William Ackman’s Lemonade Stand: Breaking Down Finance And Investing (Part Two, Three And Four)

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MBA 23 | William Ackman

 

Before becoming one of the top investors in the world, William Albert Ackman learned the basics of investing in his early 20s. Today, he’s a billionaire investor who runs a hedge fund and is doing amazing things in the finance and investing world. In parts two to four of this four-part series, host Solomon Ali plays and breaks down one of Ackman’s most popular videos, where he talks about everything people need to know about finance and investing using a lemonade stand. Tune in to today’s show and discover the secrets of growing a business.

Watch the episode here:

Listen to the podcast here:

William Ackman’s Lemonade Stand: Breaking Down Finance And Investing (Part Two, Three And Four)

We’re going to get right back to it about how to grow a business with William Ackman. The guy’s done an extremely awesome job and explaining everything that he’s explaining. We’re going to try to give a few points here and there. We can break it down. It can be a little simpler for everyone to understand and get it. I’m excited about it and jazzed. I hope you too as well. William Ackman is one of the great guys who was running a hedge fund and doing amazing things. When we pick people to be like guys, let’s pick those people that we can inspire to grow, to develop, to push ourselves so that we can aim for the next level.

He’s one of the people that if I’m going to look around, he’s going to be on my list with Warren Buffett, Carl Icahn and Robert Smith. Those kinds of guys that are out there doing their thing and making a difference in the world. He broke it down. He did an awesome job. Please follow me. Let’s look at it. Let’s try to talk about it a little bit. Let me point out some things from what I see because me pointing out the things that I see at the level I’m at, will help you to achieve getting to the level where I am a little faster, a little sooner. I’m inspired to get to his level. Let’s work together, help one another and try to get this done. Growing a business.

Let’s start with the cashflow state. As the business becomes more profitable, we generate more cash. The cash builds up in the company. We go from $500 of cash in the company to over $2,000 over the period. The balance sheet. The starting balance sheet had shareholder’s equity of $4,900, but as the business becomes more profitable, the profits add to the cash. They add to the assets of the company. Our liabilities have not changed and the business continues to build value over time. By the end of year five, we’ve got $4,000 of shareholder equity. That’s almost three times what it was when we started.

Making Long-Term Investments

Do you see the power of growing a business whether it’s organically by adding new lemonade stands or if it’s growing by acquisitions? The power in over time, time and consistency. A lot of you have known me say time and time again, “When you invest, when you do something, you’re doing it for the long haul. It’s not as short-term gain.” Don’t be like some of my day traders and things of that nature out there, thinking that they’re going to hit a home run. You’re going to make a few dollars. You’re going to make pocket change. If you’re looking to make the real money again, you’re making long-term investments in something that you understand.

As long as you understand it, you’ll be comfortable in waving it out. There’s something else that comes with that. It’s due diligence, do your homework, understand the industry, know what’s going on in the industry, believe in yourself and the work that you’ve done. That will give you the confidence to stand fast and stand by the position that you have made. You’ve got to do this and you can’t wish it. It’s not going to happen by osmosis. It doesn’t work that way. It takes a lot of work. Sometimes you’re not going to be able to see the results of your work. It’s going to look like it’s failing. The stock could be down or the investment could be going bad and it looks terrible. You may have to double down on it. Whatever you want to call it or phrase you want to use, but sometimes that’s what you have to do. When you’ve done the homework, you understand the industry, vendors, customers, and everything in the industry, you move with confidence and a boldness, and you’re able to hold your position with strength.

Each person plays a critical role in your company’s performance, driving and moving you towards the bottom line.

Good Business Or Bad Business

How do we think about whether it’s good or bad business? One thing to think about is what kind of earnings are we achieving compared to how much money went into the company? This is a business that we valued at $1,500 when we started. Someone put up $500 for a third of the company, we give it $1,500 value at the end of year five. It’s earning over $1,500. That’s over 100% return on the money that we put into the company. That’s quite a high number. We’ve spent $2,100 in capital building lemonade stands and we earn $2,336 in year five on the capital we invested. That’s over 100% return on capital. That’s an attractive return. Earnings are grown at a rapid rate, 155% per annum. It’s a growth company. Our profitability has gone from 1.3% to 28.6% by year five.

