What We’re Reading (Week Ending 14 August 2022) - 14 Aug 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 14 August 2022):
1. Everywhere you look there’s lag – Stacey (Trust, but verify)
What do London Heathrow’s flight caps, the inventory of retailers, interest rate policies, and the energy transition have in common? All are subject to systems lag and experiencing the effects.
Current world events show the importance of understanding systems and the inherent delays therein. By knowing what to look for, one can better see the forest from the trees. The best way to view the world is as it is. The tangible and intangible components of our lives are comprised of embedded systems…
…Every human, organization, animal, economy, and government is a complex system (with systems within this system which are called embedded systems). Another way to state this is as:
“an interconnected set of elements that is coherently organized in a way that achieves something. The system may be buffeted, constricted, triggered, or driven by outside forces. But the system’s response to these forces is characteristic of itself, and that response is seldom simple in the real world.” – Thinking in Systems
It is more than the sum of its parts – it can exhibit adaptive, dynamic, goal-seeking, self-preserving, and sometimes evolutionary behavior. They can be self-organizing, self-repairing, and resilient. Get all that? Let’s break it down into its essential parts.
A system must contain three things:
1. Elements: the building blocks; for a tree it’s the roots, branches, and leaves.7 Includes the intangible and tangible. For example, the bits within a computer are intangible.
2. Interconnections: relationships holding the elements together. In a tree system, it would be the physical flows and chemical reactions. Interconnections often operate via the flow of information. These flows of information are signals for the decision/action/leverage points within a system.
3. Function/Purpose: what is its aim; can only be deduced by its behavior. The purpose of nearly every system is to safeguard its survival. Further, successful systems work to keep sub-purposes and overall system purposes in harmony. The cells in your heart are different from your liver, but both function to keep you alive.
Of the three building blocks, changing the elements typically has the smallest effect on the whole. Swapping out all the players on a football team still makes it a football team. A human body regularly replaces its cells but continues to be a human body. Countries have regular elections, with different politicians occupying offices, yet nothing seems to change. As long as the interconnections and functions remain intact, a system generally goes on doing its thing.
Altering the function is often the most crucial determinant of a system’s behavior. It would be like if an animal’s purpose was changed from survival/reproduction to pleasure.
However, this is not to take away from the fact that elements, interconnections, and purpose are essential. If changing an element results in a changed relationship or purpose, de facto behavior is modified. Adjusting interconnections (the information flows) can materially affect a system – imagine changing the rules of football to those of soccer.
The system interacts with outside forces, but, importantly, its response is of its own character. Another way to say it is it has its own latent behavior within its structure.
However, a system’s behavior cannot be known based purely upon adding together its elements. Humans tend to think linearly, which is not necessarily how systems act.
Systems are often nested within other systems. As such there are purposes within purposes. According to Friedman’s economic theory, the purpose of a corporation is to maximize shareholder returns. Within that business, the purpose of the C-Suite may be to serve customers well or make as much money as possible anyway possible. Down at the middle manager role, the goal may be not to get fired. At the junior level it could be promotion and earning more money.
As you can see, often the sub-purposes come into conflict with the overall purpose at businesses. Like with individuals, the greater the sense of coherence within the corporation, the better the results.
What is not a system? An assortment of things without any specific interconnection or function.
“Sand scattered on a road by happenstance is not, itself, a system. You can add sand or take away sand and you still have just sand on the road.” – Thinking in Systems
Lags are inherent in systems due to their structure – it takes time for a given input to result in an output. Goods ordered from China do not instantaneously appear in a company’s warehouse.
To understand lags, first we need to take a step back into how the elements of a system are set up. The foundation of any system is its stock. These are the store, the quantity, the accumulation of material or information built up over time. You can see, count, or measure these items. The money in your bank account, the water in a bathtub, trees in a forest, or the population of a country are all examples of stocks.
Flows cause stocks to change. It’s the bathtub filling and draining, the births and deaths within a country, the dying and planting of trees in a forest, deposits and withdraws in a bank account. To understand much of the behavior of complex systems, one must understand the interplay of its stocks and flows.
A critical point is stocks typically change slowly. A forest doesn’t become deforested all at once. It takes a while for the population to unlearn skills. Groundwater can be pumped out at a faster rate than it is replenished for a long time. This occurs even when flows into or out of them change suddenly. Think of how much long it takes for trees to accumulate into a forest. Or for a productive labor force to be built up.
As such, stocks form the basis of system delays. They can also serve as system buffers. Just-in-time inventory has reduced the buffer of stocks. Taking slack out of the system results in decreased resiliency.
Time lags aren’t all bad – the stocks can be sources of stability…for a while. These delays allow room to experiment and revise policies that aren’t working.
Stocks allow inflows and outflows to be independent of each other and temporarily out of balance. Reservoirs allows residents and farmers to live downriver without adjusting their lives to a river’s yearly flows. But if hard rains happen for years, eventually the river will flood.
“Systems thinkers see the world as a collection of stocks along with the mechanisms for regulating the levels in the stocks by manipulating flows. That means system thinkers see the world as a collection of ‘feedback processes.’” – Thinking in Systems
If a system demonstrates a persistent behavior over time, the odds are good there’s a mechanism creating this consistency. It is manifested through a feedback loop. To find feedback loops, look for a system’s consistent behavior.10 Feedback loops can stabilize or de-stabilize systems. They can cause stocks to increase or decrease.
Donella Meadows in her excellent book on systems speaks of three types of delays: 1) perception delay; 2) response delay; and 3) delivery delay. Below shows the system flows for a car dealership’s inventory…
…The perception delay is intentional in this case. How often does the dealer react to changes in sales? Does he go off of daily, weekly, monthly, or some average? It’s key to pick the right time period to sort out real trends from noise.
Response delay is how much he orders. Does he order the whole lot needed or make partial adjustments to make sure the perceived trend is real?
The delivery delay is how long it takes to receive vehicle orders onto the lot.
Inventory oscillations result in a system where there are delays…
…Think about it: sales increase, causing vehicles on the lot to drop. Once they are sure the higher sales rate will last, more cars are ordered. The delivery delay means it takes time for the orders to actually arrive.
Yet during the interim period before orders hit the lot, inventory drops further if sales sustainably rise, meaning available inventory continues to decrease, so orders bump up a little more to bring inventory back to prior levels.
The larger volume of orders begins arriving, and, instead of recovering, inventory can shoot up more than expected, and the dealership can quickly turn from under-inventoried to over-inventoried. Orders are cut back, but elevated past orders are coming in, so less is ordered. Inventory eventually falls and can become too low.
2. DeepMind found the structure of nearly every protein known to science – Nicole Westman
DeepMind is releasing a free expanded database with its predictions of the structure of nearly every protein known to science, the company, a subsidiary of Google parent Alphabet, announced today.
DeepMind transformed science in 2020 with its AlphaFold AI software, which produces highly accurate predictions of the structures of proteins — information that can help scientists understand how they work, which can help treat diseases and develop medications. It first started publicly releasing AlphaFold’s predictions last summer through a database built in collaboration with the European Molecular Biology Laboratory (EMBL). That initial set included 98 percent of all human proteins.
