoming Pyhtia Capital to kick off the seventeenth edition of the guest interview series. Anonymous for obvious reasons, you will recognise our guest today as the gentleman who posts under the Twitter handle, @PythiaR.

“I view investing as testing a hypothesis. You start by establishing the state of knowledge: study the business, study competitors, learn about the industry etc. You then form an opinion about what will happen. You then invest behind that belief.

Once you’ve invested, you are running iterative tests. You refine your view. Your hypothesis was that if you dropped the ball it would bounce. You test it, and indeed it works. Then you refine it: if I drop it from this height, it will bounce this high. You can keep repeating that.

Investing is like that too. Your initial thesis might be that the stock goes up because it’s in an expansion phase of a cycle. Once it gets to the top, you sell it. But imagine if that stock didn’t go down because you were wrong about the cycle. Well, back to the drawing board that means!”

Pythia Capital

Pythia is anonymous for obvious reasons, but the insights he will be sharing today demonstrate the abundance of experience he has for a man who is still in his early years. Born and raised in Canada, Pythia is a current fund manager and CFA chartholder.

In today’s interview, we get to learn more about Pythia’s past, his experience in migrating from a political science & economics major to an eventual fund manager, and how he approaches investing with a focus on getting rich slowly and capital preservation.

The extent of detail and the context provided, by Pythia was exceptional in today’s interview.

The Interview

Investment Talk:

Good morning Pythia, excited to have you here.

I typically kick these things off with a quick introduction from yourself to outline some context for the readers who may not be aware of you, and for continuity too.

So, if you could introduce yourself, perhaps a little flavour into your backstory, and take us through the events that have led up until the present day. Perhaps also detailing what factors influenced your life in such a way that allowed you to discover investing.

Pythia:

So, without giving too much of my anonymity away, my dad worked fairly high up in corporate banking at one of the big 6 banks in Canada, and had a 30-year career managing a $6 billion book of loans, cash management, various hedging activities for major mining, energy and utility companies, and never took a single loan loss in his 30 years, so he was good at his job! He got me interested in finance, to begin with.

At university, I originally started in political science but took a 1st-year econ course that I loved. That catalysed my decision to pursue a double major in political science and economics. I also joined a student-run hedge fund on campus at the time, originally as the “HR guy” just to get my foot in the door. I worked my way up to an analyst, and then eventually ran it when the founder graduated.

You might ask, why not do finance as a program?

First, I am genuinely interested in politics, I have a long family history in the area, which informed my decision to go into it, to begin with.

Second, math was never my strong suit and I didn’t do calculus in high school, so I’d have had to do 2 years of math just to get into the program. I did indeed start on that route and was completely lost on day 1 of the pre-calculus class I had signed up for. So I dropped it and decided to figure out a different way that played to my strengths rather than bang my head against a wall.

My “different way” was to focus my education on the intersection of economics and politics, basically trying to answer 2 questions. First, how do you formulate effective policy, drawing both on macroeconomics but also microeconomics which is useful for all sorts of non-economic policy decisions?

Second, how then do you work the system and manage power dynamics to implement that policy as cleanly and effectively as possible?

I figure both those two are useful for investing.

To augment that, I worked at the hedge fund outside of class, took Aswath Damodaran’s Valuation course in the summer of 1st year (all his notes and lectures and tests are online!), and read a ton and managed my own money along the way. That experience I then leveraged into 2 internships at one of the top funds in Canada, and after graduation then joined my group I work with today.

Investment Talk:

After gaining a slice of background on yourself, it would be great to get a sense of your investment process.

So, could you perhaps outline the broader skeleton of that process, detailing the desired outcomes/goals, and method of attaining that outcome?

Perhaps letting us know what it is you look for in the companies you allocate towards.

Pythia:

Okay, so you need to understand my history to really understand why I invest the way I do now.

I started investing in mining stocks, learning in part from my dad who had a long history of lending to mining projects and management teams. Of course, what really I was doing was getting lucky: in 2010, almost anything mineral-related went up.

With the hedge fund, we focused on a pretty standard hedge fund set of ideas, both long and short. I got to try my hand at event-driven strategies, shorting, derivatives strategies, you name it. For many years I thought like a typical hedge fund manager, thinking about catalysts, trade structuring (e.g using vertical spreads instead of stock positions to express a view).

