Robert G. Hagstrom: Darwinian Investing and Multidisciplinary Wisdom

Robert G. Hagstrom is a name synonymous with thoughtful, multidisciplinary investing. As the author of The Warren Buffett Way, Investing: The Last Liberal Art, and other influential works, Hagstrom has long been a bridge between essential fundamentals and the broader intellectual frameworks that underpin successful investing.

In this conversation, we discover the ideas that have shaped his thinking – from Mortimer Adler's principles on reading to lessons drawn from working alongside Bill Miller, one of the most innovative investors of our time. He discusses the importance of a latticework approach to understanding the world, challenges conventional definitions of value, and explores how dynamic, biology-inspired frameworks can better explain long-term market developments.

Hi Robert, you've said that you didn't truly know how to read until later in life, and recommended Mortimer Adler's How to Read a Book, for anyone wanting to read in a way that goes beyond simply “getting through” the words. What did the book teach you about the art of reading?

Before Adler's book, I read every non-fiction book the same. I want to emphasize that my remarks here pertain to non-fiction books, not fictional books that are read for pleasure. One day, I scanned my library shelves looking for a book and it dawned on me that I had read a great deal of books, many of which didn't deserve the hours needed to complete.

Adler's How to Read a Book helped me appreciate that not every book deserves equal treatment. Some are worthwhile, others are not. Before allocating your valuable time to reading a book, Adler provides readers with a three-step process that begins with systematically skimming – taking a quick glance at the table of contents, preface, and bibliography to see if there is anything new or interesting.

If the decision is to proceed, next comes superficial reading which is a kind of speed-reading process to move through the book as quickly as possible. At the end of superficial reading, you then can decide whether, or not, the book deserves a deeper treatment, called analytical reading. If so, you again start reading the book, but this time more slowly, with a notebook nearby to write your thoughts and observations. By the end of the analytical read, you intellectually own the book.

No doubt, by following Adler's methodology I have been able to consume many more books, and most importantly, in a highly efficient and productive manner.

Outside of investing, what are some of your biggest passions or hobbies?

Outside of my passion for investing, set aside my continual love and caring for my family, is writing. Nothing excites me more than staring at a blank piece of paper with thoughts racing around my head. It was C.S. Lewis who said, “We do not write to be understood. We write to understand.” I guess you could say my passion for writing feeds my desire to try and understand how things work.

Could you share a bit about what inspired you to write investment books like, among others, The Warren Buffett Way and Investing: The Last Liberal Art? What motivated your deep dive into multiple disciplines to enhance your investing approach?

To fully answer this question would require multiple pages. Let me be succinct. I wrote The Warren Buffett Way in 1994 after ten years of studying Warren and Berkshire Hathaway. His long-term, business-driven approach to investing resonated with me in a way that short-term trading did not. I felt if I could write a book about Warren's methods and philosophy I would, in turn, be able to better master his investment approach.

Writing Investing: The Last Liberal Art was my attempt to answer Charlie Munger's suggestion that becoming a better investor required one to achieve worldly wisdom. This was made possible by building a latticework of mental models from various disciplines to gain a wider understanding and more insightful view of the world. This, in turn, said Charlie, was essential to becoming a better investor.

In Investing: The Last Liberal Art, you highlight how art appreciation – better observing and interpreting meaning and context – can inform investing. How do these skills translate to the stock market, and how can they help investors make better decisions?

If you were a liberal arts major, it's likely you might have taken an art appreciation course that teaches students a broad range of skills that go into analyzing and interpreting the visual arts. Just as a painting may have multiple descriptions, so too does investing.

Investors often default to an easy straightforward description of an investment without recognizing there could be other, multiple descriptions of the same investment. Art appreciation teaches one how to see multiple descriptions of the same visual.

It was the mathematician Benoit Mandelbrot who said, “Failure to explain is caused by failure to describe.” Most mistakes in investing occur because an investor defaulted to the wrong explanation of what would happen principally because they miss-described what was occurring.

In your latest book, Warren Buffett: Inside the Ultimate Money Mind, you explore Buffett's thinking process. Can you elaborate on the concept of the “Money Mind”?

It is best to think of Warren Buffett's idea of a Money Mind as one that is multi-dimensional in their thinking. Self-confident, rational, pragmatic, independent in their behavior, and not overly influenced by what others do. Warren believes those who possess a Money Mind can resist the “institutional imperative.” A lemming-like tendency to imitate what others do simply because they, and many others, are doing the same thing.

Robert G. Hagstrom's essential reads on investing.

Robert G. Hagstrom's essential reads on investing.

During your 14 years with Bill Miller at Legg Mason, what were the most significant lessons or insights you gained?