Now, the database is expanding to over 200 million structures, “covering almost every organism on Earth that has had its genome sequenced,” DeepMind said in a statement.
“You can think of it as covering the entire protein universe,” Demis Hassabis, CEO of DeepMind, said during a press briefing. “We’re at the beginning of a new era now in digital biology.”
3. Taiwan reports 1st child with cancer cured by CAR T-cell therapy – Keoni Everington
A 10-year-old girl suffering from leukemia is the first child in Taiwan to receive CAR T-cell therapy and to have fully recovered from the cancer as a result.
The girl, identified as Tingting (亭亭), was diagnosed with childhood B-cell acute lymphoblastic lymphoma four years ago. After undergoing first-line therapy, she still relapsed.
In the past, such a patient would have to wait for a stem cell transplant to save their lives. However, with the assistance of doctors at National Taiwan University Hospital (NTUH), she became the first CD19-targeted chimeric antigen receptor-engineered (CD19 CAR) T-cell recipient in Taiwan and has fully recovered, with no residual cancer cells detected in her body…
…Chou explained that the treatment principle relies on high-tech genetic engineering. First, T-cells are isolated from the patient’s body, and are genetically modified by adding a gene for a receptor called chimeric antigen receptor (CAR), which enables the T-cells to attach to a specific cancer cell antigen.
The cancer cells from childhood B-cell acute lymphoblastic lymphoma contain an antigen called CD19. Therefore, in this patient’s case, the CART T-cell technique was used to design T-cells to attach to the CD19 antigen.
Chou compared it to a precise “immunization army” that can accurately and continuously destroy cancer cells. The advantage is that a one-time injection can generate these results, said Chou, as was the case with Tingting.
In April of this year, NTUH became the first medical center in Taiwan to provide formal clinical use of CD19-targeted CAR T-cell therapy. Tingting was the first patient in Taiwan to receive the treatment and experience a full recovery.
4. An engineering breakthrough using DNA could unlock the quantum computing revolution – Chris Young
Scientists from the University of Virginia School of Medicine and collaborators used the building blocks of life to potentially revolutionize electronics.
The scientists utilized DNA to guide a chemical reaction that would overcome the barrier to Little’s superconductor, which was once thought to be “insurmountable”, a press statement reveals.
They used chemistry to perform incredibly precise structural engineering, allowing them to assemble a lattice of carbon nanotubes for Little’s room-temperature superconductor.
More than 50 years ago, Stanford physicist William A. Little proposed a type of superconductor that could be used at room temperature. This could potentially be used to enable hyper-fast computers and shrink the size of electronics devices, among a list of other benefits. In 2020, researchers from the University of Rochester revealed the first room-temperature superconductor, but high-pressure requirements make it difficult to utilize.
Edward H. Egelman, Ph.D., of UVA’s Department of Biochemistry and Molecular Genetics and graduate student Leticia Beltran applied their knowledge in the field of cryo-electron microscopy (cryo-EM) to the problem. Their work, outlined in a new paper in the journal Science, “demonstrates that the cryo-EM technique has great potential in materials research,” Egelman explained.
The researchers set about trying to realize Little idea for a superconductor by modifying lattices of carbon nanotubes. The main obstacle was controlling the chemical reaction along the nanotubes so that the lattice could be assembled as precisely as possible. According to Egelman, their “work demonstrates that ordered carbon nanotube modification can be achieved by taking advantage of DNA-sequence control over the spacing between adjacent reaction sites.”
The lattice the scientists built has not yet been tested for superconductivity, but it offers proof of principle, according to the researchers. “While cryo-EM has emerged as the main technique in biology for determining the atomic structures of protein assemblies, it has had much less impact thus far in materials science,” Egelman described.
5. Walmart – Benjamin Gilbert and David Rosenthal
David: There, one night at a bowling alley in Claremore, he meets and falls in love with a girl named Helen Robson. Helen was from Claremore, but her father, L.S. Robson, unlike Sam’s family, was a very wealthy and successful businessman, financier, and trader in the broader Tulsa area.
He ends up taking a big shine to Sam and would become hugely influential along with Helen because he marries Helen, of course. Sam would say, “The Robsons were very smart about the way they handled their finances: Helen’s father organized his ranch and family businesses as a partnership, and Helen and her brothers were all partners. Helen has a college degree in finance, which back then was really unusual for a woman, and Mr. Robson advised us to do the same thing with our family, which we did way back in 1953.”
That partnership that Helen and Sam set up is today Walton Enterprises which owns 36% of Walmart, and then individual family members and trusts—I think mostly Bud’s [Sam Walton’s brother] family—own the other 11%–12%.
Ben: This is the interesting seed plant of Walmart being a family business from the very get-go. They organized it interestingly. Each store was actually its own company so that different people could hold shares in each store—the management, different people who wanted to invest in the store, and that sort of thing—but at a really high level, Walmart always was a family partnership. It was always something where the economic and spiritual ownership and decision-making always was the Walton family. Of course, Sam’s the guy, but there were a lot of family meetings to make decisions for the business.
David: This is why, because the family was all partners in Walton Enterprises. They couldn’t just sell their stock and the partnership. The family as a whole had to decide to sell. That allowed them to keep majority control of Walmart all through history.
Sam talks about this. He says he thinks it’s the big reason why corporate raiders or larger companies like Kmart never came and acquired them because the stock was never splintered. It was all within the partnership. Then, he actually writes, “One of the real reasons I’m writing this book is so my grandchildren and great-grandchildren will read it years from now and know this: If you start any of that foolishness like changing the structure, selling off stock, going off and doing fancy thing—”
Ben: Buying NBA and NFL teams.
David: Buying NBA and NFL teams which they do now. “—I will come back and haunt you. So don’t even think about it.”…
…David: Sam and Helen get married and Sam gets posted in a bunch of places all around the country doing internal intelligence work for the army. He goes to Utah and plenty of other places. He decides that when the war ends and he gets out of the Army, he’s going to go back into retailing, but now, he has the support of Helen, her family, and her father, L.S. They’re financiers, so he knows, I now have access to some amount of capital. I can be an entrepreneur. I don’t necessarily have to work for somebody.
When the war ends, L.S. initially wants them to move back to Claremore, but Helen and Sam decide together. They’re like, well, we want your support, but we don’t want to be totally under your wing and in your shadow.
Sam got big ambitions. He and a buddy decide that they want to buy a Federated Department Store franchise in St. Louis. They’re going to be big. He comes from JCPenney in Des Moines. He wants to be a big city department store owner, magnate, and entrepreneur.
Helen vetoes this outright. We would not be talking about Walmart if Sam had moved the family to St. Louis. Helen says, look, one, I don’t want you doing any partnerships with non-family members. Sam says, “Her family had seen some partnerships go sour, and she was dead-set in the notion that the only way to go was to work for yourself and for your family.”