My first summer at the hedge fund in college was in 2011 when the EU debt crisis exploded and the US debt was downgraded below AAA for the first time. Managing that was baptism by fire, but being able to long and short helped to some degree. To give a sense of the kinds of things we would do, at the time the VIX had spiked fairly significantly and was in backwardation (meaning the near term futures contracts traded higher than the long-term futures). We figured that this would reverse in time and so we went long XIV, the inverse VIX ETF with the thesis that not only would it benefit from the VIX falling, but it would benefit disproportionately so. XIV was short the front-month futures, and what this means is that in contango, you go short the futures at a high price, if the VIX is flat, they decline in price, and then they expire and you re-short the next month at a high price.

With the curve reversed, XIV was getting squeezed both from a high VIX but also because they now had to roll from the high priced contract to the low priced contract. As the VIX settled down, XIV would benefit not just from the decline in the VIX but disproportionately so from the greater decline in the front-month futures as the curve normalized.

We were, in the end, horrendously right, but it cost us half the money we were managing as our largest client got freaked out and pulled his money. That sticks with you!

The rest of the time was less exciting than 2011, we were biased long, and there were a few bubbles that gave us some fun things to short (3D printing and Conn’s are two that come to mind), and we did fairly well. I graduated in 2015 after doing 2 internships at one of the top-performing funds in Canada in the small-cap space, and handed off the program to others, and went looking for a job while doing CFA Level 1.

For most of 2016 and 2017, I was completing my CFA and also learning our administrative systems and getting securities licenced in Canada. That took up much of my time, but I did pitch the odd thing to my boss, which generally landed with a thud as I was pitching catalyst driven/deeper value type things that aren’t really what we do.

By 2018, post licencing and CFA, I was taking a much bigger role at work in managing client money. This is where my current style started to evolve. Being responsible for a long-only book for the first time in my life, I was unprepared mentally for the 2018 selloff. It was the first time I’d had to manage assets for others without a short book, and it’s an eye-opening experience. We did fine for clients, but because of the limited bandwidth I have covering 150+ companies for work, I ran my PA long-only for the first time. It was full of low-quality cyclicals with catalysts that got absolutely blown apart. When you have a thesis that something is going to rerate in 1 or 2 years, and then a bear market hits you and impacts the business, that’s a scary situation to be in!

Around the same time, I discovered Twitter. More specifically, I discovered accounts like WTCM and Bluegrass Capital, and by extension, Fundsmith. I had read Buffett and Graham before but had always found their writings rather pedestrian relative to the love they got from the investment community (versus a book like Hedge Fund Market Wizards, which I found far more interesting).

The confluence of events that made something click in my brain was really hearing Terry Smith explain the concepts Buffett espoused, while my own PA was blowing up. It hit me like a freight train that what I wanted to do was avoid that happening ever again, and that the best way to do that was to focus on studying and learning from the best businesses in the world and collecting those businesses at prices that made me money.

To me, that necessitates a focus on a few factors, so these are what I tend to look for:

1) An exceptional business, either from an economics standpoint (high ROIC etc) and/or from a terminal value standpoint. For example, a garbage collection company is not particularly high ROIC, but I have a high degree of confidence that it will be around 100 years from now, in some form or another.

I also require that my businesses are on the right side of secular trends. I’ve seen a lot of investors get destroyed trying to squeeze the last 15 or 20 years of cash out of a business in terminal decline because the business dies after 10 years. Melting ice cubes do work, of course, but I have a tough time sleeping at night if my businesses are in terminal decline.

2) Exceptional management teams. I know Buffett says that you want a business so good an idiot can run it. I take it he has never met International Flavors and Fragrances management, who have successfully ruined what should be a great business. My motto is this: there is no business so good an idiot cannot ruin it.

The other reason management is key can be illustrated by COVID, or the great financial crisis. Crises create stresses: competitors go bankrupt, supply chains become stretched, customers have issues, you name it. These are both risks and opportunities, and smart management teams usually find ways to turn these situations to their advantages.

A very simple example might be Texas Instruments. Texas runs net cash or at least with effectively no net leverage most of the time. This might seem overly conservative considering how much cash the business generates, yet during COVID they issued $750 million of 10-year paper at 1.75% to buy back their stock below $100 per share. They doubled their money on that in 10 months. You can do things like that when you keep a pristine balance sheet in preparation for whatever may be coming your way in the future.

