Chapter 27 - Invested: Changing Forever the Way Americans Invest
Today's Chapter is based on the book “Invested: Changing Forever the Way Americans Invest”, a memoir by Charles Schwab.
Buy it on Amazon here:
https://www.amazon.com/Invested-Changing-Forever-Americans-Invest/dp/1984822543
Here’s what I have learned:
Economies of Scale
“Zak and I observe several business models that work in the long run, and scale economics shared is one of these... that is why companies that share scale with the customer make up around sixty percent of the portfolio.”
— Nick Sleep
As we have learned with the story of Sam Walton, scale economics shared is one of the best business model out there. The reason is simple: companies who can reduce their operational costs and who can share these reduced prices with their customers will make it much harder for their competitors to offer as much value to their customers. This is the successful recipe for a lot of well-known businesses that we know today such as Amazon, The Home Depot and Wal-Mart.
Charles Schwab started his company with this in mind: he wanted to build a business that would keep operational costs low to allow their customers, who were individual investors to purchase stocks at a low commission rate. But more importantly, it wasn’t about being the cheapest discount broker, it was about providing his customers the most value.
“So how did we eventually do it? How did we make it possible to trade for zero commission? Ultimately, we got there through a relentless focus on keeping operational costs low. Today, our operating expense per client dollar is about half that of our publicly traded brokerage competitors. We "pinch pennies" so we can charge our clients less.”
— Charles Schwab
“Our whole business plan revolved around keeping costs low. No lavish expense accounts, no fancy digs, no high salaries or fat commissions for our brokers. Essentially no brick and mortar beyond what we needed for operations and administration. We preferred that our customers call, not visit.”
— Charles Schwab
It is fair to say that Charles Schwab revolutionized the industry with this business model. Back in the days, most brokerage firms’ interests were misaligned with the customers as their brokers were paid via commissions. He changed the ways Wall Street help individual investors by changing the way brokers were paid (salary + bonus rather than by commissions). And unlike many other brokerage firms’ office, the company’s main office didn’t look like a fancy office but more like a discount store.
“The more the client made and the happier they were with the service they got, the more our employees made, period. We paid a salary and a bonus for client satisfaction—that was it. We didn't pressure anybody to make trades. We didn't recommend a stock or mutual fund just to make a sale. We didn't seduce our clients with questionable claims. We didn't tell stories.”
— Charles Schwab
“The moment you entered our office, you knew you were in a discount store. I was chef, server, busboy, and chief bottle washer, working behind the counter, stuffing envelopes, licking stamps. When things got busy, it was all hands on deck.”
— Charles Schwab
Furthermore, Schwab was adamant in adopting new technology in his company. He quickly realized that if he wanted to achieve his goal of reaching zero commissions, he had to find ways to reduce operational costs and technology was one way of doing it. As such, he was always ready to invest in technology if it had a chance to increase efficiency and to reduce costs in the long run.
“People often ask why Schwab got into technology so early and in such a big way to make it a defining part of who we are and how we operate to this day. In some ways, necessity is the mother of invention. We had to get more efficient or we were dead in the water. When I first started Schwab and slashed commissions by 75%, I had just a vague idea that I could make it work. I knew it would take volume. It was also a factor of where we were. San Francisco and neighbouring Silicon Valley were all about technology. I was surrounded by people who thought adopting technology was as natural as childbirth. It was the air we breathed.”
— Charles Schwab
Growth, Growth, Growth
“Earnings follow growth, and stock prices follow earnings.”
— Charles Schwab
Just like many that we have studied in the past, Charles Schwab was an absolute biography nut. As a matter of fact, he read a lot of biographies of people who had accomplished great things such as John D. Rockefeller and JP Morgan. He learned various lessons from these readings that inspired him into establishing a growth company.
“I saw the importance of determination, of passion and fighting hard for what you believed in, and the importance of optimism and believing good things are possible. All the people I read about had a maniacal focus on growth, how step-by-step you could take an idea and expand it, reinvest in it, make it better, bigger. That had great appeal to me and it sparked my interest in business and finance.”
— Charles Schwab
As a matter of fact, as mentioned previously, The Charles Schwab Corporation shared the benefits created by operational cost-cutting directly to its customers, and as such, the company’s profit margins were not the highest in the industry. However, it made up for it through high volume and growth. The company’s philosophy was that growth was a win-win situation for all parties. As Charles Schwab once said: “clients get better service; investors get a better return; employees get jobs and rising pay; the community gets support; and, of course, the government gets taxes. As far as I'm concerned, growth is the key to creating wealth.”