Two, she says, “I don’t want to live in a big city. I want to go live in a small town where I grew up just like Claremore. I don’t want to live in Claremore itself, but we are not allowed to move to any town that has a population of more than 10,000 people.”
Ben: Her whole thing was I want to raise my kids the way that I was raised. She looked at Sam and said, you were raised the same way in a small town and that’s what we’re going to do. Whatever business he did had to be family owned and controlled and have a small town-based strategy. What seems so intentional and so genius actually stems from the fact that she just vetoed his original idea….
…David: …Sam doesn’t stay down for long. I think he was a little disappointed that his wife had overruled him, but he finds a way. He goes back to the company that owned Federated, which is a company called Butler Brothers. They were franchisors of Federated. They’re based in Chicago.
He asks, well, do you have any department store locations that might be available in a small town of say 10,000 people or less? The Butler Brothers guys are like, we don’t really do department stores in towns like that, but we do have another spin-off operation that we run, which is our variety store franchising business.
Ben: There literally weren’t enough people they believed to support a department store. Variety stores are like glorified general stores. When you think about a town that’s 2000, 3000, or 4000 people, it really is like if you visited an old west town and looked at a general store. It’s like on steroids, but a few decades later.
David: Variety store businesses, that’s exactly it after the Depression and World War II. That was how small towns and areas were serviced to retail. They’re mostly franchise operations. This particular one was Ben Franklin, the brand name. Benjamin Franklin general store type of place.
Ben: When you say franchise operation, because it’s way too much of a burden to source your own inventory, carry your own inventory, and maintain all those different vendor relationships, if you’re in one of those towns, you’re serving 2000 people and you’re the one store there, what you really want is to sign a contract and just get the shipment of the stuff that goes into the Ben Franklin stores in all the small towns.
David: Yeah, and just be literally the merchant serving your customers. That mindset dominated. It’s worth a pause here to talk about what these stores were because it’s a very foreign concept to anything we’re familiar with today. These variety stores were also called five and dimes if you’ve ever heard that term.
Ben: A 5¢, 10¢ store.
David: The reason for that is that in most of them, every item in the store was either priced at 5¢ or 10¢. That was the level of sophistication here. The other big, big difference between how the stores operated in modern retail today, which says I’m really invented, was they weren’t self-service.
Ben: He didn’t invent that. He stole that.
David: We’re going to get to it. So you would walk into these stores and there would just be a counter area upfront that had clerks. You would tell the clerk what you wanted, and then the clerk would go back into the store, pick out what you wanted, bring it up to the front, and check you out.
Ben: Because there wasn’t really a choice. You’d be like, I need a hose, and they would go get the hose. It’s not like, well, let me see all the different brands, sizes, and colors. It was like, I know you have hoses here. Can you get me one?
David: The merchants weren’t making the decisions on the inventory. It was all just being handed down on high from Butler Brothers back in Chicago.
Ben: Yeah. I did not understand when reading this book when he kept referencing stores that were not stores where you walked around and got your own stuff off the shelf, that that is a modern concept. That is crazy.
…David: …Butler Brothers—Sam’s having this conversation with them—are like, well, probably, you want a Ben Franklin franchise, and it just so happens that we’ve got the perfect store for you in the little town of Newport, Arkansas. The current owner of the Ben Franklin franchise there wants to sell.
Newport is a little town of about 7000 people. It’s in eastern Arkansas. If you know where Bentonville, Arkansas and Walmart are today, it’s not in eastern Arkansas. Sam is like, great, I’ll take it. Now, you have to ask yourself, it is 1945 in America. The war has just ended. Unlike 1945 in Japan like we talked about with the Sony story, retail in the US is booming.
Ben: Everyone’s coming home, there was the G.I. Bill, everyone’s got new homes, everyone’s starting families, and there’s a lot of stuff to buy.
David: There’s a lot of stuff to buy. It doesn’t matter if you’re a department store in a big city or a variety store in a 7000-person town. Everybody in retail should be making money hand over fist right now.
The question that Sam didn’t ask himself and should have was why does this guy want to sell? He says in the book, “A guy from St. Louis owned it, and things weren’t working out at all for him. He was losing money, and he wanted to unload the store as fast as he could. I realize now that I was the sucker Butler Brothers sent to save him. I was twenty-seven years old and full of confidence, but I didn’t know the first thing about how to evaluate a proposition like this so I jumped right in with both feet. My naiveté about contracts and such would later come back to haunt me in a big way.”
He and Helen buy this store.
Ben: This distressed asset at not a distressed price.
David: Yes. They buy it for $25,000, $5000 of their own savings and a $20,000 loan from L.S., Helen’s father. Sam says, this isn’t what I dreamt, but I’m still going to set big goals. He decides that he’s going to set a goal that this store is going to become the most profitable variety store in Arkansas within five years.
Ben: It’s quite the turnaround and is also the first indication of Sam setting these big, hairy audacious goals. He has this subsequent obsession with set a goal, hit it, set a goal, hit it. That really does drive all of his need for experimentation because he finds himself in these situations where he has a goal set and he must invent some way to hit it.
David: It also sets the stage for what was to come. He sets this goal, and then he gets there. This is not a realistic goal.
He says, “Only after we closed the deal, of course, did I learn that the store was a real dog. It had sales of about $72,000 a year, but its rent was 5 percent of sales—which I thought sounded fine at the time—but which, it turned out, was the highest rent anybody had ever heard of in the variety store business. No one paid 5 percent of sales for rent. And it had a strong competitor—a Sterling Store which was another franchise across the street—whose excellent manager, John Dunham, was doing more than $150,000 a year in sales, double mine.”
Not only is it unlikely that he’s going to be the most profitable store in Arkansas, it’s unlikely he’s going to be the most profitable store in Newport. What does Sam do? He goes right across the street into the Dunham Store and he starts trying to figure out why Dunham is twice as successful as he is.
Ben: Yeah. Speaking of the first time Sam does something that he then does forever, he becomes notorious for going into competitor stores, bringing in a little notebook, later bringing in a little tape recorder, and just seeing what he can get away with interviewing clerks and associates at these stores.
Anytime he’s traveling with the family on vacation or anything, he’s just going into all these other stores, observing, taking notes, and figuring out what their systems are, what’s working, and what’s not working, so here he learns that valuable lesson for the first time.
David: So great. I was going to bring this up later, but I think he says in the book that he believes he has spent more time in Kmarts than any nonindividual store employee of Kmart including Kmart’s senior management.
Ben: Yeah. Also, we keep referencing Kmart. When I was growing up, it was like Walmart, Kmart. I think Kmart is kind of like Walmart, about the same scale, same size, and kind of a little lower end. That was my perception as a kid of Kmart. I didn’t realize that Kmart for a very long time was much, much larger than Walmart. They were Walmart’s big brother incumbent.
David: They were the gorillas.
Ben: I don’t remember what year this was, but I remember some quote from Walton where he’s talking about when we reached 5% the scale of Kmart. It’s like, well, that really puts it into perspective how big a lead they had.