To finish up the management side, I’ve noticed that some of the greatest examples of upside “surprise” tend to come from management creating upside in ways you can’t imagine. Nobody imagined AWS when they were buying Amazon in 2000, yet AWS today is probably worth half or two-thirds of Amazon’s entire market cap. Similarly, nobody had Instagram in their models before Facebook bought it, yet I figure Instagram is worth around $300 billion today if not more. Again, it is smart management who created that value!

3) A path to double-digit returns. Borrowing from some real estate folks I know, all returns are a function of your free cash flow yield, your free cash flow growth, and any changes in valuation over your holding period. Absent any changes in valuation, your returns will equal your yield + growth, so you can back into what a reasonable valuation for a stable business might be: if it grows 3% forever, and you want 8% return, you should pay a 5% free cash flow yield (20x).

There’s an old saying about how if it doesn’t look good on the back of a napkin it’s too complicated. This is my version of that. If you know a steady-state business growing 3% should trade at 20x free cash flow and you’re buying a business that can grow 10 or 15% for 8 or 10 years at 20x or 22x, you’re probably getting a really good deal (assuming you’re right about the business!).

On paper this is easy, but there is a lot of work in figuring out the free cash flow growth. I think this is where modelling can be very useful. Sometimes there are so many moving parts you have to lay it out on a spreadsheet to really get a good sense of the business. But in terms of the actual valuation itself, I tend to think in heuristics. To walk through a simple example:

Business A generates $1 in FCF/share, which they payout as a dividend, and trades at a 4% free cash flow yield (25x, or $25/share). I think it can grow 15% for 5 years and then grow 3% thereafter. That $1 will double to $2, and we know the terminal value of a business growing 3% assuming investors want an 8% return is 20x, so $2 of FCF x 20 = $40/share. That should give you some idea of what the returns will be over the next 5 years. You get ~$7.75 in cash, and then $40 when you sell it, for a compound annual return of ~13%.

As a closing thing to think about, when you go study self-made billionaires, they all have 1 thing in common: they all got rich the same way. Every single one of them found something that had exceptionally high returns on invested capital or equity, and they reinvested a lot of money over time against that thing. Many of them reinvested over 100%: they went out and found other people who gave them money to do something. Finally, they paid a very very low price to “buy” the opportunity: many of them did it via sweat equity, but others such as Bernard Arnault may have bought a business at a very low price and then grown it over time.

Regardless, I think if there is one “first principle” of investing it is this: what you want is as much ROIC x reinvestment as you can get, and to pay as little as possible for it. That’s it. It’s one of those things that sounds easy, isn’t in practice, but it’s helpful to revisit this first principle and bring everything in your analysis back to it.

And that, in a nutshell, is what I’m looking for. It really is not complicated!

I will add, though, that this strategy for me is the perfect match for my personality.

First, my family are all academics. I am the first person in 2 generations on my mom’s side of the family who does not have a PhD, and many of those PhD’s are from Stanford, MIT, and Harvard. I am genetically predispositioned to think like an academic. I like studying things, seeing how they work, what makes them tick.

I am, and this will seem weird, also the embodiment of a typical Taurus. I’m not a huge believer in astrology it just is useful as a singular way of accurately describing myself. I like habits and routines, and I like nice things and creature comforts.

Recall that I said above that it had clicked for me that my goal was to focus on studying and learning from the best businesses in the world, and collecting those businesses at prices that made me money? Now you see why. It is the investment style that matches who I am at my core. I like collecting nice things! I like habits and routine (owning the same businesses for a long long time), and I like studying and testing things.

Investment Talk:

Thank you for the exceptionally detailed overview of some of your history and how that led to the style you opt to utilise today. I think personality is a huge factor in one’s investment style.

Bezos had a great quote that essentially stated that people who are often right, are those who change their mind often.

There is a basket of behavioural biases that, at times, sit atop the bicycle of one’s investing outlook. Conviction and stubbornness often draw a thin line between the two.

What is your take on the importance of being open to altering one’s opinions once the evidence suggests we should?

