The Weekly Investing Digest (for the week of 20/2/2023) - Beware of Managements Bearing Change
Investing Resources from a Week in the Fintwit Pits
As earnings season wraps up, I am making a mindful decision to review the quality of businesses of which I have a partial interest in.
I find myself having the same frustrations with management that I have always had. This reflects a mental defect most of us suffer from: having expectations of others that they haven’t committed to, and have no history of conforming to.
The remedy of this defect is to invest in what management has done, and has said they plan to do. Hoping for a complete change in management philosophy is a fool’s errand - even those investors who hope to affect change by taking large or controlling interests in a company are constantly frustrated in their efforts. Buffett stopped overt and confrontational activism some 5 or 6 decades ago.
FICO, CACC, 0696.HK, and BTI - each of these businesses run fairly efficient, cost-conscious operations that, to varying degrees, aim to return capital to shareholders. The different capital structures and reinvestment opportunities demand different approaches, whether that be share repurchases, repayment of debts, or issuing dividends. For the most part they are capital light, and head count, PP&E, capex, and opex are managed conservatively.
The likes of AMZN, and GOOG have been run on a different operational algorithm. Amazon has simply been a reinvestment machine. These investments have taken place in two forms. Firstly, by offering services at low prices to entice customer loyalty and lock-in. Secondly, by actually building massive real world infrastructure.
Google (Alphabet), in a similar vein, pursued a policy of taking a portion of their ungodly search cash flows and investing them into moon shot projects, M&A, and more recently share repurchases. The former has largely been a value destructive policy; they have shown very limited ability to incubate successful new businesses internally. There’s a case to be made that they are one of the greatest tech investors of all time; the purchase and subsequent scaling of YouTube and Android have been monumental successes.
This climate of success, and focus on investments (however you define the word), has lead to operational expenses and headcount growing at rates in excess of revenue growth. This is of course a diminishment of value for investors. The continuing and marginal shareholder will do well from here only if today’s “investments” translate into more profits tomorrow. In Google’s case, it is more than likely that investors will only do well if management makes a dramatic change in their approach to capital allocation and expenses. As we’ll explore later, betting on change is a substandard investment strategy.
Buyback confidant, and fellow quality investor Stu McKinnon (@stumvc007) posted a piece of timeless investing wisdom this week:
This is a point that has been made by Buffett many times over the years:
We feel change is likely to work against us. We do not have a great ability to predict where change is going to lead. We do have an ability to identify businesses where change isn’t going to be very important.
If someone tells us a business is going to change a lot, in Wall Street they love to tell you that is a great opportunity… We don’t think it’s a great opportunity at all. It scares the hell out of us because we don’t know how things are going to change… As long as we don’t have to make these kinds of decisions, why should we?
Warren Buffett, Berkshire Hathaway Annual Meeting 1996
These points ring as true today as they ever did. Change, for the most part, is the enemy of the investor. We are trying to lay out cash today to receive more tomorrow. In my own personal experience, I have invested in companies which I thought weren’t subject to rapid change, but actually were. I was then confronted with a double problem.
Firstly, it is hard to predict the cash-flows of a business that is being subjected to changing operational dynamics. For example, who could have foreseen Meta’s quarterly free cash-flow going from ~$10B a quarter to effectively $0? The market certainly didn’t - which leads me to my next point. Wild gyrations in underlying business performance begets wild gyrations in share prices. While we may all pretend not to be affected by the changes in the quoted prices of our securities, it is seldom true. Such large swings in prices, which have been catalysed by business-specific developments, have affected my ability to make well thought out investing decisions. I suspect you might be the same.
This is the reason why Buffett focuses on companies with long, storied histories. If it took many decades to build an economic position, it will probably take many decades for that cache to be depleted. Lindy, as Taleb would say. On the other hand, Thiel observes that rapid growth rates belie the half-life of company: if you can capture a market in 6 months, that’s about how long your dominant market position would endure. This is observed in biology too - rapid division of cells and reproduction is observed in animals with short life spans (mice and rabbits), whereas steadier and predictable growth is closely associated with longevity (the blue whale).
