What We’re Reading (Week Ending 18 February 2024) - 18 Feb 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went 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 18 February 2024):
1. Where Will Virtual Reality Take Us? – Jaron Lanier
In the intervening decades, V.R. has thrived at two extremes in the quest for “killer apps.” It has long been an established industrial technology: if you’ve flown, ridden, or sailed in a factory-built vehicle in the last thirty years, virtual reality may have played a central role. It’s been used to design surgical procedures and train surgeons ever since our first simulated gallbladder, at Stanford Med, some three decades ago; Boeing, Ford, and many other companies started using VR for design in the early days as well. And then there are the visionary, mystical, and philosophical applications. V.R. can be a way of exploring the nature of consciousness, relationships, bodies, and, perception. In other words, it can be art. V.R. is most fun when approached that way.
In between the two extremes lies a mystery: What role might V.R. play in everyday life? The question has lingered for generations, and is still open. Gaming seems likely—but, for most gamers, not so much. There are many reasons why V.R. and gaming don’t quite work, and I suspect that one is that gamers like to be bigger than the game, not engulfed by it. You want to feel big, not small, when you play. (“Star Wars” might have got this right with holographic chess.) Apple’s initial round of Vision Pro apps, like those from its competitors, aren’t entirely compelling, either, and can even have a lonely, dystopian flavor. (Watching a simulated big-screen movie, by yourself?) But my belief is that the quotidian killer apps will come. Maybe you’ll use V.R. to learn quickly about the Airbnb at which you’ve just arrived. Maybe V.R. will help you assemble ikea furniture. Maybe!
Virtual-reality headsets come in various forms. A major divide has to do with how they acknowledge the real world. Some headsets obscure the surrounding environment completely; this is typical in gaming headsets. But there is another option, which I used to call “mixed” reality, and which came to be known as “augmented” reality in the nineteen-nineties. Some mixed or augmented headsets, such as the Microsoft HoloLens or the system created by Magic Leap, allow you to see the real world through the headset glass so that it can be combined with virtual content using challenging optical techniques. Others, like Apple’s Vision Pro and the recent offerings from Meta, capture the real world with cameras, then render it as part of the virtual environment so that it can be combined with fabulated content.
Camera-based mixed reality is vastly easier to accomplish than the optical version, but it is concerning. Early research by a Stanford-led team has found evidence of cognitive challenges. Your hands are never quite in the right relationship with your eyes, for instance. Given what is going on with deepfakes out on the 2-D Internet, we also need to start worrying about deception and abuse, because reality can be so easily altered as it’s virtualized…
… For most of the technology’s history, however, virtual experiences have been hard to build and maintain. This has been one of V.R.’s biggest problems. I saw the first V.R. teaching demonstration of general relativity at least as early as 1992, and have seen dozens more since then; they’re often wonderful, and help users grasp the concept in new ways. But they only run for a year or so because there are too many variables in a V.R. system for creators to keep experiences available. Graphics chips change, and with them the layers of mediating software. That’s true for other programs, too, but with V.R., when the properties of a headset (like field of view) or an input device shift, the whole experience and interaction method must often be rejiggered. It’s too much ongoing effort, so it usually doesn’t happen; developers move on to other projects. The exceptions have been locked-down V.R. experiences that assume a minimal level of interaction, which limits the magic…
…Apple is marketing the Vision Pro as a device you might wear for everyday purposes—to write e-mails or code, to make video calls, to watch football games. But I’ve always thought that V.R. sessions make the most sense either when they accomplish something specific and practical that doesn’t take very long, or when they are as weird as possible.
