I just uploaded my full audio recording of the 2018 Daily Journal Meeting to SoundCloud.
My full transcript of the 2018 DJCO Meeting is now available. You may read it here: link
I just uploaded my full audio recording of the 2018 Daily Journal Meeting to SoundCloud.
My full transcript of the 2018 DJCO Meeting is now available. You may read it here: link
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.
“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;
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:
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)
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
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.'”
“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
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.”
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,”
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
“They’re emulating people who are out there – athletes, musicians, military personnel – people they look up to,”
“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.'”
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”
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,’.”
Youths’ tattoos aren’t always cause for alarm, report says (link)
“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.”
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.
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:
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’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:
Investment Lesson: Actively look for assets that have burned investors. They may present excellent opportunities due to;
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.”
Deprival Super-Reaction Syndrome
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
Wall Street Needs You to Borrow Against Your Stock (link)
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.
“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.
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:
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:
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,”
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.
Question: Would customers choose this company’s product or service if they were well informed and had access to their competitor’s products/services?
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;
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.”
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.”
“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.”
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.
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?
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
Why China Can’t Stop Hating Japan (link)
“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)
Incentive Caused Bias
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.‘”
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
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.
“‘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: April 10-16, 2017 (Week 15). Please Enjoy.
Companies who buy things they do not need, will soon have to sell things that they do. Toshiba is learning this lesson the hard way.
“Toshiba is looking to cash out (its prized computer-chip business) assets to stay alive.” (link)
“Last month, nuclear-reactor maker Westinghouse Electric Co., which is majority-owned by Toshiba, filed for bankruptcy in the U.S., and Toshiba said it expected to book a 1 trillion Yen loss…to account for losses at Westinghouse.”
The stock market works like a wealth transfer mechanism which funnels money from the impatient to the patient.
As a patient investor, Warren Buffett has been on the winning side of this equation for his entire career. He has capitalized on companies selling things they need in order to pay for things they didn’t. An excellent example includes his purchase of a pipeline from Dynergy in 2002.
In November 2001, Dynergy had bought a pipeline from Enron for $1.5 billion. But not too long after, its credit ratings collapsed and it desperately needed to lower its debt levels. So in July 2002, just 8 months later, it sold its pipeline to to Berkshire Hathaway for $928 million. And there you have the wealth transfer mechanism at work. (link)
I don’t think we’ve come to grips with just how easy it is for a communist government to game a capitalist system. Let’s take the following quotes for example:
“A recovery in producer prices in China and a broad rally in commodities have helped stoke Chinese stocks in Hong Kong,” (link)
“The economic data is not bad, and commodity prices have increased compared to last year.”
I tend to view this news with great skepticism. Reason being, there’s just too much incentive for communist governments to manipulate commodity prices through artificial demand. The positive ripple effect of artificial demand through a free-market system is profound. Just a little bit can go a long way as I describe below.
An entire eco-system is then built on top of the foundations of artificial demand. The longer this heavy handed market manipulation persists, the more real investors perceive it to be, and the bigger the bubble becomes.
As Gordon Gekko said, “The illusion has become real, and the more real it becomes, the more desperate they want it.”
There were many great examples of human misjudgment in last week’s WSJ:
Wells Fargo: (link)
United Airlines: (link)
Commins & Columbus, Indiana: (link)
Disliking Bias & Pavlovian Association: “To top it off, Lotte this year became the target of raucous protests by Chinese nationalists, who uploaded videos of themselves ripping up Lotte products in stores…The Chinese protests,…came after the company made a deal that allows the U.S. military to put a missile-defense battery on a Lotte golf course in southern South Korea.”
The other week an analyst suggested that Apple could acquire Disney if there’s a cash repatriation holiday. When asked for the probably of such a deal, the analyst responded that it’s “greater than 0%” (link)
“Greater than 0%” means practically nothing. For example, I’d bet there’s a greater than 0% chance that we’re in the Matrix. So the chance that we’re living in a vivid computer simulation and that Apple could acquire Disney both have probabilities greater than 0%…
It’s been found that higher rates of Thyroid Cancer are caused by:
This is a mind-blowing article about genetic modification. It revolves around Crispr, a bacteria is found in the our immune system’s bacteria and acts like “the Borg” from Star Trek to fend off future diseases. Scientists want to hack Crispr and use it to cure genetic diseases. Ultimately, they could use Crispr to hack egg, sperm or embryos to pass on genetic alterations, thereby permanently altering future generations.
I can just imagine a future where genetic modifications replace vaccinations. It also makes me uncomfortable thinking about the Gattaca-like implications and abuses of such technology.
