Circle Of Competence Issue #10

May 6, 2018

Department of General Finance

 

Reality Sets in at Lampert's Sears

More news on Eddie Lampert and Sears. It is painful watching someone who has made a costly mistake continue to defend his or her position until the bloody end. And this could very well end bloody. 
 

Here's How One Family Office Bought a Wind Farm

Ever thought of buying a wind farm? Look no further. 
 

Puerto Rico's Bank Exodus

The only people who benefit from an exodus of bank capital here are the banks that stick it out and are able to reduce competition. Not great for consumers who need capital, access to deposits, and lending.

 

Tesla Repeats Industry Mistakes from 1980's

Interesting article quoting several auto executives who seem to think that Tesla's attempt to fully automate their production of vehicles is repeating key mistakes made by GM in the 1980's. 

 

Hedge Fund Puts $150M to Invest in Homes on Startup Point

Interesting twist home equity loans (or rather, simply taking an equity position in a person's home) discussed here. Point Digital Finance invests for a minority equity position in a person's homes with plans to simply recoup their portion of equity upon sale of the property. The idea seems neat, but two things stick out to me that I don't like about the idea. 1) The entry into some markets (California, Colorado, etc.) seems a bit late in the game for equity returns and 2) I am not sure from the article, but it seems that this is more of an equity product than a loan/debt product and therefore the returns do not include cash flow over time. The model seems innovative, but would have been much better timed closer to the aftermath of 2008-09 recession when there were better home prices to be had nationwide. 

 

John Malone's Prized Operator Bob Johnson

I have always wanted to read letters to shareholders by John Malone, long heralded as one of the best capital compounders of his day. He invested $500,000 in BET with Bob Johnson and returned $805 Million. Need I say more?

 

Keeping Quiet and Living with an Inner Scorecard

Just great advice for any investor from Guy Spier.

 

 

Department of Podcasts

 

Highly recommend The Investor's Podcast by Preston Pysh and Stig Brodersen. Preston was featured on the Warren Buffett Documentary the night before the Berkshire Annual Meeting.

 

The Investor's Podcast Episode 179

Great episode and interview with Doug McCormick, a partner at HCI Equity Partners in DC, about the business of Private Equity. 

 

The Investor's Podcast Episode 188

Jesse Felder, Tobias Carlisle, and Stig and Preston all discuss their stock picks for Q2/2018. I think they bring some excellent ideas to the table as well as some sharp criticism on a couple of the ideas. You will learn about a few different industries as well as asset classes in this episode. Highly recommend.

 

The Investor's Podcast Episode 180

Thoughtful interview with Bill Miller, a well-known, talented deep value investor.

 

 

Department of Technology

 

CRISPR - Cas9 Improved 10,000 Fold by Synthetic Nucleotides

New breakthrough in the CRISPR-Cas9 method to improve accuracy of genetic editing. 

 

New Discovery in Quantum Entanglement

We are another step closer to full scale quantum computing with this new discovery. Interesting read!

 

Researchers Keeping Pig Brains Alive Outside of Body

How long until someone uses a human brain to run this same experiment? The ethics here are dicey at best... 

 

Do Investments in Deep Technology Make Money?

Interesting article on “deep” tech investments - less software application and more hard science problems (chemistry, physics, biology). Would love to get my hands on some reports that give more numbers and insight into these investment themes and areas. 
 

C2RO - Cloud Robotics

Freshly funded cloud robotics platform company. I’ve been waiting for the next wave of robotics - namely when most of the processing is done off of the hardware and in the cloud. This gives the robots vastly more capabilities with larger deep learning models being deployed in the cloud in real time vs. being trained and stored on the robot itself. What’s more exciting is the fact that many robots can learn different skills and environments... and simultaneously upload these learnings to the cloud, enabling other robots to download and learn the new skill. I get excited about exponential ideas like this.
 

Soft Robotics Funded with $20 MillionInteresting company solving the problem of “one size robot does not fit all” solution space - I.e. picking up various sorts of objects without damaging them. Hence, “Soft” Robotics. 
 

Tencent Leads $820M Funding of Robotics Company Ubtech

Interesting company that has raised quite a bit of cash for humanoid robots. The robots are coming.  This is certainly a trend worth watching.

 

 

Department of Letters

 

Warren Buffett's 2017 Letter to Shareholders

Pure Gold. His discussion on the bet between him and Protege Partners is especially relevant to the everyday investor - fees make you poorer and your money manager richer!

 

Warren Buffett's 1990 Letter to Shareholders

I've been re-reading the Master's letters recently and I find a few nuggets in each one. One that caught my attention was this quote from his section on non-insurance operations (emphasis mine):

 

"Take another look at the figures on page 51, which aggregate the earnings and balance sheets of our non-insurance operations. After-tax earnings on average equity in 1990 were 51%, a result that would have placed the group about 20th on the 1989 Fortune 500.

 

Two factors make this return even more remarkable. First, leverage did not produce it: Almost all our major facilities are owned, not leased, and such small debt as these operations have is basically offset by cash they hold. In fact, if the measurement was return on assets - a calculation that eliminates the effect of debt upon returns - our group would rank in Fortune's top ten.

