to another episode of our Value investing Series.

We have a very special guest with us today.

So in thinking about introducing him,

I have to start off with a series of experiments,

a series of studies that were done

at Stanford by the professor Walter

Mischel in 1960s and '70s.

These are also most widely known as the Stanford Marshmallow

Experiment that you might have heard of.

Essentially, it was an experiment.

It was basically a bunch of studies in which children were

offered a choice between one small reward provided

immediately, or two small rewards if they waited

for a short period, which was about 15 minutes, during which

the tester would leave the room and then return.

The reward was sometimes a marshmallow, but often

a cookie or a pretzel.

In followup studies, what these researchers found

was very surprising.

These children who were able to wait longer for the preferred

rewards tended to have better life outcomes

as measured by SAT scores, educational attainment, body

mass index, and other life measures.

Now why am I mentioning this?

Our guest today is no psychology professor.

But he happens to be a Stanford alum.

And he happens to be a world famous value investor.

In speaking about his investing process and philosophy,

you will see parallels between delayed gratification.

Let me share a quote from his recent interview

with all of you.

He describes his process saying, "We

tend to benefit in life when we sacrifice something today

to gain something tomorrow.

That is true for companies.

That is true for individuals."

His focus, he says, is on businesses

that have the capacity to suffer, that is, they can

reinvest their capital at high rates of return

so that the wealth will continue to compound

into years into the future.

Thomas Russo, our guest, is a preeminent investor

of our times who began his investing journey in 1982

after an encounter that changed his life.

He was studying law and business as a graduate student

at Stanford when Warren Buffett came to address his investment

class.

As Mr. Russo explained in a recent interview,

he was dazzled by the speed of Buffett's mind,

his quirky delivery, and his beguiling

habit of courting everyone from Bertrand Russell to Yogi Berra

and the wisdom of his deeply thought ideas.

This inspired him to finding his own investment vehicle

and starting his value investing journey.

We are so glad that he's here in person

to share his experience and his journey

and his insights with all of us here.

Thank you for coming.

So without any further ado, ladies and gentlemen,

please join me in welcoming the one and only Thomas Russo.

[APPLAUSE]

THOMAS RUSSO: I'm so pleased to be here.

I actually thought the setting would

be a much different setting.

I thought we'd be underground in some catacombs with a group

of people worshipping an outlawed

faith in Silicon Valley, the faith of value investing.

But here we are, next to the free food,

the wonderfully lit room, great chairs.

So being a zealot in the investment business today

doesn't bear the marks that it did 2000 years ago

for religious zealots, I guess.

It's a great honor to be here, especially at this time.

It's a really good excuse to get away from the markets, which

is something that's welcome.

Even though I say that, we've had an unusual period of time

which reaffirms what [? Surapa ?] described

as this value investing preference for businesses that

have the capacity to suffer, because you think

about my last three years, we've certainly suffered when

compared to the S&P 500, which has been elevated by sort

of global capital flows.

And we've had businesses that, right through this,

have been investing in their strong global brands,

but showing a modest growth at the reporting level

because they often invest a portion of their net profits

against future business prospects.

Now recently, almost a third of our portfolios in beverages--

and the world is now quite reaffirmed about the value

of beverage brands through the noise about the AB InBev

acquisition of SABMiller-- we own both those shares,

and it's helped generate performance recently

in the face of a plunging market.

And then I was reminded of this again today, which

was the results of an announcement by JT Tobacco

to acquire American Spirit from Reynolds American Tobacco.

Well, quite extraordinarily, the price

was almost Silicon Valley-like.

It was 300 times operating income

for a business-- they paid $5 billion for a business

that I think had around $500 million in revenue,

much smaller base of profits because it's still

investing in its own growth.

But they saw something that they could take around the world.

And it reaffirms-- within a business like RJR,

where people often overlook the investment

because it lacks sizzle-- that the strength of the brand,

the predictability of cash flow, and the ability,

most importantly, to reinvest that cash flow going forward--

leaves it quite valuable.

I'm going to come over here so I can move some of these around.

I did, in fact, also welcome the chance

to come up because I'll talk tomorrow

to the students in Professor Jack McDonald's class, which

I've done for the past 25 years, having

graduated from his class.

And it was there that Buffettt came to our class

and provided some early insights.