David: You mentioned a notepad. It’s actually a yellow legal pad that Sam uses. Famously, he has this yellow legal pad and he’s going into competitor stores. He starts diving into dumpsters trying to get sales receipts, inventory orders, and stuff to figure out how these stores are operating.
He quickly realizes from both Dunham across the street—and also, he’s doing this all over the countryside, going into small variety stores all over Arkansas just trying to learn—that price, running promotions, and cutting prices on big marquee attractive items like health and beauty aids, toothpaste, mouthwash, makeup, and that stuff really drives customers in.
He starts doing that and he has some success, but there’s a problem. We talked about Butler Brothers as the franchisor. They’re controlling all the inventory. Sam as the merchant is just getting whatever they send to him at whatever cost they prescribe.
The Butler Brothers are doing great. They get about a 25% markup on all the inventory and they don’t even do anything. It’s almost like they set up the whole system just to keep these prices high out in the countryside and they just get a 25% skim off the top.
What does Sam do? He starts figuring out who the manufacturers are of some of these goods. For manufacturers that are also located there in the south in the Midwest, he starts driving around, knocking on their doors, and asking if they’ll do side deals with him and just clandestinely sell him some of the merchandise that he otherwise would be ordering from Butler Brothers and that they would be selling to Butler Brothers. They just give him a deal directly on that.
Ben: He’s operating a small enough scale that Butler Brothers doesn’t really notice. To be frank, there wasn’t good tracking or accountability at this point. There weren’t computers yet.
David: There’s no computerized inventory here.
Ben: You’d have to really be paying attention to figure out, oh, maybe Sam is not ordering quite as much of this stuff from us as he should be.
David: He’s driving around himself. There’s no management. He has some clerks working in the store, but it’s just Sam and Helen running the place. He’s out, he drives to visit them, and he’s got to get a deal done on the spot.
He goes, knocks on the door, and meets these people. He’s like, I want to buy it right now. I’ve got a trailer hooked up to my pickup truck outside. Can you just load the inventory right into the back and I’ll drive it back to Newport? He says, I bring them the inventory, bring it back, price it low, and just blow that stuff out of the store.
Ben: Which is an invention. This is a brand-new concept that we take for granted now, but it’s totally a Sam Walton invention to meet his own needs which is to create something that is astonishingly low price to get people in the store, take no margin on it, and make it a loss leader. Who cares? Get people in the door spending time in your store and they look at other stuff.
This would become a cornerstone of Walmart forever after this and for every other retailer. Even in the pricing of SaaS products now, when you look at it, it’s like, oh, I’m on the free plan. It’s not that he invented loss leadership as a category, but he figured out how to make it work in the retail model.
David: He figured out how to really merchandise and operationalize. Dunham’s across the street running promotions, but Dunham wasn’t thinking about, oh, well, maybe I could sell even lower if I go haul my pickup truck out to these manufacturers and get goods at a lower price.
Ben: Right. Of course, once you’re hauling your pickup truck to go meet the vendors directly, it’s not that far of a cry to say, well, what don’t I have in the store that I’m getting from Butler Brothers? What could be interesting? You start getting good at doing these direct deals, sourcing your own inventory, and figuring out how to merchandise products that you personally believe will sell.
This is really where he started to hone that skill, craft, and sixth sense for deeply knowing the American consumer—or let’s say consumers in this area in his communities—and having a real spidey sense of what would make them go crazy and have a real product-market fit in people’s homes.
David: Price, selection, and convenience are the holy trinity of retail, but nobody really knew this yet. Frankly, all of those things are important, but for the majority of people out there in the world, in America at the time, and certainly the vast majority of people in these small towns, it’s selection and convenience.
Ben: Life was inconvenient, so you’re going to go through some inconvenience to get things. Selection, there wasn’t much of no matter what. We just came out of the Great Depression. Price is very important.
David: Customers will go to great lengths to get lower prices.
Ben: People would make day trips. People would drive five hours to other cities to get a deal on goods.
David: It’s crazy. He says, “Here’s the simple lesson we learned—which others were learning at the same time and which eventually changed the way retailers sell and customers buy all across America: say I bought an item for 80 cents. I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater. Simple enough. But this is really the essence of discounting: by cutting your price, you can boost your sales to a point where you earn far more at the cheaper retail price than you would have by selling the item at a higher price.”…
…This is incredible. He actually hits his goal. By year five of the Newport store, he’s doing $250,000 in sales at a $30,000–$40,000 annual profit. Remember, he bought the thing for $25,000. That’s including the crazy 5% rent charge in his expenses.
Ben: His operating margin on this is 24%. He’s making very, very real profits on this little store that he’s got.
David: If he had a better rent deal it could be 28%. But at those numbers, it is the most profitable store in Arkansas and the biggest store by sales not just in Arkansas but the whole Midwest and South region. He has found a winning formula here.
Ben: Which is interesting because I’m pretty sure at this point, he’s got a bunch of direct deals cut with the suppliers and he’s added a bunch of products of his own. He’s really merchandising. He’s really showing up on Ben Franklin’s radar and the Butler Brothers Corporation’s radar, and they know what he’s doing at this point. But it’s good for them. Even though it’s good for Sam, it’s also good for them because of volume and customers.
David: Right. He’s by far the best-performing Ben Franklin store in the country at this point. Unfortunately though, like I said, there’s a reason that Walmart is not headquartered in Newport, Arkansas. Butler Brothers weren’t the only related party to Sam who figured out what was going on here. His landlord that had pulled one over on the previous owner and had the super onerous rent terms also figures out, of course, how great Sam is doing despite having the deck stacked against him.
He decides he wants to take over the store. Year five is when the lease expires and there wasn’t an option in the contract to renew the lease. The landlord goes to Sam. He’s like, you know what, son, you’ve done a great job. Thank you for turning this property of mine around. I’m going to take it from here.
Ben: Just to contextualize this, it’s a 7000-person town. There are not really many other available storefronts. He’s got tons of shelves in there with tons of goods. It’s a meaningful amount of inventory that’s being carried on the business. It’s not like you can be like, oh, cool, I’ll move next door. That option does not exist.
His landlord comes to him and says this and he’s like, wait, oh my God, I have no other options.
David: He says, “It was the low point of my business life. I felt sick to my stomach. I couldn’t believe it was happening to me. It really was like a nightmare.”
I say this as a saving grace although the reality is Helen’s father would have financed Sam’s next venture no matter what. But the saving grace for Sam’s pride at least was that the landlord did buy out the value of the Ben Franklin franchise license, the hard assets, the inventory, the fixtures, et cetera in the store. He pays Sam and Helen $50,000 to take over the store. I’m going to guess that’s a 2X return.
Ben: What was the operating income from the previous year?
David: Thirty to forty thousand dollars.
Ben: Wow, brutal.
David: But at least they get the $50,000 out. This is now 1950. Sam and Helen hit the road again looking for a new town to bring their traveling circus to.
Ben: And have a little bit more knowledge on lease negotiation.
David: Yes. They go up to the other corner of the state in Northwest Arkansas. This is where they started looking around for the next place to set up shop for two reasons.