Key Performance Indicators

This is an awesome business to invest in. That’s what you’re looking for. What he’s focusing on is the same things that you will need to be focused on. You have to know your numbers. You manage and grow your business by understanding your numbers. You’ll manage your people. We call them key performance indicators. It’s tying people into the performance. Each person plays a critical role in the performance of your company driving and moving us towards the bottom line. Please remember that in the future.

Let’s look at the person who put up the loan. That person put up $250 and the business has been profitable. We’ve been able to pay them their interest of 10% a year, $25 a year. They’re happy because they put up $250. They’re getting a 10% return on their loan. The business is worth well more than $250. We’ve got more than that in cash. As a result, they’re in a safe position, but they’ve only made 10% of their money. Let’s compare that with the equity investor, the person who bought the stock in the company. That person earned $1 share in year five versus an investment of $1 share. He’s earning over 100% or about 100% return of his investment versus only 10% for the lender. Who got the better deal?

The equity investor. Why did the equity investor have the right to earn more than the lender? The answer is they took more risk. If the business failed, the lender is entitled to the first $250 of value that comes from liquidating the company. If you sell off the lemonade stands and you only get $250, the lender gets back all their money. They’re safe. They got their 10% return while the business was going, they got back to $250, but the equity investor, the person who bought the stock is wiped out because they come after the lender.

Equity Investor Versus Debt Investor

We’re going to go over those two pages and talk about that difference between the equity investor and the debt investor or what we call the debt, which is a lender. The lender is always the bank. Do you feel we need to go back or would you want me to talk about it? What do you think? What do you say, “I’m going back?”

MBA 23 | William Ackman

William Ackman: When you’ve done the work and you’ve done the homework, you understand the industry, the vendors, the customers, and everything in it.

 

There’s senior debt, junior debt, mezzanine debt, convertible debt. It’s all debt that comes in different orders of priority in a company. The rate you charge is inversely related to your security. The better the security and the less risk, the lower the interest rate you’re entitled to receive. The more junior the loan, the higher the interest rate you’re entitled to receive. You can avoid the complexity. All you need to think about is debt comes first to a safer loan, but your profit opportunity is limited. The equity is informed. There’s something called preferred equity or preferred stock. There’s common equity or common stock. Stock and equity are synonyms, they’re options, but not worth talking about. The important point is that equity gets everything is leftover after the debt is paid off.

It’s called a residual claim. The good thing about it is that business grows in value. You don’t owe your lenders anymore, but all that value goes to the stockholder. The question is, why was the lender willing to take only a 10% return when the equity earned a much higher rate of return? The answer is when the business started, there was no way of knowing whether it would be successful or not. The lender made a bet that if the business failed, they could sell the lemonade stand. It cost $300 to make it. They would have some lemons and lemonade. Even if they sold at a much lower price than the dollar they originally projected, the lender felt comfortable that they’d get their money back, whereas the stockholder is taking a risk.

They were betting on the profitability of the company and they were taking a risk that if it failed, they would lose their entire investment. They have the potential to have a higher return in the event that business was successful. Let’s talk about risk. A lot of people talk about risk and the stock market is a risk of stock prices moving up and down every day. We don’t think that’s the risk you should be focused on. The risk you should be focused on is if you invest in a business, what are the chances you’re going to lose your money? There’s going to be a permanent loss. When you’re thinking about investing your own money and you’re thinking about one investment versus another, don’t worry about whether the price moves up and down a lot in the short-term. What matters is, you get your money back, you earn a return on your investment.

