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Tag: Warren Buffett
Wall Street Recap: September 17-23, 2017
September 26, 2017 / Richard Lewis	/ Leave a comment
My full notes and analysis from the past week: September 17-23, 2017. Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.
Investing in "Hot" Industries
"A lot of the places where the industries are doing a great job for the world, it's very hard to make money out of it. Because these wild enthusiasms come into it. I don't have a favorite industry." – Charlie Munger
In the depths of the ocean, the glow from a small lure stands out among the darkness. Fish from the surrounding waters swim toward the lure, tempted with the promise of a free lunch. Little do they realize that they are swimming right into the jaws of an angler fish and their impending doom.
Likewise, "Hot" industries have historically acted like an angler fish, attracting investors who unwittingly swim into the jaws of poor investment returns. Think back to the hot industries in history such as autos, airlines, and dotcoms. The lure of those industries was typified by two compelling elements;
A story of a world-changing product or service,
Stellar growth wrapped around massive consumer demand.
Even though those industries had favorable long-term tail-winds, industry returns were abysmal and left thousands of bankrupt companies in its wake. Why?
Two key reasons:
Durable Moats are Illusive: "Hot" industries are defined by growth and rapid change. This constantly evolving environment makes it incredibly hard to predict winners and losers. The best product or service today may become obsolete tomorrow. And a perceived competitive advantage today may vanish overnight.
Wild Enthusiasm Attracts Too Much Capital: Wild enthusiasm attracts massive amounts of capital into hot industries. This in turn increases competitive pressures and drives down the returns on invested capital.
Examples of "hot" industries from the last century:
Autos: "Autos had an enormous impact on America, but in the opposite direction on investors."…"of the two thousand companies, as of a few years ago, only three car companies survived. And, at one time or the other, all three were selling for less than book value which is the amount of money that had been put into the companies and left there." – Warren Buffett (link)
Airlines: "Here's a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact–though the picture would have improved since then–the money that had been made since the dawn of aviation by all of this country's airline companies was zero. Absolutely zero." – Warren Buffett
Nifty-Fifty Tech Stocks: A study found that the compounded annual return of the Nifty-Fifty portfolio from the peak in 1972 to 1998 was actually quite admirable, 12.5%. The study also found that the Technology stocks in the Nifty-Fifty were significantly over-valued at the peak, and, as a result, performed poorly over the 26 year period. On the other hand, predictable and "boring" consumer staples stocks like Gillette, Phillip Morris, and Coca-Cola all performed well, and, in hindsight, were still undervalued at the peak of the investment craze. (link)
Mental Model: Viscosity
Viscosity: the state of being thick, sticky, and semifluid in consistency, due to internal friction. Liquids show a reduction in viscosity (stickiness) with increasing temperature. (link)
Hot industries are like a fluid with low viscosity. They are fluid, in a state of change, and have little resistance to deformation by (industry) stress. All of which make them hard to predict.
Meanwhile, industries and businesses that are highly viscous are "sticky". Their future can be predicted with reasonable confidence.
As a fluid increases in temperature, its viscosity decreases (i.e. becomes less sticky). Applying that model to investing, as an industry becomes "hot", it becomes more fluid and less predictable.
This has implications regarding the usefulness of a company's historical financials. As an industry's "temperature" increases (i.e. becomes more fluid and subject to change), a company's historical figures may no longer be an accurate representation of its future performance. Using a company's historical financials in this new environment invites error and potential over-valuation. (Or under-valuation if the reverse is true; low viscosity moving to high viscosity)
Investment Lessons:
Avoid "Hot" Industries: Subject to intense competition and an ever shifting environment, it is challenging if not impossible to predict winners and losers in a hot industry.
"We make no attempt to pick the few winners that will emerge from an ocean of unproven enterprises. We're not smart enough to do that, and we know it." – Warren Buffett
Invest in Sticky "Predictable" Businesses: Investing in sticky businesses follows Buffett's prescription of not fooling yourself and not losing money.
"…we try to apply Aesop's 2,600-year-old equation to opportunities in which we have reasonable confidence as to how many birds are in the bush and when they will emerge." – Warren Buffett
"Hot" Industries: In the News
Netflix, Tesla, and Blue Apron are the hottest companies in hottest industries. Each one is contending with wild enthusiasm and a flood of investment capital. Some of the most recent developments threatening these companies are listed below.
"Facebook Inc. is loosening its purse strings in its drive to become a major hub for video. The social-media giant is willing to spend as much as $1 billion to cultivate original shows for its platform," (link)
"It also signals Facebook's readiness to spend more than before to become what Chief Executive Mark Zuckerberg calls a 'video-first' platform."
HBO, Amazon, Netflix, Facebook, and Apple are all "banking on video to capture the fleeting attention of users and seize billions of dollars in advertising that is expected to migrate from television to digital video."
"Apple Inc. is preparing its own billion-dollar war chest for content."
"For Netflix, Disney's decision to hold on to rights to 'Star Wars' and Marvel movies will add to the pressure to create appealing original content of its own to replace some of the high-profile franchise films Netflix will lose starting in 2019." (link)
"The big problem is not aggregate costs, but costs versus competitors. If your costs are out of line, you're going to get killed eventually." – Charlie Munger
" VW, the world's biggest carmaker, says it will build 50 all-electric models by 2025 and electrify 300 models by 2030."
"The speed of the shift is remarkable…The switch is driven by policy: "European regulators were previously content to set environmental standards and let manufacturers decide how to meet them. Since the emissions cheating scandal, they are quite reasonably inclined to be more prescriptive…This is prompting a rapid change in consumer behavior: few people will risk buying a car that may be of limited use within a decade."
Mercedes, Smart, BMW
"Daimler boss Dieter Zetsche said the Mercedes owner's 'entire portfolio' will be electrified by 2022. The Smart brand will become fully electric by 2020, making it the first internal comustion engine marque to make the switch."
"BMW told reporters at the show: 'Our top priority now as a company is electric mobility.'"
Nissan-Renault-Mitsubishi alliance
"The chairman and chief executive officer of the Nissan-Renault-Mitsubishi alliance is pushing ambitious targets for the auto makers in an effort to leapfrog Silicon Valley and swipe market share, even as some of his biggest rivals look to scale back." (link)
"He is also planning 12 new electric cars, forays into robotaxi fleets and the debut of a fully autonomous car within six years."
"With the explosion of technology that is coming, it is going to make it very difficult for smaller players to follow. Mr. Ghosn said. "You're going to have a premium for the large car manufacturers because we are the only one who are going to be able to invest in all the fields, all the products, all the markets, all the technology without making any shortcuts or without having any blind spot."
"Albertsons Cos. is buying the Plated meal-kit service, the first acquisition of a prepared-meals company by a national grocery chain as supermarkets scramble to keep shoppers coming to their stores." (link)
Bob Miller, chief executive of Boise, Idaho-based Albertsons, said in an interview Wednesday: "We think there's an opportunity to grow this thing tremendously," adding that the supermarket will give Plated a "cost advantage" over other meal-kit companies by the scale of its food purchasing and network of 18 manufacturing plants.
"The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money." – Warren Buffett
Psychology of Human Misjudgment
Confirmation Bias
Anti-Soros conspiracies sweep the globe (link)
"Conspiracy theorists have an explanation for everything. So the fact that the Financial Times should publish a column defending Mr. Soros will simply be taken as further evidence of his nefarious influence."
Deprival Super-Reaction Syndrome
Along with the migrating steelhead, Oregon river pool holds life lessons (link)
"He recalls watching a man catch a wild steelhead. The man was furious because by law, he could keep a marked hatchery fish, but had to throw back a wild fish. He tore the fish's mouth and bashed it against a rock."
"'As a species, we can be unbelievably kind on an individual basis – a person will give you the shirt off their back on the trail. But start creating vested interests and people can be unbelievably brutal.'"
Over-Influence by Authority
Shortcomings in Tesla's self-driving tech cited among factors in fatal crash (link)
"Joshua Brown, a Tesla owner, was killed last year when his car ran into the side of a truck that was turning across the roadway in front of it."
"He said Brown had put a higher level of trust in the Autopilot system than was intended and that the driverless technology had not been designed to operate on the road where the crash occurred…Brown had his hands on the steering wheel for only 25 seconds during the 37 minutes leading up to the crash."
Say-Something Syndrome
Instragram video of weapons leads to an arrest (link)
"A Texas gang member suspected of violent robberies, home invasions and murder, was captured by the LAPD after…he posted a video of himself on Instragram displaying a gun collection,"
Forgetting what one is really trying to do
What started out as a plan to reduce the pigeon population in Lisbon, has turned into a mission to provide "dignity and quality of life" to pigeons.
Lisbon Has Too Many Pigeons, So It Built Them a Luxury Resort (link)
"Since the birdhouse opened…its mission has crept beyond mere population control. Caretakers have equipped the facility, which costs 250 euros per month to maintain, with a pigeon first-aid station, and there's talk of offering services such as deworming and, paradoxically, a nursery….'Pigeons deserve and need dignity and quality of life,' she says"
"A majority of life's errors are caused by forgetting what one is really trying to do." – Charlie Munger
Simple Psychological Denial
Ex-Pakistan PM's wife wins Lahore by-election (link)
The Panama Papers "revealed documents detailing (Mr. Sharif's) offshore accounts, and show his family owned assets he could not account for…This was followed by the supreme court's ruling that his unexplained wealth made him unfit for office."
"But many of Mr. Sharif's supporters believe the guiding power behind the supreme court ruling was the army,"
Tattoos: Lollapalooza Effect
Youths' tattoos aren't always cause for alarm, report says (link)
Consistency and Commitment:
"A 2016 Harris Poll found that most adults who have gotten a tattoo-86%-have never regretted doing so,"
"People think if they have committed to it, it has to be good. The minute they've picked it themselves it gets an extra validity. After all, they thought it and they acted on it." – Charlie Munger
Liking Tendency
"They're emulating people who are out there – athletes, musicians, military personnel – people they look up to,"
Incentive-Caused Bias
"People who get inked typically say they feel sexier, rebellious, attractive or strong."
"As many as 38% of young people 18 to 29 report having a tattoo…'More often', she says, '(tattoos are a) generational act of solidarity.'"
Mental Model: Parkinson's Law
Parkinson's Law. Observation that "work expands to fill the time available for its completion," and that a sufficiently large bureaucracy will generate enough internal work to keep itself 'busy' and so justify its continued existence without commensurate output. (link)
Trump champions UN while urging reform (link)
"'While the United Nations on a regular budget has increased 140 percent, and its staff has more than doubled since 2000, we are not seeing the results in line with this investment,' said Mr. Trump"
Various Fascinating Excerpts
A test of compassion (link)
"'For the first time in my life I was really proud of German,' she says…But the initial enthusiasm soon wore off…(when she) quickly realized what a hard slog it would be to absorb so many immigrants from an entirely different culture. The trigger was when an elderly Syrian man told her that 'Hitler was a good man, because he gassed all the Jews.'"
Japan Post share sales faces uncertain journey (link)
"Mr. Nagato was hauled before senior figures in the ruling party and told to 'work for a living, rather than gambling,'."
"Human resource managers named tattoos as the third physical attribute likely to limit career potential (non-ear piercings and bad breath were the top two)."
Russian-built nuclear plant revives Chernobyl fears in eastern Europe (link)
"All the profits go to Belarus, all the risks are on the Lithuanian side" – Regarding Nuclear power plant being constructed in Belarus, near the Lithuanian boarder.
Waters Rise and Hurricanes Roar, but Florida Keeps on Building (link)
"Florida was built on the seductive delusion that a swamp is a fine place for a paradise."
"The risks of building here are far better known today. Yet newcomers still flock in and building still rise, with everyone seemingly content to double down on a dubious hand."
Wall Street Recap: Part 2
September 22, 2017 / Richard Lewis	/ 2 Comments
Part 2 of my full notes and analysis from the past two weeks: September 3-16, 2017. Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.
The "Burned Cat" Phenomenon
Investors who get burned by an asset bubble often develop a learned apprehension towards that asset class, regardless of its future economics or valuation. In other words, they go about acting like Mark Twain's cat who, after sitting on a hot stove lid, never sat on a hot or cold stove lid ever again. (link)
Learned apprehension can lead to depressed asset prices as well as severe under-investment in new supply.
