What We’re Reading (Week Ending 24 November 2024) - 24 Nov 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 17 November 2024):
1. Cash! – The Brooklyn Investor
Over the past few years, people have kept talking about mean reversion to value and whatnot, but I have ignored that for the most part for the reasons I’ve been saying here. The growth / value spread just seems to me so much reflecting values being taken away from the old economy into the new one. Yes, sounds like 1999 bubble, but it just seems true. Retail just seems to be going down the drain, old school marketing / advertising just seems to be losing to online marketing etc…
…The massive transfer of wealth has been going on for decades, or more than a century. Industrialization just sucked the wealth and value out of skilled workers / craftsman and transferred it to large corporations via factories. Formerly skilled workers were transferred into factories that required no skill (therefore, lower income). All the value-added accrued to the owners of the factories (capitalists). Same with national chain restaurants and retail. WMT transferred wealth from the local shops / restaurants to Arkansas; former store-owners end up having to work at WMT for lower pay (as unskilled workers). This is nothing new.
Now, the same thing is happening at so many levels at the same time that it is quite frightening. Just as a simple example, I’ve mentioned this before, but companies like Squarespace and Wix (or free options like WordPress) have sort of wiped out a large part of the web development world. People who knew a little HTML / CSS / Javascript might have been able to make a living not too long ago, but not now. All that ‘wealth’ is transfered to the companies that provide the platform for people to build it themselves.
Photographers are complaining for similar reasons. You no longer need to hire a photographer for low-end projects. You can just buy photos from various photos sites for very low prices, or even have AI generate the exact photo you need. I have used AI to generate artwork, photos and text in various volunteer work, and it is scary. I thought to myself, jeez, I would have paid an art student $300 for this 3 years ago; now I do it for free online via AI…
…This is why when people say the stock market as a percentage of GDP is going up, the concentration of stocks in the market is getting too high etc., I think it is obvious that this is happening because the wealth and value is actually being more and more focused and concentrated, so the market is only reflecting reality…
…A similar group of very rich and smart people are saying that long term rates can’t stay low and they must move substantially higher due to these unsustainably large and growing federal deficits. Do I worry about that? Yes. But, I look to Japan as the model of an aging society and growing government deficits. Sure, there are plenty of differences (Japan is a high savings nation), but I still can’t get around the fact that slowing population growth and maturity of the U.S. economy would make growth harder to achieve going forward. Almost certainly, we can’t get back to the growth of the post-war baby boom generation. So given that, how do interest rates go up? Deficit-driven inflation? We haven’t really seen that in Japan, and even in the U.S. until Covid and Ukraine. So is the recent inflation really deficit-driven inflation? Or exogenous event-driven inflation? Maybe a combination of both.
This is not to say I don’t care about deficits. Of course it’s a problem, and we need to deal with it at some point. My opinion is just seeing things as an investor. I am just telling you why, as an investor, I am not yet concerned too much with the deficit and inflation.
2. Off The Beaten Path Investing – David Katunarić and Lawrence J. Goldstein
Goldstein: I started at Burnham when they had about 22 senior analysts following every industry in America, or so they thought. One day, after discovering the pink sheets, or actually, I found the pink sheets afterwards. I saw a list of trucking companies. It was in the Standard & Poor’s transportation manual, which came out weekly, supplements to put in the looseleaf book. I got a list of every trucking company in the United States and there must have been well over 50, maybe more, and every one of them had lower earnings or losses, except for four companies. Those four were Roadway Express, Denver Chicago Trucking, Merchant Fast Motor Lines and Overnite, spelled N-I-T-E. I called them first, and I ended up making a friend of J. Howard Cochran, the founder and president. At the beginning, he sent me a copy of his monthly financial statement. There were no rules against doing that. I remember they were printed in purple ink on a ditto machine. His first report he sent me was the five months ended May. He had earned in those five months, per share, I remember $1.86. He told me also that in the trucking business, the second half of the year is better than the first half. I said, “Let’s see, five months $1.86, times 2 is over $3.60, and I’m missing a month and the second half is better, so it’s got to be higher than that.” The stock was $1.75 or $1.25 off it. I couldn’t believe it. So I wrote a report, gave it to my boss, head of research.
He said to me, and I can hear it to this day, “Listen, kids, this is an institutional research department. We don’t write or recommend reports on dollar-stocks.” So I knew I was onto something. My boss was crazy. It ended up, by the way, they earned almost $4 a share that year. I got to laugh, it’s funny – I could buy the first share at $1.75, and I did. A number of years later, I think two decades later, or less than, Overnite sold out to, I think it was the Southern Pacific Railway, they sold out for $100 million. This thing was worth $500,000 when I met them. So the pink sheets made sense to look there. Basically, what I came to do was to look left when everybody’s looking right, look down when everybody’s looking up, and find companies that are off the beaten path, overlooked or ignored by otherwise intelligent investors…
…Katunaric: What would you say, Larry, in these 40-some years that you’re managing Santa Monica Partners, how has your investing approach changed since then? What are some lessons that sparked the change?
