Invest Like the Best with Patrick O'Shaughnessy
00:07:09 · Dan Loeb
[00:07:09] S2: The roots of Third Point really come out of my experience as a credit investor in my time at Jefferies. Jefferies was like my laboratory for studying some of the best investors. My clients were people like David Tepper, who had not yet started Appaloosa, but started Appaloosa. Guys like Eric Mendich, who ran the trading desk at Goldman. Firms like Angelo Gordon, Farallon, was able to watch firsthand how the best, I guess at that point, we would call them either distressed debt, or event driven or risk arbitrage investors. So my natural first lens was to think about credit. But on the equity side to think about it in terms of a hierarchy and a mental model, I completely thought about it through the lens of event driven investing. Merger arbitrage a little bit off to the side, because that's less directional. But on the non merger arb part, which is really just a mathematical exercise in earning a return and the risks that you're taking, but in terms of a fundamental investment lens, I think it would be best characterized by those types of firms and the best book, which I think is still relevant today would be Joel Greenblatt's book, the classic, You Can Be a Stock Market Genius. I think the original title was You Can Be a Stock Market Genius Even If You're Not That Smart. I think he took that part out because investors don't like to think of themselves that way. That's a brilliant book. And most of people I know in that world kind of use that as their framework. Talked about things like spin offs, demutualizations, privatizations, post reorg equities. That's how I thought about things. I was totally unfocused on business quality, the moat, return on capital. I barely even thought about relative multiples for different kinds of businesses. All I thought about is, am I buying something really cheap that has the following characteristics? A new security is often created, which is priced and valued at a very cheap price because of a lack of liquidity. So when a large company or any company spins off a subsidiary, especially in those days, or part of the business, there's a new stock being born. The existing investors at that point in time, especially usually mutual fund types, or folks that didn't want to, for whatever reason, it maybe wasn't in their sector, they just weren't doing the work. So just routinely sell it.
00:09:44 · Dan Loeb
So there'd be this sort of liquidity gap. And if you could figure out the value of the business, those tended to be good trades. That was exacerbated by the fact that the management teams would go out in the case of a spin off and do a roadshow that would present a very conservative view. Some might even say sandbag the numbers. Why? Because people are always creatures of incentives. Their incentive package would be set at the time of the spin off. So they would come out very conservatively, but there's more. The companies themselves were inefficiently operated within these larger businesses. So margins were lower than they should have been. Sales were probably less. The management team didn't have the incentives to really optimize the businesses. So that was an incredible business model. And that dynamic that I just described, it applied to spin offs, it applied to privatizations, applied to demutualizations, it applied to newly created companies like Visa or MasterCard. So that was a beautiful business and it was sort of under appreciated for a long long time and you could generate really excess returns. We'd take that basic framework and start applying it to other things like the synergies that come when you combine two companies in a major merger, something like the Union Pacific Norfolk Southern merger, things like that. From 1995 when we started the fund, probably up until the early twenty thirteen to '15, that was our bread and butter and how we thought about investing. And
00:11:23 · Patrick O'Shaughnessy
[00:11:23] S0: what changed in that era? How would you describe that landscape today? Does Joel Greenblatt's book still as valuable as it was when you first read it? Are there opportunities like that that still exist? Are they too small for someone like you as an example?
00:11:35 · Dan Loeb
[00:11:35] S2: No, they still exist all the time. The real opportunity today is understanding those types of opportunities, and looking for something that combines that with a business quality lens. So let's talk about how my business evolved, and how we evolved. I think if you look at a lot of the people who have underperformed or haven't survived the last decade or so, when people are really stuck on the idea of deep value, low multiples, being really stubborn about how they viewed businesses and less flexible about moving into higher multiple companies or growthier companies. So we basically just started to look at companies that grew faster, that had better returns on capital that were quote unquote quality businesses, that kind of opened up a whole new world for us. So I would call that the other significant part of what we do, would be quality investing, thematic investing. And that's when we started to organize our team around industry experts and less generalists and less around the transactions. And if I would suggest a couple of books, I'm sure people have mentioned them, I think he may have even interviewed some of the people who wrote them. Probably the two most consequential books that I read that had the most influence on me in that area. One would be The Outsiders talks about more from the perspective of the managers who understand capital allocation along with great operations. So companies like Danaher, TransDigm, and others. The most influential and eye opening book to me was this book Quality Investing by Cunningham. And that I think really lays out the idea of super high quality businesses with good moats and high return on capital, and that you might want to own for many, many years. Now, happened last year was really interesting because a lot of these companies that appeared to be super high quality, it's probably the worst year going into the beginning of this year because of the disruption of AI. A lot of these apparently high quality companies very rapidly became less so.
00:13:51 · Patrick O'Shaughnessy
[00:13:51] S0: One of the most distinctive things about you and the business is how much of that you've done, how much changing of your stripes or evolving of your strategy you've done relative to others. And I'm curious, I'm assuming that's going to have to keep happening, the world's going to keep changing, probably at a faster clip even than before. How have you done that? And how do you think about the conditions or the cultural touch points? Or what is the key to doing that well across thirty years now for you?
00:14:17 · Dan Loeb
[00:14:17] S2: In 2013, I was in a room. It was a dinner in Davos, which I don't go to anymore. It was a Goldman Sachs dinner. Eric Schmidt was there and gave it talk. And if you go back to 2013, it was a time of when you look back at it was almost quaint in terms of the technological innovation. This was probably around the time that maybe the Uber app came out and the iPhone was starting to come up with some interesting apps which were starting to be adopted. The SaaS revolution was sort of at the front end. Companies like Microsoft were starting to find their footing. Think about all the period from the dot com bubble through the GFC. The nineties were at times of incredible technological innovation. And yes, stuff was happening, but I don't think we felt there was a lot going on. There are other things going on in those years, but it was the sexy industries at times were natural resources, energy, financial services. So he said to the room, it will be your natural tendency to think that this increase in technological innovation and disruption and change that we've been experiencing for the last couple years is an anomaly, and that things are going to go back to a kind of a steadier type of innovation and growth. But hold on to your seats because things are only going to accelerate from here. And he was really right. I think you could have said that again in 2017. You could have said it again in 2020. I think you can really say that right now. Like it has just continued to logarithmically accelerate and we're going through something now where we're at the front end of AI. At this point, we're just gonna have to learn to live with this. In the same way, I don't know that from an evolutionary standpoint, brains have been able to deal with things like social media and some of the other changes. It's going to take a lot of work for us to just prepare ourselves as a species, and even mentally, how to ingest all this information. And Brad Gerstner talks about this book, Essentialism. And I think we also have to adopt this idea of essentialism because you can't do it all. You have to figure out the things that are most important and most relevant to what you do. As your