Note: Before you read the intro and first snippet, please understand this is the very first draft. It has not been revised, edited, or structured yet. Meaning the real version might change, add, or delete things. The goal is to get it started, to write something then I'll be able to perfect it. Join the book mailing list below. Thanks, enjoy! - Carlos Valadez (Charlie)
Introduction: The Stone Cold Truth
If you’re here, you may simply want to expand your knowledge. Or, you know that there’s something missing in your investment strategy. For most people, it’s not something they can easily put their finger on, which makes it even more vexing when it feels like the truth is right outside of your reach. The truth of the matter is that all of the great investors out there who make a habit of sharing their strategies aren’t you. And you are not them. As such, it’s very difficult to follow their directives because they are playing the game with a stacked deck. They’ve already made fortunes upon fortunes and now sit upon a mountain of success. It’s hard to look down from there and remember what it feels like to be a hungry, less-experienced investor, just as it’s hard to be putting your first $10,000 into the stock market and be able to imagine what it would be like to have $10 million at your disposal to invest in something special.
Blindly cloning anyone’s investments isn’t a good strategy. It can make you rich if you have enough funds and hit on the right tip, but that sort of ideology is akin to saying that playing the lottery is your retirement plan. You are just gambling when you play the lottery, and when you blindly follow investment ideas based on something you read in a blog, saw posted on social media, or heard in a YouTube video, you’re doing something even worse - spending your money on someone else’s guesses. Don’t get me wrong, sometimes those guesses are good, but even when they are, they still belong to someone else. If you make $50,000 on a tip you got from an overheard conversation in line at Starbucks one morning, you might be $50,000 richer, but you’re not a single cent smarter, and nowhere closer to replicating that success than you were when you decided you needed a vanilla latte. When it comes to how you are going to invest your money to achieve your financial goals, the ultimate deciding factor on any investment also needs to be your own opinion. If you’re using someone else’s opinion to guide your strategy, you might as well hang the Wall Street Journal on your wall and throw darts at it, then go with whatever they land on.
To achieve greatness in your investment portfolio, you have to put in the work. You have to do the research, ask the tough questions, think like a contrarian and understand that what’s good for Warren Buffett is probably not all that good for you. There is a fundamental mindset flaw in many investors’ strategies that is hard to see until you shine the spotlight right on it and illuminate it for what it is. That’s exactly what this book is here to do, to cast light upon the misconception.
Now if you’re smart and you’re skeptical, at this point you’re probably thinking, Hey, Carlos! If I’m not supposed to follow the advice of people who have made a whole bunch of money in the stock market, why should I follow your advice - given that you’re selling this book because you’ve also made a tidy profit in the stock market?
Well first and foremost, good on you for being smart and skeptical! Those are two qualities that are essential to doing anything in the age of the Internet and digital technology. Fifty years ago, the guys who wanted to sell you snake oil and call it the miracle cure for cancer, obesity, and arthritis had to call you on the phone, send you a letter in the mail, or knock on your door to give you their spiel. Nowadays, they’ve got about 10,000 other channels to try and worm their way into your subconscious and convince you that they know more than anyone else about the Next Big Thing.
The Internet has made trading on the stock market remarkably convenient and makes approaches like mine that much more accessible, but it also allows every hack, thief, and get-rich-quick schemer free reign to weasel their way into your field of vision if you let them.
I will say this repeatedly throughout this book: Trust yourself and trust the numbers. The data that is out there is going to point the way for you to find success, and your own opinion, based on doing research on every stock deal you consider, is going to be your wayfinder from Day One going forward.
As for me? The best reason I can give you for adopting this approach, which I will refer to throughout as the Three-Stage Theory, is this. I’ve studied this sequence for a number of years to fully comprehend it, and, I’ve been using the same method to make every single dollar and amass the net worth I have gotten today. The Three-Stage Theory evidently evolves over time as your ability to invest goes up. Fundamentally, the way you evaluate a stock to decide if it’s worth your money, changes, and that is what sets this theory apart making it entirely possible to outperform the market and beat professionals until you stand right beside them.
I’ve taken on this book project because I want to see other investors break through the threshold and take on the market at full potential. There’s so much potential left on the table followed by disinformation, fake news, and flawed strategies online that it can be frustrating to watch as someone who doesn’t think that wild financial success should only be limited to people who have already made their money elsewhere.
