We dig into the mania behind the Reddit mob fighting against Wall Street short-sellers and compare it to other bubbles and manias. In particular, we see a close connection with the dot-com bubble and real estate crash of 2007.

—

Watch the episode here

Listen to the podcast here

“This Time It’s different!” | Making Sense Of The GameStop Stock Market Madness

Let’s start with this. Let’s talk about what’s different. I had CNBC on in my study working from home after COVID from March of 2020 through December. I finally got tired of it. Every day when the market was green and it was up, I felt great. When the market was red, I felt terrible. I wanted to kick my kid so I was like, “Enough.” January rolls around and I clicked the TV off. This happens a couple of times a decade. Ian and I text each other like, “Are you seeing this?” Most of the time, one of us misses it. In this instance, Ian is like, “Have you seen this thing with GameStop, Robinhood?” I’m like, “No.” Ian calls me a few fun names and then he’s like, “You’ve got to dig into this.” I started digging into it. Ian, why don’t you start us off with what’s happening?

I picked up on this on a Wall Street Journal story before it hit mania level. That’s how a lot of these things happen. It starts off a little bit obscurely. Maybe people are picking up on it and some blog is noticing it. It started with Reddit, then a blog. Someone notices the Option’s Action and Jim Cramer tweets about it. All of a sudden, more people on CNBC Watchers and that’s still fringe, but then it somehow makes its way to ABC and NBC. My wife has asked me about it.

In essence, what’s happened is there’s a Reddit page that it was started in 2014 and the founder of this specific Reddit page lives in Mexico City. He’s not even a part of this Reddit page, but it was created for people that wanted to take more risks that didn’t want to hear the standard advice that you would get from a big broker at Merrill Lynch or Morgan Stanley. They wanted to take more risks. They wanted to do a little bit more. They knew what they were getting into and the different risks. They traded with different options. They would go after companies that were heavily shorted. This is going to be all over the papers. This is going to be the next thing that regulators are all over, should you be able to short a stock? Shorting is you borrow funds. You don’t even own it and you sell it short. Meaning you bet that a company, let’s say if its stock price is 30, is going to tank.

Let me help a little bit here. You understand the stock market better than I do. For those of you that are reading who don’t understand the stock market as well as Ian or me, when you do a short, is it an option or is it a regular stock purchase?

It’s an option because you don’t own the stock. That’s the crazy part about it. You’re just betting against it.

The speculative piece comes into the fact that you need to get qualified as a normal human being to buy options. I haven’t qualified to buy options. I’d never done it. Ian does this. My brother does it. A lot of my friends do it. I don’t feel comfortable so I stay away from it. It’s not simply buying a share of stock. It’s an option. Some companies like NVR don’t even sell options or allow them to be traded because it’s so speculative. In this instance, it’s not the actual piece of stock. It’s the option.

The most basic piece of this is investors are betting against the company. I’ve never gotten into the short game because it’s hard. It would be like if you were betting on a football game and you bet on a series versus the whole game. I have a better chance of knowing which team will win, but at any given series, anything could happen. It’s very volatile. The people that are doing it usually have an inside track. Shorting, if you’ve seen the movie Wall Street is what Gordon Gekko does.

He bets against the company, and then he goes out and makes a big smear campaign to make it even worse. These Wall Street firms bet against it. They bet billions of dollars that a company like GameStop would crash, and then they try to put out information to accelerate that. They put rumors out that they’re going bankrupt. They have the media in their pocket a little bit. It’s important to talk about what GameStop is. For people that don’t know what GameStop is.

I had heard of it, but I didn’t know what it was a few days ago.

GameStop is like a Best Buy for video games. It’s a Circuit City for video games. It is brick and mortar shops that sell video games. It’s going the way of Blockbuster. Your son is not a gamer yet. I can’t wait until he is. By the time he’s six, he’ll be beating you in Madden football. He’s only two. It happens very fast. One day IJ can’t play video games. The next, he’s kicking my ass. That’s the way it works. I play a lot of video games with IJ. We love GameStop. We love to go there. It’s like Barnes & Noble where you peruse books, but we peruse video games. The people that work there know a lot about it. They’re gamers. They’re nerds.

They tell you about all the games and we’d like to chat it up. The other cool thing about GameStop is you can bring your old games like if I have an old Madden version, they’ll give me $15, $20 for it and apply it to the next purchase. We’ll often go in there with 4 or 5 old games and it buys you a couple of new ones. That’s important to say first. If you can envision that model, it’s going out of business because you don’t buy discs anymore for games. All the new video game systems, there’s nothing to put into it. You download it digitally and you don’t have an actual disc anymore.

As the outsider on this and someone who doesn’t go there, let me qualify this for people. When you go to Amazon, everyone loves Amazon, but it’s not like going to your corner market to get a cup of coffee or buy a book. You build relationships with those people and you feel a draw to those people. The corner store has a draw and it does not have as good of a business. A lot of times, they go out of business. What’s happening here is the people who are into GameStop like it. They have a draw. They’re loyal to it. They don’t want to see it attacked and flayed by the 21st century equivalent of Gordon Gekko. They know it’s going to happen. It’s very rare that someone gets a chance to take a big swing at the Gordon Gekko equivalent of now. These are loyalists who believe in it but know it’s going the way the dinosaur. They have a lot of passion.

