Sean Iddings is co-founder of the Intelligent Fanatics Project which helps investors and entrepreneurs see further by standing on the shoulders of organizational and leadership giants.
The book series of the same name, co-authored by Ian Cassel, is the introduction into the overall project. Sean is also a member of MicroCapClub.
Safal Niveshak (SN): Sean, you have graduated magna cum laude with a B.A. in Music Therapy. What led you into this “non-musical” world of investing?
Sean Iddings (SI): I had always been intrigued by the market and entrepreneurship from a young age. Music was my first love, so I never looked further into those other curiosities. It was a friend I worked with during college that told me about the markets/business and encouraged me to look into them. Since I was depressed about my musical future, I was finally ready to entertain those curiosities.
My musical training had revolved around “mastering the masters”, so I immediately sought out the investing masters. After reading Ben Graham’s Mr. Market analogy, I instantly got it and was hooked.
So, while my background is non-traditional for an investor/entrepreneur, I’m blessed to have it.
SN: How have you evolved as an investor and what’s your broad investment philosophy? Has your investment policy changed much through the years as your capital has grown?
SI: Yes, I’ve evolved immensely. I’d say that I’ve found much better tools over the years. I started out looking in the right places, but I had deficiencies and still do. One early one was to gloss over “mastering the masters” and focusing on learning from my own experience.
My broad policy of investment continually morphs. It has been simplified to this: put in the hard work and compound.
The potential payoff of deferred gratification over a lifetime is truly amazing. And such a policy extends outside the investment realm, into learning and other areas of our lives.
SN: You’re primarily a microcap investor. How are the dynamics of microcap investing different from say midcap of smallcap investing? What excites you most and worries you most in being a microcap investor?
SI: On the whole, few things are different between microcaps, midcaps, small caps and large caps. Business is business no matter what size. Microcap investors, like any investor, are buying a piece of the business pie. So, the mechanics are the same.
What is different is the business’ development and needs. Microcaps are small, like babies, and need a lot of care and attention compared to a midcaps or large caps, who are like adults and can largely fend for themselves. The management and leader’s job is more important the earlier in the business’ development.
Liquidity in purchasing microcaps is really the only difference directly observable by an investor. Yet, illiquidity is not much of a problem for small investors and can be a benefit.
Investing in the wrong leader and organization is what worries me, so that is where I spend my time.
SN: As I understand, microcap investing may involve sifting through as many as a few hundred companies, before finding a potential great stock idea with moderate risk. How exactly do you tackle this task? Please share your process?
SI: Sifting through every public business is a difficult task and most people don’t or won’t do it. I’ve done it but don’t anymore. I felt I wasn’t as prepared. How can you tell a great leader and organization without internalizing those who were?
I spend majority of my time not sifting through companies now. I’m stock piling my subconscious “pattern recognition” with the great leaders and organizations of the past. This is my preparation.
The preparation is two-fold: I’m building a repertoire of “songs”, so when I hear a tune today rhyming a similar melody and harmony, I’ll be able to identify and act accordingly. Luck is preparation meets opportunity. This extends into any business endeavour.
Additionally, I believe such preparation leads to a more fruitful, productive and exciting life. The preparation is just hard work that has limited short-term payoff.
SN: That’s a wonderful insight Sean. Thanks for that! You have co-authored this wonderful book titled the Intelligent Fanatics Project. What inspired you to write the book?
What’s the biggest lesson you wish the reader should take from the book?
SI: As I said, my trick is to identify the outliers in a given area and then internalize their work. Take for instance music. I started learning note-for-note the music of Jimmy Page (Led Zeppelin), Jimi Hendrix and many other guitar virtuosos. When I got to jazz, I looked to Joe Pass and Carlos Jobim. Not only is building pattern recognition good for any craft, it lays a foundation for your own unique voice to develop.
I believe this is the simplest and fastest way to achieve mastery. Our most precious resource, more valuable than money, is time. If an investor or entrepreneur wants to start making better decisions now, to save precious time, this is the way to go.
Ian Cassel and I utilized the same principle with the Intelligent Fanatics Project book, only with the elite-level, or “intelligent fanatics”, business leaders and their organizations. We looked for those who were able to sustain success for decades, a major feat for a business.
Of these examples, many listed in passing by Charlie Munger, the leaders and their organizations shared many qualitative characteristics with each other. Those being: incentives, culture, leadership style, employee development, etc.
