What We’re Reading (Week Ending 21 February 2021) - 21 Feb 2021
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 21 February 2021):
1. 12 Things I Remind Myself When Markets Go Crazy – Ben Carlson
1. There is no such thing as a normal market. Uncertainty is the only constant when investing. Get used to it.
2. The most effective hedge is not necessarily an investment strategy. The best hedge against wild short-term moves in the markets is a long time horizon.
3. Your gains will be incinerated at some point. Investing in risk assets means occasionally seeing your gains evaporate before your eyes. I don’t know why and I don’t know when but at some point a large portion of my portfolio will fall in value. That’s how this works.
4. You still have a lot of time left. I’m still young(ish) with (hopefully) a number of decades ahead of me to save and invest. That means I’m going to experience multiple crashes, recessions, bull markets, manias, panics and everything in-between in the years ahead.
The current cycle won’t last forever just like the last one or the next one.
5. Know yourself. One of the biggest mistakes you can make as an investor is confusing your risk profile and time horizon with someone else’s. Understanding how markets generally work is important but understanding yourself is the key to successful investing over the long haul.
6. There’s nothing wrong with using a “dumb” strategy. Buy and hold is one of the dumbest investment strategies ever…that also happens to have the highest probability of success for the vast majority of investors.
There’s no shame in keeping things simple.
7. The crowd is usually right. Being contrarian will always make you feel like you’re smarter than everyone else, but the crowd is right more often than it’s wrong when it comes to the markets. Yes, things can get overcrowded at times but being a contrarian 100% of the time will lead you to be wrong far more often than you’re right.
2. The Beginning of the End – Dan Teran
Some view third party food delivery operators, such as DoorDash, UberEats, and Grubhub, as heroes of the pandemic, a lifeline to restaurants, creators of employment for masses of essential workers that are responsible for slowing the spread of the virus by keeping diners safely in their homes.
Others view these firms as unscrupulous predators, draining profits from independent restaurants while undercompensating and mistreating delivery workers, all to satisfy the appetites of venture capital investors who have gambled billions of dollars on a business model that may never generate more cash than it has consumed…
…While the pandemic has driven unprecedented demand and introduced new narratives, the facts remain largely unchanged – the third party delivery industry is bad for independent restaurants, bad for delivery workers, and serves customers who are indifferent so long as their food arrives. The pandemic has brought these harsh truths irreversibly into the light, and it is for this reason that we will look back on this year not as one of good fortune for third party delivery, but as the beginning of the end…
…The case for the downfall of third party delivery begins and ends with the business model. Peter Drucker refers to a business model as “assumptions about what a company gets paid for.” Today’s third party delivery operators make the following assumption:
Restaurants will pay 30% of revenue for new customers, serviced by a third party delivery network.
This sounds reasonable. A few extra meals a night to new customers would better utilize existing resources and make the restaurant more profitable. A nice story, but not true.
While sales representatives from DoorDash and UberEats tell restaurateurs they are paying for new customers, in reality they know they will also be charged 30% to service existing and repeat customers, too. Industry data first shared with Expedite suggests that more than half of the orders placed on third party delivery platforms today are from repeat customers.
While third party delivery has always been a bad deal for restaurants, delivery did not represent a significant share of most restaurants business prior to 2020, and so the damage to a restaurant’s bottom line was obscured. The pandemic has brought an inconvenient truth into focus: third party delivery will kill your business if you let it, and third party delivery operators do not care.
How could third party delivery kill your business while bringing customers in the door? The model below shows a P&L for a restaurant that does ~$1M in sales annually at a 15% EBITDA margin, this would be considered very good by any standards. As you can see at the top, as third party delivery takes over more of the business, the business becomes incrementally worse. In this case, third party delivery begins to kill the business as soon as they reach 50% of revenue––sooner if you want to draw a salary, repair equipment, or pay back investors.
During the pandemic, many restaurants have gone from doing ~20% of their business through third party delivery platforms to ~80%, and watched their income statements turn from black to red, as fees ate their business alive. The message from third-party operators? Too bad.
3. SaaS Stocks Prove to Be Winners as Business World Moves to the Cloud – Chin Hui Leong
Before cloud computing arrived, traditional enterprise software was hard to deploy and costly to maintain.
Applications had to be installed by location. To do that, companies had to invest heavily in IT infrastructure, networks and software licenses. The implementation was also complex and could take as much as 18 months, according to an example cited by the Harvard Business Review.
And that’s not all.