They don’t want to see it go away quite yet. They’re not ready for it to go away. It’s changed. The internet doesn’t play sides. It will wipe you out if you can’t be as fast and efficient. That’s why Amazon won and bookstores didn’t.

The rent is way cheaper on Amazon than it is at GameStop. That’s why you’ll lose.

GameStop hasn’t made money in a while. There are no earnings. If you look to a price to earnings ratio, there’s no PE ratio because there’s no earnings.

You know more about this stock than me. It speaks to its leap in price from $4.

It was at $4 for a reason. I’ve long felt that GameStop was going out. The reason why I feel that way is like anything, when you invest in something, a lot of times, it’s good to invest in something that you use. The time that I bought at Amazon is when I downloaded it on my phone and found I loved it and started buying a lot. I should have bought it right then. I would have made a hell of a lot more money than buying it later in the cycle like I did. With GameStop, I’ve been talking to Danny Joyce about this for a couple of years. I’m like, “I don’t go there too much anymore with IJ. We just download it through Wi-Fi. We buy all of our games from the Xbox store in a download. I can’t imagine GameStop lives. That’s the story of it. All these folks on Reddit, which is a chat room for the most part. They all got themselves hyped up and let’s go after all these bastards that are shorting our favorite company or this stock. They want to stick it to someone.

Ian has used a bunch of terms here that it’s important to talk about. He’s used nerds and geeks. These are loyalists who rarely have a chance. With the technology change, it’s both things pulling against themselves at the same time. You’ve got a brick and mortar that is most likely going to go extinct, but because of technology with things like the platform we’re going to talk about that let you buy $100 worth of stock and cut a broker out. These people who feel like they have been the victim many times are rallying around something they are passionate about.

 

For the record, I’m one of these nerds and these gamer geeks. IJ and I play video games all the time. I’m crazy about video games. I understand why there’s outrage at someone shorting a company because you are betting on all those people to lose their jobs and all those companies to go away. You’re trying to accelerate it. To me, I don’t know that there’s a lot of value in our society for the concept in general. You’re going to hear from Congress a lot about should we even be allowed to short a company and accelerate its demise.

This is what happens a lot of times. Things go from the fringe to mainstream. In getting ready for this, I read articles in The Journal and The New York Times, the normal stuff that pops up in your feed. People like Elon Musk and the senator or congressman from New York, she’s in there too. This is going to become a rail item. This is going to dominate network news in the foreseeable future.

Elizabeth Warren, AOC, they’re all talking about it now. Both sides, Republicans and Democrats seem to be siding with the little guy, which is smart politics. All of these people got together and they agreed, which is fascinating that they all have been disciplined enough to do it. We’re going to buy this stock. We’re all going to buy it. There’s another company called Robinhood that’s in the middle of this. Robinhood is a tech company. They are an app and they make it easy to buy and sell stocks. They make it cheap. They make it easy to get in. You can even buy fractions of stocks. Someone who only has $100 to invest could buy 2 or 3 shares of GameStop at $40. Normally stocks move because a mutual fund goes and buys $100 million worth of shares and it moves up.

This is crowdfunding. From a micro perspective, lots of people are buying $100,000 and they bought enough to rip the stock price up. It’s costing the Wall Street firms billions. Several Wall Street firms have had to get injections. One of them needed a $2.5 billion injection of capital because they almost went bankrupt over a two-week period. What happened is all of these people getting in on this. The stock went from $4 to $40, to $80, to $180, to $280, and it hit $500 at one point. It’s 100x for a company with no earnings that’s about to go bankrupt. Nothing’s changed in GameStop’s business model except for the fact that people felt like doing this. It’s become a bit of a mania.

This is the high-tech stuff we do here on the show. That’s the stock chart.

The stock chart is definitely a hockey stick straight up. It got to a place where the Robinhood CEO was on CNBC. He all but admitted they have a liquidity problem. They had to shut down anyone buying any new GameStop and this threw everyone in outrage because it’s rigging the game. It would be like moving the field goal posts in the fourth quarter wider for someone else to win. It’s that kind of outrage. Once I’ve gotten into a stock, I should be able to buy and sell appropriately. They shut off a whole side of it and the stock dropped 40%. This got everyone outraged. Elon Musk tweeted about it. Portnoy went on a three-minute rant that went viral. All these big-name billionaires are getting in the mix and saying, “This is bogus.”

For me, it’s a fascinating theater to watch the mania taking place, but there’s outrage on all sides. Wall Street’s outraged that a bunch of people could get together and manipulate a market. If you’re a trader or a private equity firm or a hedge fund, their argument is there are laws against pumping and dumping, pump and dump law. That’s when someone goes in hypes and outright lies to try to get a group of people to buy something that’s not there.