SN: How do you go about finding an intelligent fanatic? What are some of the most important qualities you look for in such managers/owners?
SI: As Charlie Munger superbly stated, “The best way to get a good partner is to be a good partner yourself.” Every investor should drill that quote into their heads. Why?
While it might seem like a no-brainer if you are privately partnering and directly working with a person, it doesn’t seem as necessary as a passive public investor to be a good partner. But it is! Great leaders like Ken Iverson understood this, “We’re not dogs on a leash, doing tricks to manage the stock price or maximize dividends quarter by quarter. We’re eagles. We soar. If investors want to soar, too, they’ll invest in us. The speculators, we don’t need.” It’s always a two-way street in business.
If you want to soar, you have to be a good partner. On top of that, if you internalize the thought patterns of intelligent fanatics, well by golly you should deserve to invest alongside them too. You’ll subconsciously drift towards those people, well before they are known. And when times get rough, you could have the necessary conviction to stick around, because you know how truly rare these individuals and organizations are and what they are capable of.
SN: Please share an example from your personal investment experience of encountering or investing in a microcap business managed by an intelligent fanatic?
SI: There is one company and leader. What tipped me off initially was the company’s incentives. This CEO clearly gets incentives. He’s 6 for 6 on my scale. You don’t find someone who checks all the right boxes, and you need all the boxes checked to get the “world to work for you.”
Since I’ve partnered with this company, the company has continued to grow even when a goliath $100 billion large cap competitor slapped it with a lawsuit. Now talk about quality of brand and getting a team to pull its weight in a trying time.
I like the analogy with the African Bushmen and lions. The company, even with its small stature like the African Bushmen, showed that it would be a fair fight for the “lion”. The goliath company backed off and there is no more lawsuit.
SN: What are some of the characteristics you look for in high-quality microcap businesses?
SI: My preference is a company with a dominant position within a small but growing niche. The longer the runway for growth, the better.
Within this, I’d prefer not to invest in a company that needs significant amounts of capital for growth. I am not 100% strict in this rule of thumb. There are a few examples of companies that I can recount that have been successful in growing in a capital-intensive industry, however, the probability for error is higher. It would take a special leader and culture – i.e. Kenneth Iverson who ran the U.S. steelmaker Nucor – to get me interested in making an exception.
Most importantly, I look for win-win relationships across the board. A company that can provide those for customers, suppliers, employees, the community, etc. will succeed and sustain success. Why? As Herb Kelleher from Southwest Airlines said, “The business of business is people. Yesterday, today and forever.” Any win-lose, or zero-sum based, human relationship does not last. Let me give a personal example.
I’m not familiar with the rate of divorce in married couples in India, but in the U.S. more than half of marriages will end in divorce. The cause? Aside from divorce being more acceptable today, any divorce is caused by a win-lose relationship.
I witnessed this first hand as my parents divorced a few years ago. While they lasted 30 years together the win-lose agenda both parents had worn on them and they eventually gave up. Most win-lose relationships don’t last remotely as long.
I want to find and invest in a compounder, so I want a business to compound upon their win-win relationships. Those are the only that will last and is an impenetrable moat. The score takes care of itself and shareholders will be happy.
SN: How do you assess a management’s quality, especially given that information is scarce in case of small and microcap companies?
SI: Talking directly with management is invaluable. Reading any information that could give a clue to the person or organization’s ethics and treatment of other human beings is priceless. It is the little things that count.
I only partner with people who I like and trust. I make sure to ask questions to assess my ability to like and trust them. Flexibility with each unique situation is a must, so I don’t have a concrete set of questions used with everyone.
As for questions I ask directly to management, I try to keep them open ended. I ask indirect questions that might allow me to parse the manager’s views on win-wins, as I described in the previous question. Do they have blind spots? Who do they care most about? Do they believe they are at the metaphoric poker table with drunk Texas oil drillers, with little skills, or are they at the professional’s table? Etc.
SN: You may be doing a lot of scuttlebutt for finding your ideas. What is your process for the same? How do you employ margin of safety in your scuttlebutt process?
SI: I have no concrete process. Knowing what and where to look comes from internalizing the intelligent fanatics and organizational outliers of the past. Each new thing I learn leads me to a new “avenue” or pathway.
SN: How do you think about valuations? How do you differentiate between ‘paying up’ for quality and ‘overpaying’?
