If you are curious to learn more about analyzing businesses, and picking stocks, this episode is a fascinating look behind the curtain with a season hedge fund analyst, who now teaches a variety of courses on the matter.
Steve is the founder of Behind the Balance Sheet (https://behindthebalancesheet.com/), the premier investment training consultancy. The company runs Forensic Accounting Courses for leading institutions like Schroders and Baillie Gifford – since the first course in June 2018, over 500 investment professionals have taken the programme. More recently, courses have been made available to private investors online (https://courses.behindthebalancesheet.com/).
Steve also produces bespoke research for a small group of institutional clients. Steve is regularly in the press, in the UK’s Investors Chronicle, in the Times and the Financial Times, on Times Radio and on leading investment podcasts, including Bloomberg Odd Lots and the Grant Williams Podcast, talking about accounting issues at quoted companies.
Steve spent some 20 years as an equity analyst at different investment banks, covering various sectors, and was consistently rated in the top 10 in his sector in Extel, II and Reuters surveys. He moved to the buy-side in 2005 and was a partner and head of research at two multi-billion dollar hedge funds; he specialised in using a deep dive research approach to identify special situation opportunities. Steve trained as an accountant and lives in London; he enjoys reading, yoga, and skiing and is interested in investment theory, wine and classic cars.
His book, the Smart Money Method https://behindthebalancesheet.com/the-smart-money-method) was a #1 Investing bestseller on Amazon in the UK, US and Australia. Stephen publishes a free weekly newsletter at https://behindthebalancesheet.substack.com/ and has a monthly podcast (https://behindthebalancesheet.com/podcasts) on all major platforms.
• We dive into Steve's book, "The Smart Money Method, How to Pick Stocks like a hedge fund pro," the inspiration behind it, and its intended readership.
• Steve elaborates on his belief that investors often waste time on fleeting information, emphasizing the importance of discernment in what we consume.
• Steve delves into the significance of understanding the industry a stock operates in and what he specifically hunts for.
• We discussed often-overlooked elements in company financials that Steve believes deserve more attention.
• Moving beyond mere numbers, Steve shared his approach to evaluating company management, stressing its crucial role in investment success.
---- Crisis Investing: 100 Essays - My new book. To get regular updates and bonus content, please sign-up for my substack: https://bogumilbaranowski.substack.com/ Follow me on Twitter: https://twitter.com/bogumil_nyc Learn more about Bogumil Baranowski Learn more about Sicart Associates, LLC. NEVER INVESTMENT ADVICE. IMPORTANT: As a reminder, the remarks in this interview represent the views, opinions, and experiences of the participants and are based upon information they believe to be reliable; however, Sicart Associates nor I have independently verified all such remarks. The content of this podcast is for general, informational purposes, and so are the opinions of members of Sicart Associates, a registered investment adviser, and guests of the show. This podcast does not constitute a recommendation to buy or sell any specific security or financial instruments or provide investment advice or service. Past performance is not indicative of future results. More information on Sicart Associates is available via its Form ADV disclosure documents available adviserinfo.sec.gov
Stephen Clapham: AI-generated transcript may contain errors.
[00:00:00] Bogumil: Well, hello Steve. Nice to see you. How are you?
[00:00:02] Stephen Clapham: I am very well, and I'm really looking forward to our conversation. Thank you for having me.
[00:00:07] Bogumil: Excellent. As you know, I'm a big fan of your podcast that we'll talk about in a second. I really enjoyed your book, but before we get started talking about those two and your career, I'm curious about Steve, and I like to ask my guests about their childhood and upbringing and how they think this time influenced their relationship with money and led them to an investment career.
So if you indulge me, share as much as you want. I'm very curious to get to know Steve from the early days.
[00:00:34] Stephen Clapham: My father wouldn't have known a stocker share if it hit him in the face. I mean, you know, he had no idea about investing. He, you know, just, I mean, my father had left school, um, He started work age 12. So, you know, he, he was not an educated man and he, he was, would've been incredibly mistrustful.
I mean, he, sadly he died when I, I was quite young and he, he didn't see me, um, start a career in investing. But had he seen it, he would've been baffled and would've, um, I think been probably been quite suspicious that it was, I was doing something crooked or something. Uh, you know, I, I don't think he would've been, I don't think he would've been overly impressed, to be honest.
So, um, my upbringing and my career are two completely separate incidental things. I got into investing totally by accident.
[00:01:30] Bogumil: Let's, let's talk about that accident. How did it happen?
[00:01:32] Stephen Clapham: Well, I, I was very, um, I, I was very fast track consultant, so I, you know, I trained as an accountant in Scotland. You can pass your exams in 18 months. And I passed my exams in 18 months and I hated auditing. It was, I mean, it was dull, dreadful, boring. So I, um, I applied for an overseas secondment, which I could, the firm I was working in for you could do.
And I got posted to the Netherlands. And so I went out and did a few months auditing in the Netherlands. And then one of my clients there said, oh, we need some help. Can you come back and help us? And so I said, sure, you know, and so I went back and helped them as a manufacturing business. And, um, I helped them implement a new system and I basically stayed in Holland.
