What We’re Reading (Week Ending 30 January 2022) - 30 Jan 2022
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 30 January 2022):
1. How Inflation Swindles The Equity Investor – Warren Buffett
There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.
It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.
And why didn’t it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.
I know that this belief will seem eccentric to many investors. They will immediately observe that the return on a bond (the coupon) is fixed, while the return on an equity investment (the company’s earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate returns that have been earned by companies during the postwar years will discover something extraordinary: the returns on equity have in fact not varied much at all.
2. Complexity Investing & Semiconductors (with NZS Capital) – Ben Gilbert, David Rosenthal, Brinton Johns and Jon Bathgate
David: I’d heard a little bit about complexity theory and the Santa Fe Institute, which I want to get into. I think Bill Gurley talks about this fairly frequently and Michael Madison, and that’s how I kind of originally got turned onto it. Tell us a little bit more about what is it? Because it’s not at all about investing. It’s about the world.
Brinton: That’s right. In fact, I think it was Bill Gurley that recommended Complexity to Brad. Complex adaptive systems are all around us. That’s what governs the world. That’s how the world works. We don’t know how the future is going to unfold because the system is interacting together and it creates what’s called emergent behavior.
Emergent behavior makes predicting useless in most cases, and we can have guidelines, and heuristics and those are all helpful. As far as exact outcomes and what’s going to happen in the future, those are a lot more difficult.
Santa Fe Institute started with a group of scientists from the Los Alamos National Labs. They came together—they were mostly physicists—and they started talking to economists. It was sort of hard sciences and soft sciences, and the physicists were like, hey, economists, guys. You guys seem really smart, but your theories don’t work. All your math doesn’t work. So what’s up with that? With our math, it’s extremely precise. In fact, when the math is off just a little bit, Einstein’s like oh, your math is off. Pluto should really be here and come up with a Theory of Relativity.
David: It’s like we literally made the atomic bomb, it works.
Brinton: Yeah, it works. So they started coming together around this idea of complexity. What is complexity? How do we define complexity? Where does it sit? Because we are living in this complex, adaptive system, how do we think about the future? How do we think about life? How do we think about going forward?
For us, this sparked an interest in biological systems and we found this sort of biology vein much more interesting than the traditional economics vein, and much more applicable to investing than the traditional economics vein…
…We just learned so much. I remember sitting outside of this cafe in Palo Alto with Brad and we have just sort of been at this course with Deborah Gordon, this lady that teaches at Stanford, here to study ants. I thought, man, this concept of resilience is really fascinating. It’s really more about resilience than it is about predicting the future and it’s about adaptability.
Biology doesn’t really care that much about the future. They care about adapting to this wide range of futures. Bees don’t really care if it’s going to snow tomorrow, they can adapt to snow. They’ve learned how to do that over millions of years. What if we looked at companies like that?
Of course, we kept reading, we kept writing. This is probably 2011–2012, and in 2013 we published this long paper that you reference, which is super geeky, but it’s got a lot of pictures because that’s the way we think.
David: You’ve got the Back to the Future DeLorean in there.
Brinton: It’s got the DeLorean. What more could you want? We were really hoping for a DeLorean for the office. That’s our dream office furniture.
Ben: On the note of ants, this is probably the first and best example of an extreme version of resilience in an organization. Can you share the insight you had there?
Brinton: Yeah. We attended this class by Deborah Gordon and she has been studying this group of ants for 30 years in New Mexico. They obsess over this group of ants. They know what every ant is doing at all times. What they found was really fascinating.
They found that about half of the ants of the colony weren’t doing anything. They were just sort of sitting around and then they had half the hands doing these defined jobs. That’s very counterintuitive. We think of ants as sort of the ultimate productivity machines. Then it turns out ants aren’t optimized around productivity. They’re optimized around longevity. They’re optimized around resilience, around living as long as possible, let’s say it that way.
That was really insightful for us. We thought, man, all these companies are optimized around productivity and Wall Street only makes it worse because we’re obsessed over quarterly earnings. What if companies were really optimized around this long-term thinking? Of course, we see that with lots of companies, most of them tend to be run by founders, because founders have a lot of skin in the game, they think long-term, but there are CEOs that think that way also.
We know that the average tenure of a CEO in a SP 500 is less than five years. They’re not optimized like ants are. They’re trying to get a lot of returns really quickly. But companies that take this long-term view are so much more interesting.
David: When I read that, in your paper, the thing that hit me over the head, I was like, oh, this is Warren and Charlie’s laziness bordering on sloth.