 

Equally important, our return was not earned from industries, such as cigarettes or network television stations, possessing spectacular economics for all participating in them. Instead it came from a group of businesses operating in such prosaic fields as furniture retailing, candy, vacuum cleaners, and even steel warehousing. The explanation is clear: Our extraordinary returns flow from outstanding operating managers, not fortuitous industry economics."

 

Wow. 51% ROE!

 

Another couple of interesting tidbits I noticed:

 

Buffett's wife, Susan, was nominated to the board to replace Ken Chace. 

 

The section on the economics of property/casualty insurers vs. reinsurers is very educational and I would highly suggest paying close attention here, because it seems that this year marked the entry of Berkshire into long-tail, select cat(astrophe) insurance contracts which provided for additional, long duration float. 

 

Yes. It's a Bubble. So What.

Wonderful article by Research Affiliates on certain bubbles in history, the current investing environment, and certain stocks and individual assets (Tesla, Cryptocurrencies, etc.). My favorite quote:

 

"At the beginning of 2000, the 10 largest market-cap tech stocks in the United States, collectively representing a 25% share of the S&P 500 Index—Microsoft, Cisco, Intel, IBM, AOL, Oracle, Dell, Sun, Qualcomm, and HP—did not live up to the excessively optimistic expectations. Over the next 18 years, not a single one beat the market: five produced positive returns, averaging 3.2% a year compounded, far lower than the market return, and two failed outright. Of the five that produced negative returns, the average outcome was a loss of 7.2% a year, or 12.6% a year less than the S&P 500."

 

Negative Equity, Veiled Value, and Erosion of Price-to-Book
Every investor should read this piece by O’Shaughnessy asset management on how price to book ratios do not always reflect whether a company is truly cheap or expensive. 

Based on book values that are biased lower via stock buy backs, understated intangible assets, and long lived assets that are depreciated too quickly, they show how some stocks can appear to be expensive but in reality are quality companies that offer solid value going forward. 

After studying Buffett for years, this is one of his biggest lessons learned that he explains in several of his shareholder letters - i.e. that often times a company has a fantastic brand or hidden assets that don’t always show up in a balance sheet. In fact, his favorite companies are the ones that don’t need heavy capital expenditures but continue to compound wealth based on intangibles (think See’s Candies) - Capital-light compounders.

This is a must read! 

 

Amazon CEO Jeff Bezos' 2017 Letter to Shareholders

Another great letter from Jeff Bezos on the incredible growth of Amazon's underlying business products. I've seen many an investment pitch on Amazon, and I understand the entire flywheel approach, the 'invest for the future cashflows' philosophy, the customer-centric approach... but for the life of me, I can't seem to make ends meet on the current valuation. Love the company, can't get square with the current price. Maybe I never will and it will look expensive forever. Only time will tell. 

 

Vltava Fund 2018 Q1 Letter to Shareholders - Of Robots and Men

Interesting discussion of systematic (algorithmic, robotic decision making) funds vs. discretionary (human decision making) funds and the different investment horizons between the two. Can you guess who has a shorter vs. longer investment horizon? 

 

Also interesting tidbits regarding relative valuation of UK market at 15x CAPE vs. 33x for US market. The author seems bullish despite Brexit. 

 

Wedgewood Partners 2018 Q1 

In this letter, they discuss the re-entry of volatility into the markets in Q1. I particularly enjoyed their long term charts illustrating where we are in the market cycle. 

 

Fairfax Holdings 1998 Letter to Shareholders

I continue to work my way through Prem Watsa's letters and liked this one's commentary on the market environment back in 1998. It is interesing to note that he was very attuned to the market's valuation risk and adjusted Fairfax's portfolio heavily in favor of bonds and cash and away from equities (7% of total portfolio vs. up to 35% in earlier years).

 

Here was my favorite section:

 

"We continue to be very concerned about the level of the U.S. stock market as discussed in our 1996 and 1997 Annual Reports – even though the S&P 500 increased again by 26.7% in 1998. The possibility of deflation, mindless long term investing in mutual funds and a lack of investment ‘‘values’’ in the North American stock markets do not appear to bother most investors. In fact, speculation is rampant in the U.S. markets as demonstrated by the ‘‘internet’’ stocks. America Online has a market cap that exceeds the total market cap of the five largest Canadian banks even though AOL has been a public company for only six years. Amazon.com has a market cap that is in excess of Sears (U.S.) even though Sears annually earns more than twice Amazon.com’s revenues. Finally, Yahoo! has a market cap in excess of Boeing even though the latter has revenues of $55 billion compared to Yahoo!’s $190 million. The speculative juices are flowing freely in the U.S. but the music will stop and many investors (speculators!) will not have any chairs to sit on. Caveat emptor!

 

How times have changed for Sears and Amazon! But nonetheless, are we surprised about the market crash that ensued when valuations were at such insane levels?

 

 

Feature: Berkshire Hathaway Annual Meeting Stream

 

Yahoo! Finance Annual Meeting Full Length Video

This is by far my favorite day each year when it comes to investment related events. At 87 and 94, Buffett and Munger continue to share wonderful advice and experiences with the investment community that is principled and timeless. What a legacy they have created. THIS IS A MUST WATCH!

 

 

What are YOU reading this week? Drop me a line if you have an interesting article, company, or theme I should be studying! You can also give me a shout on Twitter at @competence_co

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