And once I'd implemented that system, the, the London office was doing a project for Phillips and eol and they said, oh, can you come and help us do that? So I stayed with them, and then London office persuaded me to come back to London. And I, I, I carried on doing these, um, Implementation project. It is quite technical.
I won't bore you it, but I became ever more expert in this narrow field that I thought, if I don't get out of this, I'm gonna be in trouble. So I, I, I applied for a job and I got a job at the number five, um, FTSE 100 company in the uk. And I was interviewed by the finance director and I was too off the finance director.
So I was a pretty fast track candidate. And, um, we'd all, we'd agreed, everything. And then the guy, my direct report who reported to the finance director or cfo, called me up and he said, um, we made a bit of a mistake. The human resources departments pointed out that you are too young for the grade, so you know, you'll be doing, don't worry, you'll be doing exactly the same job, but you'll get, you know, a thousand pounds less, uh, you know, whatever it was.
I've forgotten what the numbers were. And, um, I said, so sorry, I don't quite understand this. I either do the job or I can't. Oh, you can do the job. It's just a, a, you know, a technical thing. And I said, you know what? I don't wanna work for a company where your performance and your career track is dictated by your age.
So, you know, thanks, but no thanks. And I was recounting this story, a friend of mine, he said, well, why don't you go into the city? And I said, well, don't be stupid. You know, cities for Toffs and you know, people that have been to the right school. And, and he said, yeah, I know what you mean. But he said, I bet you know, there's this thing, you know, analysts, I don't really know what it is, but my secretary, her boyfriend works in one of these firms and I bet you he could tell you, you know where to look.
So he called his secretary and his secretary said to her boyfriend, when are you free? And he said, you know, next Tuesday at nine o'clock. And I went in. Met him and he offered me a job. He said, oh man, you're just exactly the sort of person that we want. And I just thought, well, you know, I don't really know what this is, but I don't, you know, I'm not enjoying what I'm doing.
I don't wanna go and work for some big industrial corporation where it's got these, you know, stupid rules about how old you need to be before you can, you know, pass a certain grade. And I mean, to be fair, I was, you know, way younger than the average person. But, um, I just went in knowing nothing. But it sounded quite interesting, quite exciting.
And I, I thought, oh wow, I don't, you know, this is amazing. It was really interesting, really exciting. And I got fantastic training and, um, you know, I didn't look back. I mean, I, I spent most of my first 10, 15 years on the sell side, and I then moved to the buy side because one of my clients said, oh, you're coming to work for me.
And I said, and um, I, you know, I went to work for the, what was then the biggest financials hedge fund in the world doing the non-financial investments. So they always did a bit of stuff outside the banks and insurance and property. And so I was responsible for, for that.
[00:05:34] Bogumil: It sounds like it was meant to be. They would always find you and you would always find a way
[00:05:39] Stephen Clapham: Uh, I mean, it's quite interesting. I mean, in my podcast I always ask people, you know, did you always want to be an investor? And so half of people say, oh, you know, when my, when I was seven, my grandmother taught me about investing. Or they say, oh no, it was a complete accident. And you know, John Armitage, who manages Edison Capital, CIO and co-founder of Edison, manages I think something like 28 billion and he's got a 27 year track record, which is as good as any investor.
I've ever seen, um, and must be one of the top hedge fund managers in the world, I would imagine. I mean, he got into it completely serendipitously, completely accident. I mean, you know, just, and I mean, I, I think, you know, for a lot of people, your career is quite serendipitous and it's not necessarily part of a, a plan that can be, you know, investors or, or other careers.
You know, I think you eventually you just find something that you, that you're, that you enjoy and therefore you'll be good at it. So, you know, if you'd speak to successful people, they've, they're probably, they could probably been successful in other endeavors, but there's very few endeavors which are as challenging as the investment world, as you know.
[00:06:52] Bogumil: But I think it's very encouraging that you don't have to know that, uh, you have to be an investor at the age of five or six. You can discover it later. In my case, I was fascinated with economics, business history, so I was getting my degrees in that direction, but I was not really interested in the stock market.
It was about the time when the internet bubble burst. A lot of my professors lost money, or at least that was my impression. And they told me that the stock market is a casino, so we would
[00:07:19] Stephen Clapham: It's.
[00:07:20] Bogumil: it could be, you can make it one, but I picked up a book, one up on Wall Street by Peter Lynch and he said to the stock are small pieces of businesses and somehow this one idea.
Opened my eyes and I started reading every investment book I can find and I couldn't look back and I thought that this is the best place for me to deploy everything I've been curious about. And if I'm right now, and then these ideas could make money. So it's not only an intellectual pursuit. I have one comment about the age I.
I was born in Poland. I went to schools around Europe. And in Europe. A lot of my professors told me, what you heard is that you have to be of a certain age to speak up in the room. And they told me, if you get an internship out of school, just remember you're young. I think they could tell that I have questions.