I first met Bill Miller in 1984. I was an investment broker at Legg Mason and he was director of research. Bill would periodically recommend books on philosophy, psychology, history, biographies, and finance. I would track down the book and then give him a call with questions. We soon became good friends.

After I wrote The Warren Buffett Way, Bill asked me to join him at Legg Mason Capital Management. He was managing the Legg Mason Value Trust, the only mutual fund to beat the S&P 500 Index for 15 years in a row. Bill asked me to manage a growth equity investment strategy based on the tenets outlined in my new book.

All during this period, and the years following up to this day, Bill has always been generous in his willingness to share what he has learned. He has an intellectual generosity that is rare in the competitive field of money management. The most important insight I gained from Bill was the willingness to continually evolve in how I think about the world. That I shouldn't become stranded on a desert island of absolutes believing that I have learned everything there is to be learned.

Importantly, Bill was the very first investor to evolve through all three stages of value investing. From the low accounting factor approach recommended by Benjamin Graham, to buying better businesses articulated by Buffett and Munger, to becoming one of the the first value investors to solve the puzzle of how to value technology companies.

Had Bill Miller not evolved in his thinking he would have never beaten the market for 15 years in a row and become the legendary investor that he is today.

How should one best adopt a similar mindset of continuous development?

Read, Read, Read. You cannot evolve and move forward if you cease to learn. Don't be naïve to think you know everything – or worse, that you now know everything there is to learn about the future. Be pragmatic in your approach. Observe what is working, try to figure out why it is working, and then try to determine if it is sustainable. Lastly, try to value it.

Bill Miller famously combined value and growth investing. How did his approach challenge or align with the philosophies you wrote about in The Warren Buffett Way?

Warren Buffett said all intelligent investing is value investing. In Berkshire's 1992 Annual Report, he articulated, for the first time, that value investing had nothing to do with low price-to-earnings ratios, low price-to-book value, or high dividend yields but had everything to do with the discounted present value of companies' future cash flows. Whether the company was a slow growth “value” stock or a rapidly growing “growth” stock it could be a value investment.

When Bill read this, it helped him to pivot from exclusively owning low accounting factor stocks to purchasing stocks with higher cash flows and higher returns on capital which ultimately led to better stock returns. When I joined Legg Mason Capital Management, my portfolio invested in growth stocks valued by the discounted cash flow model outlined in my book. Bill's Value Trust owned a combination of both classic value stocks that were undervalued along with growth stocks that were also undervalued.

It is important to note that Bill had already reached the conclusion that both “value” stocks and “growth” stocks could be undervalued many years prior to me writing The Warren Buffett Way.

You've mentioned reading a surprising amount of philosophy during your time with Bill Miller. Could you elaborate on how philosophical frameworks shaped your understanding of value investing?

I would say that my experience working with Bill Miller led me, with his help, to study the deep well of intellectual thought that is philosophy. Particularly the works of William James and the philosophy of Pragmatism along with Ludwig Wittgenstein and his philosophy of language.

James' philosophy of Pragmatism is aligned with Darwin's evolutionary theory which is central to understanding markets. Whereas Wittgenstein's thoughts on language, that words you choose give meaning that form a description that then provide an explanation, helps one to understand variant perceptions in markets. It is hard to imagine how one can successfully navigate markets without this understanding.

Can you give an example of how these philosophical ideas helped you see value in companies others overlooked?

Classic value investors have a tendency to be stubborn and absolute in their definition of value. Relying on outdated low accounting factors to greenlight whether something is of value. At the same time, turning up their nose at high-multiple stocks that are outperforming the market.

By recent example, classic value investors have continued to claim that the Magnificent 7 were and are overvalued – that they were and are in a bubble ready to burst. A pragmatist would look at the Magnificent 7 to try to determine why these stocks were going up in price substantially higher than the rest of the market.

One had to only look at the earnings per share growth over the last five years to clearly see that, on average, these stock prices (ex-Tesla) were simply tracking earnings per share growth. On top of that, these companies had far superior returns on capital which further justified higher stock prices. William James would tell you to examine what is working and why. Figure out the “cash value of the idea.”

By the way, Amazon has been a high multiple stock for 25 years and it became a $2.4 trillion business. Over that time period, the stock price of Amazon compounded at a 27% average annual return versus the S&P 500 Index which compounded at a 9% average annual return. I guess you could say that despite almost every classic value investor telling you Amazon was overvalued, it turned out to be an amazing value stock.

Both Charlie Munger and Bill Miller have emphasized a latticework approach to investing and life, one that is based on a working knowledge of a variety of disciplines. How has this concept evolved in your thinking, and are there any new disciplines you now find essential?

In Investing: The Last Liberal Art, we argued there was much to learn from reading fiction, particularly mysteries written by Edgar Alan Poe, Sir Arthur Conan Doyle, and G.K. Chesterton. I continue to believe there is much more about investing that can be learned from reading literature including the works of Jorge Luis Borges, Henry James, and Shakespeare to count just a few from a much longer list.