SI: I’m cautious to put too much emphasis on trailing accounting numbers. Microcaps are small and if you find the right leader, with the right team and system, reinvesting heavily back into their business, previous results can be misleading.
Although I would state that the more short-term an investor’s focus, the more it is necessary to value previous results. This is especially true with larger more mature companies.
I try to focus on owner earnings. I try to understand the growth capital expenditures. This is hard to do, as some growth capex is expensed as personnel, etc., but it gives a rough estimate to (a) the true current earnings and (b) gives me a mental picture of the map to which the growth capital can expand. The question is if the management is capable of executing the navigation of that map.
Investing alongside an intelligent fanatic with a large runway, and the right ingredients, is practically priceless. At any point the valuation will likely look modestly expensive but in retrospect what might have looked expensive was actually dirt-cheap. Now I said practically priceless because no one should pay an astronomical price for such an opportunity. If you are early enough most people won’t yet know the company or that the leader is an outlier, then the price is likely attractive. It’s when the masses know the fanatic is a fanatic that is when it is too late.
SN: How do you determine when to exit from a position? Are there some specific rules for selling you have?
SI: My selling can be summed up into three categories: garbage – recycling – eating.
In the past I’ve made a number of “garbage” sells. Appropriately named, these have been garbage investments. It’s when I’ve made a mistake on my qualitative due diligence. Or the thesis turns for the worst into garbage. I want to throw the garbage out as quickly as possible. Otherwise, the garbage gets smellier and worse over time. I’ll share a garbage sale example of a mistake in a later question.
More common for me lately has been “recycling” sales. As you can imagine it’s reinvesting my non-high convictions for my best convictions. I held a few tiny positions in a couple companies that I felt fit my criteria for management quality and risk reward. These were sold, not because the thesis had changed, but the risk/reward for my best convictions were greater. Those smaller positions I sold were largely reinvested into the company with the lawsuit I mentioned earlier. I added significantly during that trying time.
Selling to eat is another important one. To me, there are two sub categories of this. Sometimes it is necessary to sell to cover a non-investment cost like eating. The other is selling to be gluttonous or to eat when not necessary by taking profits off the table of an investment that is getting better. I try to minimize any “eating” sales as much as possible.
SN: Do you believe in investment checklists? If yes, what are the most important points in your checklist?
SI: I won’t win many friends, but I am not a fan of external checklists. I’ll tell you why. Elite-level musicians do not use checklists. Such a conscious mental crutch would be detrimental! An elite musician, or even a good amateur, does not think consciously when they perform. Music flows from them. It is only possible because they have deliberately internalized the music so much that what they play is effortless. They are operating from the subconscious mind that holds most of our super brainpower. Just think, our conscious mind is roughly two tablespoons worth of our brain and our subconscious is the rest. Why not use the 98%?
Let me talk about how much a crutch conscious thinking can be. When I solo over a jazz tune, if I try to consciously think what I want to play, I’m already a measure behind. Life, business and investing is like that. Time is moving quickly. The world is dynamic. If you want to perform like a virtuoso without missing a beat, the only way is preparing your patterns so much they are effortless.
Elite investors like Warren Buffett and Charlie Munger don’t have checklists, nor do other fanatics in other fields. They prepare like a musician and let their pattern recognition do the work. The results are effortless. They clean up while everyone else is “measures” behind!
SN: When you look back at your investment mistakes, were there any common elements of themes? Please share a couple of cases of your failures in microcap investing, without naming the companies if you so desire. I am quite sure our audience will learn valuable lessons here.
SI: I remember being slightly apprehensive with one of my companies after meeting their CEO. Something was just off about him. I couldn’t verbally tell you why… I just felt that way. Nonetheless, the business was at, what I believed to be, an inflection point. Then, after buying a position, I later uncovered some data on the CEO that showed this individual is not as ethical as I prefer, and I started to hear about some boardroom shenanigans. Fortunately, I got out without losing too much money, but the experience enforced the lesson that quality of management really matters to me. Any cracks or indications that leadership lacks integrity should be an immediate pass or sell. As Buffett said, if you find someone who lacks integrity, but has the intelligence and energy, you better watch out.
SN: What tricks do you use to save yourself from behavioural biases? What are the most common behavioural mistakes you make?
SI: Let’s step back a moment. Intuition, or gut feel, is based on every experience in an individual’s life. Our intuition is much more powerful than any supercomputer available today as we can instantly associate billions of fuzzy connections. When you don’t have the requisite experience for something, however, your intuition uses these “natural” short cuts. These are the behavioral biases, which have been helpful for human survival for 1,000s of years. Today, however, biases are ineffective in a complex modern world.