I'm, I'm curious, I'm inquisitive. And they said, at some point you'll be able to ask those questions, but wait. And I thought, if I don't ask them now at 20, I will not know it at 40. And I thought there's some sort of lack of logic in that. And when I came to New York and I was giving my first pitch, first stock at the age of 24, I was half the age of the second oldest person in the room.
And I have to tell you that the whole room gave me full attention and full respect for the fact that I did their work, did the research, and they didn't care that this was my first stock that I ever worked on. And I thought this might be an environment where I can flourish. And I think that's the environment that you found working at the, at the firm that you found.
[00:08:44] Stephen Clapham: Well, uh, you know, I was in the south side to start with and they, you know, they don't care how old or young you are. They care how good your ideas are. And I, funnily enough, I mean, I worked with, um, a guy who's a number one engineering analyst, and he must have been twice my age.
[00:09:03] Bogumil: Mm-hmm.
[00:09:04] Stephen Clapham: mean, I mean, I didn't work for.
But, uh, you know, we were in, we were grouped in, in indu industrial sectors, so I was in the industrials as opposed to consumer or the oil and other, or the financial sec. And, and so we had, you know, an engineering guy, an autos guy, a construction guy, a house building guy, you know, and electrical and, and, and tech and electronics, um, tech hardware and, and, um, those guys were all pretty much 20 plus years of my, you know, beyond my age, um, 20 plus years of experience.
So, um, I think it's, I think it's quite good, um, working with people who are a lot older because they've got, they've seen it all before and they can tell you, I, I think they quite enjoy having. Younger people in because they realize that you got a different approach, fresh ideas, and, you know, maybe a different way of doing things.
[00:10:03] Bogumil: And The quality of questions that I received, I think helped me continue to grow. And, and I like the idea that the, we had people of all ages all the way to their eighties, so people that were, you know, 60 years older than me.
And I took advantage of it by just asking them questions. And I was very curious about all the things that went wrong in the past. And I spent a lot of time with all kinds of mentors that taught me not places where I shouldn't go. And, and that helped me throughout the career. But I am curious to hear about your books.
So it's called The Smart Money Method, how to Pick Stocks Like a Hedge Fund Pro. How did the
[00:10:38] Stephen Clapham: have it here, but I, somebody was in the office and they said, oh, could I have a copy of your book? And, uh,
[00:10:44] Bogumil: but how? Tell me how it came about and who is the perfect audience for it.
[00:10:48] Stephen Clapham: You know, I, I didn't set out with any particular sort of goal. I, um, I'd always wanted to write a book because I always, you know, fancied seeing my book on the shelf of a store. And I just had the idea that, you know, everybody should write one book in their life. And I dunno where that came from, but I had no sort of big plan or anything.
And, um, but I did, I did think, oh, well, you know, a book would be quite nice. And I, um, I'd kept a notebook. Um, when I started the hedge fund, I was coming back from a conference and I, I'd learned a huge amount. So it was a one week long conference and, you know, I'd taken copious notes every meeting, but what the note notes I didn't take were the most valuable interactions were at night.
Having a drink with competitors and colleagues, and I'd learned all this stuff. You know, it was like, oh, you know, we were, we would have arguments about stock and, oh no, that couldn't be right. Cause I do this this way and I do this and this. And I, I was on the plane and I was thinking, you know what? I should just write these things down.
So I started writing down what I'd learned from other investors. They, oh, I could use that. And if I don't write it down, I wouldn't remember in, you know, a month's time. And I filled up this notebook. It was an 80 pages notebook probably, and I had 80 pages of notes. They weren't all, you know, densely packed words filling the whole page.
I mean, most of them had an idea and it was three or four lines if you're looking at this check, that sort of thing. And so, When I finished the notebook, I thought, well, what am I gonna do with this? And so I started, I thought, you know, I'll just type it up because why have I got it in a notebook? It'd be better digitally, right?
[00:12:36] Bogumil: Right.
[00:12:37] Stephen Clapham: So I just did a Word document, and when I was sitting down and in my study at home to do some work in the evening, I, I, each time I did that, I would write up a page or two pages, just depending, no, how many words. It was just, just five minutes, you know? And, um, I then did all that and I thought, oh, what am I gonna do with this?
And I, I really wasn't too sure what I could do with it. And I came up with an idea. I've got these things called artifact cards. I don't know I've got any in the office. Maybe not. But there, there's a brilliant guy who came up with this idea. They're little cards about that size, and you buy a pack of them and there's.
I dunno, 80 cards in a pack. I came up with the idea of writing all the chapter headings, you know, each heading page of the notebook on one of these cards. And I then sat at home and Saturday morning and laid them all out in the kitchen table. And I then sort of said, well, how do these fit together? It's not something you normally do within a Word document, you know, and doing it spatially with cards is, is, is, you know, your brain doesn't think digitally, your brain thinks physically, or my mine does.
And um, so I laid these out and I thought, you know, there's a pattern to this. And I thought, you know, what? If I, I could write a book around this because I've got the makings of a book and I could write about my research process, because when I look at this in this way, This is actually sort of mapping out how I do research.