1) Depressed asset prices
Investors may develop an irrational resistance towards an asset which has burned them before. Making them reluctant to invest, even at very attractive prices. Example:
Elon Musk experienced this "Burned Cat" phenomenon while working for a bank early in his career. He found Brazilian debt trading for 25 cents on the dollar, which was guaranteed by the U.S. Treasury for 50 cents on the dollar. He presented this investment idea to the Bank's CEO who promptly rejected it saying, "the bank had been burned on Brazilian and Argentinean debt before and didn't want to mess with it again." (link) Taken aback, Elon tried to explain that you couldn't lose unless you thought the U.S. Treasury was going to default, making it an effective "no-brainer". The CEO still declined.
2) Severe under investment in new supply
During an asset bubble, investors eagerly build out new supply, over-extend themselves, and set the ground for their own demise. Following the bust, investors may become hesitant to develop new supply, even when favorable economic tailwinds present themselves. As a result, an industry that was once defined by chronic over-supply, can shift into one defined by chronic under-supply. Examples:
Ethiopian Famine
This feast or famine industry cycle contributed to Ethiopia's 1983-1985 famine. Having been burned by a bountiful harvest and low prices the year before, "Ethiopian farmers produced less grain and more cash crops or livestock, reducing food production in the following year." (link)
Ireland Housing
Ireland's real estate market is experiencing the after-effects of the "Burned Cat" phenomenon. Leading up to the financial crisis, Ireland produced one of the most severe housing bubbles in the world. The subsequent bust resulted in years of under-investment in new housing. The country has since developed a chronic shortage of new homes and property prices are rapidly rising.
As the Financial Times described: (link)
"With Ireland facing a chronic shortage of homes and property prices again rising rapidly,"
"Builders are struggling to meet 10 years of pent-up demand for new homes, while rents are rising and Dublin faces a growing homelessness crisis."
"Housebuilding, which declined to a trickle after the crash, has stepped up markedly yet acute strains remain. Although private builders are projected to complete 18,000 homes this year, industry figures estimate 30,000 units will be required for years to come."
"Figures this week showed annual property inflation on a national basis is advancing at 12.3 per cent."
Misjudgment underpinning the Burned Cat Phenomenon:
"Burned Cat" investments are influenced by a lollapalooza of human misjudgment, including:
Extra-Vivid Evidence: Investors who have been burned by an investment won't soon forget.
Pavlovian Association: Through negative reinforcement, investors learn to reflexively avoid an asset class.
Over-Influence from Authority: News coverage of a "burned cat" investment is likely to be prominent, negative, and pessimistic.
Social Proof: No one else is investing in it, so that reinforces the notion that it's the right thing to do.
Bias from the non-mathematical nature of the human brain: Investors tend to naively extrapolate past returns which contributes to extreme valuations during bubbles and busts.
Investment Lesson: Actively look for assets that have burned investors. They may present excellent opportunities due to;
The market's unwillingness to invest in the asset, even when favorable economics and valuations exist.
Severe under-investment in new supply, which sets the stage for future supply shortages. (Pay special attention to areas where supply cannot ramp up quickly.)
Standard Causes of Human Misjudgment
Social Proof: Rationalized/Normalized Terrible Behavior
At Home Among the Giants (link)
Wllie McCovey: "I tried working as a bus boy in a whites-only restaurant, but I quit after a week. All the things that make you cringe was normal talk then. You took it or you walked away."
"The five most dangerous words in business are: 'Everybody else is doing it'." – Warren Buffett
Social Proof: Fear of Missing out
Leveraged Loans too Popular (link)
"Some companies that reprice loans have cut debt-to-earnings multiples. But for many, nothing has changed other than the strength of investor demand for debt."
"When demand is strong, any investor that declines the lower yield risks seeing another buyer take their place, and many are battling to keep their money invested."
That Airline Seat You Paid for Isn't Yours (link)
"Political commentator Ann Coulter…erupted in a Twitter tirade earlier in July after Delta moved her from a preferred aisle seat to a window seat in the same extra-legroom row."
"…passengers think they can buy the rights to a specific seat…Airlines say that legally, you don't."
Contrast Caused Distortion
Passive Migration: Denver Wins Big as Financial Firms Relocate to Cut Costs (link)
"If you're talking to someone who's been in Denver, they'll say it's getting unaffordable, but if you're coming from San Francisco, the reverse sticker-shock is wonderful," said Ms. Droller.
"And while Denver home prices reached a record in June, they are still far below San Francisco."
Incentive Caused Bias
Wall Street Needs You to Borrow Against Your Stock (link)
"Morgan Stanley's finance chief said, 'that the bank expects more clients to take out loans in the months ahead. 'That's been a real key driver of our wealth business.'"
"The Massachusetts securities watchdog last year accused Morgan Stanley of developing a sales program that encouraged brokers to pitch these loans regardless of whether clients needed them."
"Several Merrill Lynch brokers said they have asked long-standing clients to open a securities-backed line of credit to help them hit bonus hurdles,"
"The guy tells you what is good for him…So you're getting your advice in this world from your paid advisor with this huge load of ghastly bias." – Charlie Munger
Lesson: Watch out for rapidly growing products and services on Wall Street. They likely are associated with massive incentive-caused bias.
Consistency & Commitment Tendency
Merrill Lynch brokers asked long-standing client to open lines of credit "assuring that clients wouldn't need to use it or pay any fees for opening it."
"Brokerage executives have said the longer a client has one of these loans tied to their account, the more likely they are to use it."
"People think if they have committed to it, it has to be good." – Charlie Munger
Lesson: Beware of commitments, even seemingly harmless ones.
Lollapalooza Effect: Examples
"I would say the one thing that causes the most trouble is when you combine a bunch of these (causes of misjudgment) together, you get this lollapalooza effect." – Charlie Munger
LIBOR: Incentive Caused Bias, Pavlovian Association, Social Proof, Envy/Jealousy
The LIBOR was a terribly flawed benchmark. It was easily to manipulate and bankers were highly rewarded for doing so. Everyone around them was doing it, and they were all getting rich. Hence, "studies have estimated that hundreds of trillions of dollars of financial contracts around the world were created based on the benchmark.
Libor: A Eulogy for the World's Most Important Number (link)
"It turned out that banks were skilled at getting Libor to move in favorable directions. After all, it was their employees who were guesstimating their borrowing costs, so it was simple enough to skew those figures in helpful directions."
"But government investigations soon showed not only that manipulation was wide-spread and easy to pull off, but also that government officials and central bankers had known for years about Libor's vulnerabilities but failed to act."
"If you carry bushel baskets full of money through the ghetto, and made it easy to steal, that would be a considerable human sin, because you'd be causing a lot of bad behavior, and the bad behavior would spread." – Charlie Munger
Fire Ants in Japan: Stress-Induced Mental Changes, Social Proof, Extra-Vivid Evidence
The sudden stress from the arrival of fire ants in Japan, along with extra-vivid coverage from the media prompted faster and more extreme reactions. Furthermore, Social-Proof amplified the power of this reaction.
Evacuate the Sandbox! Japan Is Freaking Out About Fire Ants (link)
"The mild panic here is partly due to sensationalism in the mass media, with some reports falsely depicting fire ants as murderous," said Mr. Hashimoto.
"Better safe than sorry, said one wrestler."
"He drew a parallel in Japan's experience with how U.S. fire ant infestations in the 1950s were caught up in fear about communism."
"Shares of pesticide makers have surged on the Tokyo Stock Exchange, and one manufacturer started selling ponchos made from industrial-strength material that allegedly protects the wearer from fire ants."
"He added, 'It is necessary for everyone in the nation to recognize correctly the characteristics of fire ants and address the matter calmly.'"
"One consequence of this tendency is that extra vivid evidence, being so memorable and thus more available in cognition, should often consciously be underweighed while less vivid evidence should be overweighed." – Charlie Munger
Part 1 of my full notes and analysis from the past two week: September 3-16, 2017. Periodicals covered in this Wall Street Recap include the WSJ, FT, NYT, and LA Times.
ROE & Customer Ignorance
Ideally a company's product or service would increase in demand as its customers become less ignorant. This is not always the case. Some companies build their businesses upon the ignorance of their customers. As a result, their moats decrease in direct proportion to the savviness of their customers.
Moats built upon ignorance have become increasingly tenuous as technological developments and market conditions have led to savvier customers.
Ignorance removal may occur with:
Increasing competition. A more challenging competitive environment increases the pressure for businesses to cut costs, which incentivizes ignorance removal.
Early adapters and social proof. Early adapters who assess the benefits of less known products, may induce others to adapt later on.
Declining search and discovering costs. Low S&D costs lead to savvier customers.
Examples of Ignorance Removal
Honeywell (Increasing Competition)
China has become an increasingly competitive market for international businesses. This is due in part to the improved quality of Chinese-made products in conjunction with savvier customers. (link)
The fact that Honeywell's struggles in China are related to the "savviness" of its customers and the quality of competing Chinese brands is disconcerting.
Football Helmets (Early Adapters, Social Proof, & Extra-Vivid Evidence)
The first football helmet from Startup firm 'Vicis', "tested better for safety than any helmet in NFL history." Yet only "about 50 of the league's 1,700 players-roughly 3%-took the field in week 1 in a Vicis helmet,"
The rest of the league continues wearing helmets that have inferior safety ratings. Riddell and Schutt, who have long outfitted most NFL players, continue to dominate the market.
The resistance to the new helmet comes from:
Consistency and Commitment: "They are loathe to change, because of the familiarity they have with the helmet they have been using all these years,"
Bias from non-mathematical nature of the human brain: "Executives and players say NFL locker rooms are largely populated by men who believe long-term brain damage is something that will happen to someone else and who fear the consequences of any dip in performance due to an equipment switch."
While the incumbents may benefit from these psychological tendencies in the short-term, it's a tenuous proposition to suggest that, without sufficient improvements to their helmets, their moats will endure. Early adapters and social proof will aid continued adoption of safer helmets. Furthermore, extra-vivid evidence of any injury sustained with a Riddell or Schut helmet could drive wide-spread adaption of safer helmets.
Toys "R" Us (Declining search and discovery costs)
Highly reliant upon ignorant consumers, retailers and consumer brands have crumbled under the pressure of increasingly savvy-shoppers. Having built their moats upon high search and discovery costs, they're unable to withstand rapid declines in consumer ignorance. Toys "R" Us is one such example.
"Industry-wide, toy sales have been strong in recent years, though much of the growth is shifting to online sellers like Amazon.com Inc. and discounters like Wal-Mart Stores Inc. Amazon's toy sales were up 24% last year, compared with 5% for the overall market and five years of declines for Toys "R" Us,"
Investment Lesson
Lesson: Beware of moats built on exploitation. Seek moats built on reciprocity.
A moat built around consumer ignorance is tenuous in nature. For a long-term sustainable advantage, search for companies that would benefit from declines in ignorance. Or as Charlie Munger might say, find companies that deserve to earn sustainable high returns on equity. Companies who exploit ignorance don't deserve it.
One of Charlie Munger's three investment holdings is Costco. Costco offers best in class service at best in class prices. Both of which are highly valued by its customers. Neither of which is easy to duplicate. Hence, Costco deserves the favorable return it earns.
Checklist Question
Question: Would customers choose this company's product or service if they were well informed and had access to their competitor's products/services?
Drive for Efficiency Gains
Companies will accumulate operating inefficiencies as they grow. When this growth inevitably slows or declines, companies may seek to expand margins by eliminating these inefficiencies.
Cycle: Growth —> Excess & Inefficiency —> Slowdown —> Drive for Efficiency Gains
Such strategies include;
Simplify management structure (eliminate bureaucracy),
Trim staff and eliminate redundant positions (can include industry consolidation),
Simplify product offerings,
Focus on core competencies (can include disposing of non-core assets),
Become more adaptive to consumer demands and industry trends,
Improve capital structure and return more cash to shareholders,
Close poorly performing stores.
Examples of Companies Seeking Efficiency Gains following a Slowdown
Problem: First Sales Decline after 13 years of growth.