One, closer to Helen’s family in Oklahoma, Claremore. Two, like I said, Sam keeps it real. He was like, there’s some really good quail hunting up there and I really wanted to be closer so I could drag my bird dogs out and go hunting.
Ben: Yes, and more specifically, it’s not just that there’s good quail hunting. It is that he will be very close to four states which each have their own quail hunting season so that he can get the maximum amount of quail hunting in with an easy drive from his house.
Lots of business decisions being made here on family—we need to be in a small town and we need to only work with family. For Sam, I need to be able to hunt quail in the maximum amount of time that I possibly can.
David: The opportunity that they find and settle on is in a little town of 3000 people—less than half the size of Newport—that already in this town of 3000 people had 3 variety stores operating. Newport had 2 for 7000 people. This town has 3 for 3000 people.
As Sam says, he loves competition. That town is Bentonville, Arkansas. Sam probably almost assuredly is rolling over in his grave right now.
Ben: The new Walmart campus.
David: The new Walmart campus that they’re building. It looks absolutely gorgeous, which I’m sure he would be furious about.
Ben: Yes. If you thought Warren was a penny-pinching, very plain, no frills, no fancy things entrepreneur, Sam Walton—hard to argue who’s more frugal and less showy. Sam eventually got into airplanes for very practical use, but Sam was not a showy guy.
David: Actually, the anecdote that he and John Huey open Made in America with is I think it’s 1985 when Forbes ranked him the richest man in America and all these reporters start descending on Bentonville. They want to go interview the richest man in America. He still drives an old pickup truck that has cages in the back for his bird dogs because he goes hunting in the four states nearby.
It’s this big sensation that the richest man in America drives a beat-up, old pickup truck with cages in the back. He’s like, well, what am I going to drive my dogs around, in a Rolls Royce?
Ben: All right, so they arrive in Bentonville. Bentonville and the world are forever changed, but it doesn’t happen all at once.
David: No. The store that they buy is another Ben Franklin franchise that had done $32,000 in revenue the year before, quite a distance from the $250,000 that they left Newport with. Sam decides, all right, well, this is a small market. This is a small store. There’s a lot of competition, but I have big ambitions. He’s got his ear to the ground in retail and particularly in the Ben Franklin franchise network.
He hears through the grapevine that there are two Ben Franklin stores up in Minnesota that were trying a radical new concept. They were redoing the whole way. The store was laid out, the way it worked. They were removing the upfront counters, turning them into checkout counters, and letting customers go into the store, browse the merchandise, pick it up themselves, select it themselves, and then checkout.
He’s like, I got to go see this. He takes the overnight bus up from Arkansas up to Minnesota and checks them out. He’s taking notes the whole time on his yellow legal pad. He says about that trip, “I liked it. So I did that too”
Ben: I love how he’s so obsessed with first-hand experience. He couldn’t just hear about this and then implement it. He’s like, I must see it for myself because he so fervently believes that he picks up insights from actually spending time in stores and actually talking to customers. It seems like he does that more than any other entrepreneur we’ve ever talked about on this show, this obsession with first-hand experience.
David: I think everybody can apply this to their business. I was thinking about it while reading the book. I started so many passages and I already listened to lots of other podcasts unlike when we started Acquired and I didn’t listen to any other podcasts.
Ben: We should find the best ideas and incorporate them, yeah.
David: There’s a great quote about this when Walmart actually gets started later. I’m going to tease it for now. On July 29th, 1950, just about 72 years ago, they reopened the Ben Franklin store that they bought.
Ben: Still a franchise.
David: Still a Ben Franklin franchise, still working with Butler Brothers for “most of the inventory.” But they want to send a message that this is a new era, doing the self-service new store in Bentonville. They renamed it Walton’s Five and Dime and it became the third self-service variety store in the entire country.
Ben: It’s fascinating that they picked this name because part of the reason why you do a franchise is the brand. Sure, it’s nice to get the inventory, negotiated relationships, prices, and all this stuff, but really what you’re buying is people who know what a Ben Franklin is, so they would come to the store.
What Sam is saying is, eh, I feel pretty good about building my own brand. I know I’m in one way or another paying to use the Ben Franklin brand, but we’re not going to use it.
David: It really was rational because even though Sam on the margins is doing his own direct deals with manufacturers at this point, it’s a ludicrous concept that somebody in a little store in Arkansas could source all of their inventory and do all of their logistics by themselves. That is completely freaking crazy that a store servicing 3000 people in a little town would handle all of that themselves.
But they launched with a new name. It’s a new concept. It’s self-service. It causes quite a stir. I couldn’t find this exactly, but I believe, in that first year when Walton’s Five and Dime is open—remember, the previous Ben Franklin iteration of the store had done $32,000 a year in revenue, something like that—Walton’s Five and Dime did $90,000 in sales the first year.
I don’t know what the competitive dynamics were between the 3 stores in Bentonville, but remember, the town only had 3000 people. If you assume the previous three stores roughly had an equal market share—it’s a big assumption but just for argument’s sake—that would mean that the whole market size of Bentonville, the whole TAM, is $90,000. They did $90,000 in revenue, so what was happening here?
Ben: Yeah, is there a massively expanding TAM, did they expand that market because people are just buying more stuff than they otherwise would have?
David: I don’t know what happened to the other two stores, whether they went out of business or not. Certainly, they wouldn’t have right away. I think what happened was this caused such a stir that people started coming to shop at Walton’s Five and Dime from other towns.
Ben: I think it was the first time that Sam realized that shock value would bring customers much like I didn’t need anything the first time I went to an Amazon Go to try the cashierless checkout. People came for novelty value here. That taught him the lesson of, oh, maybe we should always have novelty value. Maybe there are reasons why people should be coming to Walmart even if they aren’t necessarily looking to buy something.
David: Yup. If you think about it, put yourself in the shoes of customers back then. Sam talks about this a lot in the book. For so long—we’ll get into the competition with Kmart—everybody thought Walmart, Sam, and all their customers were just kicks in the sticks. They are just complete morons out there. Nothing could be farther from the truth.
He says, my customers were also sophisticated retail customers. They knew about what was going on in the cities. They had relatives there they’d go visit. It’s not like they didn’t want first-class shopping experiences in their own hometowns.
Clearly, this makes a big splash. Sam realizes that he might have a tiger by the tail here so he starts looking. Unlike in Newport where he was satisfied, the store kept growing and he did $250,000 a year in sales. He starts looking to open up more locations.
Ben: More Five and Dimes.
David: He also doesn’t want to have all of his eggs in one basket and one lease like he did in Newport.
Ben: Right. Didn’t he open a store directly next door to one of his competitors just so that his competitor couldn’t expand their store? It wasn’t a high-performing store for him, but at least it didn’t let them get the square footage.
David: Yes. Clearly, he’s very competitor-focused. It’s funny. There are so many Jeff Bezos-isms that when you read this book and you learn about Walmart and Sam Walton, you realize that they were originally Walton-isms, Sam-isms, but in the whole Amazon we’re customer-focused and we’re not competitor-focused, Sam would have said absolutely not. We are absolutely competitor-focused. We’re focused on taking the best stuff from our competitors and implementing it here.