The practical side of V.R. is a scattering of wonderful niches: in addition to surgical simulation and vehicle design, the technology is used by oil companies to simulate geological structures, by drug companies to envision molecules, and by planners working on city centers. The new frontier, which might apply more to everyday life, is the spontaneous creation of practical apps that you might not even bother to save. My research group, for instance, has presented a prototype system—the “mixed-reality copilot”—that allowed us to recreate, with a single voice request, a program that allows you to use your hands to paint and sculpt with virtual stuff. A decade ago, it took months to make that kind of program. Hopefully, in the near future, one will be able to ask for a V.R. relativity simulation tailored for a student who has color blindness and A.D.H.D., and it will simply appear. More prosaically, you might walk through a facility in augmented reality, asking an A.I. for instant advice about potential safety hazards and fixes. These ideas might even work already: one of the curious features of this accelerated period of A.I. development is that there aren’t enough minutes in the day to try everything.
On the weird edge, it turns out you can change your body plan in V.R. You can become different animals. You can map your body to that of a lobster or an octopus, and experience, to a significant extent, the control of that other body. The brain has had to adapt to many body plans over the course of its evolution, and it’s pre-adapted to work with more. When you change your body, you can also play with the flow of time. By shifting the rhythm of the natural sway of your limbs, and also how the objects around you move and change in response, you alter the reference points that your brain uses to mark the flow of time. You can speed it up or slow it down. In V.R., you can change the rules of the world. You can exist in strange geometries that are too hard to describe in words. You can become an archipelago of parts instead of a continuous animal. You can blend and share bodies with others, to a surprising degree…
…There are fresh, urgent reasons to reaffirm the value of experience. It is impossible to judge technology without a sense of its purpose—and its only plausible purpose is to benefit people, or perhaps animals, or the over-all ecosystem of the planet. In any case, if we pursue technologies that make it hard to delineate the beneficiaries—for instance, by blending brains into robotics not to cure a disease but just because it seems cool—then we make the very idea of technology absurd. The central question of the technological future is how to identify the people who are supposed to benefit from technology, especially if they seem to have melted into it. If people aren’t special, how can we act in a way that benefits people? We can’t. The principles of ethics, design, and even technology itself become nonsense. What can that specialness be? It must be something that is not technologically accessible, since technology expands unpredictably. It’s a little mystical. The definition of people must be one of apartness. We must now put people on pedestals, or they will drown.
When I put on a V.R. headset, I still notice that I am floating there, that I exist independently of the information I experience. But then there’s the moment I take off the headset, which is the very best. In the nineteen-eighties, we used to try to sneak flowers or pretty crystals in front of people before they would take off their headsets; it was a great joy to see their expressions as they experienced awe. In a sense, this was like the awe someone might experience when appreciating a flower while on a psychedelic drug. But it was actually the opposite of that. They were perceiving the authentic ecstasy of the ordinary, anew.
This is the kind of experience you can have only if you use V.R. fleetingly, not constantly. Here we come to one of the greatest differences between what I love about virtual reality and how it is often promoted today. Venture capitalists and company-runners talk about how people will spend most of their time in V.R., the same way they spend lots of time on their phones. The motivation for imagining this future is clear; who wouldn’t want to own the next iPhone-like platform? If people live their lives with headsets on, then whoever runs the V.R. platforms will control a gigantic, hyper-profitable empire.
But I don’t think customers want that future. People can sense the looming absurdity of it, and see how it will lead them to lose their groundedness and meaning…
…But the truth is that living in V.R. makes no sense. Life within a construction is life without a frontier. It is closed, calculated, and pointless. Reality, real reality, the mysterious physical stuff, is open, unknown, and beyond us; we must not lose it.
Just because owning a major tech platform is desirable, that doesn’t suggest there is no other way to succeed in the technology business. There are water companies and soda companies, and then there is fine wine. All are viable businesses. The metaphor isn’t perfect, but I suspect that V.R. entrepreneurs will find their sweet spot by emulating Napa Valley…
…A.I. is often portrayed as a godlike, transcendent project that will take over the fabric of our physical reality, leading to a singularity, meaning nothing that matters now is likely to matter after. But singularities, like the ones we hypothesize in black holes, are the very definition of ignorance. There is no learning that bridges the before and after of a singularity. It is the absolute rejection of intelligence. Virtual reality is sometimes stirred into this mix. But our best understanding of how reality works is entirely bound to finitude. Physics is all about conservation principles. There are no infinities, only S curves. There is no free lunch. Technical culture often longs for freedom from finitude. A profound truth, however, is that the greatest mysteries are found in conserved systems, which can become rich and complex, not in infinite ones, which stretch out like blank white sheets to the edge of the cosmos.