"Lego said Tuesday that its revenue for the first half of this year fell 5% from a year earlier to $2.4 billion, its first revenue decline in 13 years." (link)
"Lego (said) its organization had grown too bureaucratic 'to support global double-digit growth.'…We have added complexity into the organization which now, in turn, makes it harder for us to grow further,"
Solution: Seek efficiency gains through cutting jobs, reducing layers of management, & speeding up product roll-out.
"We will build a smaller and less complex organization than we have today, which will simplify our business model in order to reach more children."
"On Tuesday, Lego said it would cut roughly 1,400 jobs, with between 500 to 6000 of these coming from its Billund, Denmark, headquarters alone."
"It is also working to reduce layers of management and administration to speed product rollout, which Mr. Knudstorp said can involve 20 teams on average before a product is ready for global launch."
Eli Lilly
Problem: Experiencing Industry-wide Pricing Pressure & Expiring Patents.
"Health insurers and politicians have stepped up pressure on prices…" (link)
"Lilly cited a number of issues that are plaguing many drug makers, including the need to lower costs and raise investment in new drugs ahead of patent expirations that are expected to erode sales of older products."
Solution: Seek Efficiency Gains through cost cutting and dramatic reduction in the work force.
"That has left companies leaning on cost cuts and efficiency improvements to drive profit growth. The result is a dramatically shrinking workforce."
"When the pressure gets heavy, the scrutiny turns to the size of a company's payroll,"
"Drug companies have cut more than 269,000 U.S. workers since the beginning of 2007,"
Unilever & Nestle
Problem: Experiencing Shifting Consumer Tastes and Declining Sales.
"Amid this shift (in consumer tastes), sales from traditional players have flagged, spurring consolidation, cost cutting and restructuring." (link)
Solution: Seek efficiency gains through Cost Cutting, Industry Consolidation, Restructuring (simplify product offerings), Boost Dividends, and Make Acquisitions to Accelerate Growth.
"In response (to activist posturing) the two consumer-goods firms (Nestle and Unilever) have focused on cost cutting and promises to boost dividends while going on the hunt for nimbler food and beverage brands with the potential to accelerate growth."
"Nestlé, Unilever and other big companies in the sector are making (acquisitions) to catch up with fast-changing consumer tastes."
Problem: Dealing with Major Corporate & Political Scandal, recently became the largest auto company, by volume, in the world.
"VW long pursued the industry's crown, only to face billions of dollars in penalties related to a U.S. regulatory scandal. It used software to cheat on diesel-emissions tests, a result of a growth-at-any-cost philosophy that claimed Detroit's auto giants a decade earlier." (link)
"We're a big company and don't have any interest in getting anymore bloated." (link)
Solution: Optimize business through Restructuring (selling any business segments no longer considered critical).
"The company is open to talks and a new team is working to sell any businesses no longer considered critical. These noncore assets account for as much as 20% of the company's current annual revenue,"
"…in order to see how we can optimize our business,"
Problem: Expanded store count too fast and with too little consideration for cost. Struggled with major shifts in the retail sector as well as disruptions in its supply chain.
"In 2012 and 2013, Aerogroup expanded to 125 retail stores, a 'rapid pace' that meant the company didn't always get the best terms on leases, according to court papers." (link)
"Last year, the company's supply chain was disrupted when the sole sourcing agent in Asia stopped providing goods. The interruption cost Aerosoles customers permanently, court papers said."
"Intense industry competition," & "major shifts in the retail sector."
Solution: File for bankruptcy production, close a majority of company stores, and (presumably) focus efforts on sales through department stores, online retail, and home-shopping networks.
"Some 74 of Aerogroup International Inc.'s roughly 80 stores are candidates for immediate closure, with proceeds of the liquidation earmarked to help fund a continued sales effort, according to court papers."
"In addition to its retail operation, the Aerosoles brand is sold at well-known department stores, on home-shopping networks and Amazon.com."
Changed in a "Big Way"?: Value of U.S. College Degrees
"You have to be thinking all the time to see if something has changed the game in a big way." – Warren Buffett
For decades properties surrounding U.S. colleges had a can't miss combination of limited supply and an ever increasing demand for degrees. On several occasions I've been advised by successful real estate investors to buy college properties . This was sound advice for decades, and may still be, but what if the game has changed in a big way? What if the demand for U.S. college has shifted dramatically lower, and with it, demand for university housing? Two WSJ articles shed some light on these very real, yet uncommonly held concerns.
1) Americans Losing Faith in College Degrees, Poll Finds (link)
"Four years ago, (Americans without college degrees) used to split almost evenly on the question of whether college was worth the cost. Now skeptics outnumber believers by a double-digit margin."
"Overall, a slim plurality of Americans, 49%, believes earning a four-year degree will lead to a good job and higher lifetime earnings, compared with 47% who don't…That two point margin narrowed from 13 points when the same question was asked four years earlier."
"Meanwhile, student debt has surged to $1.3 trillion, and millions of Americans have fallen behind on student-loan payments."
2) U.S. Colleges Slip in Global Rankings (link)
"The U.S. continues to lay claim to more elite research universities than any other country in the world, but that dominance is beginning to fray."
"(This) marked the first year that schools outside the U.S. seized the two top positions in the 14-year history of the list."
"This marked the fifth year of consecutive decline in the overall showing of the U.S. This ranking listed 62 U.S. schools in the top 200. In 2014, 77 U.S. universities ranked in the top 200.
"…there are clear warning signs and fairly significant flashing red lights that the U.S. is under threat from increasing competition,…Asia is rising. It's worrying time for stagnation for the U.S."
"In recent years, Chinese universities have worked to internationalize their course offerings and attract more foreign students. The efforts have paid dividends: in 2016, according to government figures, more than 440,000 foreign students were studying in China, with students mostly hailing from South Korea and the U.S. That figure marks a 35% increase over 2012."
"The rise of Chinese universities also comes as the Chinese Communist Party has invested heavily in research universities."
Investment Implications
The tailwinds that favored college housing for the last 30 years have slowed. If the demand for U.S. college degrees has indeed shifted downward, I'd expect demand to dry up in traunches, starting with third tier universities and moving on up. This would imply that real estate around third and second tier universities is more vulnerable to a downward shift in demand, while first tier universities would fair relatively well.
Investment Lessons
Lesson 1: Insist on thinking things through.
It'd be far too easy to blindly follow the advice of a successful investor. To avoid going terribly astray, insist on thinking things through. Do not simply take an expert's word for it.
Lesson 2: Look out for things that have changed in a big way.
In the past, college housing benefited from huge long-term tailwinds. But as the famous investment clause suggests, past performance does not guarantee future returns. Do not naively extrapolate past trends into the future. Rather take time to assess what drivers will harm or benefit an investment moving forward.
Question: Has anything changed in a big way?
Disliking Bias
Why China Can't Stop Hating Japan (link)
"Beijing sanctioned a relentless diet of anti-Japanese propaganda. A besieged party eager to rally the masses saw no better vehicle than reviving attacks on the 'historical criminal,' Japan. Over time, policy towards Japan has become so sensitive that any Chinese official who advocates reconciliation risks career suicide."
"If you [say] any nice words about Japan then you will get an angry reaction from students,"
Reciprocation: Role Theory
"Leaders in Beijing still use the idea of Japan as China's enemy to rouse the citizenry. The Japanese, seeing themselves depicted as China's foe, have increasingly begun to act like one."
"Sixth: bias from reciprocation tendency, including the tendency of one in a role to act as other persons expect." – Charlie Munger
Bitcoin: Reinforcement & Social Proof
1) China Bans Digital Coin Offers as Celebrities Like Paris Hilton Tout Them (link)
"The losses haven't deterred some (crypto currency) buyers, many of whom have made so much in other deals that they are eager to take more chances."
"In a year, he turned an in heritance of $80,000 into a couple of million dollars. "It was pure luck, literally," he said. Mr. Bardi then put $1 million into Bancor, even as the price was falling"
"While Mr. Bardi said he is mindful of price swings, and isn't willing to take a chance on another token offering, he said he believes in Bancor's product and has no plans to sell. "I'm not really touching it," he added."
"Nothing seduces rational thinking and turns a person's mind in mush like a big pile of money that was easily earned." – Charlie Munger
2) Bitcoin in sharp drop after Jamie Dimon 'tulip bulbs' barb (link)
"(Jamie Dimon's) comments were dismissed by fintech executives who said Mr. Dimon had criticized bitcoin before but the currency continued to surge."
"If you think about the doctrines I've talked about, namely, one, the power of reinforcement — after all you do something and the market goes up and you get paid and rewarded and applauded and what have you, meaning a lot of reinforcement, if you make a bet on a market and the market goes with you. Also, there's social proof. I mean the prices on the market are the ultimate form of social proof, reflecting what other people think, and so the combination is very powerful. Why would you expect general market levels to always be totally efficient, say even in 1973-74 at the pit, or in 1972 or whatever it was when the Nifty 50 were in their heyday? If these psychological notions are correct, you would expect some waves of irrationality, which carry general levels, so they're inconsistent with reason." – Charlie Munger
Pre-suasion: Fear of Missing Out
Newport Beach precious metal dealer Monex accused of $290-million fraud (link)
A complaint against Monex, a precious metals investment firm, says that the company encouraged its sales force to use this 'pre-suasion-esque' sales pitch:
"If gold were to increase in value by $100 per ounce in the next year, and you had a 30% to 40% net gain, you'd feel pretty good, wouldn't you?"
Uncertainty & Extra-Vivid Evidence
Florida Gas Stations Running Out of Fuel as Irma Threatens State (link)
The unknown path of Irma, along with extra-vivid evidence of its destructive power induced widespread panic and buying across the entire state of Florida. There's an investing lesson in there somewhere.
"Because of Irma's unknown path, panic buying has been widespread in the state, rather than confined to a few counties…'You basically had all 67 counties with a run,'"
"This storm has the potential to devastate our state," Rick Scott said (link)
U.S. Colleges Slip in Global Rankings (link)
"Elizabeth Perry, a professor at Harvard and expert on China, said the Chinese are actively 'gaming' the system. 'They are hiring an army of postdocs whose responsibility is to produce articles,' she said. 'They are changing the nature of a university from an educational institution to basically a factory that is producing what these rankings reward.'"
Economic Warfare: Companies in the Crossfire
International disagreements and conflicts result in economic "attacks" much more frequently than they do in military attacks. Be careful that your investment doesn't end up a casualty of economic warfare.
Examples of Recent Activity
Germany & Turkey: Germany threatens to cut aid to Turkey
"…prompting Berlin to issue a travel advisory for the country and threaten aid cuts." (link)
"The two countries' ties started fraying last year, after Germanys parliament adopted a resolution branding the killing of more than a million Armenians by Ottoman Turkey in 1915 and 1916 as genocide, sparking protests in Ankara."
Saudi Arbia & Qatar:
"Saudi Arabia, the United Arab Emirates, Bahrain and Egypt in June severed diplomatic ties and closed their air routes and land and sea borders with Qatar to protest its alleged support for regional extremist organizations and terrorist groups." (link)
USA & North Korea:
"A U.S. proposal for new United Nations sanctions would clamp an embargo on its oil and textile trade and slap a full asset freeze and world-wide travel ban on leader Kim Jong Un and key regime members and institutions." (link)
"We are worried that cutting off oil exports will inflict damage on North Korea's hospitals and an ordinary people," Mr. Putin said
(De)Commoditized Flights
The statements below address what's happening in air travel, but doesn't address why.
"Passengers get into anything that flies if the ticket is cheap."
"For a small fare difference, (passengers) still pick less-comfortable airplanes. Airlines say cost is the No. 1 factor when evaluating new airplanes." (link)
To draw the inference that customers only care about price would be misleading. After all, price is the only factor in the purchase decision which customers can easily assess. Factors such as comfort, amenities, and service are either not easily assessable or completely unknown. So of course air travel has tended towards commoditization. After all, why pay 20% more for a flight when I have no idea what I'm getting for the extra money?
Why not give consumers an easy way to objectively assess comfort, amenities, and service and see what happens? If an American Airlines flight had an 87 rating on comfort, amenities, and service, I'm likely to pay up for that flight over one with a 62 across the board. Or better yet, attempt to assign some dollar value to them.