I'll go through a couple of quick slides.

As an investor, you're always, at least in the value investing

world, encouraged to invest for the long term

and let market disruptions pass you by, hold on.

And I was reminded of this in June of 2008,

when I was in Africa with my family on a safari.

And every day we'd go out to visit the range

and look for animals.

Each one looks more ferocious than the next.

And every single time, the guide would say, look,

if you're ever separated from the group, and you're alone,

and you're being charged by a lion or anything

else-- a chameleon, anything that

might come at you-- freeze, and it'll ignore you,

run right past you.

But if you run, they'll chase you down.

That was the rule again and again and again.

Finally we came upon this guy.

And he said that, that's a Cape Buffalo.

If ever you're alone and you're separated from the group

and you see one coming charging at you, run like hell.

And so that happened in June of 2008,

when the market was just in free fall.

And at the time, I sort of felt like maybe we

should run like hell.

We didn't, and we haven't.

It's my belief, it's been my belief,

that equities are the preferred form

of investing for one capable of enduring short-term pain

for long-term gain.

Equities will be the best way to do that.

And along that line, I would just

want to make a point about this other Stanford experiment

that you referred to.

I do believe definitely in deferral in the investment

world-- as you can see, a little less as it

comes to marshmallows.

I tend to grab the big ones and eat them quickly.

But the principle's the same.

In fact, I incorporate the principle in one

of the early lessons that Buffett

gave at an annual meeting of Berkshire, where he said,

you know, really, investing is as simple as "Aesop's Fable."

It's about the bird in hand versus the bird in the bush.

The only thing you need to know-- because you know what

you have-- what you need to know, which is uncertain,

is what you'll end up with when.

And he says, it's as easy is that,

and then he says, it's as hard as that.

I'm in an audience at Google.

And I think I read that the minutes spent

on YouTube in the last second quarter versus the prior year

was up 60%, and that's on a million users.

And I can tell you that if you keep up that type of growth

rate, it won't take that long.

You'll know what you're going to have, which is a lot,

and it's going to happen soon.

But in most businesses you're not

blessed with 60% growth rates.

There's something much less commanding.

But it is about what you'll end up with.

And so I think that's a good emblem.

This I take from one of our largest holdings,

which is Nestle.

They, like Google, talk extensively

about corporate culture, because that

is what you can bank on when you make an investment.

We own businesses that are supposed

to reproduce themselves over time,

and you need a strong culture.

And the head of Nestle's Japan business once showed this slide

and remarked about how lovely he thought

that 700-year-old temple was.

And then he said, now, none of the wood's 700 years old,

but the temple is.

And I thought of that as sort of an apt metaphor

for what businesses are like.

I mean, none of you will be at Google at some point,

but Google will hopefully still be Google.

The timbers are all changed out here,

but it still stands for the same thing.

And you'll be a very different company when you're all gone.

But Google should still stand, in light

of its context at that time, as a business

with the same virtues and values as it is today.

And that corporate culture is extraordinarily

important to myself because most of the money that I oversee

is invested through me by wealthy families, family

offices.

And for them, it helps a lot to hold a business

for a very long time.

And the only way you can invest based

on that belief is if you get the corporate culture right

I came out of Warren Buffett's visit to my class in 1982

at Stanford Business School with a couple of sets

of information captured here.

First, the $0.50 dollar bill.

That used to be the old-fashioned way of thinking

about value investing.

If you buy $0.50 dollar bill, your margin of safety was quite

great because of the discount.

Your internal rate of return, however, depended exactly

on when that discount closed.

And if it closed in a year, you'd make 100% on your money.

If it took 10 years, you'd make 7% on your money,

and so on through the Rule of 72.

It's also problematic because it's taxable.

So in that old model, if you took that $0.50 dollar

and realized the dollar, you'd pay 40% tax on that now

because long term gains have been less favored.

And you have to redeploy the money

into finding something else.

That didn't seem like much of a thoughtful way

to conduct affairs from my perspective,

especially since, at business school,

Warren gave the class the primary benefit.

He talked about the only one thing

that the government gives you as an investor, which

is the non-taxation of unrealized gains.

They give you one other thing, which

is that you can deduct losses for tax purposes.

But you don't you want to go there.

You're much better off finding something

that you could hold so that the gains that you get over time

are unrealized.