What We’re Reading (Week Ending 27 September 2020) - 27 Sep 2020
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 27 September 2020):
1. Q&A With Li Lu – Longriver
We only offer our services to university endowments funds, charity funds and family offices focused on charity. We are very picky with our clients and do not manage money simply to make the rich richer. This is how we feel like we are contributing to society. If you arrange your life in this way, you will be more at ease and less anxious. You will be able to walk through life unhurried and at your own pace.
A lot of investors have told me that they want to invest like I do but their clients won’t let them because they’re always thinking about how much money they can make in the next hour or so. I personally think that you should not take these kinds of people as your clients. They then say that if they didn’t have these clients, they wouldn’t have any clients. And then how would they go about finding clients like mine? I didn’t have any investors when I started, only the money I had borrowed. My net assets at the time were negative.
Munger likes to ask, how do you go about finding a good wife? The first step is to deserve a good wife, because a good wife is no fool. Clients are the same. When our fund started, it was my own money for many years plus some from a few close friends who believed in me. Over time, as you accumulate more experience and build your track record, suitable people will naturally find you. And amongst them, you can choose the most suitable. You can do it this way very gradually with no need to rush – and with no need to compare yourself to others. The most important thing is therefore to be able to let things come as they are. You must have faith in the power of compounding and the power of gradual progress. Compound interest is a gradual force: 7% compounding over 200 years will give you a return of 750,000 times, right? That’s not too bad at all. But this is the power of compounding.
2. The Stock Market Is Less Disconnected From the “Real Economy” Than You Think – Nathan Tankus
There is one big area you can say that the stock market is disconnected from the economic outlook— size. By definition, it tends to be bigger companies which are on the stock market. So inevitably the stock market can’t capture the thousands of small businesses that are failing. Yet, even here, disaggregation of the S&P tells us a lot. Again, there is a wide and sharp dispersion right now, with average returns for large firms a lot higher than smaller firms. This wasn’t the case in February. More than half the companies in the index have less than $25 billion in market capitalization, and the average year-to-date return for all these companies (equally-weighted) is negative.
The clearest indication that the stock market is being driven by economic fundamentals is that growth and declines in sales so easily explain stock market returns. If stock market returns and the “real economy” were very disconnected, we’d expect the sales factor to be submerged in a sea of speculation. Instead, the chart below shows us another story. Once returns are broken down by sales growth, we see dramatic differences based on sales growth and decline. Returns are in fact highest for companies with the strongest year-over-year sales growth. Among those with sales growth greater than 20% are familiar companies like Amazon and Netflix, but also much smaller companies like Nvidia and Paypal. In other words, tech stock returns are being driven by tech sales.
3. Egregious Founder Shares. Free Money for Hedge Funds. A Cluster***k of Competing Interests. Welcome to the Great 2020 SPAC Boom – Michelle Celarier
“SPACs are a compensation scheme, like people used to say about hedge funds, but it’s even worse,” Ackman tells Institutional Investor. “In a hedge fund, you get 15 to 20 percent of the profit,” he says, in reference to the incentive fees hedge funds earn on the gains in their portfolio. “Here you get 20 percent of the company.”
For a small fee of $25,000, he explained in a recent letter to investors in his hedge fund, “a sponsor that raises a $400 million SPAC [the average size this year] will receive 20 percent of its common stock, initially worth $100 million, if they complete a deal, whether the newly merged company’s stock goes up or down when the transaction closes.”
Even if the stock falls 50 percent after the deal closes, “the sponsor’s common stock will be worth $50 million, a 2,000 times multiple of the $25,000 invested by the sponsor, a remarkable return for a failed deal,” he wrote.
Meanwhile, Ackman noted, the IPO investors will have lost half of their investment.
And there is another advantage: The 20 percent stake is also referred to as the “promote,” a nod to the work sponsors perform in landing a deal. However, that money is considered an investment, not a fee, which means sponsors can pay a lower capital-gains tax on the return if the stock is held longer than a year.
“To make matters worse,” Ackman added, “many sponsors receive additional fees for completing transactions, which can include tens of millions of dollars in advisory fees, often paid to captive ‘investment banks’ that are often 100 percent owned by the sponsors themselves.” Underwriting fees paid in a SPAC IPO are around 5.5 percent of the capital raised, he noted — higher than those of the average IPO.
4. A Few Rules – Morgan Housel
The person who tells the most compelling story wins. Not the best idea. Just the story that catches people’s attention and gets them to nod their heads.
Tell people what they want to hear and you can be wrong indefinitely without penalty.
The world is governed by probability, but people think in black and white, right or wrong – did it happen or did it not? – because it’s easier.