Such a system would contribute to the de-commoditization of flights. But as it stands, these factors are wholly unassessable, and thus, I'll continue to be over-influenced by price.
"You need to have a passionate interest in why things are happening. That cast of mind, kept over long periods, gradually improves your ability to focus on reality. If you don't have the cast of mind, you're destined for failure even if you have a high I.Q." – Charlie Munger
Flood Insurance: Highly Skewed Losses
"(In Florida) Homes and other properties with repetitive flood losses account for just 2% of the roughly 1.5 million properties…But such properties have accounted for about 30% of flood claims paid over the program's history." (link)
The Economics of Politics
"Here we are in the minority…and we're dealing from strength because they don't have the votes…Here the vote is the currency of the realm. It's all about having the votes." – Nancy Pelosi (link)
"They're the only two people who came to the meeting with a deal to be made." – President Trump on cutting a deal with Democrats.
Demand Excellence
"'The lesson', he said, was that 'if you don't demand excellence, you're not going to get it.'" – Don Ohlmeyer (link)
Censoring Social Media in China
"Last year, officials imposed stricter controls on (social media) apps, forbidding sexual content and original reporting during live-streams. The government has also shuttered dozens of live-streaming sites and fined some hosts for obscene language." (link)
"Mr. Li understands the government's power to break stars, and said he had cleaned up his act to avoid trouble."
Future of Augmented Reality
"A lot of people underestimate what is happening,..This is one of those things that is going to completely change the game in the next two or three years. It's like right before the Big Bang…It is definitely not a novelty,…This fundamental shift will change how we interact with computers, live our lives – and sell furniture." – Michael Valdsgaard, head of digital transformation at Ikea, an early adopter of ARKit (link)
China credit expansion
"No other economy in history has grown this fast without confronting some kind of a big crisis." (link)
Hilarious Foot-in-mouth moment
"Martin Schulz, leader of Germany's Social Democrats, had some strong words for a Hamburg landlord planning a huge rent rise. It was 'daylight robbery', 'immoral', the 'unscrupulous exploitation of poor people'." (link)
"But there was embarrassment in store for Mr. Schultz. A presenter revealed that Ms. Braun's landlord was a construction company owned by Hamburg City Hall – which is Social Democrat-controlled. All 150 studio guests erupted in laughter."
My full notes and analysis on the Wall Street Journal from the past week: January 30-February 5, 2017 (Week 5). Please Enjoy.
Donald Trump: "I love depreciation"
Trump on Depreciation
"I love depreciation," he said in the second presidential debate last October. (link)
"Every other country lives on devaluation,…They play the devaluation market and we sit there like a bunch of dummies."
"Mr. Trump suggested Tuesday that Japan and China are devaluing their currencies."
"The U.S. dollar slid to its lowest level since November on Tuesday amid weak U.S. data and new indications that the Trump administration would prefer a weaker dollar." (link)
Japan depreciation
"The Kyoto-based company (Nintendo) reported net profit of 64.7 billion yen, more than double the year-earlier level, a figure it said was boosted by the weak yen." (link)
Mexico depreciation
"Further peso weakness could make the country even more competitive globally."…"A weakening peso would again give them even more of a competitive edge" (link)
Banking Moral Hazard
Should we start worrying about moral hazard at banks again? I'm beginning to think the answer is yes. There's just too much incentive for banks to game the system. Take this for example:
"Banks must pass the Fed's stress tests in order to boost dividends or buybacks to shareholders." (link)
Here's what makes that simple point very worrisome:
Banks are being incentivized to game the system in order to boost dividends or buybacks.
They are using the same consultants who helped them avoid Basel II capital requirements before the financial crisis.
The stress test models offer false precision: "What models cannot measure is the chance that banks all act as a herd — creating financial panics." (link)
The Fed is considerably intertwined with the stress tests. Should anything go wrong, they will feel responsible for bank failures and ultimately bail them out again.
Focus on What You Can Control
I always love Amazon's approach:
"There's always a number of things that can impact customer spending, both positively and negatively during any quarter," said CFO Brian Olsavsky on a conference call. "What we do, is continue to focus on the things we can directly control: for us that's price, selection, customer experience. And on those dimensions we felt we made great progress." (link)
Exxon: Agency Costs
Exxon is unbelievably good at limiting agency costs and aligning management with long-term shareholder interests. Just check out these two examples:
Policy on Writedowns:
"Exxon hadn't booked a decline in the value of its assets since at least 1990. This is due in part to the company's practice of being more conservative when initially recognizing the value of new oil and gas that it discovers," (link)
"The company's senior leaders wanted to avoid writedowns because in accounting terms, they have the effect of making the company's investments appear more profitable,"
"We don't do write-downs," former Chief Executive Rex Tillerson told trade publication Energy Intelligence in 2015. "We are not going to bail you out by writing it down. That is the message to our organization."
Policy on Executive Stock Options:
"Half of the equity award may not be sold for 10 years from date of grant or until retirement, whichever is later, and the other half is restricted from sale for five years." (link)
Very Low VIX = Very Low Returns
Historically speaking,
"stocks have done poorly in the year following very low VIX levels. The S&P's annual gain has been 2.7% after the 100 lowest readings and nearly 29% after the 100 highest readings. The overall average was 8.8%."
"A low VIX isn't in and of itself worrisome, but the "calm before the storm" idea has some basis in history. Some of the lowest historical VIX readings preceded sharp, unexpected stock selloffs such as the 2008 financial crisis and the 1994 interest rate scare."
Japan and the Weimar Republic
I couldn't help but think that Japan's monetary policy draws parallel's to the Weimar Republic.
When the Weimar Republic went off the gold standard, there became no legal limit as to how many notes it could print. And print they did.
Meanwhile, the BOJ wants to buck a global tide of rising rates, and have announced "it would buy an unlimited-number of five- and 10-year government bonds at prices that translate to a benchmark yield of around 0.110%." And buy they did. (link)
How long can the Rising Sun fight a Rising Tide of interest rates?
Ferrari: The Boundaries of Brand Dilution
It's less than 2 years since Ferrari's IPO, and the race to test the boundaries of brand dilution is on.
Historically Ferrari has established brand equity through exclusivity. Just as recently as 2013, head of Ferrari, Luca di Montezemolo, announced plans to sell fewer cars in 2013 than the 7000 it delivered in 2012.
Luca stated, 'this is a far-sighted decision to strengthen our brand equity, from what I learned from Enzo Ferrari… We must resist people who say the competition will benefit from us making fewer cars… When others penetrate our markets, we are happy to meet this challenge.' (link)
In 2014, the company sold 7,255 cars. That year, Luca resigned following tension with Sergio Marchionne.
By 2016, the number of cars shipped increased to 8,4000. Sergio Marchionne believes he could boost production up to 10,000 cars. (link)
At the moment, Ferrari cannot sell more than 10,000 cars a year because of emission standards. I suspect however that electric vehicles will ultimately be exempt from this number, giving Ferrari an open path to even more significant brand dilution.
Ralph Lauren: Brand Dilution
As Ferrari tests the boundaries of Brand Dilution, many fashion retailers, like Ralph Lauren, are desperately trying to recuperate brand equity after years of brand-destructive strategies.
"Ralph Lauren said it remains committed to Mr. Larsson's restructuring plan, which has included limiting discounting, lowering inventory and reducing the number of products the company is selling."
Know the key drivers within your industry: Coal
Key Drivers within the Coal Industry.
1) Demand and Competition from China
Chinese consumption and production policies have a huge impact on coal prices. Here's what's happened in just the past year:
Coal Prices Tripled: "International prices for metallurgical coal tripled in 2016 from a decade low. Rule changes in China that limited work in mines, mine retirements in Australia and U.S. production cutbacks sparked the rally. Many troubled mines were suddenly profitable."
Coal Prices Halved: "Coal prices have tumbled by nearly half since November, after China relaxed restrictions on the number of days mines can be open…"
2) Government Regulatory Environment.
The House voted to "repeal a rule that limited companies from dumping mining waste in streams. The coal industry views the environmental rule as burdensome regulation."
"It's a very optimistic time now for the coal market because those regulations are being pushed back,"
3) How fast can coal miners ramp up production and re-open plants?
"…mines world-wide have already ramped up output to take advantage of the rally in prices."
Toshiba: Learning from Other People's Mistakes (OPM)
Warren Buffett has said that's it's best to learn from "other people's mistakes" as much as possible. Well I think there's much to learn from Toshiba's perilous venture into nuclear energy.
Toshiba's nuclear ambitions made for a great investment story. They planned to leverage Westinghouse's nuclear reactor design to reduce costs by cranking out many "cookie-cutter" power plants. This low cost strategy, combined booming demand, would lead many investors towards an optimistic view of the company.
At first things started out well:
"Southern chose Westinghouse's design for the first new nuclear plant to be built in the U.S. in 30 years, and the next month Scana also chose the AP1000 for a plant in South Carolina." (link)
But eventually the twin pillars of Toshiba's plan, low cost and booming demand, eventually dissolved leaving them with losses that could approach $6 billion. How did this happen?
Their misery stemmed from two major sources:
Replicating Errors: Any error in their cookie cutter power plant design was replicated throughout all the power plants they were building. Leading to very costly mistakes. (link)
Stagnation: The nuclear industry has stagnated or declined in most every country but China. Largely as a result of Fukushima and political headwinds. This lead to increasingly ferocious competition.
We should learn to watch out for:
Very large tail risk (Fukushima)
Political risk
Execution risk (Difficulties of Implementing the strategy)
Investing outside of your circle of competence.
I would not have seen the risks of replicating design errors in the reactor design.
Other major issues from this story:
Toshiba exposed themselves to unlimited losses: The deal restricted Westinghouse's ability to "seek further increases in the contract price," Southern said—meaning that if the nuclear plant couldn't be completed in a timely manner, Toshiba would shoulder the costs.
Toshiba had a high profile accounting scandal in 2015 (link): Warren Buffett says, "In the world of business, bad news often surfaces serially: you see a cockroach in your kitchen; as the days go by, you meet his relatives,"
This Week in Human Misjudgment: Pavlovian Association
Currently lots of human misjudgment centered around anybody involved with Trump. For example:
"Uber Technologies Inc.'s chief executive, Travis Kalanick, said he is stepping down from President Donald Trump's economic advisory council, saying that his participation has been misunderstood as an endorsement of the new administration's policies." (link)
"The announcement "follows criticism of the ride-hailing firm over perceptions that it supports the Trump Administration, with some celebrities and others using social media to call for people to delete Uber's smartphone app."
Under-estimating risk:
Be wary of trading strategies. Many often underestimate the risk involved. Here's one example of where it may be occurring:
"It really came down to the leverage," said Mr. Skalak on why he switched from stocks to futures. On a good day, Mr. Skalak said he can make $600 to $1,000. He pulls out of the market if his daily losses approach $400, a policy he adopted after some steep losses." (link)
First: His strategy is likely dependent on being able to pull out of the market in a calm and orderly fashion. During market panics however, liquidity can dry up and severe fluctuations can wipe out years of profits like it did to the Carry Trade back in 2008.
"These rare and unexpected changes in the market, such as the sudden devaluation of a currency, can wipe out years of accumulated gains. Thus, higher interest rates in the lent currency may be the payoff for bearing the risk of a peso event. But determining the effect of an unlikely future event is something of an experimental nightmare." (link)
The carry trade is often described as "picking up pennies in front of a truck,"
Second: This trader sough out a strategy where he could apply a great deal of leverage, but here's a few warnings against leverage:
What Ever Happened to Rick Guerin?
LTCM Case Study
Currency Swaps & Interest Rates
Very insightful article into the relationship of currency swap and interest rates.
Foreign bond investors measure investment attractiveness by the hedged yield differential. Therefore, to understand the demand for bonds from foreign investors, you have to know both the yield differential and the cost of hedging currency risk with currency swaps.
Example: (link)
"At the end of January, a 10-year U.S. bond yielded around 2 percentage points more than its German equivalent and 2.4 percentage points more than a Japanese bond."