Don’t worry whether the price moves up and down in the short-term. You invest for the long-term. I’m a lender. I’m a private equity guy. I invest in stocks, but here’s how I invest in a company and I want you to understand this because a lot of you get all of this confused. What’s the difference between debt and equity? Debt is normally a creditor’s possession. Equity is ownership possession. Debt, we don’t share in the risk of what goes on in the company. Normally, if you had to file bankruptcy, under the bankruptcy rules and everything, the creditor will be getting paid back their money first. If there’s anything left, it will be divided amongst all the equity holders. Some say, “As a private equity guy, why do you like being the bank and loaning money rather than doing a different model like some of the other private equity?”

I don’t like risk. When I invest in a company, I invest as a lender. I am going to give you $100. In exchange for $100, you’re going to give me a security note and it’s going to be a contract between the two parties. The two parties, what we’re agreeing on is when that money is going to be paid back. How that money is going to be paid back? There’s always going to be a clause in there so that you don’t have to pay me back in cash. You may be able to pay me back in equity. That’s one way that you’re going to pay me back.

The rate you charge is inversely related to your security.

The other way is when I loan you that money, I may say that I am going to take a 10% ownership in your position. I am still going to be a creditor that you’re going to have to pay me my $100 back over the next 3 to 5 years. While you’re paying me back, there will be an interest rate attached to that. I am also going to take a certain percentage of the revenue that’s coming in. Let’s say that percentage is 20% of the revenue that’s coming in. That would be my deal in my structure, because why would I invest money in your company and take all the risk and you’re going to bring the human labor? If that’s what you’re bringing it, I’m taking the risk.

We’re risking our money and you’re bringing the human capital. You’re going to do the work and be getting paid along the way. That’s my way of balancing it out. In the future, what we are hoping and praying is that we’re successful. This lemonade company that Bill is showing, I will take that public in a heartbeat, seeing a company that’s doing 100% something in its numbers and stuff, and showing that type of growth, that’s phenomenal which means I would have a good stock. That would be like, “You don’t have to pay me back in cash. How about we convert that to equity?”

Equity investors think about things similarly. The riskier the business, the higher the rate of return the equity investor is going to expect. The lower the risk business, the lower the return the equity investor is going to expect. Equity investors don’t get interest the same way a lender does. What equity investors get is the potential to receive dividends over the life of a company. Let’s talk about raising capital. You started this lemonade business. The point of this was to make money in the first place, business is doing well.

As having started the business, coming up with a name and concept, heart of the people, I’ve made nothing. The business is growing in value, but where is my money? I need money to buy a car. For example, I want to buy a car for $4,000. What are my choices? What can I do? You’ve taken all the cash, the business is generating, will you invest it in the business? The good news is you’ve taken all that money. You’ve been able to use it to buy more lemonade stands. The lemonade stands are more productive. It’s growing the value of the business faster.

This is what entrepreneurs have to learn. They took all of their great cash from the business, from the one lemonade stand, reinvested it back into the business, then they took all the cash from the two lemonade stands and reinvested it back in the business. From the third lemonade stand and reinvested back into the business. Sometimes that may mean that you’ve got to get a second job out there, work at night so that you can reinvest all of your resources back into the business. That may mean that you have to bring on other partners that are willing to do and provide human capital, which means doing some of the work. You can keep all the resources within the business to grow, to generate those types of returns. That’s what we’re talking about here. That’s what I want you to understand. Read this over and over again. It’s very important to grab this, digest it and use it. The management team is not known, they don’t have a track record and being successful in doing what they’re doing. A startup business, no historical numbers. It’s a dream.

MBA 23 | William Ackman

William Ackman: The more junior the loan, the higher the interest rate you’re entitled to receive.

 

Number one, how do you avoid losing money? What is a rare good place to invest? My first piece of advice is despite the story about the lemonade stand, I’d avoid investing in a lemonade stand, in startup businesses where the prospects are not well known. You don’t need to make 100% and have a fortune. You need to invest an attractive return, 10% to 15% over a long period of time, your money grows significantly. How do you avoid risky investments?