Goldstein: It’s not changed at all, except that you don’t write to the SEC and ask for the 10-Ks and Qs and the proxy and have it take two weeks if you get it. Now you hit a keyboard and you get it all. That’s changed. The second thing is now there are people like you. There are a lot of people – I don’t mean you personally – who are on top of what’s called microcaps. So everybody’s searching for the goal. Obviously you’ve developed a business and you want to develop a bigger business. But that’s what happened. Competition that didn’t exist. When I did it, there was one firm that got big, Tweedy Browne. You know them? What happened to them was terrible. They got so big they had to buy ordinary stocks…
…Goldstein: When I bought Mastercard, it was not a huge company. When they went public, if I remember right, it was $39, $38, $37. I can’t remember the exact price, and it’s since split 10-for-1. So my cost is, I guess, $3 and change. I forget the exact split. I have to look it up. Let’s say it’s $10, $15 – but I think my cost is less than $15.
Katunaric: I saw somewhere that it was a hundred-bagger since the IPO. Maybe I read it last year. I think it was one of the best performing ones, but I’m not sure also.
Goldstein: I’ll focus on that for a second. The reason I bought it, was in 1971, I went to my boss, Tubby Burnham, and I said, “There’s a business that’s going public, Madison Avenue.” Madison Avenue is where all the advertising agencies were in New York, every one of them. The company that was going public, it was the second company to go, ad company. The first one was a company called Puppet, Koning, and Lois. They had been public for some period of time and the stock did okay. The second one was Batten, Barton, Durstein, and Osborne, which subsequently changed their name to BBD&O, which subsequently changed their name, and it’s the same company to Omnicom, which is the world’s first and second largest advertising agency. Why did I want to buy it? I said to my boss, “Advertising companies are required if you have a consumer product to sell. It’s a royalty company. They get a royalty on every new consumer product that’s marketed to the world.” That’s what I think it was. If you’re going to sell a new widget, you want to advertise it. They get a cut of that. So, a great business. I said, “That’s exactly what Mastercard is.” Everything that anybody buys, they get a cut. By the way, there’s no risk to their business. They don’t make loans. Banks make loans. They get a cut. Banks have risk, but Mastercard, it’s like every time you turn on the water, you get a free glass…
…I tell you, the biggest recommendation to me, and the biggest thing I don’t believe or understand is, Warren Buffett, he has never bought it, except for himself when he was a kid. He bought Oxy. I don’t know that much about Occidental, but there’s nothing better than TPL if you want to be in the oil business. They just own the stuff and you can take it out at your cost and pay them not only for that, but the right to get to the well and leave the well and for the water for fracking. If you run a hose or a pipeline, pay them. What better business is there than that? None.
Katunaric: I agree. You pitched me TPL extensively yesterday and the asset light nature of the business was really attractive.
3. Here’s How Trump Could Lose the Coming Trade War – Paul Krugman
All indications are that China’s era of torrid economic growth is behind it. For decades, Chinese growth was fueled mainly by two things: a rising working-age population and rapid productivity growth driven by borrowed technology. But the working-age population peaked around a decade ago and is now falling. And despite some impressive achievements, the overall rate of technological progress in China, which economists measure by looking at “total factor productivity,” appears to have slowed to a crawl…
…China, however, has built an economic system designed for the high-growth era — a system that suppresses consumer spending and encourages very high rates of investment.
This system was workable as long as supercharged economic growth created the need for ever more factories, office buildings and so on, so that high investment could find productive uses. But while an economy growing at, say, 9 percent a year can productively invest 40 percent of G.D.P., an economy growing at 3 percent can’t.
The answer seems obvious: redistribute income to households and reorient the economy away from investment toward consumption. But for whatever reason, China’s government seems unwilling to move in that direction…
…So what do you do if you have lots of capacity but your consumers can’t or won’t buy what you make? You try to export the problem, keeping the economy humming by running huge trade surpluses…
…China appears to be exporting close to $1 trillion more than it imports, and the trend is upward.
Hence the coming trade war. The rest of the world won’t passively accept Chinese surpluses on that scale…
…That’s why the Biden administration has been quietly pursuing a quite hard line on China, retaining Trump’s tariffs and trying to limit its progress in advanced technologies. It’s why the European Union has imposed high tariffs on electric vehicles made in China, which is probably only the beginning of expanded trade conflict…
…Trump’s insistence that tariffs don’t hurt consumers — even as businesses across America are planning to raise prices when his planned tariffs hit — strongly suggests that neither he nor anyone he listens to understands how global trade works. Not a good thing at a time of trade conflict.
4. Is the United States Going Broke? – Ben Carlson
There seem to be two extreme views when it comes to government debt levels.
One is the view that government debt doesn’t really matter all that much since we have the global reserve currency and the ability to print as much of that currency as we’d like.
The other view is that government debt levels are reaching a tipping point that will lead to calamity…
…It is true that U.S. government debt is enormous…
…Total government debt in the United States was around $23 trillion heading into the pandemic so debt levels are up 50% or so this decade alone.
It’s also true that the interest we pay on government debt has risen considerably because we’ve taken on so much and interest rates are so much higher than they were in the 2010s…
…But you can’t look at debt levels on their own. You have to think of them through the lens of a $30 trillion U.S. economy.