"But if investors fully hedged themselves against currency exposure, the pickup in yield would disappear completely. After that cost, a U.S. 10-year bond would offer a yield 0.06 percentage point lower than a domestic equivalent for an investor with euros, and 0.7 percentage point lower for a Japanese investor."
"The relative attractiveness hasn't increased as much as the nominal difference in yields suggests," added Mr. Inkinen.
"Hedging an investment mutes its impact on the exchange rate, but if Japanese and European investors want to benefit from higher yields on bonds elsewhere in the world—particularly U.S. Treasurys—they would have to buy more bonds unhedged against currency risk."
Bullish Oil Bets Climb to Record (link): " Long positions exceeded shorts by such a degree that it's the largest net bullish position in 10 years of data from the CFTC."
Strong demand for Italian commercial real estate (link): Investing in Italy "is a way to move up the risk curve and deliver returns promised to investors,"
Investment Grade Bond mania: "Investment-grade companies have sold $146 billion of bonds this year, the most for any comparable period on record going back to 1995,"
Systemic Risk in China's lending environment (link): The default "rippled through the world's largest internet investment marketplace, hitting investors who hadn't even bought the securities."…Individuals seeking higher returns invest in these unregulated securities with a few swipes on their phone.
WeWork is just a duration mismatch? hmm… (link): WeWork's "business model is to sign long-term leases with landlords, but take short-term rents from its own tenants, meaning that revenue is volatile and losses could pile up in a recession."
Businesses are struggling to charge more (link): The Fed noted earlier this month that "increases in input costs were more widespread than increases in final good prices" – an indication that businesses are struggling to charge more."
The Facebook IPO still haunts the Nasdaq (link): "…since the glitch-filled IPO of Facebook Inc. on the exchange in 2012, NYSE has landed the majority of the dollar volume raised in tech IPOs valued at $1 billion or more,"
Oh Mon Dieu…
Think about this the next time you examine your daily habits.
"EA said its mobile game "Star Wars: Heroes of the Galaxy" was a significant driver of digital sales, with fans now spending an average of 155 minutes a day playing it."
In the course of a year, that equates to 16 hours per day for 59 days straight of doing nothing but playing this video game. Over the course of 60 years, that's 9.7 years.
Statistic of the Week
"Americans now lose $500 million a year to street crime but $8 billion a year in ATM fees."
January 23, 2017 / Richard Lewis	/ 1 Comment
Buffett & AIG
AIG paid Berkshire Hathaway $10 billion to bring "stability to their balance sheet" and gives them "greater certainty". (link)
Meanwhile, Warren Buffett has said, "We pay a high price for certainty." Howard Marks added to this comment, "People who want to buy bargains should prefer uncertainty."
Translation: AIG paid a high price and Buffett got a bargain.
China & Autocatalytic Reactions
China's economy achieved yet another year of "stable" GDP growth, but their growth comes at the expense of increasing disorder everywhere else in their economy. This type of behavior is known as an "autocatalytic reaction.", which is a mental model that I now use to think about China's economy.
Autocatalytic Reaction: "Order can be created in a system by an even greater decrease in order of the systems surroundings…The order of the Earth's atmosphere increases, but at the expense of the order of the sun. The sun is becoming more disorderly as it ages and throws off light and material to the rest of the universe." (wikipedia)
China creates GDP Stability at the expense of Economic Chaos everywhere else. Below are examples of China's autocatalytic economy in action.
"GDP Stability"
IMF Raises Growth Forecast for U.S. Economy (link)
"(China) is laboring to keep growth chugging along…the government used its long-worn playbook of state policies to stimulate growth."
China Hits Growth Goal On Big Does of Stimulus (link)
"Beijing is expected to double down on old growth drivers this year – including fiscal spending and the property market- to keep the economy stable in an important year of leadership change."
"Beijing posted the lowest annual growth in a quarter-century, and economists say it only got there by relying heavily on short-term measures that are likely to delay much-needed reforms to bloated state-owned companies and the country's inefficient financial system."
"Economic Chaos"
A Risky Twist on Repo Trade in China (link)
These "dai chi" agreements are outrageous…Used to temporarily move funds around in order to skirt government audits, as well as take on more risk. Doesn't this sound familiar to AIG and credit default swaps?
"A little-regulated practice that companies have used to borrow hundreds of billions of dollars and move risky assets temporarily off their book."
"The risk is that dai chi agreements tend to be informal and often don't leave a paper trail."
"These transactions, by one estimate, may easily top $1 Trillion in value. The practice is just one of the many unexpected risks that have sprouted up in China's long credit boom."
China's credit boom has "helped send Chinese bond prices to a 14 year high in mid-August and pumped up markets for everything from iron ore to garlic."
"Traders say the deals are so opaque that even estimates are hard to make."
"Banks sometimes use the dai chi agreements to move risky assets temporarily off their books during earnings periods or audits, the people said. Brokers like Sealand typically use them to borrow quickly and flexibly-leveraging their investments many times over,"
Copper Tethered to Dollars' Moves (link)
Chinese investors are grasping for any investments to get their money out of China or the Yuan. As a result, they are creating volatile and unusual behavior in Copper prices, among other asset classes.
"Metals and other commodities that are priced in dollars tend to fall when the dollar appreciates…But copper and the dollar have been moving nearly in lockstep recently, a phenomenon that many analysts attribute to rising appetite for copper among Chinese investors seeking to protect their wealth against the risk of a sharp Yuan depreciation against other global currencies, primarily the dollar."
"In November, the correlation between copper and the WSJ Dollar Index reached its highest level since 2007."
"In five hours on one day, we say (copper) prices trade in a range that would normally take a year" to play out.
Bitcoin Trading Faces Greater Scrutiny in China (link)
"China is trying to limit the ability of Chinese individuals and companies to move their wealth abroad, a trend that contributes to a depreciating Chinese yuan and risks destabilizing the broader financial system."
Trump & China
If Trump stops China from dumping highly subsided products into our markets (link), I think he'll unintentionally destroy the lynch-pin holding together China's economy…highly subsidized factories.
To give more detail to this picture, this is what I imagine much of China's economy looks like:
China's local governments fund themselves by land sales and real estate development. But the land is only valuable if there are people and jobs.
The easiest way to create jobs is to subsidize industries which can generate LOTS of jobs, like steel production. Steel production creates jobs in mining, transportation, energy, engineering, and of course factory workers.
With lots of people working, or soon to be working, demand for real estate skyrockets. This in turn creates more jobs because workers are needed to build all this new real estate.
It might be ok if only a few cities in China used this model, but I believe this to be pervasive. As a result, China is creating WAY too much steel and other products. With an oversupply of subsidized goods, they must dump them into U.S., and global markets for whatever prices they can get.
If the Trump administration stops China from dumping its highly subsidized products into the U.S., subsidized factories all over China will quickly implode and take entire cities with it. Being so highly leveraged, China is not in a position to handle the impact of such an event.
This of course is just my hypothesis, and I welcome any disconfirming evidence.
"Retail Meritocracy" & Deteriorating Moats
It feels like we've entered a new area that I'd like to call "retail meritocracy". Brand names use to serve an important role in signaling both value and quality to consumers. But with easy access to internet reviews and scores, brand name goodwill seems to be rapidly deteriorating for many companies.
Luxottica appears to be a good example. Luxottica has a dominant position in the old world distribution and marketing platform of sunglasses and eyewear. In this old model, floor space and brand names served as a solid barrier to entry. But there's been a trend towards commoditization of sunglasses and eyewear as consumers become more comfortable with buying off-brand names like Warby Parker. Online reviews, ratings, etc. have weakened Luxottica's competitive moat.
Merger to Create Eyewear Giant (link)
"The merger joins two companies that previously risked stepping on each other's toes as Luxottica expanded into lens manufacturing and Essilor moved into frames…both companies could shrink because of a harsher price competition for frames and lenses."
Why Golfers Covet the Costco Ball (link)
In another example of "retail meritocracy", Kirkland brand golf balls became a hot selling items when it was discovered that they perform nearly as good as Titleist Pro VI golf balls. "This is just a perception killer," The Kirkland golf balls retailed for $1.25/ball, while Pro VI's retailed for ~$4/ball.
We have entered a time of retail meritocracy where many brand-name-moats are being eroded more quickly than anticipated.
Know what's being measured
It's important to know what's being measured. Sometimes we forget. Here are some examples:
Private Prison Industry Gets Boost From Election (link)
A likely example of lying with statistics.
The DOJ found that private prisons were more dangerous than government-run facilities.
"Contractors criticized the report, saying it compared private and government-run prisons even thought they house different types of criminals."
"The private facilities are dominated by lower-security, illegal immigrants who have committed crimes, a demographic in which gangs are prevalent."
Rocky Route for Rail Line (link)
"If you cut 30 minutes off, I'd be for it,"
Note: Nowhere in his comment does this frequent Amtrak traveler consider the $120 billion cost.
Fed Officials Shift focus on Growth (link)
When the Fed and U.S. Government talk about the success of their economic programs they largely speak of 1) an increase in overall demand and 2) a reduction in unemployment. When they say the economy is "healed", they are likely measuring it by overall demand and unemployment numbers.
Global Growth Fuels Netflix Surge (link)
"The streaming video giant has prioritized growth over profit as it pursues its international rollout"
Success is being measured by user growth…which is the same metric used by Netflix's competitors. All of its competitors are foregoing profits for revenues…
Oops! When Little Errors = Big Mistakes.
Two examples of little mistakes that lead to big errors.
Student-Debt Picture Darkens (link)
The U.S. government WAY underestimated how many students have "defaulted on or failed to pay back their college loans."
Previous numbers "overstated repayment rates for 99.8% of all colleges and trade schools in the country."
"The new analysis shows that at more than 1,000 colleges and trade schools, or about a quarter of the total, at least half the students had defaulted or failed to pay down at least $1 on their debt within seven years."
In 2015, the reported number was 347 colleges. Today it stands at 1,029.
Afghan Payroll Cut in Corruption Fight (link)
The U.S. military was paying 30,000 Afghan soldiers that didn't exist! That came out to $13 million per month. Now, the U.S. military will only pay Afghan soldiers who were biometrically enrolled in the nation's army.
The Growth Promise
Why does it seem that troubled companies always insist upon expanding into growth markets? Why are they so eager to grow a business model with fundamental problems? Examples include:
Pearson Drops as Future Darkens (link)
"Pearson said its revenue fell 30% in the fourth quarter making for a full-year decline of 18% that it called unprecedented."
"…which has put pressure on Pearson's business even as it seeks new sources of growth in emerging economies such as Brazil and China."
Can Revlon Regain Some of Its Lost Luster? (link)
"One way Mr. Garcia intends to lessen Revlon's reliance on the U.S. is by entering China."
I'm Curious. Is this an Accounting Illusion, Real, or Both?
Railroad Mavrick Buoys Investors (link)
I'm curious about this case. I wonder if Mr. Harrison's operating efficiencies are real or are merely accounting related. After all, he's able to do what no one else in the industry is capable of doing, which should raise some questions.
"Each time the message was similar: Mr. Harrison has proved himself able to cut costs and improve operations and is a better executive than you current team."
On the backs of the second longest bull-market in history, artificially low interest rates have created intense competition among investors for any yield whatsoever. Furthermore, ultra-low interest rates have incentivized land-lords not to sell, which has reduced supply and intensified competition further.
Texas Billionaires Joined to Strike Deal (link)
Plano Texas's raw land has gone from $8 to $10 a square foot a few years ago to $60 today. Due to growing appeal to corporate tenants.
"The property attracted the attention of about 40 investors."
Ultimately it was won by the investor able to secure a high loan to equity ratio.
"It's unusual for an investor group to be able to borrow such a high percentage of a deal's value, as Mr. Ware's group did.
Participants said it worked because the bank will get an equity like return if the group hits the "jackpot" with the new leasing and land development.
Investors Pump In Cash But Supply Is Lacking (link)
Investors piling money in: "Investors are piling money into real estate funds, but fund managers are finding it challenging to spend it."
Hunt for returns in an Ultra low interest rate environment: "The record level of dry powder comes as investors increasingly have turned to commercial real estate in a hunt for returns. Ultra low interest rates at global central banks have made returns on offices and shopping malls look attractive compared with other asset classes such as bonds.