This quote from 18th century portrait painter Sir Joseph Reynolds perfectly encapsulates the situation: “Innovation, strictly speaking, is a little more than a new combination from images of which have been gathered and deposited in the memory. Nothing is made out of nothing; he who lays up no materials produces no combinations.”
So, my trick is “lay up the materials”. I deliberately build my pattern recognition of the greats by depositing their words, lessons, etc. into my memory. They have achieved the top of their game, so they more than likely have made great decisions in their life. I take their priceless experience and make it my own. Now I have a world of quality decisions and lessons to draw from. Doing so bypasses biases!
SN: How do you avoid the noise and the overload of information that is available these days?
SI: I pick my sources carefully. I’ll give you an analogy: if you want to internalize Jimi Hendrix into your toolbox, listen to and internalize Hendrix. Don’t listen to and learn someone else’s version of Hendrix. Go to the source, or as close as you can. This instantly weeds out all of the useless noise.
SN: How do you think about risk? How do you employ that in your investing?
SI: The biggest risk for me is opportunity cost. Everything I buy and do comes at the cost of not buying or doing something else. Talk with elders about their regrets, and you’ll find they misunderstood and poorly managed opportunity cost across their lifetimes. I try to minimize time wasted on companies I’d never own at any price. I try to minimize all the noise and useless activities. I try to only invest in the opportunities and activities that have the best potential for future payoff.
Furthermore, I am a firm believer in holding myself to excellence in everything I do. I feel if I get complacent in one area it will be felt in other areas. I’m looking to build positive feedback loops.
SN: What’s your two-minute advice to someone wanting to get into microcap investing? What are the pitfalls he/she must be aware of?
SI: Look to those who have already been successful and steal from them. Don’t restrict yourself to investors.
Be careful to who you listen to. I think a major pitfall in any area is to listen to the noise and the wrong people. Learning takes time and unlearning takes 10x more time.
SN: Which unconventional books/resources do you recommend to a budding investor for learning microcap investing and multidisciplinary thinking?
SI: You might guess that I’m a truffle pig for biographies of successful individuals regardless of domain. When an autobiography is available, it is hog heaven!
I love podcasts and any other sources that go directly to the source.
MicroCapClub is a fantastic community of experienced microcap investors. While it doesn’t have companies listed in all countries, you’d do yourself a favor by internalizing how the successful microcap investors think.
If you want to join Ian Cassel and I in our quest to build our own pattern recognition for intelligent fanatics, enter your email for weekly updates in our research at www.intelligentfanatics.com. We have a second book coming out with under-the-radar IFs later this year and have many exciting things in development.
SN: Which investor/investment thinker(s) so you hold in high esteem?
SI: There are a number of people who I hold in high esteem in the investment arena. One is my partner Ian Cassel. He not only is a phenomenal investor, more importantly he is a phenomenal human being.
Additionally, while I’ve had limited communication with Sanjay Bakshi, I can instantly tell you he is both a great investor and human being. These two gentlemen are fantastic complete models to steal from, because they have few, if any, bad traits to discard like a banana peel. Talk about examples of “the best way to get a good partner is to be a good partner yourself,” they deserve their success.
I try not to restrict myself to only investment thinkers. If an individual has reached the top, I not only hold them in high esteem, but I take their best qualities and thoughts.
SN: Hypothetical question: Let’s say that you knew you were going to lose all your memory the next morning.
Briefly, what would you write in a letter to yourself, so that you could begin relearning everything starting the next day?
SI: Great question. I’d simply write: “Experience is the best teacher… especially someone else’s experience.” And then I would point myself to my notes.
SN: What other things do you do apart from investing?
SI: Investing is all I do. Investing in knowledge, investing in relationships, and investing in mental and physical activities that promote a healthy lifestyle. I live by Ralph Waldo Emerson’s quote, “The purpose of life is not to be happy. It is to be useful, to be honourable, to be compassionate, to have it make some difference that you have lived and lived well.” The potential payoff of a life well lived is priceless.
SN: That was brilliant, Sean. Thank you so much for sharing your insights with Safal Niveshak readers. I wish you all the best for your work and life.
SI: Thanks Vishal! I hope your readers find this useful in some way.[/show_to] [hide_from accesslevel=’almanack’]
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