And so I started, I wrote the first chapter and I found, I said I had breakfast with a friend of mine who's a PR guy. And he, I said to him, do you know interview? Who's written a book? How'd you get a book published? And he said, oh, I know an agent. And he introduced me to the agent. The agent came into the office at the time I was at the hedge fund, came into the office and I had a chat with him.
I, I'd sent him the chapter of the book and he said, oh, you know, I think you know what you're talking about. I think we can get this book published. We'll get you a book deal. And, um, he managed to get the name, an email of a lady at Wiley who I had a couple of email exchanges with, but she couldn't find half an hour to have a Zoom call with me.
So, um, I was speaking at an investment conference and I saw Harriman house. My publisher had a stand. I, I went over to them. I said, look, I've got this agent who is, I mean, I think he's quite good, but he can't get anybody interested in my book, my book's about finance.
And you're a finance book publisher. Do you think you'd be, uh, would you even consider, and you know, I was very sort of self-deprecating about it and quite depressed after, you know, not even being able to get in front of someone to talk, talk to. And they said, well, why don't you send us a chapter and we'll have a look at it?
And sent 'em the chapter and they said, oh, you know, why don't we have a cup of coffee? We'll be in London in, you know, three weeks time. And I went and had a cup of coffee with them. And they said, well, actually, you know, I think if you did this and did that, it would be a good book. So yeah, why don't you, why don't you, um, why don't you sign up with us?
So I said, well, send me the contract. They sent me the contract. I didn't even look at it, I just signed it, you know, cause I thought, I need a book publisher, because I assumed that in order to get a book published, you needed a publisher. I didn't know anything about it. I'd never investigated it.
And at the end of it, I had a book and I then sent it to the publisher and they edited the first half really well. They then changed the editor. It didn't do such a good job in the second half, and I said, I think you, I think it needs a bit more editing. In the second half. We did a bit more editing and it was sort of ready in March, April, 2020.
And I thought, actually, it seems a bit stupid to publish a book in the middle of a pandemic without saying anything about the pandemic. So I stupidly added a blog that I'd written onto the end of the book, and that was stupid because I came up with these ideas about what the pandemic might mean without having any real knowledge or understanding of it.
So if, you know, if I had to do it again, I wouldn't include that chapter. But the rest of it I was pretty happy
[00:16:47] Bogumil: I thought it was a good chapter. I actually wanted to ask you about it at some point. I thought it was a good chapter and.
[00:16:53] Stephen Clapham: I, you know, the rest of the book had, you know, decades, you know, 10, 15, 20 years of. Practical application, and that had like an hour's thought and I just didn't feel that, you know, I felt the rest of it, I could, you know, I would die in that hill and, and on, on that bit of it. I just, that was the best I could do at the time, and I thought it'd be foolish to publish a book without.
And I, and, and also I thought, you know, maybe people would be interested to know what somebody wants to say, somebody has to say about the long-term implications of the pandemic. So I thought, anyway, the publisher thought it was a good idea to include it, so I included it. You know, it's sold really pretty well and it, you know, most books don't make any money. My books made me a bit of money, but it's made Harriman house a lot of money.
They, they came back to me and they said they wanted to, you know, they wanted me to just write my second book and they told me what they wanted me to write it about, and they, they upped the royalties by like 75%. And I said, no. I said, and I know what, what it's all about and you need to do a lot better.
And so, and I said, and this is that. I don't wanna write that book. Here's the book I wanna write. And he said, oh, we wouldn't publish that. We don't want that.
[00:18:09] Bogumil: I think you're gonna say self-publish that one.
[00:18:11] Stephen Clapham: Yeah. Well, I, I, we'll see. I mean, I, I, I'm writing book two and book three at the moment. Not very, not very rigorously. I mean, I'm, I haven't written any of the second book for, since Christmas, and I'm just doing research for the third book.
[00:18:26] Bogumil: So in the book, the Smart Money Method, there are a lot of lessons and I'm curious which ones you would pick for somebody that's new to investing. Maybe somebody on the path that wants to become an analyst, but also I think, I'm thinking always of, of clients that want to be more knowledgeable about the investment process and have somebody run the money for them.
[00:18:46] Stephen Clapham: Occasionally get, people will email me and say, oh, I loved your book. And quite often, you know, if I'm speaking at private investor conference, I was speaking at a conference a few weeks ago and I was, you know, I'd gone in to set up and there was a guy sitting in the front row with his wife, very excited.
And so I just went over a chat with him and he said, oh, I'm, I'm, I'm in the middle of your book. I'm really enjoying it. And it gives me a great deal of satisfaction that the book has helped thousands of people,
and I had, you know, a professional fund manager leave a review with his name saying, you know, this was the book I wish I had when I was setting out, starting in the industry. And that, you know, that, that, that to me is a brilliant compliment. Although I have to say, if the person who left the one star review and the one word review useless is listening, can you please be a bit more constructive?
[00:19:41] Bogumil: So I, I write articles and I wrote three books and I can share with you my experience and I agree that it's hard that you get some feedback. And some of the feedback is, I think somebody had a bad day and has not read the book. So in the last book, in the first few pages, I say what is in the book and what is not in the book.