The argument on Robinhood is, “We know exactly what we’re doing. We like the company. We’re buying it. We’re buying as many shares as we can.” What’s wild is normally when these kinds of things happen, you’re like, “People are going to get hurt,” because they are. It’s going to go to zero. A lot of these people are buying $100, $200, $500. Their comments on Reddit are like, “Go to zero. I don’t care. It feels good to be part of this movement.” It’s like a silent protest.

The little man is getting a shot at the big guy. They’re doing it from their mom’s basement because in many instances, that’s where gamers are at. It’s like their way to participate. It’s storming the gates.

I made $500 on DoorDash. I’m going to put it all into this movement and I’m going to buy it. I know it could go to Zero, but I’m going to be able to say I was there when we bankrupted a hedge fund.

It’s like making a charitable donation. Who cares? I don’t get the tax right off for it, but it feels fun.

There is also a constituent that doesn’t understand the market. It doesn’t understand that when something goes from $40 to $400. It’s the reason why Las Vegas shows you how many reds hit in a row on roulette because they want you to go bet red. They want that to draw attention to the table. If I see there are seven reds in a row, I’m thinking maybe the tables tilted a little bit. It brings people to the table to bet more. They don’t know whether it’s going to be red or black, but it draws attention. Now, GameStop has drawn enough attention where people see $4 to $400. What’s happened is all these kids are posting pictures from their accounts like $100 went to $7,600 cashed. People see that and they think I want in on that. They’re buying the stock at $400 thinking it’s going to $4,000. That’s the way this works.

I want to interject something here and we can file this away in the category of half-ass internet research. This is a line that I highlighted. The schemes organizer whose Reddit username is unprintable in a family paper, we can say it here if it was written in this paper but they can’t say it, claims he has turned an initial investment of $50,000 into a windfall of more than $40 million.

All these stories are coming out. There’s a contingent that are defiant and don’t care. There’s a contingent that legitimately think they’re going to go double, triple, quadruple their money at this point. They’re getting in so late that Robinhood became the number one downloaded in App Store. This one is so viral on Apple and there had never been anything close to that. It overwhelmed Robinhood. They had to shut it down. Now people are saying, Robinhood are a bunch of scammers and they did this because they felt pressure from Wall Street. Listening to the CEO of Robinhood on CNBC, his voice was cracking. He’s in way over his head. It has nothing to do with him feeling pressure from some billionaire. They have a liquidity crisis. They got overwhelmed. They are over their heads and they didn’t know what else to do. Now they have allowed them to go back to trading so the stock is back.

Here’s what I want to do now. We’ve talked enough about this particular episode. I want to draw a parallel and I want to go into something a little bit different because I feel like we’ve gotten the subject matter out there. The Robinhood CEO being on CNBC to me is one of the first chinks in the armor. His voice is cracking. I saw the interviewee. He doesn’t live in a college dorm room. He’s a CEO and he lives in something that’s equivalent to maybe one step above it. It’s like the turtle that’s on the fence post. It’s like, “How the hell did I get here?” There’s that side of it. Let’s get back into when we were younger kids. We were the one storming the castle and feeling like we were being left out. Ian was 23 and I’m 24. It’s 1999. The tech boom is happening. We both missed it. Ian, why don’t you start that story and talk about the tech boom.

One of my best friends growing up, I grew up in a small town in Michigan. None of us had any money. He graduated with an engineering degree. He got the job that we all thought you should get if you went to college growing up in Michigan. He got a corporate job at Ford. That couldn’t be any better. If you told any of us before we went to college, you could get a corporate job at Ford, GM or Chrysler. We’d say, “We nailed it. We did exactly what are expected of us growing up.”

It’s like landing a job at Amazon or Google now.

The internet doesn't play sides. It just will wipe you out if you can't be as fast and efficient. Click To Tweet

On Michigan, you did it. You’ve arrived the job. He gets a great job. Nine months later, he lets me know that he quit Ford. Immediately in my head, I’m thinking, he must have got a job at GM, the myopic thinking of a Michigander growing up. He’s like, “I’m done working. I’m a day trader now.” I’m like, “What?” I didn’t even know what day trader meant. I started questioning him. It’s absurd. Everything he had, he pulled everything together like $10,000, have rolled it up to over $1 million. He was buying penny stocks. Penny stocks, they trade on what’s called the pink sheets. They are loosely regulated, but not as regulated as an S&P 500 or Dow Jones, any of the other indexes. There’s not much information. The requirements for a pink sheet stock are loose. The quarterly press releases they put together, the finances that you can find are very hard and opaque to try to get your arms around. I thought this is bullcrap.

Let me say this about penny stocks too, they’re harder to buy. It’s not like you can go to the same trading houses to buy. Nowadays, it’s easier than it was back then. Back then, it was hard to buy penny stocks because the internet wasn’t what it is now. It’s just penny stockbrokers.

It was before he got rich, but here’s what changed. All those day traders started being able to buy all that stuff on the online platforms.

Right there in the late ‘90s.

It got a little riskier, more dangerous. It’s similar to this Reddit thing and Robinhood. I wanted to get in. I remember my emotions. I was broke. I remember he went on a trip to Vegas with a bunch of his other trader bros. He was like, “I got your flight, Mathews. I got you. I’ll put you up in my hotel room and pay for your flight.” He’d flip me a couple of $100 chips to play with. I was broke. Part of me resented it, but the other part of me was like, “I’m not below a Vegas trip for free.”