Moreover, how do you reconcile between high conviction and the presence of any confirmation biases that may be lurking within this conviction?

Pythia:

I view investing as testing a hypothesis. You start by establishing the state of knowledge: study the business, study competitors, learn about the industry etc. You then form an opinion about what will happen. You then invest behind that belief.

Once you’ve invested, you are running iterative tests. You refine your view. Your hypothesis was that if you dropped the ball it would bounce. You test it, and indeed it works. Then you refine it: if I drop it from this height, it will bounce this high. You can keep repeating that.

Investing is like that too. Your initial thesis might be that the stock goes up because it’s in an expansion phase of a cycle. Once it gets to the top, you sell it. But imagine if that stock didn’t go down because you were wrong about the cycle. Well, back to the drawing board that means!

This is, in my view, one of the greatest advantages of owning businesses for a long time: you become familiar with how they react to different things. I have owned BAM for 4 or 5 years now, and effectively nothing they do surprises me anymore. Sure they might beat or miss my estimates for a year but in terms of the direction of their business, the ability of management, or the deals that they do, nothing surprises me anymore.

That may change in the future. If BAM did something that surprised me, there is a result of my hypothesis test that I did not expect, and then it’s back to the drawing board for me.

In terms of biases, I think this view helps because it forces you to remain dispassionate. For me, this is all an academic study where I am learning about great businesses and coming up with hypotheses about how much money they can make in the future and what that might be worth to the market, and then testing it in real-time. My goal is to be right about making money (a nod to @nachkari’s “do you want to be right or make money”).

With that view, when it comes to short sellers or bears or conflicting points of evidence you should want to investigate them because remember: your goal is to be right about making money. I might have very high conviction about something, but it all comes back to being right: if it looks like I might not be right about being able to make money, then I get out.

To conclude here, the way I avoid biases is to be dispassionate and focus on my goal which is to be right about making money. The trick is to tie your ego to something that is constructive: my ego is tied to whether I make money in the end NOT whether I am right about my initial thesis. I am happy to be wrong in my thesis, as long as it means I don’t lose money.

Investment Talk:

I personally find that assessing the return of the portfolio, versus some benchmark of the investor’s choosing, is not enough. For additional context, investors should be assessing their risk-adjusted returns in tandem.

This view appears to be lost in the current market, with some investors, most notably newer investors. It doesn’t matter until it does.

Do you feel that younger/newer investors should be taking the steps to assess their risk-adjusted returns, and if so, why do you feel that is important?

Pythia:

I’ll refrain from talking about things like business risk or balance sheet risk. Those are so well talked about I’m sure readers can do their own research. I want to talk more about the psychology of this.

At work, I am managing money for other people. These other people can leave, get scared, do dumb things, are emotional, think differently from me, and cannot have the confidence that I do in the investments I choose to put in their accounts.

What that boils down to is that there is no one right way to invest. I deal mainly with very wealthy people who have sold or run their businesses. It might be “optimal” for me to put their money in the S&P 500, but that would ignore the fact that they used to be entrepreneurs. They love stories, they love owning businesses, they are involved in their portfolios and like control. You cannot sell them an index they will feel comfortable with, and yes, it is sales! A lot of managing other people’s money is dealing with the unique psychological profile of your client base, be they large pension fund CIO’s or entrepreneurs.

People say that volatility isn’t risk. Apparently, those people don’t run money management businesses because it absolutely is a risk if your client base packs up and leaves. Whether they do so comes down, largely, to their own psychological makeup and characteristics.

So to your question, yes I think looking at returns alone is a waste of time, even relative to a benchmark. We benchmark ourselves, but a lot of our value add for clients is actually telling them about the companies they own so they feel like they still own a business, because that’s what they love.

Similarly, there are clients that want VC-style, high beta, high-variance outcome type investments because that is what they love and feel comfortable with. I can’t say that approach is wrong, it depends on what the person’s own makeup is and how well the investing style matches with that.

Clients make bad choices when what you are doing for them isn’t a match. If they want low volatility and you put 50% of their money in early-stage biotech, even if you are right, they will not thank you. They will, however, tear you a new one and leave and maybe sue you if you are wrong. If your clients want high risk and you put them in a consumer staple stock, even if you are right, they will get bored and leave.