History is deep. Almost everything has been done before. The characters and scenes change, but the behaviors and outcomes rarely do. “Everything feels unprecedented when you haven’t engaged with history.”
Don’t expect balance from very talented people. People who are exceptionally good at one thing tend to be exceptionally bad at another, due to overconfidence and mental bandwidth taken up by the exceptional skill. Skills also have two sides: No one should be shocked when people who think about the world in unique ways you like also think about the world in unique ways you don’t like.
5. My Favorite New Investing App On Earth – Joshua Brown
The most valuable resources to understand companies can be found among the materials filed by the companies themselves. They must give out information and make disclosures from a regulatory standpoint, and this is where research should begin. But then again, we’re faced with the problem of having to sift through too much stuff and keep track of too many filings. If we’re not professional analysts covering these businesses for a living, it’s too much work for too little reward.
Which brings me to quarterly conference calls. They are, in my opinion, the most bang for your buck in terms of time spent versus what you come away with. You get to hear from the CEO and CFO every 90 days, walking you through the latest developments at their respective corporations. Then you get to hear thoughtful questions being asked of the management by Wall Street’s sellside analysts, who know these businesses inside and out. If you want to get to know a company like Adobe or DR Horton or Caterpillar or Lyft, one hour per quarter, listening to the conference call, is a cheat code. It gets the job done and you can listen while doing other things, like commuting, exercising, bike riding, hot air ballooning, whatever.
But here’s the problem – a problem I believe has now been solved:
Have you ever noticed that the Investor Relations pages on public companies’ websites are always different from each other and hard to navigate? IR pages suck. And nothing is worse than trying to listen to the latest conference call on a company’s website from your phone. You have to not only keep the phone’s screen open, you also must stay on the Chrome or Safari app to continue listening. If you close your internet browser app, the audio turns off. This prevents multi-tasking and makes the listening experience on the go a huge pain in the ass. It’s the opposite of a podcast – clumsy, unreliable, complicated, annoying and too chore-like to become habit forming.
What if I told you there was a way to listen to any earnings conference call you want, in the form of a podcast, from an app on your phone? What if learning about DataDog, Crowdstrike, Salesforce, Gilead and all of the other exciting companies that are changing the world was as easy as checking out an episode of Joe Rogan or Bill Simmons or even Downtown Josh Brown 🙂 ? Sounds pretty good, no? Well then, my friend, do I have the app for you. It’s called, appropriately enough, Earnings Calls, and is available now for your phone. It’s absolutely free to use and you should start using it today.
6. Rory Sutherland – Moonshots and Marketing – Patrick OShaughnessy & Rory Sutherland
At Red Bull, there’s no evidence whatsoever and there’s no logic to suggest that there’s a massive gap in the market for a drink that tastes worse than Coke, costs more than Coke, and comes in a smaller can. And indeed, if you’d have done market research, everybody would have told you to get lost. And indeed, when they tested the taste, people did tell them to get lost. That is one of those things which is an extraordinarily well rewarded case of capitalism rewarding you disproportionately the more counter intuitive your idea is. To be honest, if your idea makes sense, someone will already have tried it. It’s what I say, if there were a logical solution to this problem, someone would already have found it. So the place to look, if you want to have disproportionate upside in investments is invest in something which has an element of absurdity to it.
7. The 10 Most Useless Phrases in Finance – Barry Ritholtz
1. “Don’t Get Complacent.” What, exactly, should an investor do with this bit of advice? How does a lack of complacency manifest itself in an investment portfolio? Should the recipients of this advice liquidate some or all of their holdings? Or should they merely be on the lookout for some heretofore unknown risk – as they always should?
“Don’t have a smug or uncritical satisfaction with oneself or one’s achievements” makes for a nice sentiment in a high school valedictorian speech or a college paper on Epicurean philosophy, but it is not what street types describe as “actionable advice.”
As someone who is in the advice business, I like to offer specific and identifiable actions, as in “buy this and sell that.” To be fair, something like “Hey, you have had a great run during this rally. Be careful about getting overconfident” is not the worst advice one could get – it’s just squishy and hard to express in a trade.
2. “Profit Taking.” This phrase tends to appear anytime there’s been a run up in asset prices, followed by reversal. It is never a simple consolidation or just a break from a relentless buying spree. Instead, the claim is that buyers at lower prices are now sellers at higher prices, booking a profit. This is always proffered without evidence or explanation.
Ironically, the correction in the stock market that began toward the end of the summer – about an 11% pullback in the Nasdaq 100 Index following a 77% gain from the lows less than 6 months earlier – was very likely actual profit taking as a driver of the selling.1 And yet, the one time the phrase could have been used accurately, no one seemed to bother with it.
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 the shares of Amazon, Netflix, and PayPal.