My advice would be to invest in public secured and in listed companies. Companies that trade on the stock market. It’s because those businesses tend to be more established. They have to meet certain hurdles before they go public and stocks are liquid. You can change your mind if you want to sell. If you invest in a private lemonade stand, it’s hard to find someone to take you out of that investment unless that business becomes fabulously profitable. That’s piece of advice number one, invest in public companies.

A Business That Lasts Forever

Number two, you want to invest in businesses that you can understand. There are lots of businesses that you come in, that you deal with, in the course of your day and your personal life, whether it’s a retail store that you know because you like shopping there or it’s a product, your iPad that you think is a great product. You have to understand how the company makes money. The business is too complicated. You don’t understand how to make money even if they have a great track record, I would avoid.

A lot of people thought NLA was incredible because it appeared to have a good track record. Few people understood how they made money. It is good to avoid it. Another important criteria is you want to invest in a reasonable price. It could be a fabulous business that’s done well for a long period of time. If you pay too much for it, you are going to earn a good return. Last bet is that you want to invest in a business that you could theatrically own forever. If the stock market were to close for ten years, you wouldn’t be unhappy. If you are going to compound your money at a 10% or 15% return over a 43-year period of time, you want a business that you can own forever. You don’t want to constantly have to be shifting from one business to the next. What are businesses that you can own forever? There are few that meet that standard.

Maybe a good example is Coca-Cola. What’s good about Coca-Cola is it is a relatively easy business to understand. You understand how Coke makes money. They sell a formula, a syrup to bottlers, into retail establishments, and they make a profit every time they serve a Coca-Cola. People are going to drink a lot of Coca-Cola for a long period of time. The world’s population is growing. They sell in almost every country in the world. The nature of people is to drink a little bit more Coca-Cola. It’s an easy business to understand.

If you invest in a business, chances are you’re going to lose your money.

It’s also a business that is unlikely to be competed away as a result of technology or some other new product. It’s been around long enough. People have grown used to the taste. Parents give it to their children and you can expect that it will be around a long period of time. I think that’s one good example. Another good example might be McDonald’s. You may not love McDonald’s hamburgers, but it’s a business that has been around for many years. You understand how they make money. They build these little boxes, rent them to the franchisees. They charge them royalties in exchange for the name and they sell hamburgers and French fries. People have to eat this relatively low-cost food, the quality is good and they continue to grow every year.

The consistent message here is to try to find a business that you can understand. That’s not particularly complicated, but has a successful long-term track record and make an attractive profit and can grow over time. One of the key things to look for in a business that lasts forever. We want a business that sells a product or a service that people need, that is somewhat unique, and they have loyalty to this particular brand or product. The people are willing to pay a premium for that. Another good example might be a candy business. People are going to buy generic versions of many kinds of food products, flour or sugar. They don’t need to have a branded product. When it comes to candy, people don’t tend to like the Walmart version or the Kmart version. They want the Hershey or Cadbury chocolate bars or the See’s Candy. They want the brand and they’re willing to pay a premium for that.

We’ve talked about this before, solving someone’s problem. That’s the business that lasts forever. When you can identify a problem that either customers have or business to business where you can solve a problem, that will give you the longevity, that will give your business to solve someone’s problem.

That’s a key thing. You want the product to be unique. You don’t want it to be a commodity that everyone else can sell because when you sell a commodity, anyone can sell it and they can sell it at a better price. It’s hard to make a profit doing that. If you’re investing for the long-term, you want to invest in businesses that have little debt. In our little example before we talked about lemonade stand, there’s $250 worth of debt that didn’t put too much pressure on the lemonade stand company. If you put $1,000, we hit a rough patch, the business could have gone out of business for failure to pay its debts. The shareholders could have been wiped out.

What he’s talking about, investing in businesses with little debt and investing for the long-term is when you invest in and you’re not carrying a lot of debt, the advantage is it gives you access and allows you to have access to more capital.