Investing in a foreign country is often akin to investing in non-voting B Shares of common stock or Subordinated Debt. While such investments will allow you to share in a country’s success, it also means that you may share disproportionately in the country’s woes.
Foreign investors are particularly vulnerable to “economic persecution” during periods of political or economic hardship. When a country or political party becomes concerned about self-preservation, foreign investors, who are not part of their “shared identity”, become easy targets for their ire.
The following are three examples where foreign investors were treated as a subordinated class. From them, we can extract some valuable lessons.
Indonesia has been targeting foreign copper mining corporations with higher taxes and increased pressure to sell their Indonesian assets to domestic investors.
“As part of its push to earn more from the mining sector, Indonesia banned ore exports and placed restrictions on exports of mineral concentrates in 2014 to push companies to invest in domestic smelting.” (link)
“Indonesia has asserted more control over foreign investment with the aim of redistributing economic benefits in a more equitable manner, an effort that began after the fall of dictator Suharto.”
“It said the divestment obligation was meant to “facilitate” mining companies to join with the government and “bring justice” for the people of Indonesia as the “absolute” owners of the country’s resource wealth.”
“Freeport derives roughly one-third of its copper output from Indonesia.”
Brazilian prosecutors were surprisingly aggressive towards Chevron after an oil spill in 2011. They sought $20 billion in damages and filed criminal charges against the executives. Meanwhile, State owned oil company Petroleo Brasileiro which owned 30% of Chevron’s well, was not sued by the Brazilian government. (link)
“But Brazil remains a politically challenging place to operate, with complex environmental licensing procedures and requirements that a lot of equipment and labor be made and hired locally.”…”Oil companies were rattled in 2011 when a minor oil spill by Chevron prompted Brazilian prosecutors to seek nearly $20 billion in damages and file criminal charges against executives. The charges were ultimately dropped, and Chevron agreed to pay $42 million to settle the suits in 2013.” (link)
In 2015, Russia passed a law limiting foreign ownership of Russian media companies to 20%. There was really only one company affected by this law, CTC Media, whose stock price subsequently crashed. Before the announcement, CTCM had attracted many value investors who were enamored with its strong financials and compelling valuation. (link)
What good is it to own a foreign company if you’re forced to “sell low” every time things get bad in that country?
The financial industry uses “tombstones” to announce particular transactions. Perhaps we should use tombstones to announce economic mistreatment of foreign investors. Using the examples above, I imagine they’d look something like this:
Be aware that governments can often turn on foreign companies or investors when it suits them. Before investing in a foreign country, ask yourself:
Whether you’re buying a stock or drafting an NBA player, it pays to avoid standard causes of human misjudgment. (link)
In the case of the 2008 NBA draft, most NBA teams committed a huge error of omission when it came to Russell Westbrook. He went overlooked and underappreciated by nearly everyone but the Seattle SuperSonics. There were three key causes of misjudgment associated with this oversight:
“There wasn’t much data to predict his future. Most experts pegged Westbrook as a mid-first round pick.” (link)
“He didn’t start in high school until his junior season and didn’t earn a scholarship to UCLA until after his senior year. He couldn’t dunk until he was 17 and owes his career to a late growth spurt that shot him to 6-foot-3.”
“Westbrook’s combine performance, against players who were supposedly better than him, only made the Sonics more curious. ‘He was the best athlete in the gym,’ Weaver said. ‘I was sitting in my seat trying to contain myself.'”
“One day, Weaver went to Presti’s office and declared: ‘I’m looking at everybody, and I don’t understand why this guy is not the best of the group.'”
“If you can keep your head when all about you are losing theirs…” (link)
“There’s never going to be a formula that will make you rich just by going through some numerical process. If that were true, every mathematical nerd that gets A’s in algebra would be rich. That’s not the way it works.” (link)
“Interestingly enough, although I consider myself to be primarily in the quantitative school…the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight”. This is what causes the cash register to really sing.” (link)
The Seattle SuperSonics relied on qualitative factors such as Russell Westbrook’s character, competitive drive, and shear athleticism, to develop a high-probability insight that paid off in spades. (link)
“That was the day Westbrook sold him. Presti and Weaver looked at his story-overcoming the odds to become an indispensable part of a winning team-and saw his relentless competitive streak. ‘We don’t know how good Russell Westbrook will be,’ Presti said, ‘but the person that Russell Westbrook is will allow him to maximize his potential.'”
Following the 2017 Daily Journal meeting, Charlie Munger treated everyone who stayed to an informal fireside chat. For over two hours, he graciously answered any questions. I transcribed this fireside chat verbatim and as accurately as possible.