I remember emotionally being like, “How did he get ahead of me so fast?” It was the frustration with myself that I missed it. I missed something. I’m like, “Mentor me, show me how to do what you’ve done.” I got into a bunch of these stocks, but I got in late. I got in once everyone else was talking about it. There were chat rooms you’d go on. There was this chat room called Raging Bull. You’d get in there. People will be talking about these stocks I bought. One was this Vegas casino that was coming. They’d be like, “Big news coming out on Thursday, big news.” I’d texted a few other friends, “Big news on Playstar.”

A note to yourself, if you’re getting all your best information from a site called Raging Bull, you are 1 or 2 degrees from a boiler room.

I’m a relatively intelligent guy on most rational decisions I make. I became completely irrational. I lost everything and so did he. Within twelve months, he was back in another corporate job. It all happened in about a six-month period.

What I want to get to is the word irrational. That’s what happens. It’s irrational. Irrational is in the realm of emotion. When things are in the realm of emotion, what happens is you get wrapped up in it. Ian got wrapped up in this. I remember thinking like, “Why am I not participating in this? Why am I missing it? I’m doing something fundamentally wrong. I should be participating in this.” If you remember at the time that this is crazy. This is when Pets.com had paid for one of the most premier Super Bowl ads. They were out of business within 24 months of paying all this money for a Super Bowl ad. There was a ridiculous commercial about someone. It wasn’t even a text. It was an email. The commercial was a bunch of letters. Someone was looking at it, thinking, they were sitting at their desk, and they’re going to buy these stocks. The commercial was, you’re showing the picture of a keyboard with a ladies’ fat ass hitting the keyboard. It was sending emails out and these people were buying in euphoria. That was the pandemonium that was happening at that time.

It’s the fear of missing out. There was a big feeling I had of, “This is unfair.” I’m working sixteen-hour days at GE and I’m making $50,000 because I was just out of college and I’m like, “This is bullcrap.” He’s screwing around sending me pictures from the golf course, making money, and I have nothing in my account. I remember that it was this unfairness of, “I want my share of that.”

We’re going to leave this person’s name out, but Ian and I have talked about this. I’ve never met this person, but I know stories. There’s a story that Ian told me years ago. As I’m starting to learn Ian’s friend base, I’m like, ”Isn’t that the same guy?” This is my recollection of the story. Ian, you can correct it, but they’re in college. He decides not to go to class for the entire semester. He also decides not to shave or cut his hair. Back then, you can show up in class. There were two times where they gave the final. He went to the morning class and sat there and stole the final exam, turned into Scantron and left. He immediately went to the barber and got his haircut, his beard shaved. He goes back to his dorm room, spends the whole day answering the tests. He had all the answers, shows up in the evening, takes the tests, turns into Scantron and aces the test. Is that pretty close?

He’s the smartest guy I’ve known. He’s a brilliant guy. He always was trying to outsmart the system. That’s the same guy, 100%. I saw him a month before finals. I went up to his college party one weekend and all of his textbooks still had plastic on them. All of them were lying on the floor. That’s the lengths he would go to beat the system. Rather than using his brains to show up, study and grind, which is that’s more me. Go to class, get the grade, show up at work, make money, build it the old-fashioned way over time. He was always looking for, “How do I short circuit that and get fast, easy results?”

It’s not the way either of us was raised. We come to our generation and when there’s time to take the chips off the table, but I didn’t know Ian back in 1999 during the stretch of time and I’m 24. I remember coming face-to-face with an internet millionaire myself. At 24, I’m building houses. I live up in the DC Metro market on the suburbs where I could split a crappy apartment with two roommates and I would drive to work. We were building Orion Homes floor plan called an Oberlin. The Oberlin when I was 24 was a freaking castle. It was huge. It was a single guy who I met one time. I don’t remember, but it was either red or yellow sports car. He was older than me, but not by much.

I remember we did the pre-drywall inspection. I was like, “This guy is young. He’s got a nice car.” I installed the carpet and the carpet was outlandish. The flooring rep who sold him the carpet said, “You can cancel on this house, but you’re going to own this carpet.” They made him buy the carpet. They were like, “Nobody else was buying this carpet.” He’s moved into a castle. He’s young. I remember driving a crappy truck back and forth to work. I’m like, “I’m missing out.” I started to do a little bit of research on internet stocks and look at things. I never felt comfortable to do it, but I felt the emotional draw that I was missing out. It pissed me off.

While you’re grinding, you’re out there in cold weather, walking sites, getting mud all over yourself and coming home with a salary. It looks so easy, this free money and this stuff that’s happening. When I look at that whole experience now, the big question is, Gary Vee came on CNBC and the traders are mad like, “What value does Robinhood or these apps add?” He had a great point. He said, “They removed friction. That’s what the internet does. You could get over it. You get over yourselves. The internet removes friction. It gives people access to things.” It’s incredibly insulting for all these Congresspeople that are coming out and thinking that there should be rules on who can get into what stocks and things should be stopped.