The Three-Stage Theory follows closely to what billionaire Seth Klarman once said in a 2011 meeting when interviewed by charlie rose over value investing: “Warren Captured the idea himself in his 1964 article the super investors of Graham-and-Doddsville and in it he talks about, value investing is like an inoculation you either get it right away, or you never get it. And, I think it’s just true. I actually think there’s a gene for this stuff. Wether its a value investing gene or contrarian gene.” This is the exact thought process I have towards the Three-Stage Theory, you either get the concept right away, or you never get it. And, if you do get it you have to put the work into it, acquire patience, and be willing to rewire your brain to try a different way of thinking and a different way of doing things. I don’t have a business nor a finance degree to my name. In fact, I barely graduated from high school. I grazed through it by taking credit recovery 2 weeks before school ended so that I may walk the stage. As far as college goes? I only attended a couple of semesters before dropping out. The main reason I went, apart from practically being forced by my parent's old traditional ways, was because I had qualified for FAFSA which is a government grant since my parents couldn't even afford to put me through community college. I knew I could take advantage of this opportunity and instead of using it for its sole purpose of paying for classes and textbooks, I used the money to start investing in the stock market. By the time I was 17 and a half years old, I was already fascinated by the stock market and knew that’s where I wanted to focus my attention. This is all thanks to the day I was 10 years old when my father was watching the classic 1970s “Wall Street” movie. It certainly escalated by the fact he kept pushing books like “The richest man in Babylon” or “Who Moved my Cheese?” on me. When I began investing I completely blew it on my first two attempts. I had practically lost all my money twice trying to use other people’s investment strategies. Those approaches ranged from day trading or shorting stocks to trying to catch breakout pumps on penny stocks. To say the least, not only did it end in a disaster but it was a constant headache. At a point, I even tried to be a shameless cloner and just copy what the greats bought, but I was quickly turned off by that when I realized it would take me several decades to achieve a millions status getting their average returns. It just appeared slow, very settling.
Don’t get me wrong the greats like Warren Buffett, Charlie Munger, Joel Greenblatt, Seth Klarman, Peter Lynch, and the other gentlemen have inspiring success stories, they’re role models for every entrepreneur and investor, and good humanitarians who could easily play the role of Scrooge with their financial pedigree, but instead tend to be generous and kind with their knowledge and time.
But none of them are where you are, and where I was. None of them are trying to make their first million in the stock market right now.
If you’re reading this book, it’s because you’re an investor who is tired of being average. You’re in the rat race at your job, but the lure of additional streams of revenue is driving you to do more. Your salary takes care of your living expenses and your family, but you have bigger goals than that. Maybe it’s to drive a Lamborghini or that new Mclaren. Maybe it’s to buy a vacation home on the beach or in the mountains. Maybe it’s simply to have extra money because you want the comfort of financial freedom. Maybe it’s just because you like to win.
They’re all great reasons. Anything that motivates you to succeed will motivate you to rethink your investing strategy and give you the work ethic to do the work, make the call, and see the returns start rolling in. Hard work, dedication, the numbers, and trusting yourself. That’s where we’re going to start. That’s the foundation of the Three-Stage Theory of investing.
Part I: Why Do It?
I know it’s easy to skip ahead to future chapters, read my theory on investment, break down the technical parts of it, and toss this book on the coffee table, never to be picked up again. It’s not unlike skipping to the last page of the latest fiction best-seller to see who dies or reading the plot of a movie on Wikipedia before you go see it in the theater. We all thirst for knowledge, and a lot of the time we have no patience to take it sequentially and build it from a strong base up to the lofty tower we aim to create.
The Three-Stage Theory isn’t just a mantra, a plug-and-play formula, or my way of getting you to subscribe to a newsletter that gives you tiny bits of information each month with promises of grand secrets to be revealed at a later date. It is an alternative investment strategy, however. One that requires a rewiring of how most people approach investing in general and specifically investing in stocks and other commodities.
I’m going to give the elevator pitch for it before we go any further because I don’t want to keep dangling the carrot in front of your nose and asking you to keep hopping to the beat of my drum. I want you to have a basic idea of what I’m talking about so you can start turning it over in your own mind and considering it on your own terms.
The Three-Stage Theory (Elevator Pitch Version)
The Three-Stage Theory is a form of value investing that evolves as you reach the next stage. It is a way to analyze different commodities in an order that maximizes your full potential to achieve high returns depending on your capital size. The capital size is the foundation of the theory, categorized as Small Money, Medium Money, and Big Money. In the first stage, small money, you are going to focus on buying cigar butts, companies with a free puff. In many occasions, it will indeed be a bad business, but at a great value. And, that is the first thing that needs to be understood, that it’s not about a great business but about a great investment. Let me emphasize, a great company does not mean a great investment, and a great investment does not mean a great company. The mantra here is that you want to buy $1 for 50 cents. Boring companies with little to no media attention are your new best friends because you strongly believe they are temporarily being mispriced and the market will end up correcting the mistake. That’s the ideal place to be if you have only a small amount of money to invest. You have a massive advantage with small money that many dont seem to comprehend, more on that later.