And so another urgent question is whether people can enjoy the storied reality of finitude after coming down from the high of fake infinity. Can being merely human suffice? Can the everyday miracle of the real world be appreciated enough? Or will the future of culture only be viral? Will all markets become Ponzi-like fantasies? Will people reject physics forever, the moment we have technology that’s good enough to allow us to pretend it’s gone?
2. Pods, Passive Flows, and Punters – Drew Dickson
You’ve surely noticed what has happen to Nvidia lately. We used to just call these winners FANGs, and then FAANGs and then FAMANGs, but Nvidia has insisted on joining the league table. It now has a $1.7 trillion market cap. And in the last five years, the stock is up about 1,700%. Guess what else is up about 1,700%?
Nvidia’s earnings estimates.
How about Facebook, aka Meta, which goes through periods of hatred and love with equal vigor? Well, over the past seven years it has bounced around a lot but still has generated nearly 260% returns. And forward earnings projections? They’re up 280%.
We can stretch things further back, and look at Google over the past 14 years (earnings up 885%, stock up 980%); or Amazon during the same period (earnings up nearly 2,500%, stock up about 2,800%).
Or we can go waaay back and analyze Microsoft over the past 22 years. Forward earnings projections have increased from $0.93 in February of 2002 to $11.57 today. That’s nearly 1,150%. The stock is up just over 1,200%.
And finally, from one of my favorite former-CEOs Reed Hastings, we have good old Netflix. About 18 years ago, analysts were forecasting that Netflix would generate 11 cents of earnings in the coming 2006 year. Here in 2024, they are forecasting a whopping $17 of earnings in the coming year. That is a whopping EPS increase of 14,889%.
And how about the stock? We’ll it is up a whopping 14,882%.
Fundamentals matter, sports fans. Fundamentals matter.
Admittedly, some of these examples above are very long-term, but even when we self-select with some of the biggest, most exciting, long-term winners out there, and ignore the losers (of which there are many), it is still clearly apparent that it is the fundamentals that matter most.
So basically, it probably isn’t terrible advice to ignore the rest of it. Ignore the noise. Ignore the talking heads on CNBC. Ignore prognostications of meme-stock sith lords. Ignore the volatility. Embrace it, actually. And just focus on the fundamentals. Get those right, and you will likely win.
3. “The Practice Of Value Investing”, by Li Lu – Graham Rhodes
If you invest in a company in a sustainably growing economy, your company’s profits and your investment return will also grow sustainably. If you speculate on other people’s short-term trading behaviour, there can only be one result in the end: gains and losses must equal because this is a zero-sum game. If you add up the gains and losses of all speculators in the market, they will sum to zero. This is the biggest difference between investing and speculating. I’m not denying that there are some speculators whose chances of winning are higher and who can go on winning for longer; equally there are some who will always be the sucker at the table and never strike it rich. If you give it enough time though, when you add the winners and losers together, the net result will be zero. The reason is that speculating on short-term behaviour in the market adds nothing to the economy nor to corporate earnings growth. Some people say they use a mixed model of “80% investment, 20% speculation”. If they do 70-80% of their work correctly, then such participants’ returns will reflect the compound growth of the modern economy. However, the remaining portion will be caught up with all the other speculators and their result will be the same – zero.
Now that you know this result, will you choose to be an investor or a speculator? This is a personal choice and there is no right or wrong answer. The only difference is the impact you will have on society. Investors will help all parts of society enter modernity’s virtuous cycle – the stage in which it enjoys continuous compound growth. If you are interested and would like to learn more about this, you can refer to my monograph, “Discussions on Modernisation”.