And I hope that somebody that spends a few dollars actually reads that page. And then if those things are relevant to them, then go ahead and buy the book. I thought that maybe that's a solution, but I think I'm much more excited about the people that come up to me and read the book and they say that it made a difference in their life, either because they're investment professionals or they're people that have money managed by somebody else.
They feel empowered to ask better questions when they're in the room with an investment professional. So I think it plays a whole range of roles in different people's lives and. I choose to surrender and kind of let the book take a life of its own and see where it goes and who is gonna benefit from it the most.
But I think your book is as relevant for somebody that wants to be in an investment profession and wants to learn as somebody that's just curious about it.
I'll share with you some highlights that I'm curious to talk about more. You write I believe investors spend far too much time reading information, which will expire worthless today, tomorrow, next week, or next month. And I, I really paused and, and I thought it was a, a remarkable observation because even serious investment professionals and I've been in rooms and conversations where so much time is spent on something that clearly will expire within a day or two.
What are your thoughts?
[00:21:21] Stephen Clapham: Investors don't think, right, I've only got X amount of hours to make a return for my clients, and therefore what I've gotta do is I've gotta spend that time wisely.
Because if I waste that time, that's time that I won't get to spend researching. And I used to think about, well, what am I doing and is that going to get the best bang for my time? Because the, my scarcest resource, what's time, right? I mean, I, you know, I worked for a multi-billion dollar hedge fund. I, you know, if I wanted to go to Australia to look at a plant or something, I would get on a first class flight and go to Australia and the money was irrelevant because the, you know, the fund, you know, was incredibly profitable.
My time was precious. I think this goes back to being a management consultant, because when you're a management consultant, you've got, you know, a very long list of tasks and you've gotta get a whole group of people to execute because you're, you know, you're implementing a big computer system and when you press the button, everything has to be ready.
And if one thing's not ready, it can delay the whole implementation. And obviously you're paid to implement it on that particular Saturday. So you spend one day a week just planning, because if you don't spend that time planning, it won't happen. And I, you know, when I started in this city, uh, in the stock market, nobody planned anything because, oh, no point in planning.
Cause you don't know what tomorrow will bring. And that's a very stupid attitude because you've only got 40, 60, 80 hours in a week depending on how, how hard you wanna work. Like I say, most people probably work 60 hours a week, are involved in running money. Most people are are pretty dedicated. I've, I've seen, but it's still, you know, you've got a huge volume of information flying at you.
So I used to think about, okay, so if I do this, what am I gonna get out of it and how far will it take me down the road of making a return on the Capitol? And if I couldn't see a fairly direct route now, you know, obviously knowledge is never wasted because when you're an investor, You might go and see a company and think that is a garbage company, a garbage industry, that's hugely valuable because it means that you'd never have to waste time seeing anybody in that industry again, right?
I mean, even a waste of time isn't a waste of time. So you've gotta, you know, you've gotta think about it quite carefully. But, um, I found very few people consider the idea of, should I look at this really complex business where it looks at like a really fun toy to play with, and I can spend a lot of time solving that puzzle?
Or should I look at this really simple thing, which won't take me very long? And actually it could be equally profitable? Nobody says, oh, everybody says, oh, that looks like a really interesting thing. I'm gonna spend my time in that. Nobody says, oh, actually, well, for a third of the time, I could make as much money.
And that's the way you should think. You shouldn't go chasing the complicated things. You chase the simple things. Chase the easy things. Easy, easy. Wins. And I mean there, you know, there I say easy wins. I mean, there's not, there are no easy, easy wins. But, um, I think a lot of people get, um, drawn to the com complexity and I think a lot of people just feel that they've got to know the answer to everything.
So I spent some time working for a wealth manager. So two or three days a week I picked international equities for them. I ran money for some of their higher risk clients. You know, the clients that were looking to make a big return and didn't mind having an 8, 10, 12 stock portfolio. Or they used to cause the private bankers a bit of concern.
But, um, you know, grown up investors, grown up clients. And, um, I was a member of the investment committee and every month the investment committee would sit down. And ask when are interest rates gonna go up? And every month. And they would, you know, it was like a three or four hour meeting, and they spend the first half hour talking about interest rates.
And I said, you're completely wasting your time.
[00:25:44] Bogumil: Mm-hmm.
[00:25:44] Stephen Clapham: Uh, you don't know when it's gonna happen. And if it happens this month or next month, what difference it's gonna make? Because the stock market is not going to implode. And you're not gonna change your allocation to treasuries or Gils as a consequence of that because you need that.
You need them there to dampen your equity exposure. So you're not gonna, you're not gonna say, oh, interest rates are going up, so we'll sell all our Gils. You're gonna carry on with the guilt. So knowing even if you knew the answer, even if you had a crystal ball and you knew the answer, you wouldn't actually do anything different.