In the second stage, medium money, you move on to buying $1 for $1 because you believe that $1 will turn into $2 in the future. In other words, you begin to buy OK business at OK prices. You’re no longer trying to find the diamonds in the rough. You’re looking for consistency and better quality; you’re not trying to reinvent the wheel. You’re playing it safer but with just enough risk to maximize your potential returns. By this stage, you already have a good amount of money to invest, but your goal is to keep it growing exponentially.
The third stage, big money, sees you buying into the top, high-quality, successful companies for more-than-favorable prices with the expectation that they continue to rise in value, thus bringing you a good return. The prices aren’t great, you are now buying $1 for $2 with the expectation that it will turn into $3, then $3.10, $3.25 and keep going for the many years to come. I like to call this group the “forever stocks”, they are stocks you buy with the mentality to hold forever. Only now, you have a significant nest egg, you can put money into these behemoths because you’ve caught a small wrinkle in the market and the returns are good enough to move the needle, saftely,
In essence, the Three-Stage Theory is about finding the highest probability of achieving a high return with the available capital while at the same time keeping the “Value Investor” title. We willl do a deep dive into that later, but for now I want to get back to the question of why.
The Followers Predicament (inception, matrix, copying, mirror) Someone else’s stock idea of what is best for them is not necessarily what is best for you. That’s true for many reasons. However, it goes beyond that, because you don’t know how much the stock they chose could go up or down by, you’ll have no idea where to get in, how long to stay, nor when to get out. The whole point is to push your possible returns to their full potential so that you can make the big bucks. But, how are you supposed to do that without having full control of the game plan? Say you were influenced to buy a stock someone else picked up, or recommended. If that security began to fall you would instantly begin to worry if something went wrong. Now you are stuck in the predicament of trying to find out if the holding is still fine and the drop is temporary or worse a negative catalyst that completely changed the game plan. You might end up selling for a loss in panic, or later find out that person you mirrored had sold before it dropped. Or, what if you sell due to fear and uncertainty and you later find out that person doubled down and the stock rose back up by the time it comes around to you. Additionally, you need to have the advantage of beating everyone else to the punch and you won’t be doing that either by piggyback riding off someone.
Doubting Yourself
The biggest fallacies that people fall into with investing in the stock market is thinking other people know better than they do, and second-guessing their own decisions. That’s not exactly revolutionary thinking. I mean most of us are constantly being influenced in nearly every decision we make all day long by other people and by second-guessing ourselves. It’s one of the most vexing things about being human is not being able to consistently differentiate between what our brain tells us is the best choice and what our heart and our insecurities tell us we should do in order to be like everyone else. You could say that the Internet, particularly social media, has made it much more difficult to avoid falling into the trap of valuing other people’s opinions far more than our own. But it’s not technology’s fault, it’s part of human nature, a part we have to actively identify and overcome in order to rise above and be successful when we start to dive into the investment game.
Don’t believe me? Almost 2,000 years ago, Marcus Aurelius (the real-life philosopher, not the Emperor in “Gladiator” wrote, “We all love ourselves more than other people, but care more about their opinion than our own.”
The problem is that when we arrive at an opinion, a plan, or in this case, an investment strategy of our own, it’s usually done in the vacuum of our mental monologue. We might be iron-clad in our belief of how we’re going to move forward, at least until we share the information with another person, see a Tweet by a famous investor - or really just anyone - on what he would do in these current market conditions, or read a negative news article about the company we just decided to invest in.
In the blink of an eye, all of our hard work, research, and analysis comes crashing down because some guy we’ve never heard of posted on Twitter that the thing we want to invest in isn’t any good. History tells us that our survival over the millennium has depended on doing things in tribes and clans where the survival of all is more important than the survival of one. If you tried to survive on your own back in the times of cavemen and before there was anything resembling a civilization, you either got eaten, froze to death, starved, or some delightful combination of those three things. Thus it’s in our basic instincts to seek the approval of others, in order to believe we are doing things correctly and are coming down on the right side of whatever the matter at hand is.
Unfortunately, doing so repeatedly leads us to make poor decisions when we know better. We can think of the analogy of the lemmings racing off the cliff without a single thought because it’s in their instincts to naturally follow a leader, even if that leader has no idea where the hell they are going. There’s even a diagnosed psychological condition called allodoxaphobia, which translates into worrying about others’ opinions so much that you struggle to perform ordinary tasks, notably make decisions. That’s a bit on the extreme side, but the fact remains that for many people, especially inexperienced investors, going against the grain of ‘what everyone else thinks’ can be extraordinarily difficult to accomplish. The bigger problem is that because we aren’t doing our own research and making our own valuations of stocks, we don’t have any faith in the choices we make. The minute they start to trend in the wrong direction or don’t immediately take off, we start doubting ourselves and our decisions and panic ensues.