Relatively speaking, the speculative part of the market verges on being a casino. From a social welfare point of view, we do not want this casino to be too big. However, without it, the market would not exist. We should therefore see speculation as a necessary evil – and a part of human nature – which cannot be removed. We cannot deny the parts of human nature which love to gamble and speculate but we cannot let them overwhelm us. Otherwise, society will sooner or later face the consequences. The wounds of the 2008-2009 Global Financial Crisis from which we have just emerged are still fresh in our memories. And once you understand the principle of a zero-sum game, you will begin to see these speculators as Mr. Market…
…There was another company at the time which taught me something revealing. This company owned a lot of gas stations, and so I became interested in gas stations. There were two gas stations near where I lived, one on each side of the same intersection. However, I realised that one gas station had many more customers, and that cars would come to it regardless of which direction they were heading. Both gas stations had the same price and their gas was the same as it was made to the same standard. I felt this was very strange and since it was my company’s gas station anyway, I went to have a look. The gas station which attracted all the customers was run by a family of Indian immigrants, who all lived there too. As soon as a customer arrived, they would come out to offer him a glass of water. Whether you wanted it or not, they would always offer it to you first and then strike up a conversation. If the kids were home from school, they would come out and help you tidy up your car. The other gas station was run by a typical American. He wasn’t a bad guy but the gas station didn’t belong to him. He was just an employee hired by the real owner, so he wouldn’t come out from the store and nor would he pay much attention to what was happening outside. Thanks to this one difference, I calculated that in a given period, one gas station attracted almost four times as much traffic as the other.
From then on, I realised it was important to know whether a company’s manager had an owner’s mindset. Through this, I began to gradually understand how a company could earn money and why it could earn more than others. The example of the two gas stations is a perfect illustration because they sold the same product and were otherwise identical. However, one’s service was slightly superior to the other’s and so it received four times as much traffic. What motivated that Indian fellow? He was an immigrant, like me. He needed money and if he couldn’t bring in business, he would have financial difficulties. The other manager could be indifferent because he could just take his salary while pretending to do his job. This was the difference. I therefore began to take great interest in how a company is run, its competitive advantages, and the sustainability of these competitive advantages…
…The next attribute is relatively special. You must be both extremely patient and extremely decisive, even though they are in contradiction. When there are no opportunities, you might go for years without taking any action. But as soon as an opportunity arrives, you must be able to become extremely decisive and act without hesitation. I have been Charlie Munger’s investment partner for sixteen or seventeen years now. We meet for dinner at least once a week and I’ve developed a deep understanding of him. Let me tell you a story about his investments. Charlie subscribes to Barron’s, a weekly magazine about the stock market published by the Wall Street Journal. He’s read this magazine for approaching 40-50 years for the purpose of finding investment ideas. And how many has he found in this time? One! There has only been one and he only found it after reading the magazine for more than thirty years. And he hasn’t found another in the ten years since. This hasn’t stopped him from continuing to read the magazine every week though. He is extremely patient and can go for a long time without doing anything at all. But when he finds an opportunity, he will go all in. And this particular investment made him a lot of money. So this is what’s required of an exceptional investor: he must have extreme patience and stay focused even when there are no opportunities. When an opportunity does come, he must then have the ability to move swiftly and decisively…
…When I was young, I always wondered about the meaning of life. Later, I gradually came to realise that the meaning of life is the pursuit of true knowledge. True knowledge can change your life and your fate; it can even change the world. Moreover, mankind is completely different from what else we can observe in the material world. The world we can see is one in which entropy increases. Energy flows from high places to low places; big things devour small things. If a large celestial body hits a smaller one, it will crush it. The entire planet and our universe are to a certain extent heading towards annihilation.
