Mark Lamonica: Alright Brian, we're here to talk about the NRL and investing, which I think a lot of people would think of it as a strange combination, but you wrote an article where you basically went through the different positions on an NRL team and picked shares that equated to those positions. So where did you come up with that idea?

Brian Han: Well Mark, whenever my wife or my kids are not bothering me, two things dominate my life. One is watching sport, analyzing the team and trying to make some money out of it. The second one is watching the stock market, trying to pick some stocks and trying to make some money out of it. The former, some people say it's gambling, the latter some people say it's investing. I like to see both of them as investing. So when you look at a sports team and assembling a sports team, the easiest way would be to fill it with the fastest players, the sexy players who score the tries. But then in reality, that might be the strategy at that time, but in reality it's more complicated than that because you have constraints, you have to be cognizant of the salary cap, the skills needed for each position, each different position. You have to evaluate the players' talent and what players you have available for those positions and you need to evaluate how they would gel as a team over a long season. So when you break it down like that, it's no different to assembling a portfolio of stocks because you're constrained by your risk tolerance, by your goals, you're constrained by what stocks there are and you're constrained by the companies behind those stocks. And as a portfolio, how that collection of stocks will perform over the long term through various business and industry cycles. So that's why I thought there is a definite parallel between selecting a team and assembling a portfolio.

Lamonica: Okay, well let's start with what you did. I have a lot of questions, mostly about NRL, which we can talk about after the video is over, but let's go through some examples. So what is a NRL position that you looked at in your article and then what are the shares that you matched up with that?

Han: Yeah, well let's take in NRL, let's take the fullback and the winger positions. They are usually occupied by players who are fast, extraordinary acrobatic skills to score all the tries and get all the adulation after the game and all of that. Now when you look at it in stock market parlance, that sounds like those high flying growth stocks, explosive growth earnings, earnings growth outlook, really witty multiples. The kind of stocks that you feel proud when you go to a barbecue and people ask you what kind of stocks you hold and these are the stocks that you want to get it out there. But at the same time, when these stocks make a mistake, just like when wingers and fullbacks make mistakes such as missing a tackle or dropping a ball, the consequences are dire and it's very visible. And that's just like high flying growth stocks where expectations are so high that when they do disappoint even a little bit, the stock prices can react quite violently. So that's why I equate those fullbacks and wingers to these high flying growth stocks which has a role in a portfolio, but you just need to understand that the variance can be great and our valuation uncertainty can be great too.

And then if you just let's pick another stock, let's say the middle forwards, the props and all of that, the lock forwards. Now they're very boring people, but they serve a clear role in a team in terms of providing the defensive stout. And in a portfolio, I would equate them to defensive stocks, income or yielding stocks. They're not sexy, but they provide the income in difficult times and they provide the reliability of earnings and cash flow to provide you with those dividends. So again, defensive stocks, middle forwards. And then when you get into positions like a half-back or five-eighth, I mean they are the linchpin playmakers around which the whole teams are built. And in stock market parlance, that would be like your blue chip stocks, the stocks where in Morningstar we assign a very high rating in terms of moat, in terms of capital allocation and just in terms of general quality of the franchise. So those are the kind of examples that I'm thinking of when I'm trying to draw a parallel.

Lamonica: Okay, let's go back to some of the first things you said when you were talking about those wingers and fullbacks, those growth shares that people invest in. So a term that you used was uncertainty. And that's obviously one of our ratings here at Morningstar and you talked about expectations for shares, but maybe talk a little bit about how those interact. If you have very high expectations for something and from an uncertainty basis, you're not exactly sure how this company is going to perform. How should investors think about that?

Han: Yes, so that goes back to the risk tolerance. So when you're buying a high-flying growth stock, invariably, not only is the earnings growth outlook very explosive, but you are essentially paying for it right now for that potentiality. And when you have multiples that are really sky high, the room for error is very low. So for instance, Tesla will come out and say our earnings or sales grew by 70%. Now, in isolation, that is a significant, very impressive growth. And then you look at the stock price and it's down 10%. And you go, what the hell is going on? 70%, you're not happy with that. But no, because with a stock with such a high PE, 70% is not what investors were expecting. They were expecting 120% revenue growth. So there is this dislocation between expectations and actual delivery. They can make a growth stock suddenly experience stock price declines. And that's just like in rugby league in a fullback position whereby the fullback could be playing really well, made 200 yards in a game, several tackle buffs. But he misses one tackle at the 79th minute that leads to the opposition scoring the match winning try and he's the villain. So that's the kind of parallel that I draw in that position.

Lamonica: And I think that that's a really, it's something I struggled with a lot when I first started investing and I first started investing during that dotcom bull market. And yeah, I couldn't understand where, yeah, that headline number was great and then the share price would come down. I think that's something investors need to learn over time that it's not that absolute number, right? It's that number compared to those expectations which are actually priced in.