In your brain is a network called the behavioral inhibition system (BIS) that naturally activates when you are thinking about what to do in a certain set of circumstances. When you have gathered enough information to make a decision, the BIS switches off and your behavioral activation system (BAS) comes online - basically your brain telling you to start taking actions towards achieving the goal you are setting out to achieve. But if you are more concerned with the opinions of others rather than in making the best possible decision, your BIS will stay active and your ability to take action becomes impaired. This leads to you either taking no action - which results in failure by default, or by going against your own thought process to take the group-think opinion. Even if it’s wrong, you take comfort in the fact that you were part of a larger collective of people failing than the possibility of failing on your own. Failure is a common enough fear, but fear of being an outcast or deemed worthless, or incompetent in our own peer group can be crippling, to the point of causing the physical manifestation of pain. People will go to great lengths to avoid the feeling of shame or of being different from everyone else, as we often see in situations where people act in large groups in ways that we can’t imagine them acting individually.
Another great philosopher, Lao Tzu, once wrote that “Care about people’s approval and you will be their prisoner.” That is a 100% true statement. When you’re so worried about what someone else thinks of your actions, you are bound to them, and not in a positive way.
Believing In Your Own System
So how do we break free of wanting validation from everyone else when it comes to our investment strategy? Well if you’ve been in the market for any length of time, I bet you’ve either struggled to make any sort of return to write home about or the money is coming in so slowly and so inconsistently that it’s given you nothing but headaches and heartaches to this point. That’s your first indicator that it’s time to break free and start creating your own way of investing. Because the other ways either aren’t working or aren’t delivering the results you want. Do you just keep jumping from one podcast to another, one paid newsletter to the next, and one talking head to a slightly different sounding talking head to keep tossing your money blindly at one stock after another?
Of course, not! But that’s hard to see when you’re in the muck of it all. You keep thinking the next one will be the “right one”. But none of those strategies are going to work for you because the people who designed them are NOT YOU. You keep searching for the perfect model and keep seeing history repeat itself, unaware that the only strategy that is going to be ideal for your goals and your working capital is one of your own design backed by facts and numbers.
My favorite analogy of going forward and figuring out things on your own without worrying about what everyone says comes from the world of professional basketball. Just about everyone has heard of Wilt Chamberlain, the default “greatest player of all time” before Michael Jordan came along. Chamberlain is the only player to ever score 100 points in a single game and that same season he averaged 50 points per game - no one else has ever averaged more than 38 points per game in a season.
Wilt Chamberlain was 7 feet, 1 inch tall and so athletic that both the NCAA and the NBA had to change a few rules to keep the game competitive for other players. He never had to shoot the ball from more than a few feet away from the basket because of his size, but that made his attempts to shoot free throws, which come from a line 15 feet from the basket, a real adventure. The length of the shot and the fact that Chamberlain had giant hands far more comfortable palming the ball than shooting it made free throws a massive struggle for him. In his first two years, he routinely missed more than half of the free throws he took, and he took a ton of them as other teams started fouling him relentlessly, knowing he struggled at the line. He was the best player in the league by far, but his game had a glaring weakness; an Achilles’ heel that other teams exploited to no end.
So in his third year in the NBA, Chamberlain went against every single coach, teammate, and wanna-be advice giver he knew and started to shoot free throws underhand, the way little kids do when they are first learning the game and are too short to get the necessary arc on their shots.
To just about everyone who saw it, it looked ridiculous. A seven-foot man flipping the ball underhanded in front of 10,000 people? He was laughed at by fans and made fun of by teammates and opponents alike. But something funny started to happen. Chamberlain started making a lot more free throws. The previous year he had converted a meager 50.4% of them. In the 1961-1962 season, he upped that conversion rate to a career-high 61.3%. He averaged 12 more points a game, and it was never more apparent than one fateful night in Philadelphia when he sank 28 of 32 free throws (87.5) en route to his legendary 100-point game.
But here’s the kicker. Even though he had far more success shooting underhanded shots, Chamberlain stopped using the technique the following season because he was too embarrassed by how it made him look on the court. He willingly gave up success in exchange for failure because he was too worried about how it made him look. Don’t be a Wilt. Don’t be afraid to venture out on your own, no matter what other people might think, in order to find your own winning strategy!
I get it, it’s not easy to be able to take what can seem like a ‘devil may care’ attitude from the outside looking in. Not only are you staking that your knowledge is superior to what the market says, but you’re risking your own hard-earned money on it. That’s the hard part about it. When I first started using the Three-Stage Theory, I was constantly freaking out about what I was doing and worried that the ideas I was coming up with and the plays I was making were all wrong. I’d start having crazy ideas about doing the math wrong, but one of the best parts about doing your own research on the fundamentals and building your own analysis is that you can go back and check your work and make sure that you did it right. It’s an incredible way to reassure yourself and not something you can do when you don’t use your own analysis. If some guy on……