Ben: While we’re here, we have to say it. Eventually, a Walmart does go back to Newport. There is a little store that is run by a family member of the landlord that screwed over Sam that does get put out of business by that Walmart going in.
Sam makes the point, “You can’t say we ran that guy—the landlord’s son—out of business. His customers were the ones who shut him down. They voted with their feet.” To me, this is that perfect overlap of are you competitor-focused or customer focused? Well, both. You have to win in a market by counter positioning in some way. Walton did it by discounting but that obviously has an impact on your competitors.
You need to be able to counter a position against someone like a competitor. So when the big realization is, oh, customers always want lower prices, and satisfaction guaranteed, and all the other Walmart-isms, that will have impacts on your competitors. You have to pay attention to those competitors. But ultimately…
David: The customers decide.
Ben: Sam is willing to blame the customer for putting the competitor out of business.
David: In 1952, just a short while later, Sam opens up a second store in nearby Fayetteville, Arkansas, because again, it’s just Sam and Helen, when she can, helping out with the bookkeeping, managing the first store. Sam needs to hire somebody to go manage Fayetteville because he’s working in Bentonville. So he brings on a guy named Willard Walker, who was managing a variety store in Tulsa before that.
The way they convinced him to move to Fayetteville and take over this new concept is they make him an offer he can’t refuse. They make him a partner in the store. This is what you were referring to earlier. They give him a percentage of the profits that that individual store makes. In fact, they set up that store and all future stores as their own partnerships. This is something I didn’t understand until reading the book.
It became a huge part of the playbook for Walmart for decades, in which every store manager in a new store opening was given first equity and individual partnerships, and then later profit sharing incentives in that individual store. That sets up a true alignment of incentives. I don’t think anybody else was doing this at that point in time and then even better.
So all the pool of existing store managers, whenever they open up another store, Sam and Helen give them the opportunity to invest dollars in the new stores and the new partnerships. Now you’re incentivized on the success of the whole network, and you’re incentivized to share information. You want everybody to do better.
Ben: They get carry and they should make a GP commit.
David: Exactly. I think this is super brilliant. I was thinking about this, with regard to tech companies today and everything. Even though employees of tech companies get much better economic deals with stock options, I think psychologically, this is a better way to do it. What Sam was doing, you’re putting your own money at work. You’re incentivized both on your own personal performance in the store…
…David: Then reading more in the book about this. So during this period and in the early Walmart Corporation period, it was just the store managers who were doing this, not the hourly employees.
Ben: There was a gigantic chasm. I mean, there’s still a big chasm today but two completely different classes of humans in those early days between the store managers who were salaried and employed by the partnership and of course the to be called associates but the hourly workers who were not.
David: So a couple of interesting things. One, the people who were the store managers, this wasn’t quite like white collar workers. It’s somewhere in between. Most of these people didn’t have college degrees. They were salaried. Then they got equity in these partnerships. It wasn’t like these were Wharton graduates that were coming in and doing this.
Ben: Intentionally not. Those folks were discriminated against in the Walmart culture, especially in the early days of think you’re better than us, college boy.
David: Totally. One of the first managers was nicknamed The Bear and he had one eye. There are some crazy stories out there. They were bringing donkeys into the store.
Ben: Right. We’re talking Walmart. So take us to Walmart, how did we get from the Walton’s Five and Dime.
David: On the employee front, after Walmart went public, Sam instituted both profit sharing at the store level with the associates, with the hourly employees, but then also an employee stock purchase program. This is cool. Home Depot modeled their employee stock purchase program after Walmart’s and it’s brilliant. It’s the same thing. You put up your own money, but you can do it pre-tax dollars out of your paycheck at a 15% discount to the stock price.
Ben: This is what Microsoft let me do when I was a PM there. In addition to your stock-based compensation, they call it an ESPP (Employee Stock Purchase Program), Microsoft only lets us have a 10% discount, so it’s very kind of Walmart to give a 15% discount for market price.
David: There are stories in the book of hourly associates that made millions of dollars in the ’70s and ’80s off of the employee stock purchase program. It’s pretty cool…
…David: I’m totally inspired by Sam, Walmart, and everything. Okay, so back to the ’50s in Arkansas. Remember, we talked all the way back in the beginning of the episode about Sam’s brother, Bud. Well, Bud had gotten into the Ben Franklin business himself after the war in Missouri. One day, Sam is visiting Kansas City and he hears about a new suburb development going in just southeast of the city called Ruskin Heights, and it’s going to have a shopping center.
This newfangled concept is right in the middle of this suburb subdivision, and there’s going to be a grocery store, a drugstore, and real estate for a big Ben Franklin store. So Sam calls up Bud and he’s like, we got to go in 50-50 on this, this is a huge opportunity. They do, and it is a banger to earn $50,000 in annual sales the first year in Ruskin Heights, then $350,000 the year after and just keeps growing and growing.
Sam says when I saw that shopping center catch on the way it did, I thought, man, this is the forerunner of many, many things to come. The only problem was Ruskin was actually kind of a red herring. This was the future. This was the forerunner of many things to come, but it was still a little bit ahead of its time. This is really a 1960s thing, not only a ’50s thing. Sam is convinced though, that it’s the future. So he starts going around Arkansas and Missouri evangelizing the towns and city planners about putting in the shopping centers.
Ben: For which they would be the anchor tenant.
David: But it’s super slow dealing with local governments. It’s hard. It takes a long time. He wants to move fast. So he starts trying to put his own real estate deals together for multi-tenant shopping centers and fails. Eventually, because back to Helen’s advice, these multi-tenant shopping centers, I see the power in Ruskin, but it’s dependent on too many other people. But if I’m willing to invest some capital, I could just put bigger stores in the same locations myself. That’s what he starts to do.
Ben: Does he become his own landlord then and just buy the land or what requires more capital?
David: That’s a good question. I don’t know at this point if they were doing real estate themselves, but certainly, they are building out bigger store concepts, requiring capital to build the stores. It’s not like there were existing structures there then to outfit them with all the fixtures and all the inventory for the larger stores. But he and Bud together, start doing this. They call these new stores “family centers” and they start doing unheard of numbers—$1 million, $2 million.
Ben: Are they still sourcing the inventory from Ben Franklin from Butler brothers?
David: Yes. They don’t yet have their own distribution, inventory, and logistics network setup. That was the big step of Walmart. These were still just like much larger versions of Ben Franklins and they were working with them to get all the inventory to them.
Ben: Already at this point, they’ve bent so many rules with Ben Franklin like changing the store layout and concept, where they’re going, starting to dictate more terms, and naming them on their own. At this point, they’re really starting to treat Butler brothers as more of a component of the Walton business rather than Walton being a franchisee of Butler brothers.