Why I bring this all up is to highlight that a lot of success in investing comes down to whether what you are doing is a match for your personality. The risk that you need to adjust for is whether you can make sound decisions according to your strategy when everything is blowing up around you. That comes down to the psychological attributes you or your clients have, and whether what you are doing is a match for that.

Investment Talk:

Ben Graham’s famous quote concerning the market mechanism being a voting machine in the short run and a weighing machine, in the long run, is one of my favourites.

It speaks to several things, but for me, the main takeaway is that the market loves a narrative. Sometimes narratives fade, and other times they exist long enough to become factual.

Could you perhaps explain why you feel this sense of narrative is so important to asset prices in the short run?

Pythia:

Most people vote using heuristics. For example, most think left vs. right means high vs. low taxes. That’s not necessarily true and every politician falls somewhere different on that spectrum, but most voters are low information (ie, they are not knowledgeable about the intricacies of policies or a party or candidate’s platform) and rely on these heuristics to make choices easier.

I think in the short term, the voting machine in the market acts in much the same manner. Narratives and stories are, basically, heuristics and easy for people to understand. Sometimes they’re true, other times they aren’t, but in the short run, we fixate on them because it’s easy, and that drives flows of money hither and thither.

Investment Talk:

Your own portfolio contains a wide variety of industries/sectors, with some names that are atypical of the sexy momentum offerings that are so frequently touted today. This is refreshing.

What does your screening process look like, and how do you typically ‘discover’ your positions?

I recall you recently stated that the majority of your own holdings were identified through discussions held on Twitter. Could you provide some insight into why that is, and perhaps why you feel Twitter, Fintwit especially, is such a great source for ideas? (If you hold that to be true, which I am assuming you do).

Pythia:

I wish I had a sexier answer than Twitter but the reality is that everything I own was sourced from Twitter. I follow people who I trust on Twitter and who know more than I do, and so I steal ideas regularly.

What I am good at is doing my own work once someone suggests something to me. In terms of finding new things, I am so stretched I really just don’t have time. I cover probably 150 companies (not necessarily in a ton of detail), in addition to being responsible for marketing and client communications and proposals for our team and I manage 9 figures worth of client money that need regular reviews and administrative things. I’d love an analyst or two!

I have taken the time to curate my follows on Twitter to those that I think are good. There are just some people who either aren’t a match for what I’m trying to do, or are consistently wrong or miss thinks or are just jerks and I don’t follow them. But the ones that are left I think are fairly high signal, and when they say something I listen and go do a bit of work.

As an example, I looked at GFL when they tried their first failed IPO and I looked at the financials and went “wow this sucks I can’t believe they are coming public”. And then they came public and I had the same reaction.

A few months later, I saw a few people on Twitter talking about GFL in a positive light as a slam dunk, and I thought okay they’re crazy but let’s go see. So I put aside my previous bias and spent more time on it, precisely because people on Twitter who I thought were smart saw something interesting there that I hadn’t taken the time to see. It’s now my 2nd largest position.

The trick to Twitter is finding the people who actually know what they’re talking about and keeping your follows to those people. Once you do that, it is an incredibly valuable screening methodology: crowdsourced from a crowd of hypercompetent experts.

Investment Talk:

Whilst I have you here, I selfishly figured it would be a good time to ask you a few quick questions surrounding one of my own holdings, MatchGroup.

I am interested to know your thoughts on their recent cash & stock deal to acquire Hyperconnect, and where/if you see any benefit in that deal?

This may seem crass, but a lot of what people do they do for the purpose of reproduction when you take it down to brass tacks. My own theory is that the meaning of life itself is reproduction because by definition those for whom it did not do not reproduce, so by default, only those that had the genetic drive to reproduce are left!

Pythia:

Match is now looking to use their near-monopoly on scaled access (ie the ability of an individual to tap into a huge market) to reproduction to move into, potentially, being a social network in a more broad sense. At the very least they are strengthening their existing business by introducing new methods of potential interaction. So I view it as an interesting deal at a reasonable price that gives them a lot of potential optionality to move in some interesting directions if they want.

Investment Talk:

Ignoring the social discovery market for a moment, the dating market is one that I would describe as being somewhat of an oligopoly. With a relatively concentrated array of bigger players, possessing some pricing power. Would you agree with that notion, and do you see the dating space becoming more fragmented in the future?