On par with 2005 to 2008: "Global fund managers have raised $446 billion for commercial property in the past four years, on par with the total raised from 2005 to 2008 in the run-up to the global financial crisis,"
Fierce competition for few properties: "With competition for deals fierce, "it has been much more challenging to invest,"…"There are very few forced sellers,"
"Landlords aren't willing to sell. Their low debt levels and readily available bank financing have made it easy to hold on to properties longer in hopes of reaping bigger paydays later,"
Increasing demand: Deflation & Inflation
'Rideables' Could Curb Car Ownership (link)
Increased demand can have either an inflationary effect or a deflationary effect. Which way it goes is largely dependent upon two factors:
1) The speed at which supply can expand to meet demand and
2) economies of scale.
In the case of electric vehicles, increasing demand has had a deflationary effect:
"…the rapid expansion of the market has led to demand for parts, making them in turn cheaper and more available, much like what happened with mobile phones."
"batteries are getting cheaper at 4% to 8% a year, and that compounding over the last five years has had a massive impact" on the electronic-vehicle industry.
Meanwhile, increasing demand has had an inflationary effect on price of oil and gas service providers (link).
Significant Housing Developments
Mortgage Lending Shift Spurs Worry Over Risk (link)
There's been a big shift in the FHA lending market for single-family mortgage market over the past 10 years.
Topped $1 trillion: "Bonds backed by certain risky single-family mortgages topped $1 trillion for the first time in November, crossing that threshold amid warnings about that corner of the U.S. housing market."
Banks have all but stopped participating: "The result: In the first three quarters of 2016, banks accounted for 9% of mortgage dollars originated by the FHA's top 50 lenders, versus 62% for all of 2010, according to Inside Mortgage Finance. Nonbank lenders accounted for 80% of mortgage bonds backed by single-family FHA loans in July 2016, versus 9% the same month in 2010…This is the biggest shift in mortgage lending since the savings-and-loans debacle in the 1980's."
"It's too costly to originate": "J.P. Morgan Chase & Co., the nation's largest bank by assets, isn't among the 50 largest FHA lenders. In 2013, it was the third largest,"…"It simply is too costly and too risky to originate these kinds of mortgages," Jamie Diamon wrote.
FHA share of the mortgage market has tripled: "the FHA share of the overall mortgage market is larger than during the last housing boom. In the years leading up to the housing bust, FHA loans accounted for less than 5% of annual mortgage volume. Since the meltdown, the share has ranged from 11% to 15% of originations.
FHA loans under Ginnie Mae has Quadrupled since 2007: "That growth has boosted the amount of bonds Ginnie Mae backs. The $1 trillion of outstanding FHA single-family loans in November that it guaranteed compares with $272 billion at the end of 2007. Overall, Ginnie Mae now backs more than $1.7 trillion in bonds, which includes loans backed by other agencies such as the Department of Veterans Affairs as well as the FHA."
Nonbank lending creates market risks: "The funding issue arises because nonbanks don't hold deposits. So they rely on short-term financing, often from banks, mostly to originate new loans. That can dry up in stressed times."
As Power Changes Hands, HUD Makes Swift Move (link)
The Trump administration seems likely to curb large housing affordability programs which make mortgages more accessible to lower income families, but at the same time distort free market dynamics. This would likely put downward pressure on home prices.
Challenges Lurk in the Economy (link)
"The U.S. home ownership rate is near a 50-year low, and the average debt load for college students is rising."
The Confidence Illusion
There's a lot of certainty and confidence going on. Investors are feeling much more confident, the fed is feeling much more confident, consumers are feeling much more confident, etc. But should we trust them? Caution would be the prudent advice.
The article, "Don't Let Others Sway You When Making Investment Decisions" (link), points out that we can be heavily influenced by people with an intense belief in ignorant views.
"We're biologically equipped with the potential to allow more-confident people to have greater sway over our own beliefs,"
"In a paper published in 2000, Prof. Shiller showed that confidence varies, often going up after the market rises and falling after it goes down. The confidence of individual investors rose 4% in July 2008, for instance, right before the market got sucked into the black hole of the financial crisis.
"So you could visualize the stock market as a poltergeist or hobgoblin who takes a twisted delight in play pranks on the expectations of the investing public."
1. Treasury Yields Resume Ascent (link)
Janet Yellen is viewing things positively.
"In a speech Thursday at Stanford University, Ms. Yellen said she doesn't see the U.S. economy at risk of overheating and doesn't expect growth to pick up much soon,"
But be careful to give too much weight to her comments. Remember that after the financial crisis, Alan Greenspan wrote:
"In the run-up to the crisis, the Federal Reserve Board's sophisticated forecasting system did not foresee the major risks to the global economy. Nor did the model developed by the IMF, which concluded as late as the spring of 2007 that "global economic risks [had] declined" since 2006 and that "the overall U.S. economy is holding up well…[and] the signs elsewhere are very encouraging." (link)
Service Providers with High Fixed Costs
For Shale Drillers, Rising Oil Prices Also Come With Rising Costs (link)
Interesting story for a case study:
During a dramatic drop in oil prices, oil & gas companies get a sort of mini-bailout by their service providers. These service providers effectively absorb some of the losses from oil & gas companies, thereby shielding them and making the decline more manageable.
But the effect is a two-way street. When oil price rebound, service providers are quick to raise prices and dampen the benefits of rising prices.
Why does this happen?
The service providers have high fixed costs. Upon declining oil prices, oil & gas companies cut demand for their services. Because service providers have high fixed costs, they will continue to provide services at a loss, sometimes just as long as their variable costs are covered.
I believe you could say that, to some extent, the fixed costs of your service providers or suppliers act as a shield in bad times. They will/must lower their service fees, thereby making the hard times more tolerable.
What should we learn from this?
1) We should look at service providers and suppliers and determine the level of their fixed costs and variable costs.
2) Oil & Gas companies should really position themselves better to take advantage of a decline in oil prices.
Before the decline in oil & gas prices, the whole industry had positioned themselves aggressively. When the crash came, no company was in a position to exploit the lower costs offered by service providers. Or buy oil assets at discounted prices.
Instead, they all waited for a rebound in prices to start working again, at which point, they completely missed out on compelling market opportunities.
The problem with that strategy is that it's hard to do. But as Charlie Munger says, "It takes character to sit there with..cash and do nothing. I didn't get to where I am by going after mediocre opportunities."
Government Corruption & Lee Kuan Yew's Advice
Scandal Rocks Samsung (link)
"(President Park Geun-hye) was impeached last month over allegations that her confidante, Choi Soon-sil, sought to shake down the country's biggest conglomerates for donations in exchange for political favors."
There's just so much corruption being exposed in governments around the world right now. If you're interested in learning more about the roots of corruption and how to stop it, I suggest reading the chapter "Keeping the Government Clean" from Lee Kuan Yew's book, "From Third World to First". Here are a few great quotes:
"Human ingenuity is infinite when translating power and discretion into personal gain." – Lee Kuan Yew
"A precondition for an honest government is that candidates must not need large sums of money to get elected, or it must trigger off the cycle of corruption. The bane of most countries in Asia has been the high cost of elections. Having spent a lot to get elected, winners must recover their costs and accumulate funds for the next election. The system is self-perpetuating." – Lee Kuan Yew
The Best Investment Quote of All Time is from…Napoleon?
December 30, 2016 / Richard Lewis	/ Leave a comment
Could the best investment quote of all time come from Napoleon? Quite possibly. It was in the unlikely place of Napoleon Bonaparte's personal diary that I found one of the best investment passages I've read. Bursting with investing wisdom, it would be understandable to mistake Napoleon for Warren Buffett. Although he's writing about the art of war, the insights apply to investing just as well.
Below I dissect Napoleon's journal entry to ascertain its valuable investing insights.
Importance of mathematics & probabilities:
To be a good general a man must know mathematics; it is of daily help in straightening one's ideas. Perhaps I owe my success to my mathematical conceptions
Beware of forecasts. Buffett & Munger don't invest in a company if they can't see its strength displayed through history:
a general must never imagine things, that is the most fatal of all.
Eliminate psychological biases & crude heuristics which skew one's perception of reality:
My great talent, the thing that marks me most, is that I see things clearly;
Identify the main issues and ask the right questions:
it is the same with my eloquence, for I can distinguish what is essential in a question from every angle.
Practice Bayesian updating:
The great art in battle is to change the line of operations during the course of the engagement; that is an idea of my own, and quite new.
Keep it simple. Stick to the fundamentals and common sense:
The art of war does not require complicated maneuvers; the simplest are the best and common sense is fundamental. From which one might wonder how it is generals make blunders; it is because they try to be clever. The most difficult thing is to guess the enemy's plan, to sift the truth from all the reports that come in. The rest merely requires common sense;
Stay curious. Do a lot of reading & research lots of companies. Eventually you'll come across a good idea:
it's like a boxing match, the more you punch the better it is.
Know how to read financial statements:
It is also necessary to read the map well."
"La victoire appartient aux plus persévérants."
Investment Lessons from a Master Sushi Chef
The best investment book I read this year didn't come from a Wall Street whiz or hot shot finance professor, rather it came from Jiro Ono, a Master Sushi Chef. Yes, "the Jiro", the one from the acclaimed documentary "Jiro Dreams of Sushi."
While in Japan this past September I picked up his book titled "Jiro Philophosy" and was quite surprised. Unlike most investment books, Jiro doesn't talk about investing at all. In fact, it isn't even an investment book. Rather Jiro Philosophy simply describes Jiro's personal work-ethic.
As I read this book, I quickly came to realize just how closely Jiro's philosophy mirrors that of Warren Buffett, Charlie Munger, and Ben Graham. It was quite surprising to see that the same principles which lead to mastery in Sushi can also lead to mastery in investing.
As a result, I have distilled the book "Jiro Philosophy" down to its 12 core principles and relate each one to the investment philosophy of Buffett, Munger, and Graham.
1. Stick to the fundamentals. Stay grounded.
"If you stray from the fundamentals – say, trying to set yourself apart from other chefs – you will completely stray off track. I believe that by adhering to the fundamentals and continuously striving to create delicious flavors, you will be able to be innovative."
"If you continue to do things the right way, it's a given that your sushi will turn out delicious."
Market manias and bubbles all have two things in common; an abandonment of fundamental investment principles and an endless series of rationalizations.
Ben Graham understood the immense rationalization power of markets very well. He experienced it first hand during the lead up to the great depression. It was his understanding that as markets move higher, investors don't become more reserved, but rather they invent knew valuation metrics to justify paying any price whatsoever. As been Graham observed, "We can find no evidence that…investors as a class have sold their holdings because PE ratios were too high."
Consequently, Ben Graham developed an immutable investment philosophy based on strict fundamental analysis to keep investors from "completely straying off track". And much like Jiro Ono, investors who have stuck to Ben Graham's fundamentals of investing have delivered "delicious" results.
With this, I'm reminded of Lou Manheim 's advice to Bud Fox in the movie Wall Street, "Stick to the fundamentals…good things, sometimes take time."
2. Gain Mastery.
"You've got to master some skills to reach the next stage."
"You won't advance to the next level all on your own. You need to train properly up to a certain point. In the case of Jiro, after a decade of training, a craftsman will have mastered everything from preparation to making sushi. He will be ready to strike out on his own."
Warren Buffett pursued and achieved mastery over Ben Graham's investment philosophy before advancing to the next level. Warren's path to mastery took on the following steps:
Discovered Ben Graham's book "The Intelligent Investor" at the age of 19.
Read Graham's 700+ page book, Securities Analysis, at least 12 times.
Attended Columbia so that he could study under Ben Graham.
Worked for Ben Graham at his investment fund.
Invested using Ben Graham's investment principles at the Buffett Partnership.
3. Put Knowledge into Practice.
"People will teach you new things and ideas, but if you don't try them out you will not change."
"No matter how good the teaching, unless you actually put it into practice, you won't be able to progress. You will only have the knowledge. People passionate about their work are always trying to improve upon what they've made. It's enjoyable and rewarding."
"Because of this, we can keep trying new things every day."