But the world of man is not the same. Mankind can turn the world into one in which entropy decreases. We can reverse entropy’s course. Through study, man can go from ignorance to erudition; through self-cultivation, man can become a virtuous person who contributes to society. Man can create things which were previously unimaginable. Since man’s arrival, the earth has changed. Today, we can even leave this planet for the stars; it is entirely possible that we go on to change the universe. As I mentioned earlier, the first investment I made was related to the wireless telephone. At the time, I hadn’t really figured out what that was. Twenty-six years later, who can bear to part with their mobile phone? Mobile phones, the internet and all these things were game changers born of knowledge. The internet is based on TCP/IP which is a protocol. At their heart, computers are permutations and combinations of 0s and 1s combined with a diode which uses silicon and electricity to tell those 0s and 1s apart. This is how knowledge can create changes which turn our world upside down.
4. Hong Kong’s death has been exaggerated – Michael Fritzell
The National Security Law in June 2020 was indeed a watershed moment for Hong Kong’s judiciary. Now that individuals seen to be endangering national security can be extradited to mainland China, there’s a fear that they will no longer receive fair trials.
But let’s look at the positive side of things. In reality, the National Security Law has really just had two major effects. One is emigration, and the other is stopping public demonstrations.
Since 2020, roughly 400,000 people have left Hong Kong, according to this data from the Hong Kong Immigration Department. But, if you calculate the cumulative number, net migration has actually started to decrease:
In other words, people are now moving back to Hong Kong. These could be individuals who avoided Hong Kong during COVID-19 and are now willing to return. They could also be people who changed their minds about living overseas, knowing that Hong Kong is a great place to make money. In the early 1990s emigration wave, many of those who left for Vancouver or elsewhere ultimately came back to Hong Kong.
While it’s certainly negative that hundreds of thousands of people have left Hong Kong, it’s not implausible that mainland Chinese immigration could make up for the shortfall. In fact, Hong Kong’s residential rents rose 8.1% in 2023 due to immigration from the mainland.
For now, the Hong Kong legal system remains reliable. The conviction rate for Magistrate’s courts in Hong Kong was 54% last year, far higher than mainland China’s 99.95%. This seems to suggest that Hong Kong judges are still independent. Hong Kong still ranks #23 in WJP’s Rule of Law Index, ahead of the United States.
Between Hong Kong and Singapore, the former remains a far larger financial hub. The aggregate market cap of Hong Kong-listed companies is 10x that of Singapore. Its assets under management are US$2.2 trillion – far higher than Singapore’s US$1.5 trillion. There are 2,000 licensed asset managers in Hong Kong vs just 1,200 in Singapore.
A key competitive advantage for Hong Kong is that its currency is freely convertible and pegged to the US Dollar. This enables the Chinese government and its companies to raise overseas capital while maintaining capital controls within mainland China.
It’s also the case that Hong Kong’s taxes are uniquely low:
- The highest marginal income tax is 17%.
- There is no capital gains tax.
- There is no withholding tax on dividends or interest income.
- There is no GST.
- There is no estate duty.
- There is no wealth tax.
- There is a 15% tax rate on rental income but with a standard deduction of 20%.
- Most import duties to Hong Kong are zero, making imported goods cheap.
- The stamp duty for purchasing residential property is 15% for foreigners and 7.5% for locals, but this stamp duty could soon be removed.
For these reasons, the PwC and the World Bank recently ranked Hong Kong as the region with the most friendly tax system in the world.
The Hong Kong government remains committed to its low-tax policy. Hong Kong has agreed to implement a minimum corporate tax rate of 15% from 2025, but so has many other major economies. The budget deficit is projected to continue at over HK$100 billion in FY2025, but 3% of GDP remains modest.
While I don’t want to minimize the political shift that has taken place, for Hong Kong companies, it will be mostly business as usual. Hong Kong will continue to attract the ultra-wealthy through its low taxes, and it will continue to be used to raise capital for companies in China and beyond.