Han: Exactly. So that's a good point you're making. So another position that I was talking about is the hooker position, in a rugby league team. Now, they're usually these underappreciated short, squirty people with cauliflower ears, and just in the middle of a ruck, getting bashed up in everywhere. So underappreciated, in fact, they're one of the lowest paid positions in league. Now, to me, that is like a value stock in stock market parlance because expectations are so low and PEs are so low, dividend yield is so high. But if you look very closely, they have intrinsic value because people don't appreciate how much work hookers go into organizing the ruck, organizing the defense and organizing the attack and the amount of tackles they go through. So when you look at it that way, it's a bit like a value stock where nobody's looking at it simply because maybe there's some cyclical challenges, some structural challenges or some company specific challenges. But if you can look over that and say there are underlying asset values there, then sooner or later the market will realize that assuming that you recognize properly what that underlying value is.

Lamonica: Yeah. And I think a classic example of that is from the U.S., it's Philip Morris. And Jeremy Siegel wrote a book that was looking at the best performing share in U.S. history and it was Philip Morris. And the interesting thing was, of course, smoking was declining. They were selling less cigarettes. They were getting sued by everybody for the health outcomes that smokers had. And yet it was the best performing stock because the expectations were so low, the dividend yield was high. It just churned out cash, gave it back to investors. And yeah, I think that's a perfect example.

Han: Yeah. And another perfect example would be in Australia, Commonwealth Bank, when they first floated onto the stock market I was at university. And I remember it went up about 60% and a lot of people sold it thinking that they were the greatest investors in the world because they thought bank is a bank. There's not much growth potential. If you had held that, I mean, we don't really have to do the maths, but the dividends that you've gotten would have covered your initial IPO outlay 40 times over. And that's not including the capital appreciation since then. So there is a thing about expectations. And that's one of the things that investors have to always remember that stock market is an expectations machine. So you can buy a very, very good stock. Your stock price could still go down because you may have bought it at a point in time when expectations were high and then the results really didn't quite match it. But that doesn't mean it's not a good company. It just means that perhaps you didn't leave enough margin of safety in your entry price to benefit from the quality of the franchise.

Lamonica: Another question for you. So you obviously use this NRL analogy in building a team and how you have to have these different positions. As an investor, do you think that you need to do the same thing in a portfolio or could an investor, based on what their objectives are, based on what they're comfortable with, comfortable evaluating companies, comfortable within their portfolio, could investor just say that I am simply a growth share investor or I simply want value shares, high dividend yields? How do you think investors should approach this? Does a portfolio have to have a little bit of everything or is it really just what you're comfortable with?

Han: I think each individual has his own preferences and I will never say that you can't have just all growth stocks or all cyclical stocks. I think you should do your research. But at the end of the day, this is about risk minimization. And one of the most important tenets in investing is diversification. Because if your goal is to assemble a portfolio of stocks for the long term, that's going to weather several business cycles because your aim is to compound over the long term with minimal turnover, then I do think that after you've looked at all the stock that you want to buy, have a look at just what is the composition if you assemble that in a portfolio. Because if it's full of growth stocks and interest rates start going up and people's appreciation of technology's potential starts waning, then you could be in for a very hard time when those tailwinds suddenly turn into headwinds. So it's really about risk minimization and it's really about diversification. Now, of course, some people are very smart. They're smart enough that they can sense the wind and then they can switch their portfolio around straight away from a bunch of growth stocks to a bunch of defensive stocks.

But let me tell you, those people are very rare in real life. So it is about having a balance, just like a sports team, having a balance whereby, Mark, you're American. So when I look at an NFL team, you need these really big, fat, immobile men protecting the quarterback. They might not look much, but they are very valuable in protecting the most important person in your team. And it's just like in a portfolio. You might not like these defensive stocks because they're so boring, the Telstra's, the infrastructures, the airports, but they might be the foundation that protects the whole portfolio against sudden shocks to your wealth, which ultimately what you really want to do over the long term with your portfolio is, number one, don't lose any money, and number two, hopefully they compound.

Lamonica: Yeah. And I think there are two really important points you made there. I think the first one is you're talking a little about this notion of rotating your portfolio and how challenging that is because, I think as you said, not only do you have to be right, you also have to be first because once everybody else has done that, any profit of rotating your portfolio is gone. So that's very difficult to do. And the other thing that I think, talking about how different shares perform in different environments, it's really important for investors to understand in a portfolio what types of shares they have because so many people are influenced by price. And in some cases, great shares are going to go down. And the last thing we want, of course, is to sell low. So understanding why potentially the value part of your portfolio is not performing well in an environment is really important to stop that poor investor behavior.

Han: Exactly. And also, it goes right down to the basic tenet of diversification. Do you want to minimize the correlation between the stocks in your portfolio? If all your stocks are exposed to the tech sector and whatever's happening in the tech industry, then if that sector blows up just like it did when you first started investing during the dotcom era, you're left with nothing. Whereas, if you had some uncorrelated stocks in there, then that could protect you on the downside from any bust-ups.

Lamonica: Yeah, absolutely. Well, thank you very much for teaching me more about NRL. I have been in Australia 10 years now, but I will say I'm pretty ignorant about NRL. So I appreciate that. And then, of course, all the wisdom on investing as well.

Han: It's been a pleasure. Thanks, Mark.