Here is interest expense as a percentage of GDP:..
…It’s shot up considerably in recent years but it’s still below 1990s levels. The Fed cutting interest rates should help on the margins…
…Spending was 45% of GDP during the pandemic. That was obviously unsustainable but things are now back to normal…
…The thing you have to understand is the United States government does not operate like a household when it comes to debt. You pay your mortgage off over time and eventually retire that debt.
The government’s budget is not at all like a household budget. First of all, the government can print its own currency. That helps in a pinch and it’s the main reason our government can’t go broke. Inflation is the true constraint when it comes to politicians spending money.
As long as the economy is growing, debt should be growing too…
…I would be more worried if you told me government and consumer debt were down in the coming decades. That would mean something is seriously wrong with the economy.
Debt grows because assets grow (remember government debt is an asset in the form of bonds for investors). Debt grows because the economy grows. Income grows. Prices grow. So of course debt will rise.
5. Wall Street’s Elites Are Piling Into a Massive AI Gamble – Neil Callanan, Gillian Tan, Tasos Vossos, Carmen Arroyo, and Immanual John Milton
While much of the speculative hype around AI has played out in the stock market so far, as seen in chipmaker Nvidia Corp.’s share price, the giddiness is spreading to the sober suits of debt finance and private equity.
Analysis by Bloomberg News estimates at least $1 trillion of spending is needed for the data centers, electricity supplies and communications networks that will power the attempt to deliver on AI’s promise to transform everything from medicine to customer service. Others reckon the total cost could be double that…
…Further proof of the “unsatiable demand” for computing horsepower, according to real-estate broker Jones Lang LaSalle Inc., is the more than sevenfold increase over two years in construction work on US co-location centers, which lease out rack space to tech firms. Asking rents in those facilities have jumped as much as 37% in 12 months, the firm estimated in an August report.
All of this unbridled spending is revving up the issuance of both investment-grade debt and riskier leveraged loans, especially in the US, handily for private lenders and fee-starved investment bankers alike. Hedge funds are looking as well to profit from AI hysteria with novel types of debt structures.
It’s also opened up a new corner of the asset-backed securities market, where sales of debt backed by data centers have already jumped to a near-record $7.1 billion this year, according to data compiled by Bloomberg News. Chuck in fiber networks and other bits of kit, and it’ll be much higher. Matt Bissonette, who heads Guggenheim Securities’ business in this area, says the number of buyers for his data-center ABS products has roughly doubled in four years…
…While Blackstone hasn’t risked that kind of capital on construction before, developers of data centers can make stellar returns if all goes well. Property researcher Green Street reckons profit margins on London sites are about 65%.
Financiers are eager to back these grand projects because future occupants have usually pre-signed long leases, making them safer bets. Some banks are offering to lend as much as 70% or 80% of the cost and occasionally more when a lease is already signed, according to a person with knowledge of the matter…
…Lenders are more twitchy, however, about data centers explicitly earmarked for AI rather than more general purposes, according to a banker who works in the sector. Such deals can carry costlier debt and less leverage, he says, because the technology still has to prove its worth.
Separately, a senior partner at a leading private equity firm says he’s troubled by the emergence of speculative development, meaning construction takes place before a tenant has been found, as it’s hard to be sure of final demand. Some lawyers talk of “zombie projects” that may never be finished.
And not everyone believes that the “if you build it, they will come” approach is a surefire winner for those gambling on an era-changing AI breakthrough. Massachusetts Institute of Technology professor Daron Acemoglu says a lot of capital will be wasted.
Despite the misgivings, the appetite for deals from bankers and private lenders — especially for sites with blue-chip, signed-up occupants — is giving most data-center owners and developers a strong hand when pricing debt. A site leased long term by a tech giant can snag bank funding at a margin below two percentage points, says Brookland’s Hussain. Co-locators typically pay 2.5 percentage points or less, he adds.
“Recently, we raised €850 million ($907 million) in nine-year bonds at below 4% and refinanced and upsized our revolving credit facilities to $4.5 billion,” says Jordan Sadler, senior vice president at Digital Realty Trust Inc., a tech property firm that has signed joint ventures with Blackstone and others for almost $9 billion of hyperscale data-center developments…
…Across the Atlantic, one utility told the Federal Reserve Bank of Atlanta that electricity usage by data centers rose 17% in recent months. In Virginia, host to the world’s highest concentration of these sites, records for peak power demand were set six times in July, according to Dominion Energy Inc.
Trying to satisfy energy-devouring data centers means the utility sector’s capital spending is set to exceed $200 billion by next year, about double what it was a decade earlier. That would have stressed utility balance sheets, but a recent easing of how Moody’s Ratings views some of the industry’s riskier hybrid bonds — letting them be treated as half equity — has opened the floodgates to companies raising capital without being downgraded.
Sales of these bonds have risen almost eightfold this year to $15 billion, data compiled by Bloomberg shows. Only issues by bulge-bracket banks match that.
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 Wix. Holdings are subject to change at any time.