“A focus on growth doesn't mean being the most profitable company in your industry. I didn't want to be the most profitable. I wanted to be the one that was always thinking about growth and how we could find the resources to be innovative. I always believed that profits were something that come naturally at the end of the line, if you got the first part right finding new ways to help the customer succeed.”
— Charles Schwab
Furthermore, Schwab believed that growth and opportunities are two sides of the same coin. In fact, by seeking growth, a company is able to grab new opportunities. As we have learned previously, consistent innovation is required for a company to continue to grow at a fast rate. As such, by being a growth company, The Charles Schwab Corporation had the objective of consistently improving their services. This is eerily similar to Jeff Bezos’ mentality at Amazon, who once said that “Invention is in our DNA and technology is the fundamental tool we wield to evolve and improve every aspect of the experience we provide our customers.”
“If you're a growth company like Schwab was, and your objective is to be the best at what you do, you've got to be looking further out. Anticipating what's around the corner.”
— Charles Schwab
“ If you're not always thinking about the next opportunity, the next great thing, your growth will stall, or worse, you'll be a sitting duck and someone will jump ahead of you with a better idea.”
— Charles Schwab
“Schwab has always been a growth company. It's what enables us to invest back in the client with new products and services that make their investing experience better and what makes them recommend us to their family or friends, adding further fuel to our growth.”
— Charles Schwab
Finally, it is fair to say that, as a growth company, The Charles Schwab Corporation is a great success story in terms of providing fantastic investment returns to its shareholders. Ever since going public back in 1987, the stock has grown at a 19% average annual growth rate which is twice the growth rate of the S&P 500 (as of the date the book was written). This means that $1 invested in the company would have compounded to $210, a 21,000% return in the span of 31 years.
The company is a great example of how internal business growth is crucial factor in providing great shareholder return. As a matter of fact, Christopher Mayer, author of the book “100 Baggers: Stocks That Return 100-to-1 and How To Find Them”, explains the concept of the twin engines of companies who have returned over 100x and how growth is one of them:
“In the book, I talk about the twin engines of 100-baggers. One engine is to have underlying earnings (or cash flow or book value or whatever the relevant metric is for the business) grow at a high rate for a long time. The second engine is to get that valuation lift.
The ideal candidate would have both of these twin engines working for you. But we live in a world that is less than ideal. And so if you get a great business that can compound for a very long time at a high rate, I wouldn’t chafe too much at paying up a bit.”
— Chris Mayer
Focus on the Customer
“There is only one boss: the customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else.”
— Sam Walton
As we have learned by studying Steve Jobs, the best products are usually made when they are created with the customers in mind. Steve Jobs built Apple with the principle of building products that they would want to use themselves. The reason why he and Steve Wozniak created the first Mac was because they couldn’t afford buying a personal computer on their own.
“You know, one of the reasons we started doing this [was] we could see that we were getting better and better at iPods, and we could see that there was an opportunity to maybe do the next thing—and what should it be? And it wasn’t driven by a bunch of market research or financial spreadsheets about how big certain markets were. It wasn’t driven by that at all. It was driven by the fact that we all hated our phones. We talked to all of our friends and all the people we knew, and they all hated their phones. And we thought, “This is a really important device, and everybody hates it. They don’t know how to use even 10 percent of the features that are on these phones!”” — Steve Jobs
Similarly, Charles Schwab created his company because he was an independent investor himself and he was frustrated with the way things worked on Wall Street. As mentioned above, the existing brokerage firms’ interests were not aligned with the customers due to the way their employees were compensated and Charles Schwab wanted to change that. As such, he decided to create his own firm, one that would be customer-focused.
“New ideas, better ways to serve, trust, growth, financial success, an attractive brand, an enduring positive reputation. All can follow from devotion to that basic client-focused proposition. Build it as if you’re building it for yourself and would recommend it to your mother.”
— Charles Schwab
By consequence, he was relentless in seeking better ways to improve services to his customers. As a matter of fact, he never paid attention to what his competitors were doing; he was always focused on coming up with new products and services that would satisfy investors before anyone else did it. This is eerily similar to the way Jeff Bezos’ built Amazon into the most customer-centric company in the world. As a matter of fact, Bezos would constantly remind his employees to be afraid not of their competitors but of their customers who will always be dissatisfied.