Throughout his life, Warren Buffett has shown an amazing willingness and ability to put knowledge into practice. This includes applying the teachings of Ben Graham as well as the four hour educational interview he had with GEICO executive Lorimar Davidson in 1950.
Much of Warren's success simply boils down to seeking out the best knowledge and putting it into practice. Warren recommends you do the same thing:
"You need to fill your mind with various competing thoughts and decide which make sense. Then you have to jump in the water – take a small amount of money and do it yourself. Investing on paper is like reading a romance novel vs. doing something else. You'll soon find out whether you like it. The earlier you start, the better."
4. Improve upon what you're taught. Otherwise you will always be an apprentice.
"Just doing as you're taught is the same as being an apprentice. I tell my young apprentices that they should think about how to achieve good flavor on their own, improve it and then experiment. I always tell them if they don't, they will be apprentices for life."
Although Warren Buffett began his career as Ben Graham's apprentice, he did not simply stick to his teaching. Rather he modified and improved upon Graham's teachings over time. As Charlie Munger describes it:
"If we'd stayed with the classic Graham, the way Ben Graham did it, we would never have had the record we have. And that's because Graham wasn't trying to do what we did."
5. Practice Beginner's Mind. (Shoshin)
Shoshin (初心) is a concept in Zen Buddhism meaning "beginner's mind". It refers to having an attitude of openness, eagerness, and lack of preconceptions when studying a subject, even when studying at an advanced level, just as a beginner in that subject would. (Wikipedia)
"That said, once they've become independent they should still pursue improvement just like an apprentice."
"Feeling you can still evolve is important."
Both Warren Buffett and Charlie Munger are enthusiastic learners who enjoy the process. In fact, Charlie has said that he and Buffett are "dissatisfied with what they know." As a result, they are always seeking to learn, adapt, and evolve.
Charlie further explains the importance of this mindset,
"Warren Buffett has become one hell of a lot better investor since the day I met him, and so have I. If we had been frozen at any given stage, with the knowledge we had, the record would have been much worse than it is. So the game is to keep learning, and I don't think people are going to keep learning who don't like the learning process."
6. The way you do the small things reflects how you do the big things.
Through Jiro's Philosophy, he stresses the importance of the small things. From cleanliness, to hot towels, to the preparation process, rice, etc. All the smallest details are given the greatest care. The way you do the small things reflects how you do the big things.
Likewise, Buffett has a keen eye for detail as displayed by the following two stories:
Story 1:
Buffett also liked Cathy's attention to detail. "When I asked her on the phone how many employees she had, she replied '504.' I love this," said Buffett. "Not 'about 500.' I think she has 505 now and is doing considerably more business. She won't be happy until she has 100 percent market share." (From the book "The Women of Berkshire Hathaway: Lessons from Warren Buffett's Female CEOs")
The following is an excerpt from the Q&A session at the 2016 Berkshire Hathaway Annual Meeting:
Warren Buffett: Yes, sloppy thinking in one area probably indicates there may well be sloppy thinking elsewhere. I have been a director of 19 public corporations. I've seen some very sloppy operations and I've seen a few really outstanding business operators, and there's a huge difference. If you have a wonderful business, you can get away with being sloppy. We could be wasting a billion Dollars a year, at Berkshire, you know $640m after tax, that would be four percent of earnings, and maybe you wouldn't notice it….
Charlie Munger: I would.
Warren Buffett: Charlie would notice it… It's the really prosperous companies that well….the classic case were the tobacco companies many years ago. They went off into this thing and that thing, and it was practically play money because it was so easy to make. It didn't require good management, and they took advantage of that fact. You can read about some of that in 'Barbarians of the Gate'.
7. Listen to good advice.
"I take customers' advice when it makes sense."
"Even when you think you are right often that's not the case. No matter what kind of business you are in, if you only work in an inflexible way, you won't find success."
"If (a customer's advice) makes sense, I will adopt it, otherwise I will never evolve."
Warren Buffett and Charlie Munger have exhibited an open mind and willingness to listen to good advice throughout their careers. In fact, if it weren't for some timely advice they might not have bought See's Candies. As Charlie Munger recounts,
"[Munger's friend] Ira Marshall said you guys are crazy — there are some things you should pay up for, like quality businesses and people. You are underestimating quality. We listened to the criticism and changed our mind. This is a good lesson for anyone: the ability to take criticism constructively and learn from it. If you take the indirect lessons we learned from See's, you could say Berkshire was built on constructive criticism."
8. Preserve your main asset…You.
In his 40's, Jiro recognized that his most critical asset as a Sushi Chef was the sensitivity in his finger tips. As a result, he began wearing gloves in order to preserve the long-term integrity of his hands.
This might seem like a mildly trivial matter, but for anybody looking to achieve and maintain success in their profession, follow Jiro's example: Identify the physical or mental attribute that is necessary for success in your field and take measures to preserve it.
Warren Buffett identifies the most important trait of an investor as "emotional stability". As Warren explains,
"To be a successful investor, you don't need to understand higher math or law. It's simple, but not easy. You do have to have an emotional stability that will take you through almost anything. If you have 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's most important is inner peace; you have to be able to think for yourself. It's not a complicated game."
Similar to Jiro's practice of wearing gloves to protect his hands, here are some routines and strategies which Buffett uses to maintain emotional stability, inner peace, and independent thought.
An alert and fresh mind:
Warren gets good sleep and takes naps when necessary
He plays bridge many hours every week.
A temperament uncorrupted by outside influences:
He Lives in Omaha
Maintains a Clear Schedule
Keeps a quiet office where he can think.
"My diet, though far from standard, is somewhat better than usually portrayed. I have a wonderful doctor who nudges me in your direction every time I see him. All in all, I've enjoyed remarkably good health — largely because of genes, of course — but also, I think, because I enjoy life so much every day."
Furthermore, Warren explains the importance of preserving and enhancing yourself through life:
"Imagine that you had a car and that was the only car you'd have for your entire lifetime. Of course, you'd care for it well, changing the oil more frequently than necessary, driving carefully, etc. Now, consider that you only have one mind and one body. Prepare them for life, care for them. You can enhance your mind over time. A person's main asset is themselves, so preserve and enhance yourself."
9. Be a craftsman. Pursue work to satisfaction.
"Pursuing work to satisfaction is the pride of a craftsman. No matter how time consuming, I will leave no task to others. I will do them all myself until satisfied. Even as I get older, I still do all the work, even if it's bothersome. I feel very pleased when I develop and create something from a new idea of my own."
Likewise, Buffett takes pleasure in doing all the investment analysis himself. He does not have a team of analysts working for him.
10. Be passionate about what you do.
"People who love their work passionately want to continue working. I'm no exception. Although I'm 90 years old, I'd like to keep on going. That's why I don't find investing time in my work troublesome."
At 86 years old, Buffett still tap-dances to work. He derives great enjoyment from researching different companies. He compares it to researching different species of animals.
11. Adapt to changing circumstances.
"Since all sushi toppings are changing, sushi craftsman must now factor this in when working out flavors."
"The oceans are quickly changing. For example, the season for katsuo (skipjack tuna) now starts six months later. But we have to serve the best of what's in season. Fish and shellfish were tastier in the past and it is difficult to find their intense flavors. The next generation of sushi chefs will face challenges in trying to find ways to bring out and enhance fish flavors."
Likewise, in investing you cannot wish for something which doesn't exist. You must play the hand that you're dealt.
When Warren Buffett started investing, he could find net-net investments everywhere. But the investment ocean quickly changed and he had to adapt to the circumstances. Over the years, Buffett has invested in a broad range of investment classes including, bonds, common equity, preferred stock, warrants, options, commodities, and special situations. He doesn't wish for something that doesn't exist, rather he adapts himself to whatever asset is on sale below his intrinsic value.
At the same time, Warren will never abandon his core principles and rationalize new investments. During the "Nifty 50" stock market, he declared that he couldn't find any cheap stocks and refused to invest. Later Buffett refused to invest in tech stocks during the tech boom of the 90's. In each case Warren has been rewarded for his patience and sticking to the fundamentals.
This leads to a crucial point. Although you must adapt to changing environments, you must also remember to stay true to the fundamentals. As it says in rule number 1, "If you stray from the fundamentals…you will completely stray off track."
So remember: Adapt, but do not abandon.
12. It's never too early to prepare
"It's never too early to prepare. You can start preparation way in advance."
Jiro began working at a local restaurant from the age of seven.
Likewise, Warren Buffett recalls his youthful experience: "By the age of 10, I'd read every book in the Omaha public library about investing, some twice."
Furthermore, Buffett said he read the 10Ks of IBM for fifty years before ultimately making an investment in the company. That's fifty years of "preparation."
Jiro Philosophy: Distilled
Distilled: The Education of a Value Investor by Guy Spier
January 26, 2016 / Richard Lewis	/ Leave a comment
Distilled Series Introduction:
Welcome to the Distilled series where I'll take some of the most influential and powerful books and concentrate their core ideas down to their most essential points.
The first book in this series proved to be quite influential on my life in 2015. For that reason, I'm excited to present The Education of a Value Investor by Guy Spier, Distilled.
Distilled: The Education of a Value Investor
Virtuous Cycle & Tilt the Playing Field:
The following section expands on the ten core elements. When reading, keep in mind that although these core elements are listed as discrete and definable concepts, they are not entirely independent of each other.
Each element interacts with the others in the form of a virtuous cycle. Meaning that when you make a positive change in one point, it will positively influence another point, which may then positively influence another point, and so on through the whole system.
Additionally, Guy emphasizes the importance of doing things that tilting the playing field in your advantage. Like a casino, you only need to have an imperceptibly small advantage. But given that enough 'bets' are places over time, you will come out far ahead. These ten points capture the general process Guy used to tilt the playing field in his advantage.
Expanded: The Education of a Value Investor
Commit Yourself Completely
Guy doesn't embrace ideas with half measures. He has shown that whether it came to both his academic and financial pursuits early in his life, or a Value Investing career later in life, he takes things to the nth degree.
"Life can change in a heartbeat." A goal that seems impossible can become entirely possible if we're willing to commit every ounce of energy to it.
This is certainly one of his main strengths. Few possess the capacity to commit themselves so completely to an idea or a pursuit. We should strive to do the same. For as W.H. Murray wonderfully stated;
"Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative, there is one elementary truth the ignorance of which kills countless ideas and splendid plans: that the moment one defiantly commits oneself, the providence moves too."
Imagine Your Future
This point was only briefly referenced, but it's certainly a critical element to both his re-education process and pursuit of an investing career.
I've often found that we have to imagine our future before it can happen
Brainwash Successful Habits
Guy talks favorably about brainwashing successful habits. Specifically he talks about needing to re-wire himself after his brief career at D.H. Blair.
This re-wiring process, by way of brainwashing successful habits, can aid the switch from a life dictated by an external scorecard to one defined by an internal scorecard. Guy calls these positive habit changing techniques a powerful tool in reconfiguring our consciousness.
"When your consciousness or mental attitude shifts, remarkable things begin to happen."
Create the Right Environment & Network
Guy talks extensively about the importance of the Right Environment & Network. Your environment has a massive influence on you, and the importance to set up a positive environment cannot be stressed enough. This includes arranging your work space, choosing the city where you live and work, and the people you associate with.
In fact, he left New York to go to Switzerland where his environment would be more insync with his personality, personal limitations, and career.
Our environment is much stronger than our intellect. Remarkably few investors-either amateur or professional-truly understand this critical point.
Guy says "Nothing, nothing at all, matters as much as bringing the right people into your life." Specifically, he espouses the benefits of being involved in a Mastermind group. Seemingly all influential people participate in one. Benjamin Franklin had "the Junto", Warren Buffett has "the Graham Group", and Guy Spier has "the Latticework Club".
More generally, he writes how critical it is to get into the orbit influential people and other like-minded, motivated, and giving people.
It's really a question of choosing to have certain people in your life (however tangentially) who embody the values you admire… creating the right environment or network helps to tilt the playing field subtly in the right direction so that you can become far more likely to succeed. Advantages are often created imperceptible step by imperceptible step, so it makes a difference to enter the universe of a firm like Ruane Cunniff.