Brinton: That’s exactly it.
David: The goal is not productivity. The goal is long-term steady returns and resilience.
Brinton: I think Warren and Charlie got this very early and there’s a lot of science behind that math, but they don’t need that. They’re so good with folksy wisdom.
3. Zoom CEO Eric Yuan on trusting your gut, learning from failure, and leaving behind an enduring legacy – Byron Deeter
When Eric joined Webex as a founding engineer, he witnessed the transformation of this first generation video and collaboration product into a major player that was acquired by Cisco in 2007. He’d also worked his way up to VP of Engineering. But by 2011, Eric was no longer happy.
“Every time I talked to a Webex customer, I was embarrassed,” he says. “I did not see a single happy customer.” Eric realized there was no way to fix all the modern problems plaguing customers by tweaking legacy Webex software. He was convinced that the only way to win back disenchanted customers was to build a new solution from the ground up.
But when he presented his ideas to his coworkers, they were not sold on cannibalizing their existing product. They also doubted whether Eric’s proposal was even possible. In the face of this tremendous pressure from naysayers to abandon his ideas, Eric trusted his gut. He decided to tender his resignation and start his own company.
Buoyed by a strong instinct that he could build something superior, Eric began creating the product we now know as Zoom. The first iteration took him only one year. “I like Nike’s mantra,” says Eric. “Just do it. A lot of my friends told me, ‘Eric, please don’t do it.’ But if it’s your dream, you need to ignore them.”…
…Eric stresses the value of building trusting relationships with customers. He prizes this above all else, even if it means leaving money on the table. “Quite often our sales team would tell me, ‘Eric, we’ve got to increase the price. Customers told us we can,’” he says.
But Eric would repeatedly refuse. He remained steadfast in his conviction that some things are worth more than money. “Our philosophy is to always keep adding more value, while keeping the same price,” he says. “Because down the road, the customer will realize ‘Wow, I paid $14.99, but the product just keeps getting better and better.’”
“If you’re a founder, don’t always think about always increasing the price,” Eric advises. He believes it’s myopic to think that short-term cash in the bank is worth more than deep usage engagement, which creates momentum that will build over time.
4. The Tech Monopolies Go Vertical – Fabricated Knowledge (Doug)
The phrase “Owe the bank 500 dollars, that is your problem. Owe the bank 500 million – that is the bank’s problem.” is something that comes to mind for some of the tech monopolies right now. There is a shifting relationship between the largest software companies in the world and their suppliers, and as the leading software companies have become ever-larger portions of the compute pie, it’s kind of become the problem of the tech companies, and not the semiconductor companies that service them to push forward the natural limits of hardware. Software ate the world so completely that now the large tech companies have to deal with the actual hardware that underlies their stack. Especially as some companies like Intel have fallen behind…
…I believe that in a few years, most of the large tech companies will have a much tighter level of integration and we will likely see much less “commoditized” platforms. Yes, they might run on partially open stacks (think open networking roadmap and Facebook) but their differentiation is going to be not only software but also hardware. We are going back to the old patterns of integration of both Software and Hardware.
The unit economics of this is profound, partially because if a company doesn’t pursue this, they will have to pay the exponential cost of AI compute at face value, but also potential competitors will have to face a new barrier to entry. The profit deserts around their moats, as mentioned in the first @modestproposal1 Invest like the Best podcast, will climb even higher. They will be able to sell products below their competitors while making a profit..
…This is a barrier to entry that few companies can really climb over anymore, with 500 million in R&D only possible by a few companies (270 according to a screener I used) and many of the companies with R&D budgets larger than 500m is large tech companies themselves. It is no surprise they are going custom, as now this is a very capital intense way to create a gulf between them and the rest. For example, something I wanted to note is that every single company mentioned so far spends more on absolute R&D than Intel! Samsung, a company that is out of the scope of this discussion rounds out the list of the companies that spend more than Intel on R&D worldwide. This is likely not a coincidence! Semiconductors are becoming more capital intense as we hit the wall of physics, and by being at that leading edge the new technology monopolies will get to operate in that world alone.
