1-24-2020

Thesis
 
“Money just sort of finds the people who do valuable things.” 
~Tobias Lutke
 
Below I discuss the premise of investing and why it is important to invest intelligently. None of the below is investment advice. 
 
But first, to finish up my thesis from a couple weeks ago, San Diego is certainly the best city in America. I doubt that it will grow like SF or LA has, but it should grow nonetheless. 
 
Ok, back to the program.
 
The original theory in markets was to buy pieces of businesses so that you wouldn’t need to build the business yourself. This has been lost on many. I suggest re-reading The Intelligent Investor. Especially chapters 8 and 20. Alternatively, “The Theory of Poker” by David Sklansky provides a similar philosophy.

More important is to know what not to do, such as buying bargains, if you relate to the following:

The bargain hunter – constantly agonizing about whether the bargain purchased was justified. Finding bargains may be unfortunate, actually. As Warren Buffett says in his 1989 shareholder letter “I could give you other personal examples of “bargain-purchase” folly but I’m sure you get the picture: It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Truth is, you might find second rate companies cheap that advance in value, but you worry about when to sell them, since you also know that you can’t hold them forever. 

 
Buy quality and hold forever. Buffett on bargains. Early in my career, a very senior financial advisor in my Toastmasters group had bought a Topeka Kansas 60 unit multifamily complex years before. He was getting squeezed on his loan, vacancies abounded, and most nights he couldn’t sleep. His advice – don’t invest in Topeka; which I interpret now as “Don’t chase bargains”.  
 
Discerning a fallen angel from a value trap (AKA coiled spring or wet napkin) is extraordinarily difficult, and only really works when the investing opportunity is a ‘one foot hurdle’. I.E. when it’s a no-brainer.
 
Today there are around 300 public companies worldwide worth over $40 Billion, and at least 8,000 public corporations (i.e. not partnerships) under $40 Billion. Those 300 companies are therefore the top 4% in the world, yet the question is how many companies will join the group 10 years from now? This is the best question that a true investor should consider.
 
Allow me this generalization: nearly 50% of the most wealthy people in the country have done so on less than 3 investments during their lives. In fact, overall, 2% of all investments will drive 99% of the returns globally. To the people that think diversification is the only way to invest, there are certainly other ways. The volatility can be gut wrenching, but if you pick the right one, you too might reach spectacular wealth. 
 
Case in point – Michael Sacca with Twitter and Mayasoshi Son with Alibaba. 
 
These two billionaires would have found it harder to get to the prestigious ‘three commas’ without that single great investment, and frankly aren’t smarter than any other investor. 
 
Some of these opportunities happen in the private markets first, but those markets are becoming more liquid, destroying the potential for a huge winner down the road. Thus, Private investing rarely pays off as much as public investing in the future. Furthermore, new SEC legislation might allow leniency on who is allowed to invest in private market funds. Scary proposition for some people who don’t understand the opaqueness/illiquidity of such vehicles.  The idea in both private and public markets is to buy ’em young.
 
Buy ’em young…
 
Let’s define the Buy ’em young description further. Amazon hasn’t been a $40 billion company since 2009 and Apple was last there in late 2006. These are obviously now the top dogs, but the question becomes, what $40 Billion companies will be at the $1 trillion ranks in 13 or 14 years? If you held Apple the entire time, you would have realized around a 32% annual return, and that’s through the ‘Great Recession’. Amazon has sported a 37% CAGR since the $40 Billion mark. Apple has been more volatile, dropping more than 30% on 3 different occasions. Over a 10 year and 13 year period, the S&P 500 gained 13.9% and 7.3% per year, respectively.
 
Alternatively, an investment in the S&P index was still a huge win for investors – 13.9% per year. A $100,000 investment would have become $367,000
 
A $100,000 investment in Apple would today be worth about $3.6 Million… Nonetheless, Apple is categorized as a value investment… I’ll address this in future memos.
 
The best companies with great products/ideas tend to attract smarter people and get better, and as they take bigger ideas they then attract more people to ensure the ideas have the greatest chance of success. Legal and financial abilities at the best companies outweighs those of most nations. This is one of the reasons that antitrust fails to regulate new tech companies – antitrust laws are too rigid, which is its biggest weakness. Of course, regulatory risks persist.
 
So, software price multiples are different than other industries – on one hand because regulatory challenges and on the other because the recurring cash flows have very little overhead. The cash flows a technology brings is similar to an annuity – you just need to be sure that the end technology customer will pay into the annuity over a long time horizon. The thought is: if the product is good, eventually the SGA costs will be greatly reduced, paving the way for incredible cash flows. 
 
But I digress…
 
The point I harangue is that the buy and hold strategy (i.e. investing) does work if you hold great companies for over 10 years or more. You really can outperform the market, but not in the short term and you can’t do it with dishonest companies or companies without durable advantages. 
 
For many investors, the waiting and holding for decades idea is incredibly tough in and of itself. The focus required to understand that business and shake off those 30% drops. Though many such investments are very obvious at the time (Steve Jobs at Apple was at the top of his game in 2006), sticking with them is the hard part.
 
There of course is the idea that ETF’s are taking over the markets, and mostly that is true, but it can never be entirely true. If it were, the value of companies would be completely dependent on the inclusion into and performance of ETFs. This, in my mind, could lead to monopolistic behavior and deterioration of CFO (Chief Financial Officer) status. After all, the value of a corporation needs to act on its own. If not, the mismanaged would be over incentivized and the properly managed would be under incentivized. You buy companies, not their prices.
 
Apple’s rise just so happened to coincide with the rise in ETFs which began largely in 2003. This isn’t pure serendipity, but the correlation is probably somewhat spurious in reality.
 
If you want to generate additional alpha with trading, there is usually one very good trading opportunity per month in the US Markets, but many such opportunities are short term in nature, and may be the second-rate ‘bargains’. You’d be better off focusing all of your attention to keeping the few companies in your portfolio performing (read the Buffett quote above).
 
A few other thoughts-
 
Book value is mostly a misnomer – PPE is valued net of depreciation and buybacks reduce the value of equity in high magnitudes versus the issue prices of the stock. I will not expand on this, because it’s pretty sophisticated and complex. 
 
Banks are rising interest rates without the threat of inflation and with lower and lower interest rates. This means that real revenue is growing yearly while expenses are staying the same or dropping. Very close to a perfect storm situation and effectively ruining bond yields.
 
So fixed Income isn’t attractive unless we have a stock market drop. In that respect, how can you time the market? If you are making money in fixed income right now, you are either buying junk, private debt, or you are earning a spread OTC (over the counter). I’d argue that these ways of profit would get killed in a recession. 
 

Psychologically, bonds make sense. But if you don’t need the money you are investing for 10 years, the return just cannot compare at all to equity. I hope this reverses and I can buy fixed income again. The 1980’s were such a special time… 

For me, 2019 was a year of a peculiar record. I have been solicited by over 400 different businesses for services; none of whom I ever knew before the solicitation. A few of them did have services that sounded appealing, such as the life insurance settlements businesses, but they all amounted to more talk than walk. I expect this number to at least double in the next two years based on monthly growth. Perhaps there’s a way to make money from the trend…
 
Finally, as they say, waiting to invest is like saving up sex for old age. Of course it is hard to buy at highs currently, but how can anyone time the market with so much vanity in the GOP? Your move Trump.  
 
Until next time, keep buying low and selling high. See you in Omaha at the Berkshire Hathaway meeting!

 

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