MBA 23 | William Ackman

William Ackman: If you invest in a private lemonade stand, it’s hard to find someone to take you out of that investment unless that business becomes fabulously profitable.

 

If you can find a company that can earn attractive profits, it doesn’t have a lot of debt. They generate vastly more profits than they need to pay the interest on their debt. That’s a safe place to put your money over a long period of time. You want businesses that have what people call barriers to entry. You want a business where it’s hard for someone tomorrow to set up a new company, to compete with you and put you out of business. Going back to the Coca-Cola example, Coca-Cola has such a strong market presence. People come to expect when they go to a restaurant, they can ask for a Coke and get a Coke. It’s hard for someone else to break it. There’s Pepsi and there are other soda brands, but Pepsi has been around a long time.

Coca-Cola and Pepsi have continued to exist side-by-side over long periods of time. When you’re thinking about choosing a company, make sure that they sell a product or a service that’s hard for someone else to make a better one that you’ll switch to tomorrow. You also want businesses that are not particularly sensitive to outside factors, so-called extrinsic factors that you can’t control. If a business will be affected dramatically at the price if a particular commodity goes up or if interest rates move up and down, or if currency prices change, you want a company that’s fairly immune to what’s going on in the world. I’ll use my Coca-Cola example. If you think about Coca-Cola, it’s a product that’s been around probably many years. Over that period of time, there have been multiple world wars, development of nuclear weapons, all kinds of unfortunate events and tragedies.

Each year the company much makes a little bit more money than they made before. They’re going to be around and you can be confident based on the history that this is a business that’s going to be around, almost regardless of whether interest rates are at 14%, where the US dollar is not worth much, or the price of gold is up or down. Those are the kinds of companies you want to invest in the long-term. Businesses that are extremely immune to the events that are going on in the world. Another criteria, if you can think back for our lemonade stand company. As we grew, we had to buy more lemonade stands. Those lemonade stands only cost $300 each. Imagine, every time you grew, you had to build a new factory to produce more products. This factory is expensive.

This is the key to investing successfully.

Keys To Investing Success

That company might generate a lot of cash in the business. In order to grow, you are going to have to reinvest more cash into the business. The best businesses are the ones that don’t require a lot of capital to be reinvested in the company. They generate lots of cash that you can use to pay dividends to your shareholders or you can invest in new high return attractor projects. The last point I would make is that you invest in public companies, it’s probably safest to invest in businesses that are not controlled.

Raising Capital

Raising capital is one of the most difficult things in your business to do.

I like public companies because public companies have a lot of owners. They have to follow the regulations and all the rules. You’re not stuck in a private company at someone’s whims on what they may want to do or if they’ve had a bad day or things of that nature. There are some rules and regulations that they must follow. The exciting thing that we’re talking about here is about how to be successful as an entrepreneur, how to invest in a company, what as an entrepreneur you should be looking at and why you should be looking at that as an entrepreneur? Business is tough. It’s more than a notion. It is hard as crap.

If you’re thinking that you’re going into business, and it’s only going to be all of this money and things of that nature, and you’re telling other people what to do, don’t go into business because it’s nothing like that. It’s problems and raising capital. It’s problems and getting people to buy into your vision. It’s problems because when we’re dealing with people, what are we dealing with? People who have their own will, their own expertise and knowledge, their own opinions. We have to be able to motivate them, get them to see our opinions and our vision of where we’re going and why it should go that way. That’s difficult sometimes. If you’re not the kind of person and we talked about this before, you’ve got to hire the right people.

You’ve got to stay in your lane. You can’t be afraid to think that you’re going to try to save a dollar because this consultant or this person is too expensive. You’ve got to sit back and say, “I can’t afford not to bring in the consultant. I can’t afford not to bring in the right people who can do the job for me that I can’t do so that we can get this done.” That’s how you stay in business. I wouldn’t recommend any of you to go and try to raise your own capital. I’m going to say it this way. I will recommend you call a guy like Solomon to raise your capital, who understands what it means to raise capital. Who understands some of the principles, who’s accustomed to working with the attorneys and things of that nature and negotiating on the other side so that you get the best deal that you possibly can get.