“I constantly remind our employees to be afraid, to wake up every morning terrified. Not of our competition, but of our customers. Our customers have made our business what it is, they are the ones with whom we have a relationship, and they are the ones to whom we owe a great obligation. And we consider them to be loyal to us—right up until the second that someone else offers them a better service.”
— Jeff Bezos
Furthermore, Schwab realized that the secret recipe to the success of his company would come from one very simple and basic belief: he had to make key decisions based on his customers’ needs and goals. He would often ask himself, “What would they think; what would make their lives better, easier, more productive’ what would they believe is the right thing to do?”
However, more importantly, he understood that this would only work if he had solid firsthand knowledge. He had to be actively spending time in the company branches talking to customers and watching what they were doing, trying to understand what they were thinking. As a matter of fact, considering that customers’ needs and habits are always changing, it is important for the company to come up with new innovative products and services and sometimes, that comes from trying to build something that you yourself would love to have.
“Steve Jobs famously said customers don't know what they want; you have to show it to them. Any entrepreneur who is out there coming up with new ideas will say something similar. Innovation springs from that internal voice saying this is a great idea, the next big thing. People will love it. Market research and testing can play a role, but they're no substitute for good gut instincts and simply building something you yourself would love to have.”
— Charles Schwab
This idea of visiting stores to better understand customers’ need is definitely not unique to Charles Schwab. In fact, this reminds me of the way Bernie Marcus and Arthur Blank would often visit their own stores alone to walk around and to ask questions to customers and staff members. All of this were with the same goal of understanding what were the customers’ need and how they could cater to it with their “whatever it takes” approach to customer services.
“Arthur and I go into stores alone and walk around, talking to customers and associates on the sales floor, learning what’s really important to the Home Depot. I love being there, because that’s where the real action is, not in my office.”
— Bernie Marcus
Taking Risks
“Luck is almost never only luck, especially in anything having to do with the stock market or in building a business.”
— Charles Schwab
Charles Schwab is a true believer that anyone can start their own business and succeed. However, it is mandatory that you put your energy where you can succeed. And that can be figured out by asking yourself a few questions: “What are you good at, what do you love doing, what can you talk about without even thinking about it and without tiring of it?”
As a matter of fact, straight from the start of his young career, Charles Schwab knew he wanted to start his own business in the finance industry, but he had yet to find out the right opportunity to do so, until he found the discounted brokerage business model. As such, he truly believes that recognizing a business opportunity and acting on it is one of the most, if not the most, important thing to become a successful entrepreneur.
“But recognizing a business opportunity is only one part of succeeding as an entrepreneur. The key is acting on your business insight and following through. How many times have you slapped yourself on the forehead and asked, "Why didn't I think of that?" Successful entrepreneurs are idea people, to be sure, but more than that they are men and women who feel compelled to act. Otherwise, it's all talk.”
— Charles Schwab
Although it is easy to misinterpret these opportunistic moments as luck, Schwab believes that it takes a lot more than that. He once said that “Insight, reasonable expectations, and experience all contribute and turn luck into opportunity. And most important, being prepared to take advantage of luck when it comes your way; making your own luck whenever you can.” This is eerily similar to how Napoleon sees luck:
“A consecutive series of great actions never is the result of chance and luck; it always is the product of planning and genius. Great men are rarely known to fail in their most perilous enterprises. . . . Is it because they are lucky that they become great? No, but being great, they have been able to master luck.”
— Napoleon
As a matter of fact, Schwab believes that taking and managing risk is an essential factor of any successful business. As an entrepreneur, you need to have the appetite for risk or else, you will not innovate sufficiently to satisfy the needs of your customers. As James Dyson once said, “we are never satisfied with a product, and are always trying to improve it.” And, as such, Charles Schwab never believed in waiting around for perfection before releasing new products. This is eerily similar to Jeff Bezos’ mentality that all decisions should be made with 70% of the date you wish you had. Bezos once said, “If you’re good at course correcting, being wrong may be less costly than you think, whereas being slow is going to be expensive for sure.”
“Better to go to market too early with the best we could come up with than too late with the best we could possibly do. Something like 85% ready is usually enough for me. Then you fine-tune as you go along.”
— Charles Schwab
Beyond the Book
Read “Improving Your Luck” by Farnam Street
Read “The Anatomy of a 100-Bagger” by Chris Mayer
Listen to “ Charlie Munger: 'Opportunity comes to the prepared mind'” on YouTube