The Full Transcript is 15,508 words. It was transcribed from this fantastic 1 hour and 48 minute recording of the talk. Below is a sample of this transcript.
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Location: 949 E 2nd St, Los Angeles, CA 90012
Event: Informal Fireside Chat following the DJCO Annual Meeting
Date: February 15, 2017
Start of Transcript
(Video 1 of 22 0:27)
Charlie: …Why do you want to strain and (feel like you) have more danger when you’re already filthy rich? As Warren says, ‘What difference does it make to him if he has an extra zero on his tombstone?’.
Question: For return on invested capital, isn’t that already taking into account leverage?
Charlie: Well of course everybody would rather have billions with a high return on capital.
(Video 2 of 22 0:04)
(Video 3 of 22 0:28)
Question: What’s your reading habits every day?
Charlie: I read 3 or 4 newspapers when I get up in the morning, and I always have two or three books that I’m reading. I kind of go back and forth between them. And that’s what I do. That’s what I’ve done all my life.
Question: What are your four newspapers?
Charlie: Wall Street Journal, New York Times, Financial Times, L.A. Times. (Questioner: No Washington Post?) No, no Washington Post.
(Video 4 of 22 1:14)
Question: (Question Regarding deferred gratification)
Charlie: What about medical school, that’s a lot of work. You’re not living very high or this or that. Later you’re a doctor and you have a better life. That’s deferred gratification.
Question: So Charlie, you’re the chairman of the Good Samaritan Hospital, do you have any recommendations or any suggestions about lowering the prices…
Charlie: Well I took that because basically it was basically a losing hand and I play so many winning hands, so I thought, I should force myself to play a losing hand, and I must say it’s been very difficult.
Question: Do you believe in a single-payer health system?
Charlie: I think a single-payer health system would work a lot better, yes. I think it will eventually come. I think the existing system is a ridiculous (inaudible) system. Ridiculous system.
Question: How should we help our children to avoid envy and jealousy.
Charlie: Well you can’t.
(Video 5 of 22 0:41)
Question: What’s your go to (valuation approach)?
Charlie: We don’t have one way of doing it. We have certain things we avoid because we don’t think we have the competency to deal with it. And we have certain things we kind of like because we’re use to them. And so, we don’t have just one set of rules. We don’t have any formulas that are exact or anything like that. And some of the stuff we do, we just know it’s a little better than our alternatives. We’re doing all kinds of stuff now that we would not have done. We would have never bought Apple stock in the old days.
(Video 6 of 22 0:51)
Question: (Regarding Todd Combs. How he got introduced to Charlie and Warren)
Charlie: He seemed like very straight forward. But you see I get a million letters from people who want to come work for Berkshire. Or want to come work…I sometimes get a check from somebody who says, “Here’s $50,000, I’ll pay this to work for you.” I sent the $50,000 back. I will say that it’s kind of a brash thing to do, and I kind of admire it because it was kind of a smart-ass stunt, and I was something of a smart-ass when I was young myself. But I’m not looking for another starting helper or something. I’m playing out the end game. Anybody who’s playing anything else but an endgame when they’re 93 is crazy. It’s an endgame.
(Video 7 of 22 2:35)
Question: So you bet against the jockey, not against the horse necessarily?
Charlie: Well, no…McKinsey. Skilling came out of McKinsey. There are a lot of manipulative types that (inaudible) McKinsey.
Question: So is it simply an observation of the people more so than the quantitative factors? You don’t need to look at the balance sheet when you’re looking at the person.
Charlie: Well I can see the chain-letter aspects of the game. And the huge leverage and the huge…he was just sort of building a chain-letter. It’s intrinsically sort of a dishonorable thing to do. Because the nature of the thing you’re…doing something that you can’t continue on its own motion. You know, making it look like oil. So it’s intrinsically sort of dishonorable. So I don’t like chain-letter operators and I don’t like drunks. I don’t like people who puff and lie and I don’t like people who raise prices on drugs that people have to have by 500% overnight just because it would work. There’s a lot of flags we’re flying.
Question: Charlie, we’ve seen a lot of folks boycotting retailers because they sell Trump brand merchandise and vice-versa because…
Charlie: I don’t like all that. Basically, I’m not in favor of young people agitating them and trying to change the whole world because they think they know so much. I think young people should learn more and shout less. So I’m not sympathetic to anybody…young people are out in the streets agitating and I say, ‘to hell with them’. That’s not my system. I think if you got Hitler or something you can go out and agitate, but short of that, I think the young people ought to learn more and shout less. They ought to act more like Chinese.
Question: Did you personally know Richard Feynman and what do you think of him?