Furthermore, he stresses the value being a giver, as well as the need to surround yourself with people who are givers and matchers, while weeding out the "takers".
What Would Buffett Do?
Tony Robbins calls this process "modeling". A related process is known as "Matching and Mirroring". Guy said that sitting down at his desk and actively imagining what Warren Buffett would do if he were him was one of the biggest elements which helped him get unstuck early in his Value Investing journey.
"Desperate to figure out how to lead a life more like his, I began constantly to ask myself one simple question: "What would Warren Buffett do if he were in my shoes?…The minute I started mirroring Buffett, my life changed. It was as if I had turned in to a different frequency. My behavior shifted, and I was no longer stuck.
He suggests using matching and mirroring to bring mentors into your life which you may not have immediate access to. You can do this by imagining them in as much detail as possible, even down to how they'd breath, walk, and act. This involves gaining a detailed understanding of them.
Choose teachers that have come to learn the truths that you still need to learn. "If you apply this lesson, I'm certain that you will have a much better life, even if you ignore everything else I write."
Play the Value "Lottery"
Guy really prescribes a lot of value to this concept. He has described how most people misattribute his success, preferring to believe that it came from the elements like the fact that he went to Harvard & Oxford. Instead, Guy prescribes a large portion of his success to playing the Value "Lottery". Guy describes this process as;
Doing something with an uncertain but potentially high upside. The payoff may be infrequent, but sometimes they're huge. And the more often I pick up these lottery tickets, the more likely I am to hit the jackpot. Doing this will subtly tilt the playing field in your advantage.
The payoff follows an exponential path. At the beginning, it looks like you are accruing no value, but in the long run, you experience large benefits. He says that you often have to do these things for 5 to 10 years before you start to see the true benefits from them.
"Over a lifetime, a myriad of simple actions like these can accumulate to create big reputational and relationship advantages. It's not about luck. It's about working harder to get these things right so that it becomes more likely that something good will happen."
The value lottery generally involves taking small actions which will benefit you on the margins. By far his favorite way to play the value lottery is through writing thank you notes. Guy started this program over a decade ago where he forced himself to write three thank you notes a day, five days per week. He now estimates that he's written over 30,000 thank you notes in his life.
Every letter I wrote was an invitation for serendipity to strike. To many people, it might seem like a waste of time. But I couldn't win the lottery without a ticket, and these tickets were almost free. In a sense, this is a value investing approach to life: pick up something cheap that may one day prove to be precious."
For more on this topic, you can also listen an interview with The Investor's Podcast and a talk at Google where he elaborates further.
Take the Inner Journey: Be Authentic & Use an Inner Scorecard
It's like that Guy focuses on this concept the most. It's a critical concept if you hope to be a successful investor. He attributes temperament to being the main reason for his investing success. Likewise, Warren Buffett says that investing is 90% temperament, and that if you had an IQ of 160, you can sell 30 of your IQ points because you don't need them.
One of my favorite quotes of the book falls under this section of the book. It explains the need for investors to undertake this inner-transformation quite elegantly:
The goal is to become more self-aware, strip away your facades, and listen to the interior. For an investor, the benefits are immeasurable because this self-knowledge helps us to become stronger internally and to be better equipped to deal with adversity when it inevitably comes. The stock market has an uncanny way of finding us out, of exposing weaknesses as diverse as arrogance, jealousy, fear, anger, self-doubt, greed, dishonesty, and the need for social approval. To achieve sustainable success, we need to confront our vulnerabilities, whatever they may be. Otherwise, we are building our success on a fragile structure that is ultimately liable to fall down.
Guy states that it's not only important to becoming a good investor, it's reward is something greater.
But the real reward of this inner transformation is not just enduring investment success. It's the gift of becoming the best person we can be. That, surely, is the ultimate prize.
Know your limitations & work around them
The element of knowing your limitations comes from both an understanding of ones self, as well as a general acceptance of the short-comings of the human mind. Only then can an investor structure a process to work around these flaws.
"The real challenge, in my view, is that the brain itself-which got us to where we are-is the weakest link. It's like a little boat, adrift in a sea of irrationality and subject to unexpected storms.
Specifically, this involves creating the right environment where you can think rationally and developing an investment process using checklists that can help you avoid making classic (subconscious) mental mistakes.
The goal isn't to be smarter. It's to construct an environment in which my brain isn't subjected to quite such an extreme barrage of distractions and disturbing forces that can exacerbate my irrationality. For me, this has been a life-changing idea.
Pursue Practical Knowledge
Guy learned about many sophisticated economic and financial models during his time at Harvard and Oxford, but he found them to be totally inadequate at explaining how the real world works. Beyond entertaining people at dinner parties, they were essentially useless.
"The trouble is, economic theories like these tend to be based on intellectually elegant assumptions about how the world operates, not on the messy reality in which we actually live."
Instead, his "Second MBA" focused on pursuing practical knowledge that explained how the world actually works. This concept was likely formed out of Charlie Munger's concept of a Latticework of Mental models. Charlie states that this kind of education isn't rewarded in the academic world, but is invaluable when it comes to investing.
"For a while, these books (Think and Grow Rich, How to Win Friends and Influence People, Tony Robbins) became my life instruction manuals. I wasn't reading them to sound intelligent at dinner parties; I was mining them for useful ideas to implement in my life. They provided me with critical first steps in my education as a value investor and businessman, exposing me to a more practical way of thinking about human nature and how the world really works."
Just Do It.
Guy only briefly talks about this topic, but it was a key element to his success. Continually throughout the book, Guy opted to take action rather than "pontificate in the library". This is an important lesson for for anyone else who struggles with perfectionistic tendencies and/or procrastination habits.
"Robbins hammered into my head the idea that, if you want to get somewhere, anywhere, and you're stuck, "Just Do It! Just make a move. Any move!" This might be obvious to many. Hell, it was obvious to me. But my bias toward analysis-paralysis meant that it was easier for me to pontificate in a library than to act. Robbins convinced me that I had to break the patterns of negative thought, push through my fears, and get moving."
Reviewed: The Education of a Value Investor
The Omaha Effect:
On May 2nd, 2015, I attended my first Berkshire Hathaway Annual Shareholder's Meeting in Omaha, Nebraska. I happily flew 1,300 miles and committed 4 days of my time and money for this moment. Why would I do this? Simple. I read The Education of a Value Investor by Guy Spier.
My admiration for Warren Buffett stretches back to the mid-nineties, where Berkshire Hathaway's lofty share price first caught my attention and imagination. And yet, even after two decades of admiration for Buffett, I never foresaw attending the Berkshire Annual Meeting. That changed after I read The Education of a Value Investor.
This book caught my imagination, much like BRKA's share price in the mid 90's. As a result, I began to change the way I thought and acted. This included my attitude towards attending the Annual Meeting. It was no longer an intriguing idea, but rather a necessity.
In this matter, I was not alone. While in Omaha, I attended the Yellow BRKers meeting at the DoubleTree hotel. In his book, Guy affectionately writes about Yellow BRKers and the influence of this endorsement was immediate felt. Alex Bossert, the host of the event, stated that 2015 was Yellow BRKers largest crowd to date. He went on to directly link Guy Spier's book as the likely cause.
Upon talking with Yellow BRKer attendees, I found that there was a general air of reverence surrounding The Education of a Value Investor. He had obviously struck a cord. I even encountered several people who, like myself, after reading Guy's book, were inspired to attend the Annual Meeting for the first time.
It's not often that you find a book that influences people in this way. Here in Omaha I'd found a group of people that were inspired enough to act on the the advice and insights they'd read. This group of value investing enthusiasts and professionals were the best endorsement a book could receive.
This year, I will be returning to Omaha to attend the Berkshire Hathaway Annual Meeting for the second time, and it all started with reading the Education of a Value Investor.
Honesty, Influence, and "the Value Investing Life":
How then does a book make such a big influence on so many people? Likely in the same way that both Tony Robbins and Warren Buffett managed to influence Guy Spier so effectively. Honesty. Guy embraced the teachings and values of both of these men because they were honest and authentic. Now, Guy has managed to resonated with his readers by following the same path.
Accordingly, the book addresses the importance of taking the "inner journey". About playing by an inner scorecard and being authentic. But these elements aren't simply about how to live a better life. Instead, they are essential for anyone wishing to become a successful investor. That's because you cannot hope to outperform the market if you live your life defined and dictated by external forces. You must first make an internal change, and only then are you prepared to be a successful investor.
Warren Buffett Insights:
Guy provides unique insights into the investing genius and life of Warren Buffett. He was able to accomplish this because he approached Warren with great reverence. He paid close attention to even the smallest details and mined Warren's life for the elements of success which he could then mirror in his own.
As a results, reading this book will introduce the reader to insights which most people tend to overlook.
The Second MBA:
Guy's journey to becoming a value investor was not a linear path. Instead, he spent his youth and early career pursuing prestigious academic degrees, a prestigious wall street job, and the success that goes along with them. His life only started to change after he experienced something of a career existential crisis.
Upon finishing his Harvard MBA he began working for D.H. Blair, an investment bank which he later discovered was a morally compromising environment (akin to the infamous Stratton Oakmont). Up until that point, he had been living his life dictated by an "external scorecard". For that reason, he lamented that he wasn't able bring himself to leave his compromising employer as soon as he should have. After 18 months, he quite his job and began what he referred to as his "Second MBA" (aka "The Education of a Value Investor").
Spend a lot of time Sitting & Thinking. Warren Buffett 'demands' it!
Buffett 'Demands' It
The following quote is perhaps my favorite saying from Warren Buffett. It's a simple yet powerful formula that dictates most of his day.
I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business. I do it because I like this kind of life. – Warren Buffett
Read. Sit. Think. It doesn't get much more straightforward than that. And yet, it's easy to overlook this quote or simply take it as mere suggestion. But the key word in his statement is 'insist'. That's a far cry from an off-handed recommendation. In fact, Websters dictionary defines 'insist' as, "to demand that something happen or that someone do something."
In other words, Warren Buffett demands it. He demands it! For anyone looking to learn from the investing wisdom of Warren Buffett, this is a good place to start.
That's why I made the picture below and hung it on my wall. It's a reminder every day that this isn't a recommendation. I must spend a lot of time reading and thinking.
Sit and Think
Cloning and Greatness
There's a second reason why I love this quote; it's unoriginal. In fact, you can trace the origins of this quote back through a long line of great men who unapologetically copied each other.
I like to imagine that Warren derived this insight from Ben Franklin, whom both he and Charlie Munger admire greatly. A quote mirroring Warren's is found in Poor Richard's Almanac where Ben Franklin wrote;
Reading makes a full man, mediation a profound man, discourse a clear man. – Benjamin Franklin
But the wisdom copying machine doesn't end there. Ben Franklin openly admitted that most of his Poor Richard's quotes were unoriginal. His typically strategy was to rewrite classic wisdom and proverbs into catchy sayings. In turn, Ben Franklin likely derived his famous quote from John Locke whose writings were a big part of Franklin's self-education. John Locke wrote;
Reading furnishes the mind only with materials of knowledge; it is thinking that makes what we read ours. – John Locke
Once again, John Locke likely derived this statement from influential thinkers he studied, such as Thomas Hobbes, Descartes, Cicero, Aristotle, and Plato. All of whom wrote extensively on the importance of thinking and meditating.
There's a distinct pattern to this. Great men, copy the wisdom of great men who came before them. Or as Charlie Munger puts it;
I believe in the discipline of mastering the best that other people have ever figured out. – Charlie Munger
This process is also known as "cloning". Warren is a Grandmaster at cloning. In his life, Warren has notably;
Mastered the fundamental principles of value investing from Ben Graham.
Mastered the fundamentals of the insurance business from Lorimer Davidson.
Evolved as an investor by embracing the ideas of Charlie Munger and Phil Fisher.
Warren Buffett has an uncanny ability to learn the best ideas that already exist and adopt them completely into his own knowledge and philosophy.
This speaks volumes to the value of "cloning". As investors, we should endeavor to do the same and master the best of what Warren Buffett has learned. We can start here.
Read. Sit. Think.

redpajama_set_name: RedPajamaCommonCrawl