There is also the high cost of maintaining the on-premise system. Enterprises had to hire teams of IT staff and consultants to integrate, support, and upgrade the on-premise applications.
Enter Marc Benioff, the founder and CEO of Salesforce (NYSE: CRM).
In 1999, Benioff founded Salesforce based on two big ideas: software should be delivered over the internet, and the service will be subscription-based.
Salesforce’s software is delivered over the internet, making its service easier to deploy and scale. The company’s subscription model removed most of the upfront cost associated with the traditional way of software deployment.
Armed with these advantages, Salesforce set its sights on the customer relationship management (CRM) market, where the problems associated with traditional enterprise software were the most acute.
The lower installation cost also allowed the company to target small and medium businesses. From there, Salesforce would gradually move upstream to take on larger enterprises.
And the rest, as they say, is history.
With an annual revenue base of over US$20 billion today, Salesforce is valued at close to US$220 billion.
Investors during the company’s IPO in 2004 would have made close to 90 times their original investment.
As Salesforce grew, the broader SaaS industry also came into its own.
4. What Your Data Team Is Using: The Analytics Stack – Justin Gage
The goal of any analytics stack is to be able to answer questions about the business with data. Those questions can be simple:
1. How many active users do we have? 2. What was our recurring revenue last month? 3. Did we hit our goal for sales leads this quarter?
But they can also be complex and bespoke:
1. What behavior in a user’s first day indicates they’re likely to sign up for a paid plan? 2. What’s our net dollar retention for customers with more than 50 employees? 3. Which paid marketing channel has been most effective over the past 7 days?
Answering these questions requires a whole stack of tools and instrumentation to make sure the right data is in place. You can think of the end product of a great analytics stack as a nicely formatted, useful data warehouse full of tables like “user_acquisition_facts” that make answering the above questions as simple as a basic SQL query. \
But the road to getting there is unpaved and treacherous. The actual data you need is all over the place, siloed in different tools with different interfaces. It’s dirty, and needs reformatting and cleaning. It’s constantly changing, and needs maintenance, care, and thoughtful monitoring. The analytics stack and its associated work is all about getting that data in the format and location you need it.
The basics:
1. Where data comes from: production data stores, instrumentation, SaaS tools, and public data 2. Where data goes: managed data warehouses and homegrown storage 3. How data moves around: ETL tools, SaaS connectors, and streaming 4. How data gets ready: modeling, testing, and documentation 5. How data gets used: charting, SQL clients, sharing
5. Stop Stressing About Inflation – Barry Ritholtz
Inflation occurs when one or more factors combine to drive prices higher. Often, wage pressures raise prices for good and services, filtering into the general economy (1960s). Sometimes, the combination of a weakening dollar and rising commodity prices send input costs higher, which kicks off an inflationary spiral (1970s). Third, there are times when the cost of capital becomes so cheap it sends anything priced in dollars or debt off into an upwards spiral of (2000s).
But Inflation is not inevitable. There are numerous countervailing forces that have been at work for much of the past 50 years. The three big Deflation drivers: 1) Technology, which creates massive economies of scale, especially in digital products (e.g., Software); 2) Robotics/Automation, which efficiently create more physical goods at lower prices; and 3) Globalization and Labor Arbitrage, which sends work to lower cost regions, making goods and services less expensive.
Put into this context, Inflation is periodic, driven by specific events; Deflation is consistent, the background state of the modern economy. To fully understand this requires grasping how scarcity and abundance act as the drivers of the price of labor and goods. My suspicion is many economists who came of age during earlier eras of inflation fail to discern how the world has changed since.
Consider what this combination implies: the dominant modern world “flation” tends to be biased more towards falling than rising prices. We live in an era of Deflation, punctuated by occasional spasms of Inflation. This suggests that fears of inflation are likely to be more overstated, even with low monetary rates and high fiscal stimulus.
The net result: Forecasters have been over-estimating inflation by more than a little and hyper-inflation by more than a lot. Indeed, the Fed and most economists got this wrong in the 2000s, radically under-estimating how the novelty of ultra-low rates, high employment, and weak dollar caused prices to go higher.
Inflation was robust until the Great Financial Crisis came along; in its aftermath, inflation was (despite all too many forecasts) a no show. Persistent under-employment led to a lot of slack in the labor force, even as the US economy saw unemployment fall to below the 4% levels.
Perhaps this explains why so many economists forecast a post GFC inflation that never arrived. Post Covid, we should see hiring and lots of pent up demand and a transitory bout of modest inflation. But even that is likely to be much less of a threat than it has been in prior decades.