Charlie: Yes. I knew him slightly. Very slightly. Well he was a genius. On the other hand he was a screwball. He absolutely was nuts about screwing around with a lot of different woman, and going after the wives of his own graduate students (I think). That’s disgusting. So he had this blind-spot. Now in physics, in teaching, he was one of the nobelist people we ever had. But in his personal life he was a little nuts.
(Video 8 of 22 2:22)
Question: Charlie, I have a question about real estate. When I look at real estate and stocks, real estate is just easier to evaluate. You know, comps, cash flow, and replacement cost. It just seems like an easier game than the equities market.
Charlie: The trouble with real estate is that everybody else understands it. And the people who you are dealing with and competing with, they’ve specialized in a little twelve blocks or a little industry. They know more about the industry than you do. So you’ve got a lot of bull-shitters and liars and brokers. So it’s not a bit easy. It’s not a bit easy. The trouble with it is, if it’s easy…all these people…a whole bunch of ethnics that love real estate…you know Asians, Hasidic Jews, Indians from India, they all love real estate. They’re smart people. And they know everybody and they know the tricks. You don’t even see the good offerings in real estate. It’s not an easy game to play from a beginner’s point of view. Real estate. Whereas with stocks, you’re equal with everybody. If you’re smart. In real estate, you don’t even see the opportunities when you’re a young person starting out. They go to others. The stock market’s always open. It’s (like) venture capital. Sequoia sees the good stuff. You can open an office, “Joe Schmoe Venture Capitalists: Start-ups come to me!” You’d starve to death. You got to figure out what your competitive position is in what you’re choosing. Real estate has a lot of difficulties.
Those Patels from India that buy all those motels? They know more about motels than you do. They live in the g.d. motel. They pay no income taxes, they don’t pay much in worker’s compensation, and every dime they get, they fix up the thing and buy another motel. You want to compete with the Patels? Not I….Not I.
(Video 9 of 22 1:44)
Question: You and Warren throughout your business history were incredible at judging people. Whether it’s Mrs. B. (Charlie interjects: We were pretty good, yes.) What was it that you and he looked for. And what were mistakes that you made that you learned from along the way in judging who would be good business partners to work with.
Charlie: Well, first there’s some very good people in Warren’s family. One of them I worked under was Fred Buffett. So we had people we knew well that were really noble people. So we had basis to compare people against. And we had basis to compare people in terms of capacity and talent and so forth. So we had a lot of data in our heads that helped us. And I think we had some genetic advantages. Not IQ points, just absolute quirks of nature that made us better.
Question: Like Harry Bottle? Tell me about Harry Bottle and what you saw in him.
Charlie: Well I worked with him in an electronics business that got into terrible difficulties and he’d help us work out of that business trouble by downsizing. He knew how to do it. And Warren had a business that needed downsizing and Warren did not know how to do it. So I put those two together and of course it worked well. (link)
Question: Charlie, could you talk about the episode at Solomon Brothers and what you really learned about people…
(Video 10 of 22 8:14)
Charlie: What I learned is that all that easy money and easy leverage and so forth in investment banking creates a culture that’s full of envy, jealousy, craziness, over-reaching, over-leveraging. It’s a very hard business to manage…investment banking. It was out of control. The envy was…these people went berserk. If one jerk got $4 million some year, the other guy was furious that he only got $3 million. And they just seethed and caused trouble. It was a very difficult business to manage. I think a lot of easy money that comes into finance just ruins practically everybody.
Question: Charlie, anything thoughts on Apple Corporation?
End of Sample Transcript
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My full notes and analysis on the Wall Street Journal from the past week: March 13-19, 2017 (Week 11). Please Enjoy.
Wall Street has become obsessed with cost cutting. And when Wall Street becomes obsessed with a metric of success you can bet that they’ll take it too far.
It seems pretty clear that today’s CEOs are being measured more and more on their ability to cut costs. Articles about corporate cost cutting appear to dominate the WSJ these days. Given the focus on cost cutting, it’s not a coincidence that profit margins have soared since the financial crisis.
(Chart Via Goldman Sachs link)
While cost cutting can lead to more efficient operations, excessive emphasis on cost cutting will almost certainly lead to problems. CEOs will attempt to game the system, and cost cutting is highly gameable.
It’s easy to boost short-term profit margins and cash flow by cutting costs which are necessary, but whose harmful side-effects will not be noticed for years. For example, a CEO may;
Adding to an unsustainable profit margin trend, a tight labor market likely means that, as the workers gain negotiating power, current profit margins will decline.