If you’re 16, 18 or 20, saying you aren’t smart enough or educated enough to buy a stock is the same as telling a sixteen-year-old, “You’re not smart or educated enough to start a business. You might lose money.” How do you think I learned how to invest in stocks? I lost money and it hurt. The next time, I wasn’t so careless. I didn’t go on Raging Bull when I bought the next stock and listened to some a-hole on a chat room. I pulled the annual report and read it cover to cover and paid attention to conference calls.

We didn’t talk about this, but I wanted to go quick aside. What’s the stock story like 30 seconds or less, where you lost money? You remember it, it hurt you and you were pissed. After 9/11, I bought an airline stock. I bought American Airlines or US Air back then. I was like, “It’s going to go up,” but I didn’t realize stocks well enough. I only bought a couple of thousand bucks. They bankrupted. Every share of stock went to zero and I lost my investment. I didn’t even know that was an option. I lost a couple of grand. I’ve seen opportunities to buy airlines over the years. I’ve never done it because I don’t know it well enough. It’s the reason I’m very lightly invested in stocks because it’s not my area of expertise.

 

Here’s mine, in a year after the financial crisis started when stocks were cratering, big houses started offering what were called structured products. They were in essence bets against certain things. I bought in $10,000 to what equates to an option. It would pay a certain dividend if within six months Lehman Brothers didn’t drop 50%. Lehman Brothers had already dropped 50%. It had already gone from a $50 stock to $25. It would need to drop another 50%. That seemed obscene at the time when I bought this structured product. After the fact, I learned that companies like UBS, Merrill Lynch and Morgan Stanley were only selling structured products because they had bet on the other side and they knew more than I did.

They knew it was probably going to drop more than 50%. They could at least collect my money if that happened. I lost 100% of that. I don’t know what I put into it, $20,000, maybe $15,000. That taught me a very big lesson that if a big house like UBS or Merrill or Morgan are pushing a product like that and they know more than me, don’t buy it. They’re doing it to cover their own ass and not because they think it’s a great opportunity for me. It was garbage.

Guys like us, or at least me, I’m not smart enough to be on the front line or I see this stuff from the inside looking out, I’m always the one who’s getting the lure stuck in my mouth and getting reeled into the moat. I want to put a bow on the tech sector move into the next bubble we saw, which was housing. For me, Ian’s friend, who went from rags to riches back to rags, at least on an earning side, and the guy who had that house, the castle that I built, to me, the way that I rationalized it was, I’m a grinder. I’m not a lottery winner. That’s okay. I’m going to have a good life, but I’m not going to have that huge rise. I’m just not going to.

That’s what I wired myself with. To me, a lot of this is noise. I’m not smart enough. I’m not going to participate in it. It’s going to happen around me. There’s going to be euphoria associated with a bunch of stuff that I’m probably going to miss. I’m going to stay in my lane because I’ve seen a lot of people who are rich that are old that stayed in their lane. I’m going to do what I know. At 24, 25, 26, many years ago for me, that’s when I made these decisions subconsciously of how I was going to progress career-wise and how I was going to invest my money.

There are many comparisons on a lot of these different things. The housing bubble, you and I were right at ground zero for all of it. We were insiders on the housing bubble, which is why we didn’t get as caught up in some of the mania. The first time I felt like, “This is stupid.” When I moved from Chicago to DC, it started off great because I sold my townhouse that Jenny and I had lived in for only a year and a half. I made $100,000 on a $240,000 purchase. I was like, “Yes, this is amazing.” This was 2004. I went to buy in DC. We found a condo we liked. We put an offer on it. We lost.

We found another condo we liked, put an offer on it, we lost. By the third time we did it, they started this thing where, you probably remember this, not only did you bid, so you bid $600,000 on a townhome or a condo. You didn’t just bid $600,000. You bid $600,000 and then you had to write in an escalation clause saying, “I’m willing to go up in increments of $10,000 until $660,000.” This was to save lazy realtors the time of calling around to get prices. It’s pretty much you’d bid on a $600,000 house, but you’d say I’ll pay $60,000 over asking. The reason why that was possible is because mortgage companies didn’t care what the appraised value was. They would give you a loan no matter what and give you a 100% of the value.

It increased your payment a little bit. There were enough mortgages to make that easy. I remember thinking this is nuts. I remember telling Paxson, our realtor buddy in Indiana who will be excited about hearing his voice again on our show. I remember telling about it and it had not hit sleepy Indiana yet, that escalation clause. I remember telling him and he was like, “That’s not right. Someone’s screwing you.” I checked around enough and then he goes, “That’s going on.” That’s when I knew this doesn’t make any sense what’s happening. I still ended up buying a condo and getting crushed on it.

For me, I was in a model home before the real estate market went tits up. I was sitting in a model home and I was selling in the DC Metro market. I wasn’t on I-95, but I was on one of the commuter corridors where it’s a main thoroughfare into DC. You could drive up and down in a couple of miles and there were housing communities everywhere. I watched the prices go bananas. We raised prices overnight, $25,000, $50,000 sometimes. The builder would make more money. We could stem demand on the sale. Back then I wrote it in my day timer, but I would put in investor next to their name, and they weren’t investors, they were speculators.