Pythia:

I definitely don’t have a variant perception here. I think there are significant network effects to dating apps and so being big is good. The difference, perhaps, is there can exist scaled solutions for niche verticals within dating (Christian Mingle, Grindr etc), so perhaps more of those arise and it becomes more fragmented, but I don’t see Match losing from that, especially as most people are on more than one dating app to increase the odds of finding someone!

In terms of pricing power, I am unsure how much they’ll have. Many daters are young, they don’t have infinite amounts of money, yet dating is very important and Match is able to effectively set it up so that money gives you an edge (the gamification of dating). Whether that results in pricing power, I don’t know, but at the very least, for the time being, Match can keep adding things to the app that people will want to pay for, but I don’t necessarily view that as pricing power.

Investment Talk:

Lastly, have you had time to dive into Bumble, and if so, how do you feel them as a potential threat to MatchGroup?

Pythia:

I’ve had less time than I‘d like to look at them, but my view now is that they’re a bit like a halfway point between a niche offering and a general offering. Tinder is like a giant free for all, and I understand how Bumble’s value proposition is different to that; but so is Hinge’s. Many of my single female friends (and I have a lot) adore Hinge and are not on Bumble, or have found Bumble’s selection of men somewhat lacking.

To be fair, they say the same about Tinder and I can see why. Guys, step up your damn game: learn how to dress, learn some hygiene, ditch the Oakley’s, and stop taking photos with fish!

Investment Talk:

When assessing a potential position, what are the three must-haves that must be present before you would ever consider allocating one cent?

Pythia:

1) Great management team with a proven track record of successful capital allocation AND a compensation arrangement that incentivises them to at least not do dumb things.

2) Secularly growing end market, with some way the company can gain share on top of that (M&A, scale, pricing advantages etc).

3) A valuation where I can walk to at least 10%+ returns on a back of the envelope calculation, once I’ve done a bit of work on the name to bracket free cash flow (or whatever other metric I want to use for valuation) expectations for the next 3-5 years.

Investment Talk:

A question on concentration now. For me, I typically prefer to allocate a tad heavier towards higher-conviction positions. In terms of organic concentration, I will allow this to occur within the portfolio without placing too much emphasis on trimming those positions that are carving out their own space in the allocation race, as it were.

What is your process for allocation and weighting, both at the start of a position, and throughout the period that the position is held within your PA?

Pythia:

My view is that positions have to earn size, they don’t just get given it.

Oftentimes I start with a 1 or 2% allocation based on a hunch. Often I’ve not finished doing all the diligence I want to but the opportunity seems compelling enough so I take a small swing. This is where the testing starts to happen. Over time I refine my knowledge about the company and learn about how it reacts to various things, what factors really drive performance vs. what I maybe thought did etc.

As time passes I either grow more or less comfortable with the investment and then I can begin to size it up. Sometimes an opportunity to do so comes quickly and usually, I’ll take a newer position up to about 5%, which is about the maximum allocation I’m comfortable with if I haven’t been following the company for at least a year.

Above 5% is reserved for companies that I’ve come to know very well either because I’ve owned them for years or followed them for years.

The only exception to this has been GFL, and the reason that I sized it up so quickly was that it fits a pattern that I feel is very much in my wheelhouse. I’d followed the waste space for about 10 months before GFL came along, so I knew I liked the business and also what made for a good vs. a bad waste business. I’ve also long admired M&A stores like Constellation Software, Heico, Danaher, or Transdigm and have a fairly good sense of what the commonalities of those businesses and strategies are.

So when it came to GFL I saw aspects of a lot of things that I liked, so I actually took a 2% position initially, following my rules. What changed my mind on the sizing was hearing their CEO speak about a short seller’s report on their earnings call. How management teams respond to short sellers is, I think, a very important indicator. The correct response, in my view, is to put your head down and execute and prove the short wrong.

In effect, that was what GFL’s CEO said on the call, and he pointed to points of evidence that refuted a number of the short seller’s claims. I liked his response quite a lot. I also liked that in that quarter they showed they could generate actual GAAP free cash flow, and so I took the position from 2% to a little over 6% that day as the stock fell. So it’s not a huge break from my rules, but it, to date, has been the only exception to that 5% cap for positions I’ve followed under a year.