Between unsustainable cost cutting endeavors, and a tightening labor market, corporate profits are likely to decline in the coming years. This means that the market is actually more expensive than it currently appears. The S&P 500 is trading at a trailing P/E of 24.52, and an estimated forward P/E of 18.27, while the DJIA trades at 21.01 and 17.72 respectively. (link) But after factoring in negative headwinds on profit margins, the market is likely trading at a forward “Price/Sustainable Earnings” in excess of 20x.
Here are some of the article which mentioned cost cutting:
Charlie Munger likes to say he’s a collector of “inanities” (i.e. Stupidities”). Here’s a collection of inanities reported by the WSJ.
“Mr. Ackman once predicted Valeant would be the next Berkshire Hathaway Inc., saying its shares could hit $330. The stock closed Monday at $12.11.”
Charlie Munger on this kind of approach:
“When you pound out an idea as a good idea, you’re pounding it in! So by asking people for their best ideas, they were getting the stuff that people had most pounded in so they’d believe. So of course it didn’t work.” – Charlie Munger
Boston & Citco
The people of Boston identify so strongly with a corporate advertisement billboard that they want to preserve it as an official landmark. Deep down at the heart of it, it’s really crazy.
“For Boston sports fans, the luminescent Citgo sign visible above Fenway Park’s left-field wall is already a hallowed icon. They are pushing the city to add protection for the 60-foot-by-60-foot sign by making it an official landmark, saying it is an internationally recognized symbol, a target for Red Sox sluggers and an inspiring unofficial milepost for runners chugging to the Boston Marathon finsih line.”
“Boston, the Red Sox, Fenway, the Boston Marathon,” said Nicholas MacDonald, a 34-year-old Massachusetts native and concierge at a local hotel, describing what the sign means to him.
“…the Citgo name- has been dominating the neighborhood’s skyline for more than 50 years.”
“Citgo tried to remove the sign in the early 1980s but changed course amid an outcry from Bostonians. There was also a failed attempt at the time to turn it into a city landmark.”
1) Liking Tendency
“Mr. Duarte…was an admirer of the late Spanish dictator Francisco Franco, both for Mr. Franco’s ‘strength and energy’ and because, like himself, Mr. Franco had a high-pitched voice.” (link)
2) Shared Identify
Former L.A. County Sheriff was “found guilty Wednesday of obstructing a federal investigation into violent abuses by his jail guards.”…”The probe uncovered various crimes related to the local jail system including beating inmates.” (link)
When a risk is hard to understand, it will seem less likely to occur. This is true in investing as it is in medical disclosures.
Stem-Cell Clinic’s Treatments Left Three Patients Blind, Doctors Say: “The patients involved did not understand the risk they were taking by going to this clinic,” (link)
“Many experiments have shown that the harder a risk is to understand, the less it will seem likely to occur.” (link)
We pay a big premium for fast solutions to big problems. This is true for corporations, governments, and consumers. Here are two examples from this past week:
1) Warren Buffett & AIG
Warren Buffett met with the CEO of AIG earlier this year, and ultimately agreed to a $10 billion insurance contract with AIG. This insurance deal was largely based on the need for a fast solution to a big problem (i.e. Activist Investors)
“The AIG directors feared disruption if they didn’t quickly address concerns from Mr. Icahn and some directors about the CEO’s ability to complete the turnaround, people familiar with the matter said.”
2) Tesla’s battery solution for Australian government
“Very impressed. Govt is clearly committed to a smart, quick solution,” – Elon Musk (link)
3) Intel & Qualcomm acquisitions
“Intel Corp. agreed to buy Israeli car-camera pioneer Mobileye NV for $15.3 billion, one of the chip maker’s biggest acquisitions ever and the latest bet on Silicon Valley’s vision of cars as turbocharged computers on wheels.” (link):
” Intel is joining a race to create autonomous vehicles that has accelerated recently as unconventional auto companies have jumped in, sparking bidding wars for companies that specialize in self-driving gear or software.”
“Qualcomm Inc. bought automotive chip supplier NXP Semiconductors NV for $39 billion.”
Investment Lessons: The need for fast solutions to big problems creates fantastic profit opportunities.
1) Look for companies which may help companies, governments, or consumers, address the “big problem + fast solution” market.
2) Be patient and capitalize on forced selling.
Fascinating article detailing how doctors who spend less on their clients have the same results as high spending doctors. Major implication: “The results suggest high-spending doctors could do less without harming patients, the researchers wrote.”
“U.S. Medicare patients whose doctors spent more on tests, scans and consultations were as likely to die within a month of leaving the hospital as patients with more parsimonious physicians, new research shows.”
“Patients of high-spending doctors were also as likely to return to the hospital within a month, according to the results, published by JAMA Internal Medicine.”