They will go 8 miles up the road from where I was. Beazer wasn’t raising the prices as aggressively as us. They could buy a house from me for $500 or they could buy it for $380 or $420 at Beazer and it would take six months. What they would do is sell that house the day it was on the market, the day it was finished. They put it on the MLS and someone would buy it because the price had appreciated 10% to 50% in some instances.

For those of you that have paid attention to real estate, you’ve seen stories like this all over the place. I remember again feeling left out, but it was 3 or 4 years later from the tech bubble. I didn’t understand or have the same vocabulary I have now, but I remember thinking like, “I’m probably going to get hurt here. I could make some money, but I don’t feel comfortable doing it.” I never acted. I never participated in that. I was fortunate. I owned my own home. It appreciated a ton. I did that a couple of times and I was able to cash out. That was my participation. Maybe because we were insiders.

At the time, I was an executive for the mortgage company within that same home builder. I was never interested in the flip market, the buy and rent. I never wanted to buy a model. On the outside, everyone’s watching this. Guys like you and I are watching tech stock owners. We’re watching real estate flippers that are driving around in nice cars. It’s easy to get emotional and think, “Look at the stuff they have. Look at the life they have.” You think about how expensive that car might be or that house might be. You think, “They must be making so much money. They must be killing it.” All of it was a bunch of crappy debt. I was on the other side of it. I saw the people that were going for these mortgages that had terrible credit scores. They were rubbing two pennies together, getting loans from mom and dad, getting 97%, 95% loans.

This was the NINJA loans, No Income, No Asset, No Job.

They didn’t have to prove their income and that was good because their tax returns had nothing on it. They weren’t making money. It was paper houses. That’s all it was. I was able to see the other side of it and not get that jealous of these people. I thought they were idiots. I couldn’t believe what I was seeing, but they kept getting loans. You’d see over and over people that wanted the house as long as the price was going up. As soon as you guys started dropping prices, everyone went out of their contract. They were all trying to get their deposit back. They were trying to spike their mortgage to get a denial if they could. I never participated in any of the real estate mania. I could see that it was all phony because I was their side. I knew it was all fueled by crappy debt.

Before we get completely out of the real estate bubble in this story, I want to tell two stories. Ian and I both have mentors in this space. His is a gentleman named Bill. Mine is a guy named Ken. We each know the other person. Bill is in the mortgage side and they’re seeing all this craziness. Ken is my boss’ boss. He’s like, “We’re not going to sell to investors anymore.” Ian and I are getting to know each other. We’re mid to late twenties at this point. We’re having a conversation. I’m like, “Ian, we’re stemming the tide. We’re going to do this. We’re getting ahead of it.” Ian is like, “You’re full of crap,” because he had talked to Bill who’d seen this movie before. He’s like, “It’s too late.” Do you remember that conversation?

You’re not ahead of it. We had 1,000 customers in backlog that were on those subprime, nuclear bomb mortgages. I was like, “You have no idea the pain we’re about to feel.”

The other side of this is I didn’t participate in the speculation, up and down the commuter route I was talking about. What I was doing is I was 28, 29. I was living in an 8,000-square foot house. I happened to host Thanksgiving one year. I had a bunch of people over. I had no business owning that house. Almost everybody was happy and proud of me, but a few people were very jealous. I saw what was coming. I also know I’m not the guy who’s going to ride the rocket up.

I knew I was going to miss the dot-com boom. I knew I was going to miss a bunch of those things. What I realized is this house has appreciated. It’s appreciated a ton. I didn’t do anything on all that brilliant. I just got lucky and I knew it was coming. I was talking to Ian. I was an insider in the industry and I’m like, “I’m going to sell this house.” I decided to sell an 8,000-square foot house in the DC Metro market. Longer story, I ended up getting relocated and got a relocation bonus to go to a smaller city with lower real estate prices. From what I sold that other house for, I could have bought a mansion on a tunnel land. Instead what I did is I bought a little three-story townhome.

Invest in things you really understand. Click To Tweet

You could have bought that whole townhome building from what you paid.

I could have bought ten of them but I bought one because I needed the place to live. I took a bunch of cash and I put it in the bank, and I bought this little dinky townhouse. The story is awesome. Someone who was pretty jealous came up to me and they were like, “Frankie, I heard you sold that huge house and you bought a condo.” All I did was nod. I said, “Yeah.” I didn’t give him a dissatisfaction or anything. I sat there. I wasn’t as smart as Michael Burry who’s in the Big Short, who did this in huge numbers. I did it one time for me.

A couple of years later, everybody’s house got pummeled. My little house that I bought, I lost a little bit of money, but I had all that cash in the bank. Someone else in that same circle heard that comment and calls me up a couple of years later and goes, “You knew.” I said, “You’re right. I did.” He was like, “You timed that incredibly well.” That was me being prudent. That’s me not investing in this stock when Ian calls me and tells me about it because I don’t know anything about it. It was me pulling chips off the table early in a situation that it made sense to. I was able to pole vault forward from it.