So this is a complete, this is, this is not a conversation that is worth having. And every month they had the same conversation, and every month I'd say, why are we having this conversation? I know it's very important that we, we understand when, when interest rates gonna go. Well. What should do, tell your
[00:26:32] Bogumil: but listen, Steve, that that's, when you think about it, if you are aware that these are pointless conversations and you see that so many investment professionals lose so much time, weekly or monthly or quarterly, on conversations like this in big rooms with a lot of smart people, a lot of time, and you're not, it gives you a huge advantage because you can get on the plane and go see that plan somewhere.
[00:26:55] Stephen Clapham: Well, I mean, I think I, you know, look, I think I was quite good at what I did, but I, I think more importantly, I had a process that I think was quite good and I, I think I was quite efficient. So, you know, I didn't need to spend as much time as other people to achieve the same result. Not because I was smarter, but just because I, I had a different approach and it, it.
It is probably simple. I mean, I mean, you know, I'm not giving away, you know, some sort of state secret. But the, you know, the funny thing is when you talk to a co consultants, they're always obsessed with process. You know, how do you screen and how do, and I remember having a very long conversation. I mean, I think I was meant to be in for half an hour, and I had a two hour conversation with one firm of consultants.
And the guy said to me, what's your process? And I said, well, I don't have one. You know, I just, I arrive in the morning and I look at what's going on and I connect the dots and I look at the share prices and I see, and you know, I went through, you know, example after example with him and, you know, I could see that he was perturbed because I wasn't, you know, screening.
You know, I didn't have 180 stock quality universe that I. And I said, you know, that's all very well if you want to do, you know, some long-term quality portfolio, that's a perfectly reasonable strategy. But I said, I'm doing special situations. I'm trying to make 50, 60% absolute return in, you know, two years and, you know, buying quality stocks.
That's not gonna happen unless the stock market goes up. And I'm, you know, I'm trying to make Alpha, I'm trying to generate alpha and, um, you know, people, I mean, I'm not criticizing any particular investment approach or investment strategy. Obviously your strategy has to encompass your skills and, and weaknesses as an individual and also the strategy.
You're, you're, you're following. And so different approaches are perfectly. Normal. But I think, you know, what I would say is the most, you know, there's a number of common themes. One of the common themes is of understand what you own and read the balance sheet
[00:29:09] Bogumil: Mm-hmm. So, speaking of balance sheet, can you talk about some of the things that you look in the company's financials that you think that other investors overlook or don't pay attention to, but they
[00:29:19] Stephen Clapham: well.
[00:29:20] Bogumil: made a difference in your career?
[00:29:21] Stephen Clapham: Well, I read the 10 k I think that's a good starting point, and I don't think many people do.
[00:29:26] Bogumil: Mm-hmm. Go ahead.
[00:29:27] Stephen Clapham: you know, so the, you know, the first thing that I do is I check what the revenue is, but I don't look at the p and l. I mean, I start with the balance sheet because the balance sheet will tell you where the problems are. And, you know, in 10 minutes I can go through the balance sheet and say, oh, okay.
There's a, there's potential issue here. And this isn't about, you know, sort of, you know, companies with loads of debt. I mean, this gonna be an, you know, a company with net cash, but the balance sheet will tell you, uh, um, give you a very strong first clue as to whether the company's being aggressive in its earnings management, as increasingly companies are.
And amazes me that people don't pay attention to the balance sheet. I, I, I just, I just do not begin to understand what an investor is doing if they aren't paying attention to the balance sheet. Because, you know, there, this is, you know, the repository of all the, the, the knowledge that you, that you need.
But I mean, you know, what are the most important things? I mean, I think it's quite difficult. I mean, you know, it depends on the company, depends on the industry. But if you're looking for companies that are cheating, I have a couple of things I tend to, to look at. I look at the margins. So, you know, I've got this forensic accounting course and I've taught between 550 and 600 people over the last five years.
Uh, um, this forensic accounting course. And, you know, people that manage 10 billion, several of them have been on the course and gone, oh man, this is fantastic. And, um, I go through, um, I went through 50 or 60 frauds when I was building the course. So I was trying to work hard, you know, fraud's, the most extreme example of earnings management.
So I, I thought, well, if I study a load of frauds, then I'll, I'll figure out what the common threads are and that'll be good examples for the course, because that's the most extreme, um, that's the most extreme case. And you know, the thing that was common about the frauds was that they all had margins that didn't make any sense. So, I mean, I say the all, but not, not all of them, but you know, you say Wirecard, the margins could have made sense, I suppose. But, um, you know, many frauds ha have margins which are unrealistic for the business. So one that we had in the UK not that long ago, was a company called Patisserie Holdings, and they owned several brands, but the largest brand was Patisserie Valerie, which was a probably a hundred year old tea shop.
So it's, it's, it's basically Starbucks, but instead of selling coffee to take away it's cakes to sit in and eat, but his margins were higher than Starbucks. And you just think about, you know, here's this a hundred million pound turnover company with a couple of hundred million pounds market cap, which is purporting to have margins that are higher than Starbucks.