After Hong Kong’s zero-COVID policy was lifted at the end of 2022, the economy has actually been on a solid footing. Hong Kong’s retail sales grew +16% year-on-year in 2023, though remaining almost 20% below the peak in early 2019:
A major component in Hong Kong retail sales comes from tourism to Hong Kong, which is now back to around 70% of the pre-COVID level:
But don’t expect a full recovery in tourism spending. Before 2019, a large portion of Hong Kong retail sales to tourists comprised goods smuggled into mainland China. In 2021, China’s border controls tightened up significantly, and most of such business now occurs through legitimate channels. I wrote about such smuggling here.
One business that is booming is Hong Kong life insurance products sold to mainland Chinese visitors. Related premiums already exceed the pre-COVID-19 level, suggesting strong demand for USD-linked policies.
Hong Kong’s real GDP grew +4.3% in the fourth quarter of 2023. Hong Kong’s export growth has now turned positive at +11% year-on-year. The unemployment rate remains just 2.9%, suggesting that jobs are plentiful…
…What’s weighing on the Hong Kong economy is the interest rate environment. Since the Hong Kong currency is pegged to the US Dollar through a currency board arrangement, it effectively imports its monetary policy and interest rates from the United States…
…Now that HIBOR has reached over 4% borrow rates for households and companies remain above the nominal income growth in the economy. In my view, that means that monetary policy remains restrictive…
…Another longer-term worry is geopolitics. If a war were to break out in Taiwan or elsewhere, US sanctions could be imposed on Hong Kong. It could lose its special trade status. Import tariffs would be imposed, and it would be subject to the same export controls as China. If the Hong Kong Dollar were to be de-pegged to another currency. But as long as the currency remains freely convertible, Hong Kong will continue to retain its competitive advantage as a hub for raising overseas capital.
5. A beginner’s guide to accounting fraud (and how to get away with it): Part VI – Leo Perry
On 9th September 2018 serial entrepreneur Luke Johnson shared his experience and wisdom in an article in The Times newspaper titled ‘A business beginner’s guide to tried and tested swindles’. Five days later HMRC petitioned the High Court to wind up his business, the cafe chain Patisserie Valerie, for an unpaid tax bill. He didn’t notice. Unfortunately I didn’t either.
On 10th October Pat Val halted trading in its shares and suspended its CFO. It noted “significant, potentially fraudulent, accounting irregularities” that had materially impacted the cash position. I was familiar enough with the brand. I worked in an office a few doors down from one. It never seemed busy but there was nothing in the accounts that gave me good reason to think about shorting the company. But if I’d been able to now I would have, even at half the price it was halted at. The reason I was so confident it was screwed was precisely because I hadn’t spotted anything wrong in its numbers before (neither, apparently, had anyone else as there were no publicly disclosed shorts on the FCA list).
Pat Val’s published accounts were as straightforward as you’d expect from a simple business like a cafe. Sales taken in cash, not much held as stock and a few prepaid expenses. The only line items of any size on the balance sheet were the capitalised cost of fitting out stores, and money sitting in a bank. Not a lot to tweak if you needed to meet numbers. That’s why the company saying that its cash position was significantly misstated, while it was short on detail, had to mean that (probably) sales and (almost certainly) profit were faked. Working backwards there couldn’t really be any other story.
Things unravelled fast. The next statement from the company, later the same day, disclosed the winding up petition from a month earlier. The following day Pat Val said it couldn’t continue trading without a capital injection, which really amounted to saying the £30m of “cash” on its balance sheet wasn’t in the bank at all. And the day after that its CFO Chris Marsh was arrested. One trick (I should say allegedly, I guess) is depositing fat cheques just before year end – to show a big credit at the point in time when you know the auditor is going to look – only for them to bounce a few days later. Another is borrowing money – again giving a big credit to cash – and just not mentioning the debt part in the accounts. Most of the time that would still show up as higher interest payments (see e.g. Globo), but when rates are close to zero you can get away with a lot more.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in Alphabet (parent of Google), Amazon, Apple, Meta Platforms, Microsoft, and Netflix. Holdings are subject to change at any time.