The truth is Frank didn’t know. Frank had a feeling in his gut that things were frothy in there. When you talk about you knew, Bill, my mentor, knew. He was 30 years older than me. Bill had been through more recessions. He had seen it. I have an alarm now that goes off when everything is going up in value dramatically, when a chart looks like a hockey stick, get away from it. Don’t just get away from that. Start putting cash in the bank. My radar goes off when everything is doing well. Frank and I went to see Warren Buffett and Charlie Munger at the Berkshire annual meeting. There was a reporter that was crushing them on missing Amazon.

Both of us were taking furious notes when they started talking about this. The way Charlie put it is, “Jeff Bezos did something no one’s done in the history of the world. He’s a genius. He pulled off an absolute miracle and we don’t bet on miracles. We missed it. He’s amazing. We’re big fans, but we don’t know much about that business.” Warren jumped in and said, “I can’t invest in everything. I invest in things I know. I invest in things I’m an expert in. I don’t chase things once every reporter already knows about it.” I remember thinking, “That is gold for anyone,” that just because everyone else got in, once it’s public knowledge, it’s too late, you missed it.

I had the exact same takeaways as you, but I related it to something. Warren Buffett, me and my way, you look at someone like Jeff Bezos and your immediate reaction is to feel like, “I missed.” What you do is you stand back and say, “That’s a beautiful rocket ship. Look at that trail it’s leaving. Isn’t that cool or beautiful or neat?” You realized, “I don’t deserve to be on that rocket ship.” There are a lot of people who are trying to be on it. They’re going to get thrown off, but I can admire it from over here and say, “That’s cool,” but it has no bearing on me or my life. Warren Buffett owns a huge share of stock in Apple, and they own a huge share in stock in many of the biotech firms. That’s great. That’s his life. It’s not mine, but I can stand back over here just witness a genius and say, “That’s cool,” but it’s not where I’m going to put my money, effort or time.

The time to be on a rocket ship is when it’s on the ground before it launches off. That’s when you’re safely in it with a seatbelt on and you’re ready to get off. The way to do that, you have to train, you have to put in years at the academy, you have to qualify for it. You have to have multiple degrees, best in your class. That’s how you get on a rocket ship and go off. You don’t let everyone else do it and try to grab onto it later by getting in quick. It doesn’t work that way.

We always hear about the rocket ship taken off. A lot of them blow up on the pedestal or they don’t even make it to the pedestal. It doesn’t even get rolled out of the factory.

For us, if you’re getting in when everyone else knows about it, you’re late. I wasn’t sending anything to Frank and saying, “We should get into GME.” I was saying, “Watch this like you would watch Jason Voorhees walking up the steps in a scary Friday the 13th movie.” You know what’s about to happen and you can’t turn away from it. I’m watching it with morbid curiosity of what’s going to happen. I have zero interest in being in on it. For both of us, invest in things you understand. For Frank to go and buy stock options in GameStop would be a silly use of his capital, given how much he knows about real estate enrichment. The returns that he can generate with a very good margin of safety in that area. That’s what it comes down to. Invest in things you understand.

I agree with that. I’m going to get into it a little bit more, but it also comes down to a little bit understanding what it is that you want, goal setting. We’ve done an episode on goal setting. People always talk about New Year’s resolutions and goal setting. What do you want? Do you need to take a huge risk like that or can you hit a bunch of singles? It’s one of the things we talk about in our business all the time, a double, a triple or a home run is awesome. I use this analogy. I’d rather be in each row. I’d rather have 4,500 singles over the first baseman’s head and get to the hall of fame because that’s a damn good-looking business. It isn’t sexy, but in the end, you end up where you want to end up. It’s pretty great.

What I want to talk about a little bit is a few different things. NVR stock, people told me to sell it. I remember the story you told me about you had a bunch of options way more than I ever had. You saw yours to fruition and you cashed out on them. You’re right. You earned them. The quote you said to me was, “Frank, I don’t need the money right now. I don’t think there’s a better steward of my capital than our CEO.” When options come due, you can sell them, but they have an expiration period. That’s usually many years into the future. I always thought it was fascinating. You may cash some, but the lion’s share of them, you let it sit there and accrue earnings with someone who was a good steward of your capital. We both giggled about other people that ran out and bought frivolous crap and were like, “Why would they do that?”

You’re talking about your condo. When I left DC, what did I do? Did I buy a big mansion in Virginia? I had millions of dollars in stock options that I had not cashed. I went and rented in a townhouse for three years with Jenny in Vienna because we wanted to be in Vienna, but we weren’t buying a house. We didn’t run out and do it. I was going to hold that as long as I could because again, invest in things you understand. I knew that our CEO was one of the smartest dudes I’d ever met in my entire life. I was close to the sun. I trusted the way he would run the company and what he would do with that investment. It’s the same as investing in the 75-unit portfolio with you.

I know you. I trust you. It was risky, but the upside was great. I at least could control one of the variables, which is, do I know the operator? What does he know? The third thing I’ll add is you can’t always have all singles. You have to take some risks. The fact that I even owned NVR, I had to leave all my friends, my family in Chicago. I left a stable company in GE. Staying at GE would have been hitting more singles and doubles. I left because I knew it could become a rocket ship if I did a good job. It was risky though. I might have failed. I might have done that.