Well, That doesn't seem that likely. I mean, coffee is a very high gross margin product. You know, coffee beans are expensive, but you pay three pounds, 50 or $3 50 for a cup of coffee and the beans are 20 cents. You know? And um, when you look at that and say, well, hang on a second, Starbucks is a huge company.
The coffee is off to take away, whereas you're eating the cake in the restaurant. So if you look at a UK restaurant, the rent is about 10, 11% of sales, and the labor costs are 35 to 40% of sales. So I don't know what percentage of Starbucks sales are to take away, but you know, if it, it must be at least half, right.
So, You know, you've got 50% of your sales aren't carrying, uh, 50 odd percent drag in terms of cost. I mean, it's just, it was just impossible that that business
[00:33:27] Bogumil: So, so it sounds like they were baking and, uh, not only the cakes, but maybe also
[00:33:32] Stephen Clapham: Yeah, no, I mean, it was,
[00:33:33] Bogumil: the numbers.
[00:33:34] Stephen Clapham: it was a complete fraud. And the, the, they, they didn't fake cash, but they hadn't disclosed the debt on the balance sheet. So, you know, the numbers are all wrong. So I like to look at that. I like to look at working capital ratios, because if you're cheating, it generally shows up in the working capital ratios.
And I like to look at cash generation because if you're generating cash, then unless the cash is fake, and for frauds, quite a lot of the frauds that cash is fake. So cash generation is not a guarantee that it's not a fraud.
[00:34:08] Bogumil: Right.
[00:34:09] Stephen Clapham: But, um, if you're not generating cash, there's usually a good reason for that. And, you know, companies that don't generate cash generally don't work out as investments.
[00:34:18] Bogumil: Can we talk about the management? So we, we, we read the financials, we know the numbers, we analyze them the way you really well describe it in the book, and then you have a whole point about the management and it's, it's a tougher point. It's more qualitative. Obviously the numbers can tell you quite a bit about how they run the business, but you're trusting your money to people that are running the business.
What are some of the things you look at and what are some of the things that you would avoid?
[00:34:46] Stephen Clapham: I mean, I don't, I I don't purport of any particular skill or talent in the judgment of, of, of the, of the management. I mean, what I like to look for are people that I think are genuine and honest.
[00:35:00] Bogumil: Mm-hmm.
[00:35:00] Stephen Clapham: So I. If you lie to me, then I'll almost certainly sell my stock. I might not sell it that day, but I won't be sticking around.
So I've had that, I mean, I, I can't tell you how many times, well, what do you know, what, what returns do you make in that division? Can you give a feel for that? And the guy will tell you a number and it's the wrong number. And I, and then I'll say, oh, really? Why is that? And I'll go, and I'll lead him down a path.
And if he's lying to me that, you know, I, I just don't, I just don't have any interest in, in owning stock in a company where the management aren't, aren't, aren't gonna be honest, because it, it's, it's just, it, it, it's just too difficult to understand what's really going on because you're, you know, management have got the best insight into the business.
And if they're. Trying to lie to you is almost invariably a bad signal. It might not be a sinister signal. I mean, I've had this happen where the guy, you know, I've sat down with the chief executive of one of the divisions and he's lied to me because he basically doesn't really understand the financial numbers.
But I'm not hugely confident about a business where, I mean, this particular one, the chief executive was a bit suspect. And I was thinking, well, you know, if the, if the head of a division, which has got a turnover of, you know, billions of dollars, doesn't understand returning capital, why, why am I here? You know, is he gonna make the right decisions?
Probably not. So, um, you know, people that lie or make things up or, you know, that, that I feel uncomfortable about. Um, I like people that are straightforward. I like people who are sort of a bit self-deprecating and you don't get much of that. You know, if you've made it to the, become the CEO of a s and p 500 company, you're usually pretty good at selling yourself.
And a lot of CEOs see their job is selling themselves, selling the stock to investors and I that, that I, I'm not, I'm not crazy about
[00:37:11] Bogumil: Mm-hmm.
[00:37:11] Stephen Clapham: know, I, I'd far rather the guy says, well, look, this is what I'm trying to do. This is, you know, this is the end goal. This is a strategy I'm gonna follow to get there and these are the KPIs that you can monitor and tell me, you know, that you can keep track of to whether I'm going to get to then go, but, you know, honestly, I've got no, I've got no real idea whether we're gonna get to 18% or 15%.
And we could get to 20, you know, if things go wrong, people that are, you know, sensible about it. They don't have a, they don't have all the answers. People that have all the answers make me feel less comfortable. And I look quite carefully at the, you know, people's past track record. What have they done?
You know, have they got a good record in capital allocation? Do they understand capital allocation? Do they understand what the business is about? Do they understand what they're doing? Most people understand their business, but they don't necessarily understand the financial consequences of the business.
And I'm looking for somebody to understand financial consequences.
[00:38:12] Bogumil: I like the sound of that. Steve, I know you have to run in a minute, but I have one last question for you. I like to ask my guests about their definition of success, and I'm curious where you're gonna take it.