For penance this week I’ll recite the following: ‘beware of management bearing change’.
There have been some great investing resources released lately. Church was no great chore this week:
*As a side note - I am generally very impressed by Bill Ackman’s investing prowess, as well as his ability communicate which is augmented by an undeniable charisma. I am less sanguine about his approach to public relations - his twitter game leaves MUCH to be desired.
Buyback Friend Devin LaSarre wrote an update on the large tobacco companies.
I did an interview with the guys from Chit Chat money this week on Fair Isaac Corporation.
The above Buffett quote on change was found in this clip.
Last week also saw the filing of 13Fs across many of the world’s best and largest investors. A couple of transactions that I thought were interesting:
It appears Buffett sold most of his stake in Taiwan Semiconductor,
This was an interesting development. It was only a quarter ago that Berkshire’s 13F revealed a large enough stake to assume that Buffett himself had purchased the shares.
The setup was familiar. Taiwan Semiconductor is a company with an usually dominant market position within an otherwise commodity-like industry. Through strategic partnerships, management excellence, and technological innovations they have developed a very strong competitive advantage. For those interested, Google extreme ultraviolet lithography to get a taste of engineering miracles that TSM has pioneered.
The share price had reached an optically cheap multiple of last twelve month earnings when Buffett had purchased shares. This had been caused by a double set of circumstances: Taiwan’s increased tensions with a nationalistic China, as well as a general turn down in the cyclical semiconductor industry.
The sale indicates a change in perception. Cyclicality, capital intensity, and large unquantifiable risks (China could invade Taiwan) are usually not the hallmarks of Buffett Berkshire investment.
Dev Kantesaria cut a large portion of his Amazon stake,
Dev bought a large stake in early 2022, and subsequent interviews indicated that the thesis revolved around an imminent inflection in operating results. This has largely not panned out in the last 12 months.
While Amazon’s focus has moved towards cost controls, and growing into the enormous infrastructure they have built, they still continue to pursue low returning business lines. Furthermore, they tend to pursue these without any real evidence that they might win these markets. Grocery stands out.
It’s not that clear that they have competently run retail over the past few years. It’s become apparent that while they are squeezing third party merchants both on fees and on advertising, this ability extract rents from suppliers has not necessarily translated into adequate financial results.
Having an adequate result from here from owning the shares relies on management executing at a high level - something that requires some faith.
Michael Burry bought a decent sized stake in Black Knight, which is currently in the process of being acquired by Intercontinental Exchange Inc,
The acquisition of Black Knight is part of ICE’s strategy to establish a virtual monopoly in mortgage origination and servicing. The deal spread is fairly wide, reflecting the current administrations hostility to large scale M&A.
Li Lu made made a large additional purchase of Google.
The shares of Google (Alphabet) have fallen precipitously since the ChatGPT-Bing affair. Price drives narrative: there are even calls for Sundar Pichai to resign as CEO. I am of the opinion that competitive threats from chat related search is overblown. Ben Thompson’s recent interaction with a seemingly sentient version of Bing Chat has shown how nascent these products are. The fact that both Google and Microsoft’s product demos showed large deficiencies in the functionality, indicates we are in the middle of a fad, not a technological revolution.
A bit of housekeeping before we wrap up for this week. The list of subscribers continues to grow at a rapid pace, and I’m excited by the prospect that people are enjoying my writing.
As I posted a few days ago, I plan on introducing a paid-tier in the following week to enable me to write more, and for any of the subscribers who wish to support me in doing so. The paid tier will be a very modest amount - I don’t know where the final price will end up though so I’d like to extend everyone the following offer: the pledge amount on offer at the moment is probably lower than where I see it long term. Those would pledge now will enjoy this price permanently. This won’t affect access to the Weekly Investing Digest, but it will probably affect everything else.
I had planned on recording these pieces, but by chance I happened to notice that Substack provides this service free of charge via the app. It’s a very satisfactory feature and will save me time failing with remedial editing software. I plan to explore long-form audio in time, but for now we’ll stay fixated on the written word.
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