Private equity firm Novel who is raising funds to buy $800 million of its own assets. Novel wants to extend its holding period of its assets beyond its lock-up period. This behavior is a dangerous trend. Here’s what’s happening:
1) Heeding to Competitive Pressure: “Investindustrial, founded by Italian deal maker Andrea Bonomi, has decided on this course of action as it responds to greater competition for assets from institutions such as sovereign-wealth funds, which don’t have restrictions on how long they can own companies. The competition is pressuring buyout firms to devise new ways to own companies.” (link)
2) Subjecting Themselves to Naive Extrapolation: “Investindustrial’s move to hold on to PortAventura park for longer comes as fierce competition is pushing up prices for companies, meaning it increasingly makes more sense to hold on to assets than to sell.”
I’ve often thought that the historical success of private equity owes much of its success to the use of lock-up periods, and to eliminate them is very dangerous. That’s because the lock-up periods help prevent two psychological biases which generally destroy investment returns.
First, it prevents buy high and sell low behavior. Being in a lock-up period, clients must ride the ups and downs with forced equanimity.
Second, lock-up periods prevent ‘naive extrapolation’. Naive extrapolation happens when investors unrealistically assume that favorable investment results will continue indefinitely. Lock-up periods help PE firms avoid this problem because they must exit their investment before a certain date. As a result, private equity groups look forward to favorable market conditions as opportunities to sell, and not as justifications to hold their position even longer. (i.e. They’re forced to sell their position when it becomes over-priced. A feat which is easier said than done.)
By eliminating lock-up period as Novel is doing, they are no longer are exploiting naive extrapolation, but instead have become the victims!
Low interest rate policies by global central banks have pushed many individuals into stocks and other risky assets. This may prove ruinous for many investors who don’t have the psychological temperament to handle the wide swings in asset prices that occur during a bear market.
Here’s one such example: (link)
“His five children, including current White House counselor and chief strategist Steve Bannon, had often joked growing up that their devout father, a product of the Great Depression, would sooner leave the Catholic Church than sell those shares. The stock symbolized his deep trust in the company and had doubled as life insurance for his children.
“As he toggled between TV stations, financial analysts warned of economic collapse and politicians in Washington seemed to mirror his own confusion. So he did the unthinkable. He sold.”
Marty Bannon, now 95 years old, still regrets the decision and seethes over Washington’s response to the economic crisis”
My full notes and analysis on the Wall Street Journal from the past week: March 6-12, 2017 (Week 10). Please Enjoy.
‘Shore up your currency, No money down!’ It sounds like a bad late night television ad. It’s also what many central banks around the world have been doing very actively in recent years.
Traditionally central banks will buy and sell foreign currency to manage the strength of their currencies. This process leads to large fluctuations in foreign exchange reserves. But it appears that many central banks have started to rely heavily upon Non-Deliverable Forward (NDF) contracts. NDFs provide central bankers a way to both keep their foreign currency reserves and manage inflationary and deflationary pressure. Additionally, NDFs suppress foreign exchange volatility, and even allow central banks to increase reserves.
But these benefits are largely illusory. Foreign exchange volatility isn’t lower, rather NDFs have simply removed it from the central bank’s books. In this way, NDFs are not much different than Credit Default Swaps used by banks before the financial crisis, or Special Purpose Vehicles used by Enron to manipulate its balance sheet.
You could say that NDF contracts have allowed Central Banks to have their cake and eat it too. China, Mexico, and India are all indulging in this cake-eating-and-holding paradox.
At the moment, NDFs appear to be effective when used in stable markets, but during times of stress, the complexion of these derivatives will almost certainly change. So the more the central banks rely on NDFs, the more pain will be felt in periods of turmoil.
P.S. I would love to find information regarding the size and growth of non-deliverable forward currency contracts (NDF). But it’s hard to get.
Since the financial Crisis, The People’s Bank of China has significantly increased their reliance on NDF’s.
“The People’s Bank of China has been using derivatives to prop up the yuan without actually spending its stash of dollars.” (link)
“The derivatives, however, make the picture look rosier than it really is.”
“Derivative interventions are considered quite unorthodox despite having a long history. One of the pioneers was the Bank of France, which in 1927 famously resorted to buying sterling in forward markets because it wanted to quell inflows into the franc without having to issue more notes. It wasn’t very successful back then, and results have remained mixed ever since.”