You have to pay a guy like me 10% or 15% for arranging all that. A guy like me also helps you to put all the books and the records together by working with your professionals and getting all that together so that you may not have known yesterday what you needed and what it needed to look like. Now, we can put it together the way it needs to look so that you have a better chance of being successful in raising the money.

I want to thank you for reading the blog. It has been a blast talking to you and sharing the William Ackman presentation with you. We’re going to come back again. If you liked this presentation and what we’re talking about, maybe you don’t like me, but give me that thumbs up because you liked the information that you’re getting. For those of you, the information is so-so, but you fell in love with me and you like me, give me a thumbs up so that we can keep this going and everything. You share wisdom and knowledge so that you don’t have to go through a learning curve.

This has been exciting talking about the things that William Ackman has been doing and things like that. He put this awesome presentation together that is extremely helpful to all entrepreneurs and anyone thinking about being in business. It helps you to remember that it’s more than a notion. People, let’s go ahead and get right back into it. I’m thrilled and excited to be here.

MBA 23 | William Ackman

William Ackman: Try to find a business that you can understand, that’s not particularly complicated, but has a successful long-term track record and can make an attractive profit and grow over time.

 

Anyone can sell it and they can sell it at a better price. It’s hard to make a profit doing that. If you’re investing for the long-term, you want to invest in businesses that have little debt. In our little example, before we talked about our lemonade stand.

Keep in mind what I said. If you give up ownership, you dilute it, bring your stock price down in many cases. If you are borrowing money, it’s cheaper to borrow money but you must be able to create the value when you borrow that money to build your business and scale and whatever you’re going to do. It’s like saying, “I’m going to borrow the money to build a house, but all I do is buy the land, but I never built a house.” The appreciation is never there. Look at it from that standpoint.

There’s $250 worth of debt that didn’t put too much pressure on the lemonade stand company. If you put $1,000, we hit a rough patch. The business could have gone out of business for failure to pay its debts. The shareholders could have been wiped out. If you can find a company that can earn attractive profits, it doesn’t have a lot of debt. They generate vastly more profits than they need to pay the interest on their debt. That’s a safe place to put your money over a long period of time. You want businesses that have what people call barriers to entry. You want a business where it’s hard for someone tomorrow to set up a new company, to compete with you and put you out of business. Going back to the Coca-Cola example, Coca-Cola has such a strong market presence. People have come to expect when they go to a restaurant, they can ask for a Coke and get a Coke. It’s hard for someone else to break it. There’s Pepsi and there are other soda brands, but Pepsi has been around a long time.

Coca-Cola and Pepsi have continued to exist side-by-side over long periods of time. When you’re thinking about choosing a company, make sure that they sell a product or a service that’s hard for someone else to make a better one that you’ll switch to tomorrow. You also want businesses that are not particularly sensitive to outside factors, so-called extrinsic factors that you can’t control. If a business will be affected dramatically at the price if a particular commodity goes up or if interest rates move up and down or if currency prices change, you want a company that’s fairly immune to what’s going on in the world. I’ll use my Coca-Cola example. If you think about Coca-Cola, it’s a product that’s been around probably many years. Over that period of time, there have been multiple world wars, development of nuclear weapons, all kinds of unfortunate events and tragedies.

Each year the company makes a little bit more money than they made before. They’re going to be around and you can be confident based on the history that this is a business that’s going to be around almost regardless of whether interest rates are at 14%, where the US dollar is not worth much or the price of gold is up or down. Those are the kinds of companies you want to invest in the long-term. Businesses that are extremely immune to the events that are going on in the world.

You don’t want to constantly shift from one business to the next.

