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Circle Of Competence Issue #11

Department of Letters

Wonderful businesses like Google don't come around often. Though they are trading at roughly 30x trailing free cash flow, if shares were to trade lower moderately to significantly, I would love to own this. Top line growth of 20%+, 'Other Bets' revenue growing at over 50%, free cash flow of ~$25B, fantastic returns on tangible capital, virtually no long term debt ($7B vs. $150B shareholder equity), and a monopolistic hold on the digital ad market with global room to grow.

One interesting note (see Note 14 in the 10-K) was the negative effect of the new tax plan enacted by Congress which resulted in a $10B one-time provisional charge due to a 15.5% tax rate charged on accumulated foreign earnings not taxed in the US.

Highlighted Company: Exor

Book value increased 45.8%, driven mostly by the appreciation of FIAT shares (30% owner). It is also interesting to note the separation of Fiat and Fiat Industrial into two separate entities.

I enjoyed the refresher of what happened in 2010 from a macroeconomic perspective - particularly from someone who was watching from afar as the crisis turned global and affected the euro. Exor chose not to hedge during the crisis and recovery, which at the time must have taken a significant amount of resolve, not knowing what the future held for the EU, euro, or global markets.

Exor made new investments in The Economist, Almacantar (a London Commercial real estate firm) and BTG Pactual (a Brazilian financial services firm) during 2010.

Final note - I thought it interesting that the Italian tourism company Alpitour (100% owned by Exor) notched a record year during 2010, given the global economic conditions.

Book value declined by 24.4% due to the mark-to-market effects of their largest investments (Fiat Industrial, Fiat, Cushman Wakefield, and SGS) despite these four investments improving their collective earnings before interest and taxes (EBIT) from 1.5B to 4.8B in just two years.

The declines in prices in 2011 were more macro driven than company driven, and the macroeconomic backdrop in Europe is discussed briefly in this letter. As Graham often states, "in the short run the market is a voting machine (popularity based), but in the long run it is a weighing machine (fundamentals based)."

Book value increased by 20.6%, CAGR of 27.9% since 2009. Typical of Elkann's letters, he discusses the largest investments of the company, but I found four quotes to be the best parts:

Ben Graham: "Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic change or deterioration in management."

The master!

John Maynard Keynes: "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."

So true.

Mark Twain: "A banker is a fellow who lends you his umbrella when the sun is shining but wants it back the minute it begins to rain."


And finally, Elkann's Grandfather Giovanni Agnelli: "Groups like ours typically go through three stages in their development: a time of strength, a time of privilege, and a time of vanity. For me the first is the only one that counts."

Powerful quote on family business.

Department of General Finance

Very compelling article about Dan Rasmussen's management company, Verdad Capital, and how he is using small cap stocks to mimic, and beat, private equity funds. His original research paper on the leveraged small cap universe is below:

For those who are more academic in taste, this is a fantastic read, spelling out the basis of Verdad Capital's strategy. It seems to be very similar to what Tobias Carlisle of is doing - namely, cheap stocks on an EV/EBITDA basis but also throws a few more factors into the mix (actively reducing leverage, small cap, credit quality, and more).

Not much in the way of words, but the theme is clearly geared towards how AI will impact the future of business and which companies are poised to gain most from the digital revolution.

These are hedge fund structures, as they should be: fair, transparent, with aligned interests. This reminds me of a famous investor who started a fund with a fee structure like this... oh yes, Warren Buffett.

Department of Real Estate

When Barry Sternlicht is selling, it should tell us something about where things are in the multifamily market - or at least where this billionaire CEO thinks they are.

Department of Technology and Startups

Moore's law is making it ever harder to develop more powerful computing chips and storage devices, however a new method of data storage based on DNA could be promising. Binary data storage simply involves representing information as 0's and 1's electronically, but DNA could represent information in binary... but the kicker is that it takes up much less space than even the most advanced storage devices today. The challenges seem to be how to synthesize the DNA chains as well as how to read the data from the DNA chain later.

This is a new and upcoming segment of the insurance market that many large players have not made moves in because of the lack of actuarial data and long-tailed nature of cyber events. Enter At-Bay, which helps underwrite the risks, but also works with companies on their current infrastructure to educate companies on where they are most vulnerable to a hack. This part of the insurance market could represent a small but growing market in years to come as most companies move data and their businesses to the cloud.

Robinhood, a commission free equities platform, has raised new venture money at a $5.6B valuation. I use Robinhood to accumulate shares slowly and would highly recommend it to young investors looking to start saving and investing small to medium amounts in equities.

Department of Books

Interesting book that attempts to map various paths from where current artificial intelligence capabilities are to the potential for AI with superhuman ability (orders of magnitude better than human performance). Discussed topics include neural-computer implants, neural networks, human augmentation, various forms of strong artificial intelligence, and more. If you are interested in a meta-view of AI, this book may be for you.

Great introduction to the historical differences between Catholic and Protestant doctrines. The book ends with a call for all believers to find their commonalities in the gospel of Christ rather than peripheral differences, but to also continue working through difficult issues that continue to divide the Church. Easy and quick read!

Department of Podcasts

Great episode of TIP where Preston and Stig interview Ian Siegel, the CEO of Ziprecruiter, about the life of an entrepreneur, how to know when a startup is likely to succeed, and personal circle of competence (product dev, sales, finance, etc. - what is your strength?).

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