Feb 17 2015: “the average daily trading volume across all NDF currency markets has grown from about $20 billion to $60 billion over last five years. The rise in activity in NDF markets is particularly noticeable for the rupee, the Brazilian real and the Chinese yuan. These economies are becoming increasingly important in the global trade.” (link)
“The Bank of Mexico launched a dollar-hedging program placing all $1 billion in forward contracts as it opens a new front in efforts to support the peso without draining foreign reserves.”…”The nondeliverable forwards are settled in pesos.” (link)
“The use of derivatives gives the central bank ammunition to support the peso without selling dollars from its foreign reserves, as it has done in recent years.”
“Besides traditional dollar buying from the domestic spot market, there was a tweak in the intervention strategy, dealers said.” (link)
“State-owned banks made ‘sellbuy’ derivative deals, converting spot dollar buying transactions into forward deals, dealers said, deferring delivery of dollars through such forwards deals. Banks sell dollars they bought in the spot market and then they buy the same unit in the next leg as a forward transaction, keeping the net position at ‘buy’.”
“‘The approach is aimed at limiting rupee liquidity in the system,’ said the head currency dealer of a mid-size bank.”
Last week, Chinese telecom company ZTE plead guilty to supplying North Korea and Iran with telecommunications equipment over a six year period. They orchestrated an elaborate system to circumvent U.S. sanctions and supply these countries with U.S. technology. For its actions, ZTE was fined $892 million. (link)
But I don’t think a fine is enough. ZTE is the #4 maker of smart phones, by volume, in the U.S. As a consumer products company, I think U.S. citizens should be warned that ZTE illegally circumvented U.S. policies and sponsored the governments of North Korea and Iran.
So I propose adhering a warning sticker to all of their consumer products. Much like you’d find on a pack of cigarettes. I imagine it would look something like this.
They couldn’t give those phones away. And it would serve as a very high-profile warning to all other companies.
“Studies have found that patients make at least one mistake as much as 70% to 90% of the time. The result: only about 7% to 40% of drugs is delivered to the lungs.”
“Coordination was the biggest and most series error…Even half a second late in inhaling and you press the inhaler too soon you get only 20% of the medication.”
Use checklists: They have the universally accepted benefit of helping us avoid catastrophic decisions or actions.
Interesting history on stock market performance over Presidential terms. (link)
“Other presidents had misleading starts. Herbert Hoover presided over a nearly 44% total return in his first 10 months for the predecessor of the S&P 500. But the index dropped 31% on an annualized basis during his entire four years in office. Unsurprisingly he wasn’t re-elected.”
Lobbying & Political Self-Interest make it very challenging to enter or disrupt some industries. When threatened by a new entrant, old corporate hegemons will use their vast lobbying resources to prevent upstart competitors from displacing them.
Meanwhile, self-interested politicians will be motivated to fight on behalf of the old hegemons who supply their state with massive employment and tax revenue.
Here are some examples from this past week.
“After falling behind in self-driving cars, GM has unleashed its powerful lobbying team to cultivate relationships with statehouses. The largest U.S. vehicle maker by sales has a long history of backing legislation to preserve its interests, including a bill in Indiana last year that would stop electric-vehicle maker Tesla Inc. from operating its own stores there.”
“The hotel industry has been at the forefront of lobbying for stricter regulations on Airbnb that it says are needed to put the service on a level playing field with traditional hotels.”
Avoid direct competition with companies which are national champions of socialist and communist countries. Specifically in industries which sell commoditized products; i.e. China & Steel. These companies will likely have a lower cost of capital than you and make your life a nightmare.
GM recently exited Europe with its sale of Opel. Among the problems they faced in Europe was the existence of car companies labeled as “national champions” who received support from their respective governments.
Mary Barra, GM’s CEO, addressed these issues in a statement:
“Our overall philosophy is every country, every market segment has to earn its cost of capital, has to be contributing.” (link)
“Europe, which has always been cutthroat due to a glut of capacity and national interests in auto makers, became even more difficult from political, regulatory, and consumer-preference standpoints in recent years,”
Carlos Ghosn, Nisan’s CEO, talked about Renault being treated as a national champion.
” Mr. Ghosn, speaking in an interview Thursday, said a merger is off the table as long as French officials see Renault as a national champion, with interests that are separate from the Japanese partners. “Nissan has been very clear during discussions with the French state that they are not going further in terms of a merger, or anything else, with the French state as a shareholder of Renault.”” (link)
There were lots of multi-year highs and lows occurring last week.