Keep in mind. All businesses have volatility and they fluctuate based on what’s happening in the market. What you want to try to do is find the business that’s recession-proof and you can find that. We spoke before liquor sells, tobacco, they tend to have sales stay the same or if not even grow a little bit consistently. That’s based on historical information on what’s happened historically during recessions and depressions in the past.

The last point I would make is that you invest in public companies, it’s probably safest to invest in businesses that are not controlled. Controlled companies are like our lemonade stand business that we took public. The problem with a controlled company unless the controlling shareholder is someone you completely trust and unless there’s someone that has a great track record for taking care of so-called minority investors, the non-controlling shareholders, it can be a risky proposition to invest in that business because you’re at the whim of the controlling shareholder. Even if the controlling shareholder is someone that you feel comfortable with, there’s no assurance that in the future they might sell control to someone else who’s not going to be as supportive of the shareholders of the business. It’s not that you can simply have a profitable business and a business that has done well. You have to make sure that the management and the people that control the business think about you as an owner and are going to protect your interests. These are some of the key criteria to think about.

It’s risky investing in private ventures because the owners are the key and the brand. They can cause you to make money or lose money or walk away and your money is all invested in it and it can be done well. The same if it’s a publicly-traded company. If you have a publicly-traded company that you’re investing in and the largest shareholder is management. You want to think twice about that because management could decide one day to take the company in the direction they wished to take it in. That may not be in the best interest of all the shareholders.

When are you ready to start investing money? My guess is you’re a student. You probably have student loans. Perhaps you even have some credit card debt, you’re going to graduate. You’re going to get a job. You don’t want to jump right in while you have a lot of debt outstanding, start investing in the stock market. Stock market is a place to invest when you have money you can put away and you won’t need for 5 or 10 years. If you’re paying relatively high interest rates on your credit cards, you definitely want to pay off your credit cards first before you think about investing in the stock market. Your student loans are probably lower cost than your credit cards. If your student loans are costing you 6% or 7%, if you pay them off it’s as if you earned a guaranteed 6% or 7% return and you’re better off getting rid of your credit card debt, and even your student loan debt before you commit a lot of material amount of money to the stock market.

Once you’ve paid off your credit card debt, perhaps you pay down your student loans. You want to have enough money in the bank so that even if you lose your job tomorrow, you’ve got a good 6 or 12 months of money set aside. Let’s talk a little bit about the psychology of investing. We’ve talked about some of the technical factors, how to think about what a business is worth. You want to buy a business at a reasonable price. You want to buy a business that’s going to exist forever, that has barriers to entry, where it’s going to be difficult for people to compete with you. All of those things are important. A lot of investors follow those principles. The problem is that when they put them into practice and there’s a panic in the world.

The stock market is heading down every day and they’re watching the value of their IRA or their investment account decline, the natural tendency is to do the opposite of what makes sense. To be a successful investor, you have to be able to avoid some natural human tendencies to follow the herd. The stock market is going down every day, your natural tendency is to want to sell. The stock market is going up every day, your natural tendency is to want to buy. In bubbles, you probably should be a seller. In busts, you should probably be a buyer. You have to have that kind of discipline. You have to have a stomach to withstand the volatility of the stock market.

In other words, if everyone’s buying it, it’s probably a signal to wait. If everyone is selling, it may be a signal to buy.

The key way to have a stomach to withstand the volatility in the stock market is to be secure yourself. You’ve got to feel comfortable that you’ve got enough money in the bank, that you don’t need what you have invested unless for many years, that’s a key factor. Number two, you have to recognize that the stock market in the short-term is what we call a voting machine. It represents the wins of people in the short-term.

Do not take money from your credit cards or borrow money from family and friends to invest in a stock or in a business. Save up your own money, do joint ventures. If I’m going to do an investment and I have no money and I want to invest in a business, I may go to 5 or 5 of my friends and we do a joint venture together creating one entity and that would go and invest in that company. I would not borrow money off of my credit cards. I would not borrow money from my family and friends. There’s no assurance that you’ll be able to make money or get that money back.