In terms of maximum weightings, I tend to top out at 10% at cost just because if something goes terribly wrong and you lose 50% above that weight it gets hard to claw your way back from.

I’m okay letting a 10% position compound up to 15% or so, but above that, I start thinking “what if this gaps down 20/30/40% for some reason I haven’t thought about” and start to trim. I am well aware that it caps my potential upside, but it’s worth considering where I’m coming from here from a values/psychology standpoint.

As I outlined above, I started in political science decided I wanted to do finance, which made me an outsider struggling to gain acceptance. I started at the hedge fund in college and had to convince people to let me do finance stuff. I started in the job I had now as an administrative person making $32,000 a year. I did my CFA and proved myself and now have a lot more responsibility and earn proper compensation (top 1% for my age in the country, thank you very much).

In short, I’ve sort of taken the hard and long way to get where I am now. I’ve worked very hard for the money I have and I am very conscious about losing it. All the conventional wisdom says “oh you’re young, swing for the fences, risk it”, but I just can’t do that. I think of the decade of work it has taken to get me this far!

Today, I save around 50% of my after-tax income. If I keep saving at that rate, and compound in the 12-15% range, I could retire as an exceptionally wealthy person at age 50. If I don’t blow up, I will have done so without undue stress, which will probably extend my life a few years. If I don’t blow up, I’ll be happier along the way as I’m compounding. Those psychological factors are worth more to me than the potential extra return I might get from having a position go from 10% to 30% because I nailed it.

That basically covers my position size caps, but aside from those, I don’t have too many rules. I don’t like trading because I don’t like transaction costs and taxes, so I tend to leave things alone. I will, of course, trade in order to take advantage of clear opportunities (e.g selling an 8% IRR to buy a 15% IRR), but I’m not optimizing my position sizing based on force ranked risk-adjusted IRR’s minute by minute. If you’re running a fund at a pod shop, you probably have to care about that, but I mostly just want to minimize the amount of work I have to do and as long as a position is around where I want it to be, I’m cool just leaving it alone.

Investment Talk:

You once stated the following:

“I feel like it's a rule that all 10-100 baggers get expensive at some point, and you've gotta drink the Kool-Aid a little bit to realize the return. We all need, as Robin Williams said, a little spark of madness.”

I am in full agreement. At times, a company will be cheap, fair, and expensive. Market timing, or front-running narrative changes, is difficult without a crystal ball. So, for me, I prefer to focus on the fundamentals each year and ensure they are doing what they ought to be doing.

Can you perhaps expand on the above quote, and then detail how you cope with ‘drinking the kool-aid’ over time to realise those returns?

Pythia:

I think you said it. You focus on whether they are doing what they ought to be doing.

I spoke earlier about remaining dispassionate and thinking of this all as a giant hypothesis test. Where, to some degree, you have leeway is in deciding what you are testing.

I am never testing, for example, that I think earnings estimates will come up this year and so the stock has 15% upside and then I’m going to sell it. Some people are really good at that, I am not one of those people.

I am instead looking and saying okay this organization is great. This management team is great and they’ve got 30 years left in them. Sell-side estimates go out reliably for about 2 years, and then they get a little unreliable. I care about whether the business is going to be great 5, 10, 15 years from now; that is what I am testing.

I would highly recommend reading the book Ender’s Game because it delves more deeply into this topic, but to keep it simple, one of the things a great military commander does is appoint sub-commanders that excel at independent thought. The reason for this is that a single human mind cannot perceive all that it needs to in order to fully comprehend complex situations. A general cannot personally respond to every minor move an enemy makes, he must rely on the ability of his men to adapt and think.

I view my CEOs the same way. I cannot possibly know software better than Mark Leonard, or airplane parts better than Nick Howley. I must, and this is the key, I must trust them to make decisions on my behalf with my money as a shareholder. They are my platoon commanders, responding to the ebb and flow of the competitive battle. I oversee, and I can make decisions to give them greater or fewer resources depending on my view of their likelihood of victory in their segment of the battle, the strategic value of that victory, and the resource intensity required to get there versus other areas.

This is why I place such value on management teams. They are the brains responding to things that we as shareholders cannot know. They’re the ones in the weeds. They’re the ones you need to trust with your money because they have the capacity to blow you up or make you a fortune in ways you can’t imagine.