Just imagine now that you are an entrant, trying to sell IaaS, maybe like Digital Ocean (huge fan). If Intel and AMD chips are all that you can use, you better pray and hope their roadmaps are strong, because now that your competitors are able to create and expand their own roadmaps faster than the large semiconductor platforms, you may be forced to eventually buy from them or just be at a structural gross margin disadvantage. You could offer identical services but make worse profits, just on the basis that you don’t make your own chips. If they lower prices, you could even lose money! You cannot compete…
…Software ate the world and hardware has been struggling to keep up recently. Now the largest software companies are slowly becoming hardware companies and pursuing an integrated strategy that only can be achieved at the largest scale possible and with barriers of entry that are quickly expanding in addition to their well-known network or aggregation effects. The walls are slowly rising, the moats slowly widening, and as we are on the cusp of a new hardware renaissance, the decisions the hyperscalers make now are going to have a long-lasting competitive shadow. Stay tuned.
5. It’s Never a Market Crash Problem – Safal Niveshak
It’s almost always an –
- I don’t know who I am problem
- I don’t know how much pain
- I am willing to take problem
- I don’t have the patience to give my stocks time to grow problem
- I bought on the tip of that popular social media influencer and did not do my homework problem
- I did not diversify well problem
- I bought the stock just because it dipped problem
6. Tyler Cowen is the best curator of talent in the world – Tony Kulesa
I am a biotech investor. I know a lot of top biotech investors. I’ve also spent close to a decade at two of the best life science academic institutions in the world.
Tyler’s understanding of biotech is that of a very broad economist. Yet, he is often beating me and many of the people and institutions that I know.
Tyler has identified talent either earlier than or missed by top undergraduate programs, the best biotech startups, and the best biotech investors, all without any insider knowledge of biotech. In comparison, Forbes 30U30, MIT Tech Review TR35, or Stat Wunderkind, and other industry awards that highlight talent are lagging indicators of success. It’s hard to find an awardee of these programs that was not already widely recognized for their achievements among insiders in their field. The winners of Emergent Ventures are truly emergent.
I have now met >5 Emergent Venture winners that work in life sciences. The average age of this group is ~20 years old.
One has attracted international recognition for his new non-profit founded this year. Tyler funded him ~2.5 years ago when his most notable public accomplishment was amassing 300 twitter followers.
Another winner has now started a company backed by top tier investors – professional talent hunters – but he received his first funding from Tyler a year prior, when he was still experimenting with what to build.
Others had been rejected by undergrad programs at Harvard, MIT, and Stanford, but their research talents have become recognized by the best academic life scientists and top biotech startups…
…It isn’t just a matter of more elite selection. In fact, Emergent Ventures has a higher acceptance rate than elite colleges. In May 2020, Tyler reported in an interview with Tim Ferriss that the award rate is ~10%. For comparison, the 2021 acceptance rates of Harvard, Princeton, and Yale were 5%, 6%, and 7%. It also isn’t a wider pool. At that time, he had only ~800 total applications since 2018.
Tyler’s success at discovering and enabling the most talented people before anyone else notices them boils down to four components:
- Distribution: Tyler promotes the opportunity in such a way that the talent level of the application pool is extraordinarily high and the people who apply are uniquely earnest.
- Application: Emergent Ventures’ application is laser focused on the quality of the applicant’s ideas, and boils out the noise of credentials, references, and test scores.
- Selection: Tyler has relentlessly trained his taste for decades, the way a world class athlete trains for the olympics.
- Inspiration: Tyler personally encourages winners to be bolder, creating an ambition flywheel as they in turn inspire future applicants.
7. Some Things I Remind Myself During Market Corrections – Ben Carlson
Time horizon is all that matters during a correction. This may sound like a humblebrag of sorts but market corrections don’t really bother me all that much anymore. The sight of my holdings falling in price day after day doesn’t bother me for the simple fact that I’ve already resigned myself to this fate.
You see I don’t put money into risk assets that I’m going to need for spending purposes in the next 5 years or so. It’s all long-term capital.
And given this money is going to be invested for the long-term, I already know in advance I’m going to have to endure corrections, bear markets and crashes from time to time.
I know my balance will get vaporized on occasion, I just don’t know when those occasions will be.
The money that I know will be spent in the short-term doesn’t go into risk assets.
An understanding of your time horizon saves you from becoming a forced seller.
It’s best to sell when you want to not when you have to. I’m guessing a lot of the selling in recent days has come from margin calls from investors who bought stocks using leverage. You don’t see massive moves of 10-15% in individual names like we’ve seen without some forced selling.
Buy and hold can be painful when stocks are falling but ‘buy on leverage and get a margin call when your stocks just got killed’ is a far worse fate.
Buy and hold requires you to do both when stocks are falling. It’s much easier to both buy and hold when stuff is going up.
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 Zoom. Holdings are subject to change at any time.