[00:38:22] Stephen Clapham: Oh, well that's an interesting question. Am I a successful person? Um, if you ask my wife, she would say not enough. Um,
[00:38:32] Bogumil: I think you, you, you rephrased my question. The question was, what's your definition of success? And I'll, I'll let you be the judge if you're there yet already or you're, you're getting there.
[00:38:40] Stephen Clapham: Well, I, I mean,
[00:38:42] Bogumil: Uh,
[00:38:42] Stephen Clapham: For me it's not a financial metric, you know? Um, I, I don't, I'm not particularly concerned about, about money, uh, per se. I mean, obviously I, I, you know, I've got a reasonable amount of it and I, I, I'm not sort of worried about putting food in, in, in the fridge or anything.
So, you know, I'm in fortunate position. I think, you know, to me, success is calibrated, not in terms of book sales or newsletters, subscribers. And success for me is actually, you know, I've. Changed career at the end of my career. And so I'm now doing something quite different. And so success for me is I'm able to get up in the morning, have breakfast with my children without high pressure, getting into the office for seven 15 to see what's happened to the portfolio over overnight.
I walk along the canal to my office and I can relax. I don't have any particular pressure on me, and I, um, can do stuff that I find interesting. So, you know, I would calibrate success in terms of having fun, challenging myself, stretching myself, and learning. Because one of the nice things about doing what I'm doing is that I can go and explore.
New avenues. And so the reason I, or one of the reasons I wrote a book was because it was a new challenge. And so success is finding the next new challenge. So I, I wrote a book, I started a YouTube channel, I started a podcast, I started a newsletter, and I've gotta find another new challenge. I'm not quite sure what the next one will be, but, um,
[00:40:32] Bogumil: that the theme is that you like teaching you, you learned a lot and you have a lot to share, and I think you, you really like teaching and.
[00:40:40] Stephen Clapham: I mean, I, I, I, I mean, I, I think, I, think helping younger people is a hugely rewarding endeavor because, you know, I just, before we, we, we started, I had an intern in and, um, She's a really nice girl, and she's going to university in September to study accounting. And so I've given her a project to go through, um, an uncoated company, funnily enough, um, go through the accounts.
So she's going back 10 years for this company and one of its subsidiaries, and we're gonna go through all the ratios and performance and everything else. And, you know, I could see that she was really excited about, you know, she, she's, she knows the basics so far, and she's going to university to study more.
But see, she was excited about learning about this. And that's great for, for me because, you know, I, I, if I can help somebody, I think that's, you know, that's what you're, your, you know, your responsibility is, you know, there at the end of your career is to pass on your experience and help people and, you know, and that, that seems like a, you know, a nice endeavor to me.
[00:41:54] Bogumil: Yeah, we have, uh, summer interns now and then with us, and I have a lot of fun showing them how things work, and there's this moment when it clicks and I can tell that it all starts to make sense to them, and it's fun to see. So I, I enjoy that too, especially if they are really passionate about it, then I can tell that they can go places with it.
[00:42:12] Stephen Clapham: I think also, you know, they ask sort of stupid questions, which, I mean, they're not stupid questions, but they're ignorant questions they don't know. And being able to explain that is a very good test of your own knowledge and understanding, right? So if you're trying to explain a difficult concept, it can be quite a difficult thing to do unless you really understand it well.
And so, you know, I, I find that that's really helpful. You know, when I get questions back from my students, um, in the online school, we've got a community. So when you, when you buy our main course, the analyst academy, You join an Analyst Academy community and you can post questions in that community. If you don't, if you don't understand part of the content or if you've seen something externally that you don't understand, post the question.
I encourage the other students to answer the questions because I think, you know, that's a great way of testing your own understanding. And then I always, of course, look and make sure they haven't led somebody to, to the wrong conclusion. That's obviously a, a risk, but that, um, that idea of making sure that you, that you, that you're able to answer those questions.
I think it's really, I think it's a, a really good, really good idea. And I, I have a lot of fun with, with all of this. And it's, I mean, it's slightly surprising cause I, you know, I didn't, I didn't set out with this goal to get to here. You know, I didn't have a particular goal. And so the fact I'm doing stuff that I really enjoy doing is a great benefit privilege.
[00:43:44] Bogumil: It makes me happy. I really enjoyed your book, your podcast, and this conversation today. Steve and I highly recommend all, all of it to anybody that's curious to learn more, no matter if they're professionals or not. I think there's a lot that they can learn from your books and your work. Steve.
[00:44:00] Stephen Clapham: Well, thank you. So your listeners can find me at behind the balance sheet.com. I'm on Twitter very occasionally these days, but Twitter doesn't seem to work for me anymore. But when I'm there, I'm at Steve Clapham. And you know the podcast you can find on all places that you find in podcasts.
Behind the balance sheet
[00:44:20] Bogumil: I think it's a good name. I think we should all look, look at the balance sheet now and then before we invest, Steve, I'll let, I'll let you run, but it was a pleasure talking to you today and I will include all the links in the notes so people can find all the resources that you mentioned and follow you.
Thank you so much for today.
[00:44:37] Stephen Clapham: thank you for having me. It's been a pleasure talking to you. Take care.