So, I think the only kool-aid it’s okay to drink is the generals kool-aid: trust in his people and their ability to do not only do the job you give them, but to do the job you didn’t even know you needed them to do.

Investment Talk:

Lastly, I like to round off this segment with some quotes.

What is your favourite quote, and why? Feel free to pick a few if you like.

Pythia:

I have 2, though they’re quite different!

The First:

“The power to cause pain is the only power that matters, the power to kill and destroy, because if you can't kill then you are always subject to those who can, and nothing and no one will ever save you.”

The Second:

“If more of us valued food and cheer and song above hoarded gold, it would be a merrier world”

The first is from Ender in Ender’s Game, it’s similar to Paul Atreides’ realization in Dune that he who can destroy a thing, controls a thing. When I read the quote in Ender’s Game it just hit me that it is indeed true. The ultimate power is to deprive your opponent of the ability to play. In Ender’s Game, Ender is notable because he does not just win, he wins so thoroughly that his opponent never has any chance of rising again to challenge or threaten him in the future.

As an investor, anything that could cause you a catastrophic loss of capital has power over you. That which can destroy you controls you. Your goal is to avoid those things that have power over you (undue leverage, position sizing that is too heavy etc), because if you do so, you have power over the market.

The second is from Thorin Oakenshield on his deathbed. It’s the only thing I would ever get tattooed (I’d get it in Quenya of course) were I to get one. It just resonates with me.

Questions from Twitter:

In this segment, we collected questions from the Twittersphere, and present them to Pythia.

@talbottzink: “How have you developed your own edge?”

Pythia:

I think my investing edge is psychological/behavioural. I’m the type of person that responds very calmly under pressure and finds sharpened thinking in those situations. I don’t get freaked out at market declines (a function of not being controlled by things!), I’m content being patient, I’m picky, I’m fine getting rich slow.

My edge is that I know myself and I have control over myself. That might not make me Bill Ackman or Stan Druckenmiller but I’ve made peace with the fact that I am not at their level and probably never will be!

@talbottzink: “What is something you emphasise in your own process/approach that you think the masses underappreciate?”

Pythia:

The importance of people. All businesses are just collections of people going about their day responding to requests from customer people or threats from competitor people. It’s all people, find good ones with good incentives.

@diptoncapital: “Do you have a process for portfolio management, i.e position sizing, trimming, adding as prices move up/down & anything else related, or is it fairly subjective?”

Pythia:

I max out at 10% positions at cost, but I’ll let them run to 15% or 20% if they continue to be reasonably valued all the way up.

Generally, I have an idea of what a reasonable set of outcomes for the business is, and as long as the valuation is within that range I’m fine holding unless something way better comes along. Most of what I own is not very volatile in terms of the business so it’s not that hard to put a range around it.

@fa88926428: “If you already love and own WCN in size, do you need to own GFL?”

Response: Not at today’s prices. Really depends on the relative valuations for the two and your tax situations in terms of selling one to buy the other so I can’t say much.

Concluding Remarks

As a lover of context, I thank you Pythia, for taking the time to share such detailed and thoughtful answers to each of my questions. The backdrop really helped.

I enjoy the thoughts you share, and it was great to learn a little about your backstory today.

Remember, you can find Pythia over on Twitter at @PythiaR.

Stay tuned, as we have more excellent guests coming soon.

You can find previous editions of the guest interview series below:

• Edition One: Bill Brewster

• Edition Two: Kris FromValue

• Edition Three: ValueStockGeek

• Edition Four: AdventuresInFI

• Edition Five: Brian Feroldi

• Edition Six: Brad Freeman

• Edition Seven: Mostly Borrowed Ideas

• Edition Eight: Richard Chu

• Edition Nine: Kermit Capitál

• Edition Ten: Liviam Capital

• Edition Eleven: David Belle

• Edition Twelve: Mark Cooke

• Edition Thirteen: 10-K Diver

• Edition Fourteen: Richard Moglen

• Edition Fifteen: Matthew Cochrane

• Edition Sixteen: Michael Mitchell

Conor,

Lead Analyst at Occasio Capital Ltd

Investment Talk

Guest Interview: Pythia Capital