“The U.S. posted its biggest monthly trade deficit in nearly five years in January,”
“The downtown Miami market is expected to see the most new condos delivered this year since 2008, roughly 3,500 units in all,”…”at the peak, developers could finance up to 75% of the cost to build a project, not that is down to 50%.” (link)
“This week marks the bull market‘s eight-year anniversary, the second-longest on record. Since the March 2009 bottom, the S&P 500 has surged more than 300% including dividends.” (link
“65,500 metric tons of copper flowed into exchange-approved warehouses Monday and Tuesday, a surge of 33%, the biggest two-day rise in 20 years,” (link)
“The price-to-earnings ratio of the S&P 500 based on analyst forecasts for the next year is near 17.7, the highest since 2004,”
“There were a total of 279 insider buyers in January, the lowest number going back to 1988,” (link)
“Short positions across stocks, exchange traded funds and equity futures last week fell to near their lowest levels in 10 years,” (link)
The yield on the two-year note, closed at 1.329%. That was the highest since June 2009.” (link)
“In 2017, with global equity funds posting record net inflows in the week ended March 1 based on data going back to 2000,” (link)
“Under the House (tax) plan, Goldman figures it would drop (corporate taxes) to 24%, boosting after-tax earnings by about 10%…The market currently trades at about 18 times analysts’ expected earnings for 2016,…Raise earnings by 10% and that price/earnings ratio slips to a more reasonable but still expensive 16.4.” (link)
“Central banks around the world are increasing foreign-currency reserves, highlighting the fragile underpinnings of the global economic recovery despite a bullish mood in financial markets.
“Two-thirds of the 30 biggest emerging markets increased reserves last year,”
“Switzerland’s holdings of foreign assets jumped last month at their fastest pace in more than two years,”
“In January, Russia added $13 billion to its $390.6 billion in reserves, its largest monthly increase in more than four years.“
“In Europe, big increases in reserves are often associated with periods of global stress….External reserves are a form of insurance for sovereigns against crisis and defaults,”
There were lots of fascinating news stories regarding China developments over the past week:
China cut steel capacity by 10.5% last year. But it was practically meaningless as most of it was long-since idled. Furthermore, despite the capacity reductions, steel production rose 1.2%.
“Chinese mills make half the world’s steel but depend on state subsidies and bailout mergers to survive.”
“From 2011 to 2015, global steel prices fell 70% as Chinese companies flooded the market with cheap steel.”
China’s theme for this year is “stability”. That means cracking down on internet-based political commentaries. Is this a signal of coming instability?
“Ending practices that skirt regulations fits with the ever tightening control the government has exerted on the internet since President Xi Jinping rose to power in late 2012. Targeting outright political dissent has expanded to include critical commentaries.”
“Any company whose service could potentially trigger social unrest should brace itself for more regulation-or at least greater scrutiny, industry insiders say.”
How can an economy be so herky-jerky? One month they have near record lending, the next they slam on the brakes, and so on.
“Chinese banks sharply scaled back lending last month, after a near-record tally in January, as Beijing tries to strike a balance between boosting economic growth and containing financial risks.”
There have been several Chinese deals halted suddenly since the Trump election. Here’s another one.
“Dalian Wanda Group’s $1 billion deal to buy Dick Clark Productions Inc. is dead…Beijing’s scrutiny of overseas investments, stemming from fear that too much capital flight could weaken the yuan, also killed takeover talks between several Chinese companies and Metro-Goldwyn-Mayer Studios late last year.”
“China recorded its first trade deficit in three years last month, driven by higher commodity prices, an unexpected drop in exports, and the effect of the Lunar New Year holiday.”
“Tuesday brought a surprise increase in foreign-exchange reserves. Wednesday, it was an unexpected trade deficit – China’s first in three years – which made the rise in Beijing’s currency hoard even harder to account for.”
“A trade deficit ought to put additional pressure on the People’s Bank of China to support the yuan, by selling down its foreign-currency reserves-but the evidence shows the central bank spent less on defending the yuan last month than in the recent past.”
Several articles address the economic costs of ideological polices. I found it rather fascinating how economics and ideology interplay in shaping legislation.
In January bullish oil bets hit a 10 year high. Two months later U.S. inventory levels his a record and oil prices rapidly sunk. This shows the difficulty of forecasting such things and the euphoria and panic that can grip market participants.
January 31, 2017: 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.”
March 9, 2017: Crude Logs Biggest Drop in Over a Year (link): “Oil prices suffered their biggest one-day plunge in more than a year after U.S. crude stockpiles hit record levels, raising concerns that even after recent production cuts, the world remains awash in oil.”…”US. inventory levels have risen for nine weeks in a row. They hit a record of 528.4 million barrels last week as imports and U.S. production increased.”
March 10, 2017 (link): U.S. crude fell below $50 a barrel for the first time this year, in the biggest two-day sell-off since June.
“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” – Warren Buffett
“Borrowers were more likely to receive aid if they threatened to go to the media with their complaints, one former employee said.” (link)