CodeGuard is another example. I invested in a tech stock. It was a $50,000 investment at a time where $50,000 was real money to me. It was a serious investment. I knew it could go to zero, but I also knew the CEO would rather get hit by a bus than lose my money. He was a smart guy. That ended up doing 15x what my investment was. I had distressed about it for years, but I knew I could control some variables and that was I trusted the CEO.

There are two things in here that I want to talk a little bit about. The first is if you make a good smart investment, when you decided to invest with me in the RVA 75-19 portfolio, there was certainly risk involved in that. It’s a $10 million deal. That looks like a home run or maybe a grand slam at 26. To me, it felt like 75 singles because I’ve done enough of this. When I talked to you about that, that’s what you felt like. It’s a big lift in aggregate, but it’s 75 smaller lifts that Frank does every day and his team does every day. Because of those things, it’s risky but it’s less risky.

If you’d have brought that to me in 2013 when you were starting your business, I might not have done it because it would have felt like, “That’s a big one for him to bite off.” You would have felt like a minnow biting a shark. Now it felt like a shark biting 75 minnows when I invested with you.

 

In 2013, I was presented with stuff like that. I didn’t bring it to you and I didn’t do it because I knew better. I couldn’t, I wasn’t ready. The other side of it is this, investors are getting their checks in the mail. We exceeded expectations. Not only that we exceed expectations, we exceeded timeframe. We beat expectations by a significant margin like more than 20% of what we promised. Ian and I talked through it and there was a way that we might have been able to scrape a little bit more. There was also a way that we could have lost a lot. The decision was, “Let’s send everybody checks now and let’s end this thing.” We had a way to do it. The feedback that we’ve gotten is incredibly positive because you’d never penalize yourself for taking a profit. That’s one of the things that we’re trying to say here. Take shots, be calculated, but also know when to pull some chips off the table.

As we wrap this up, Frank, look around right now, what asset class is not big over the last few years? There is no asset class that has not performed incredibly well unless you own restaurant stocks and hotel stocks. That is all a very temporary thing. It’s record-low rates, massive amounts of stimulus. We’re about to introduce a $2 trillion spending bill. We’re sending checks to people. The number of programs you mentioned to me that the government is sending money directly to people, paycheck protection, mortgage protection, and rent protection. There’s much money we flooded the market with. When these things happen, you see lots of hockey stick charts that don’t make as much sense from a fundamental perspective. Everyone’s going to argue that your thinking is different. Your thinking is old. This time it’s different. When you see things going up that fast, everyone making that much money, and it seems easy, it’s a great time to be thinking about selling.

Frank and I, when we have conversations, it is less about upside and it is more about what assets can we sell right now to start stocking cash for the next downturn. There hasn’t been one in a while and there was a short-term one in March 2020. If you didn’t get in, you’re in trouble. There was no such thing as easy money, there’s just isn’t. There’s been a lot of easy money and it ends the same way over the last 200 years. You can look at every one of them. They started when every asset class started going up. It started because of low rates, lots of stimulus, government is flooding it. Now is the time to be prudent, to be safe. You can never have too much cash when things are looking good.

Taking chips off the table and having cash, never apologize for taking a profit. There are times to be cautious and there are times to be bullish. I’m going to use this story to wrap it up. You and I are both kids. We didn’t grow up with much. We had to chase and for my entire life, I chased and I chased. Sometimes you need to realize you’ve gotten enough and it makes sense to let things marinate and pull back. That’s it. You have to know where you are in your life. You have to know when it makes sense to go forward and when it makes sense not to.

You need to be humble to say, “This is pretty good.” If you do that and history tells you that if you pause, and you might not time it to the day, but if you time it close enough with a pause, the upside is you’ll either have enough. You won’t have the stress or you might be able to redeploy again. That’s how I took my chips off the table in 2008 with housing. I got back in when things were low. That’s what we’re hoping that you take from this. Don’t get into the hockey stick. Don’t get into the hype. Get great at something and invest in it. Make sure it serves you well and allow it to do so.

To make real wealth, you have to earn it. Either that’s through hard work hours or it’s through hard work of knowledge. If you don’t have the knowledge, you haven’t done the homework. You don’t deserve to make the money. If you feel like you’re going to make it quick or short circuit it, you’re going to be disappointed way more often than not. That’s what we would leave on this. Frankie, we have hit bubbles, manias and animal spirits as hard as we could. Everybody, if you have not hit the subscribe button, we would appreciate it. We’re a fledgling startup. If you like our show, please give us a five-star review or share it with your friends. Get other people to read. We love all of you that are reading.

Most important, don’t short us, please.

We are blowing up. We are going to be the hockey stick that you were in the rocket ship when it started. That’s how you close strong, Frank.

Important Links:

• Jim Cramer – Tweet on Tweeter
• Robinhood
• GameStop
• Robinhood – Robinhood CEO Interview on CNBC
• Pets.com