Outsourcing Your Investing To Others

Let’s say this is not for you. “I don’t want to invest, buy individual stocks. It seems too risky. I don’t have the time to do my own research. What are your alternatives?” Your alternatives are to outsource your investing to others. You can hire a money manager or a group of money managers. There are a couple of different alternatives for a startup investor. Most common alternative is a mutual fund company. What’s a mutual fund? It’s a corporation, but where you buy stock in this corporation and the manager selects a portfolio of stocks. What they do is they pull together capital, money from a large group of investors. Let’s say they raise a billion dollars and they take that money and they invest in a diversified collection of securities.

The benefit of this approach is that with a tiny amount of money, in less than $1,000, you can buy into a diversified portfolio managed by a professional manager who’s compensated to do a good job for you investing in the market. Mutual funds are a good potential area for investment. The problem is there are probably 7,000 or 8,000 or 10,000 different mutual funds and some are fantastic and some are not perfectly good. You need to do research to find a good mutual fund manager in the same way that you need to find individual stocks. It’s not an easy thing of investing mutual funds. Here are a few key success factors in identifying a mutual fund or a money manager of any kind to select. Number one, you want someone who has an investment strategy that makes sense to you. You understand what they do and how they do it. They’re not appealing to your insecurity by using complicated words and expressions that you don’t understand. If they can’t explain to you in two minutes what they do and how they do it and why it makes sense, then it’s a strategy you shouldn’t invest in.

If you don’t understand it and they can’t articulate it to where you understand it, walk away.

Number two, this not necessarily in this order, this probably should be number one because you want someone with a reputation for integrity. If you’re starting out, you probably want to invest in a mutual fund that’s sponsored by some of the larger mutual fund complexes as opposed to a tiny little mutual fund that’s privately by a mutual fund company that you’ve never heard of. There’s some benefit in the larger institutions. You can be more confident that they’re not going to steal your money. You want an approach where the investor invests money on the basis of value. I know this sounds obvious, but value investing has a long-term track record. There are other kinds of investing, including technical investing where people are betting on stocks based on price movements.

I highly recommend against those kinds of approaches. You want somebody making investments where they’re buying companies based on their belief that the prospects of the business will be good and at the price paid relative to what the business is worth represents a significant discount. We started with a little lemonade stand company. The purpose of that was to give you some of the basics in how to think about a business, where the profits are coming from, what revenues are, what expenses are, what a balance sheet is, what an income statement is, how to think about what a business is worth, how to think about what the difference between good business is versus a bad business.

This is where we are. This is how you make investments. This is how you look at it. I want to thank everyone for joining and tuning into the show. It’s been a blast. I want to thank William Ackman for this beautiful presentation. That was one of the best presentations that I’ve ever seen. That was totally mind-boggling because he embodied everything that a person is looking to start a business, invest in a business, what it all looks like and give you a good sense of how it feels. I hope I was able to add a little tidbit here and there to something that was beautifully put together and done. Thank you. Don’t forget to tell a friend and tell another friend.

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About William Ackman

William Ackman is the CEO and Portfolio Manager of Pershing Square Capital Management, L.P., an SEC-registered investment adviser founded in 2003. Pershing Square is a concentrated research-intensive fundamental value investor in long and occasionally short investments in the public markets. Prior to forming Pershing Square, Mr. Ackman co-founded Gotham Partners Management Co., LLC, an investment adviser that managed public and private equity hedge fund portfolios. Prior to Gotham Partners, Mr. Ackman began his career in real estate investment banking at Ackman Brothers & Singer, Inc. Mr. Ackman received an MBA from the Harvard Business School and a Bachelor of Arts magna cum laude from Harvard College.

Mr. Ackman is the Chairman of the board of The Howard Hughes Corporation (NYSE: HHC). He is a Trustee of the Pershing Square Foundation, a member of the Board of Trustees at The Rockefeller University and the Board of Dean’s Advisors of the Harvard Business School.