something and you don’t get cash, bad things happen. So that’s something I’ll never buy. That excludes a whole bunch of companies. If a company is using debt to grow or maintain its dividend like many utilities do, I don’t want to own it because it’s not generating real cash. It’s borrowing money and paying that out as a dividend, and that’s going to end badly one day. That’s the second rule. And these are some of the rules that good active managers use all the time. The third one that I really like is return on assets. If you have assets and you don’t make any money on them, that’s a bad business. So I like companies that have a high return on assets as opposed to ones that have a low return on assets, and if return on assets is slowing from quarter to quarter, that means bad things are going to happen... It means products aren’t selling. I don’t want to own it. I just described three rules that I want to live by. And a fourth and final rule: I don’t like volatility because most of my capital is tied up in family, generation-skipping trusts, and I want that money to stay there. So I tend to not buy stocks that are volatile. Those are four rules. What attracted me about ETFs – and I didn’t know this until about six years ago when I started working on it – there is a way to take an active manager and turn those into rules, like the four I just gave you, and create an index or an exchange-traded fund that follows those rules so there’s no style drift. There’s no one individual making those decisions. The rules are the rules. And that’s what I’ve created: a platform.
gluten-free cakes. I spend a fair amount of my time promoting their business online to help them get more customers because it’s in my economic interest. So the point is you don’t have to be an equity owner to align your interests with an entrepreneur. A royalty stream can do that, too. They have total control over their business, but our interests are 100% aligned. Q: Let’s talk for a minute about individual investors in the equity markets. I know that you have a big new business in exchange-traded funds (ETFs). How’d you get involved in ETFs and what are your goals in that business? KEVIN O’LEARY: The reason I got involved in ETFs is I’m a big believer in active management. In other words, having somebody determine which stock to buy, how much to own, and when to sell it. The trouble with an individual manager – and I’ve loved many of them and have worked with some of them for decades – is they tend to have what’s called style drift. That’s when they start with one strategy, and then years go by, and they move into something else. And it no longer works as well. So I thought to myself, was there a way to take a great active manager – and I’ll give you an example. Let’s say you want to invest in the S&P 500. There’s many companies in there I don’t want to own, because my definition of quality is this: If a company is using sales accruals like WorldCom did, I don’t want to own it. I don’t care what sector it’s in. When you sell
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