David: Exactly. So these “family centers” that Sam and Bud were building are still Ben Franklin franchises. The Waltons are now taking over more and more of control of the concept, their self-service, they’re larger format, but it’s still part of the Butler brothers’ cartel, shall we say? Because they were part of Butler brothers, Sam and Bud were limited on how much discounting they could really do.
They were aggressive on pricing, probably more so than other merchants at the time, and they had self-service, the large format, and all this interesting stuff. But the prices weren’t that much different than other stores.
Ben: It’s worth knowing that we don’t think about the notion of discount stores today being counter positioned against something like all big stores have things at kind of the lowest price you can find them.
David: Because they’re all discounters now. I think 87% of market share in America is discounters.
Ben: Yeah. So there’s either specialty high end retail, which is often directly from the manufacturer sort of like vertically integrated or specialty sourced or something, or if you’re buying things that we consider a big regular store, they’re all discounters. At the time, there were no discounters. Everyone was marking up their goods by about 45%. If you’re buying something and then marking it up 45%, it means your gross margin is about 33% as a retailer.
David: And that was on top of the markups in the middle from the franchise operators.
Ben: The competition was so low that you totally could just do this. For reference, just so people have a sense today, Walmart probably has a gross margin between 20–24% at any given time, and every store had like a 33% gross margin. Even though Target is like a high end discounter—it’s sort of a nicer stuff, more expensive—they’re in the 29% category, but everyone was 33% or above gross margin at this point in history….
…Basically, everyone’s marking up their goods 45% and nobody has done other than Ann & Hope and a few other select folks that haven’t really rolled it out at scale or really popularized the movement. No one has done discounting, but what is discounting? Two major components. One is big loss leadership. Blow it out in order to get people in the store, do it in dramatic fashion, and then people buy other stuff.
Two is we make it up on volume, just don’t mark stuff up that much period across the whole store. Decide that you’re only going to mark things up 25% instead of 45%. Then when you do that, of course, you don’t make as much money per item. But everybody buys more stuff in your store. This hadn’t really been proven yet.
David: Yeah, and there’s another component. What you’re saying, which is Sam’s original lesson of, you actually make more profit dollars selling items at the dollar than you do at $120 because you sell three times as many. But there’s also the peace in the middle, the franchisor, the Butler brothers, remember, they’re taking 25% from the manufacturer to Butler brothers, and then out to the stores. That’s how most everything operated.
These discounters are like no, we’re going to go direct to the manufacturers for everything, just like Sam was starting to do in this but on the margins. We’re just going to completely not be a franchise operation. We’re going to own and operate everything. We’re going to operate our own back end, our own supplier relationships, and our own distribution.
Ben: There’s a great quote, this is again later in Walmart’s development. It’s when Sam Walton is informing the Walmart vendor relations team and merchandisers on how to deal with vendors.
He’s telling them, “Don’t leave in any room for a kickback because we don’t do that here. And we don’t want your advertising program or your delivery program. Our truck will pick it up at your warehouse. Now what is your best price? And if they told me it’s a dollar, I would say, Fine, I’ll consider it, but I’m going to go to your competitor, and if he says 90 cents, he’s going to get the business. So make sure a dollar is your best price.
If that’s being hard-nosed, then we ought to be as hard-nosed as we can be. You have to be fair and upfront and honest, but you have to drive your bargain because you’re dealing with millions and millions of customers who expect the best price they can get. If you buy that thing for $1.25, you’ve just bought somebody else’s inefficiency.”
David: Totally.
Ben: I love that. I mean, it is brutal but that encapsulates the philosophy so well.
David: There’s so much baked into that that people don’t even realize. To get to the point where you could do that, you need to operate the entire back-end of retail yourself. Sam and Bud and Walmart, they’re starting from they don’t have anything. To get to a point where you can have conversations with suppliers like that, you need your own shipping carriers, trucks. You need your own distribution centers. You need your own ordering systems. You need your own technology. They don’t have any of that.
Ben: You need to forecast. You need to be able to understand we’re going to sell enough of these units to go buy a crap ton at this super low price. We need to be able to be so confident that we can tell the supplier to spin up new inventory so that we will buy it to increase their production. Okay, that’s all the future. So at this moment.
David: Okay, so at this moment, Sam of course goes out. He goes and shops. He travels to the northeast. He shops in Ann & Hope. He goes out. He meets Sol Price, who he already knew.
Ben: And we’re in like the 1960s?
David: Late ’50s, early ’60s at this point, before 1962. He sees what they’re doing. They’re doing this proto discounting in big cities, and rings around big cities, not necessarily in the primo real estate downtown but where you have access to logistics hubs. You can sort of scrounge together and make this work. The idea that Sam could copy this and go do it back in Arkansas, it’s crazy. What manufacturers are going to ship stuff to Arkansas, especially big volume stuff?
He goes, he meets with Sol and Ann & Hope and he’s like, you know what, I think I can make this work. I think I can do it. Even he knows what a huge undertaking this is. He actually goes back to the Butler brothers. He’s like, we’ve been great partners. We’ve really innovated on a lot of stuff together. I’ve seen this discounting model. I think it’s the future. I know customers like low prices. I’ve got these new large format stores. Why don’t we work together on this? I need you to handle the backend. You have the scale to be able to do this. You already distribute out to small towns like mine. Let’s partner on this and do it together. And Butler brothers says no…
…David: In Butler brothers’ defense, they signed their own death warrant here, but that was the rational thing to do. This is like a counter positioning thing. they had all these other Ben Franklin franchises out there. If they had done what Sam is proposing and essentially taken out their markup on goods that they would provide to Sam’s stores, what are all the rest of their franchisees going to say?
Ben: It is literally the innovator’s dilemma because they have too much baggage to actually pull this new thing off. To be more specific about that, there is too much ongoing revenue that they would cannibalize in the short term by messing up all those relationships they had with their other franchisees where they would probably churn too much of that and risk the whole business so they could not take advantage of what could be the new wave.
David: Yep. The thing that Sam knew, the minute he saw discounting, was all of those stores were dead anyway.
Ben: Yeah, just a matter of time.
David: Somebody is going to bring discounting to Arkansas, Missouri, Texas, Florida, and everywhere else and those stores are dead.
Ben: It’s that insight that people who are out from cities want the same thing as people in cities, and so they’re just as bright. They want the same things in life. They just happen to not live in cities, so let’s not be pejorative. Let’s serve them with high quality retail experience.
David: Totally. So 1962, Sam and Bud secured a site in Rogers, Arkansas, which is pretty close to Bentonville. It’s got to say, they’re going to do this. It’s going to be chaos, but they’re going to figure out the backend, do this new discounting concept. They just need a name. Sam’s got a bunch of candidate names for what to call this new retail concept.
He’s talking with one of the early store managers, Bob Bogle, about his ideas. He says, what do you think? Bob says, you’ve got all these fancy names, but it’s pretty expensive. Building the neon signs of Walton’s Five and Dime and Ben Franklin. That’s a lot of letters. What if you just take part of the Walton name, keep that, make it a place to shop, and call it Walmart. Seven letters, that’ll be pretty cheap.
Ben: I love it.