But not to the old school economists. Perhaps they need to reconfigure their models of what causes inflation and deflation. Being wrong for the past two decades should provide the motivation to update those models. Unfortunately, we see little evidence they are interested in changing their fundamental concept of what drives prices higher.
6. Twitter thread on what it’s like working for Jeff Bezos and Mark Zuckerberg – Dan Rose
People often ask me to compare working for Bezos vs Zuck. I worked with Mark much more closely for much longer, but I did work directly with Jeff in my last 2 years at Amazon incubating the Kindle. Here are some thoughts on similarities that make them both generational leaders:..
…They both lived in the future and saw around corners, always thinking years/decades ahead. And at the same time, they were both obsessive over the tiniest product and design details. They could go from 30,000 feet to 3 feet in a split second.
In the best tech companies, product defines strategy and culture. Jeff and Mark were both product CEOs first and foremost (though Jeff is arguably more commercial). Amazon and Facebook’s products are also an embodiment of Jeff and Mark’s individual personalities and values.
Neither of them would ever dwell on success. Every time I took a hill and looked up to celebrate, Jeff or Mark had already moved on to the next hill. They set unrealistic goals and were insanely intense, disciplined, hard working and hard driving…
…The skill set required to start a company is insanely different than being CEO of a mega corporation. Scaling of this magnitude requires tireless commitment, crazy focus, thick skin, unbridled ambition. You have to be a learning machine, constantly growing and pushing yourself….
…The cultures they built are also very different. Amzn is more siloed/secretive, while FB is radically open/transparent. There are pros and cons to each (which I will cover in a future post), but culture at both companies runs deep and is rooted in the values of the founder.
7. Congress Wants to Talk About GameStop – Matt Levine
Tenev also sheds some light on how Robinhood got a surprising margin call from its clearinghouse, and how it negotiated it down:
At approximately 5:11 a.m. EST on January 28, the NSCC sent Robinhood Securities an automated notice stating that Robinhood Securities had a deposit deficit of approximately $3 billion. That deficit included a substantial increase in Robinhood Securities’s VaR based deposit requirement to nearly $1.3 billion (up from $696 million), along with an “excess capital premium charge” of over $2.2 billion. SEC rules prescribe the amount of regulatory net capital that Robinhood Securities must have, and on January 28 the amount of the NSCC VaR charge exceeded the amount of net capital at Robinhood Securities, including the excess net capital maintained by the firm. Under NSCC rules, this triggered a special assessment—the “excess capital premium charge.” In total, the NSCC automated notice indicated that Robinhood Securities owed NSCC a total clearing fund deposit of approximately $3.7 billion. Robinhood Securities had approximately $696 million already on deposit with NSCC, so the net amount due was approximately $3 billion.
Between 6:30 and 7:30 am EST, the Robinhood Securities operations team made the decision to impose trading restrictions on GameStop and other securities. In conversations with NSCC staff early that morning, Robinhood Securities notified the NSCC of its intention to implement these restrictions and also informed the NSCC of the margin restrictions that had already been imposed. NSCC initially notified Robinhood Securities that it had reduced the excess capital premium charge by more than half. Then, shortly after 9:00 am EST, NSCC informed Robinhood Securities that the excess capital premium charge had been waived entirely for that day and the net deposit requirement was approximately $1.4 billion, nearly ten times the amount required just days earlier on January 25. Robinhood Securities then deposited approximately $737 million with the NSCC that, when added to the $696 million already on deposit, met the revised deposit requirement for that day.
Basically Robinhood got a normal margin call—its “VaR based deposit requirement”—for about $1.3 billion, because its customers were trading a lot of stocks that were very volatile. This margin call exceeded Robinhood’s regulatory capital, which under the clearinghouse’s rules triggers another, even bigger margin call. You can see why that would be a problem! We have talked about Robinhood’s clearinghouse margin call before, and we have discussed the destabilizing potential of these margin calls: As things get scary and volatile, clearinghouses have a lot of unchecked discretion to demand huge piles of money from brokers at exactly the worst moment for those brokers. Here, precisely because Robinhood was so thinly capitalized, its clearinghouse had the right to demand even more money from Robinhood, exacerbating the risk of disaster. And then it just waived the whole extra $2.2 billion charge and said “ehh never mind you’re fine,” because Robinhood agreed to stop trading so much of the volatile stocks.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Amazon, Facebook, and Salesforce. Holdings are subject to change at any time.