Reading great works of literature imposes on the reader experiential learning that is long-lasting. It's different and has a different impact than reading non-fiction.

In The Structure of Scientific Revolutions, Thomas Kuhn describes paradigm shifts as moments when anomalies challenge the prevailing framework, leading to a fundamental change in understanding. You've suggested that investing may require a similar shift – from viewing markets through a static, physics-based lens to a dynamic, more biology-inspired perspective. How can this shift influence modern strategies?

There are still investors who continue to view markets within the dominant mean-reversion paradigm articulated by Isaac Newton. Others believe the better description of markets is biological, as described by Darwin. I think short-term markets can be navigated through the lens of physics while for long-term investors biology is the better metaphor.

What I find troubling is that long-term investors are constantly being held accountable to the laws of physics while not given much credit for their appreciation of the value-creating and destruction that occurs in evolutionary markets.

Can you elaborate on how a biology-inspired approach helps identify value creation or destruction in markets over the long term?

One can read Joseph Schumpeter, the Austrian-American economist, made famous with his work on “creative destruction,” introduced in his book Capitalism, Socialism and Democracy (1942) to understand that markets are a dynamic process where new entrants (innovators) disrupt existing industries driving new ideas while destroying old ideas. Combining Schumpeter with Charles Darwin will give investors the insights necessary to appreciate that markets will constantly change.

What qualities in a business do you find most predictive of long-term value creation?

High returns on invested capital.

Reflecting on your career, what has been your biggest investment mistake, and what did it teach you?

Owning a company that's value was ultimately determined by a government decision. Betting on committee outcomes is tricky.

What do you think are the most common mistakes investors make, and how can they be avoided?

That which is going up in price is good and that which is going down in price is bad. It may or may not be the case. Or as Warren Buffett once said, “Polling does not replace thinking.”

What key characteristics do you look for in a company that makes it a compelling long-term investment opportunity?

First, I think the most compelling long-term investments are companies operating in the largest total addressable market (TAM) – the global market. Being a U.S. investor why would I limit my revenue opportunity to 343 million US consumers when there are nearly 8 billion consumers worldwide.

Secondly, I'm attracted to asset-light companies that don't require massive amounts of capital reinvestment just to stay in place. Typically, asset-light companies have higher returns on capital which is the primary fuel for compounding long-term value.

Lastly, I'm attracted to companies that can quickly scale to size thereby making it difficult for the second, third, or fourth company to become a meaningful competitor.

Investing requires both mental discipline and emotional resilience. What habits or practices help you stay balanced and focused?

What has helped me more than anything in my investing career is “unplugging” the financial media. I rarely watch financial news networks. If I do, I almost always have the TV on mute. I don't listen to economic or market forecasters as it is well-known that complex adaptive systems are inherently unforecastable. And I don't listen to uneducated stock pickers who tell me that a low P/E stock is attractive while a high P/E stock is unattractive.

This leaves plenty of time to read annual reports and industry journals which work to increase knowledge at the expense of just adding more useless information. In short, I work to establish boundaries that limit market noise.

For investors just starting out, what practical advice would you give for identifying high-potential, long-term investments?

First, you must decide if you are going to become a short-term trader or a long-term investor. If you have decided to become a long-term investor, re-read the answer to the previous question. If you want to become a short-term trader. Good luck. You'll need it. Only the rarefied few consistently add money, net of gains minus losses.

If you were to write a more niche book on business and investing, what would its focus points be, and why?

As a rule, I do not discuss a book I am working on not knowing if the idea will be worthy of publishing. It may or may not. I have always appreciated a much-used quote – “Writers never finish a book – they just stop writing.” I continue to write.

Finally, if you could recommend one book (besides your own!) or source of inspiration that has had a profound impact on your life, what would it be and why?

This is a tough question to answer. So many good books written by so many great writers. But if forced, I would recommend a reader purchase the Berkshire Hathaway Letters to Shareholders 1965-2023 available on Amazon's Kindle. (There is a paperback version available for the years 1965-2014). Berkshire's letters include every important investment lesson a long-term investor would need to know.

From how to think about a business, the management that runs the business, the economics of a good business, and how to value a company. There are lessons on individual companies including insurance, banking, energy, utilities, media, food, beverage, and transportation. In addition, there are accounting lessons, economic insights, psychological missteps to avoid, and the important philosophical underpinnings that are necessary to become a successful investor.

When I wrote Inside the Ultimate Money Mind, I tabulated that Warren had written 874 pages to shareholders between 1965 and 2019. Add another five years (the 2024 Annual Report will arrive in the first week of March) you will have close to a thousand pages written by the greatest investor in the world. Nothing else in the investing library compares.