David: The legend is born.
6. The Greatest Value Investor You’ve Never Heard Of – Macro Ops
The investor is Floyd Odlum.
Buried somewhere in the junk drawer of investing lore, Odlum’s story remains unknown. A quick Google search reveals his Wikipedia and IMDB pages. Yet in typical deep-value fashion, the last link on the page revealed Odlum’s investing story.
The Holy Financier’s blog post was that last link. The blog proved an excellent springboard for a deeper investigation into Odlum’s early life, initial career and his path to market fortunes. Although Odlum (pictured on the right) and Ben Graham never met, their investment philosophies are one in the same.
We’ll journey through his upbringing, his days as a struggling lawyer and his initial attempt at market speculation. Then we’ll see how Odlum turned $39,000 into $700,000 in two years.
Odlum wasn’t just a great investor. He also had a knack for choosing the most generic partnership names, such as his first “The United States Company”. The partnership, formed in 1923, was a couple’s affair. Odlum, George Howard and their wives seeded the partnership with $39,000 ($573K adj. for inflation).
What followed over the next two years was nothing short of incredible. According to Odlum’s biography, The United States Company grew 17x from 1923 – 1925. What started as a small partnership amongst friends turned into a $660,000 behemoth ($9.47M adjusted for inflation).
Odlum’s two-year CAGR is mind-numbing. If that wasn’t impressive enough, he generated these returns while working full-time as a law clerk!
How did he generate such outsized returns?
Well, he was a deep value investor. He searched for fifty-cent dollars and scoured every corner of the market. According to documents from the Eisenhower Library, Odlum preferred two kinds of investments:
- Utility stocks
- Special situations
He defined a special situation as “an investment […] involving not only primary financial sponsorship, but usually also responsibility for [the] management of the enterprise.” The former lawyer wasn’t interested in flipping a business for a quick buck, either.
Embedded in Odlum’s strategy was the determination to see a special situation through until success, “[We will] stay with the investment until the essentials of the job have been done, and then move on [to] another special situation”.
Between 1925 – 1928, Odlum steadily grew the partnership. By investing in utilities and special situations, The United States Company AUM grew to $6M (over $88M adjusted for inflation). It was around this time that Odlum began sensing euphoria in the market. He smelled a top and he decided it was time for him to act.
In 1929, he rolled his original partnership into a new vehicle, The Atlas Corporation. Wary of a market top, Odlum sold half his assets. He stayed in cash and issued $9M worth of Atlas Corporation securities. With $14M in cash, Floyd sat on his hands. Waiting for the next market crash, which shortly followed.
But his bread and butter during the Depression was buying investment trusts. His strategy was simple. He found investment trusts that had fallen so much their stock prices were trading less than the value of their marketable securities. A good example of this in today’s markets is Manning & Napier (note: I do not hold shares).
He discovered he could buy these trusts, liquidate their assets, and reap large profits for his stakeholders. He was buying dollar bills for $0.60 and he milked this strategy for all it’s worth. He ended up buying and merging investment trust twenty-two times. The newspaper article profiled these dealings:
“He figured out that by buying all the outstanding shares of a particular trust, he was really buying cash or its equivalent at sixty cents on the dollar.”
When he didn’t have the cash to buy the trusts, he sold shares in his own company, Atlas, to fund the purchases. After exchanging his stock for the trust’s stock, Odlum would merge or dissolved the existing trust, keeping the cash and assets within Atlas Corp.
This strategy helped grow his assets to $150M ($2.2B adjusted for inflation).
Between 1929 and 1935, Odlum invested (and controlled) many diverse businesses. He owned Greyhound Bus, a little motion picture studio named Paramount, Hilton Hotels, three women’s apparel companies, uranium mines, a bank, an office building, and an oil company….
…He then pooled together another $39,000 to form his first partnership. That original $39,000 grew to $150M in controlled assets. All that during a span of just twelve years.
The math is incredible. Odlum grew assets 384,515% in a bit over a decade. That’s a 32,042% CAGR for asset growth.
And his early partnership returns are just as impressive. Odlum grew assets from $39,000 to $6M between 1923 – 1929. That’s a cumulative 15,284% return. In other words, Odlum compounded capital at an annual rate of 2,547%.
7. The Complex Case of Floyd Odlum – Frederik Gieschen
This is a piece about Floyd Odlum, a once-upon-a-time famous investor who made his fortune doing distressed deals during the Great Depression. But I want to start with a reflection on my process and the challenges of diving into a story. Here’s why.
I had read some twenty articles about Odlum, and his life seemed straightforward: a young lawyer from Colorado made his way to New York to become a dealmaker in utilities, one of the growth industries of the 1920s. He started an investment fund on the side, raised cash in 1929, and avoided the carnage. Through Atlas Corp., his publicly-listed investment trust, he masterfully acquired other trusts at steep discounts to their undervalued portfolios. By the time that Graham and Dodd published Security Analysis in 1934, Odlum had closed 22 transactions and amassed assets of $150 million. Once wealthy and famous, he married his second wife, racing pilot Jacqueline Cochran, served in the government during WWII, and retired to an estate in Palm Springs where he did deals by the pool and was visited by Eisenhower from time to time.
This story and its lessons seemed so clean. Stand back during the bubble, swing for the fences when opportunity presents itself, case closed.
I knew that Odlum’s records were kept in the Eisenhower Presidential Library. What I did not know until this week was that someone had combed through them all and put together a voluminous draft of a biography. After reading the outline, I reached out to the author, David Clarke, bought a copy of his unpublished work for $19.95, and dug in.
But then I stopped myself. This was supposed to be a short piece. Something that I could churn out on a weekly basis with a moderate amount of research. Reading an unfinished 700-page biography would blow up my schedule — and for what?
However, I quickly realized that the neat little narrative about Odlum’s life was wrong. I had no choice but to at least skim the work if I wanted to learn the real lessons of his life.
For example:
Odlum didn’t cash out before the crash. His utility stocks just didn’t decline as much and made a brief comeback, allowing him to redeploy the capital. It seems he never bothered to correct the origin story of his prescience which was repeated by one paper after another.
He made his early capital trading in utility stocks while being employed at one of the largest utility holding companies and running their foreign M&A efforts. While there is no evidence, and insider trading was not illegal at that time, Clarke suspects that this information edge played a significant role in Odlum’s early success.
Also, taking over investment trusts required convincing the board and key shareholders who often had no interest in selling. And it seems that Odlum was willing to bribe directors to get the deals done.
Around the end of WWII, Odlum made his last successful distressed investments, in oil and defense defense contractors, before departing from his circle of competence. Large bets on an airline, uranium mining, and a motorcycle manufacturer turned into sinkholes for capital in which he kept doubling down. His fortune started to dwindle.
His personal life was rife with tragedy as both of his sons died before him: one of alcoholism, the other of suicide after a string of failed deals and enterprises. In the end, Odlum’s wealth had been lost and spent. He and his wife, famous pilot Jackie Cochran, had to leave their beautiful ranch and live out retirement in a modest home.
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