Investing From First Principles | The Acquirer's Multiple®

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Investing From First Principles. Here’s an excerpt from the episode:

Jake Taylor:
So, I thought it would be fun and I’m punting a little bit to this week, because I wrote this up at my last quarterly letter. But, this is how I reason up from large data series to arrive at what you would call a capital T truth. One of the problems that we have is that, it’s really hard to figure out what is true and what’s not true a lot of times. Do we have enough data sampling to be able to say much of anything with real conviction?

Jake Taylor:
Well, the first three… The number one data set that I look at is the inorganic universe. So, this is like physics. What are the things that we can take from physics that will allow us to say-

Tobias Carlisle:
This is really first principles.

Jake Taylor:
We’re going deep first principles, yeah. So, I’m going to relate this to one specific idea, which is reciprocity. I’m going to show how each three of these data sets show that reciprocity is a capital T true thing for us to hang our hats on. In the inorganic universe, we have Newton’s Third Law, which is for every action there’s an equal and opposite reaction. That’s basically reciprocity. If you run something into something, it’s going to bounce back, or if you send a planet around the sun it’s going to come around the other side.

Jake Taylor:
The second giant data series is biology. We have 3.7 billion years worth of data to look at here. So, conclusions we can draw from biology can be useful in other domains. If you think about us, we’re all made of eukaryotic cells and that probably came about-

Bill Brewster:
You got that Toby?

Tobias Carlisle:
I remember that one means it’s multi as opposed to monokaryote, something like that.

Jake Taylor:
Yeah, we’re multicellular. Inside of these cells there is-

Tobias Carlisle:
It’s high school biology bailing me out there.

Jake Taylor:
Did they have that in Australia?

Tobias Carlisle:
Yeah, they did. They taught me stuff that’s not true. I had to discover it afterwards. Phylogeny does not recapitulate ontogeny. I’m sorry, keep going.

Jake Taylor:
So, it’s probable that eukaryotic cells came from two bacteria teaming up, and there’s a couple of reasons why we might believe that. One of the cells would be… One of the bacteria would have been providing food and maybe movement and protection. The other one would probably be providing energy to the cell. So, if you look at us today, our mitochondria they’re determined 100% actually by your mother’s lineage.

Tobias Carlisle:
The mitochondria is the powerhouse of the cell.

Jake Taylor:
Correct. So, we have one little thing inside of the cell that is totally determined by your mom’s lineage, and the rest of it is a mixture. Well, isn’t that interesting? Why would it come out be that way? It’s probably because two things teamed up together, and they were symbiotic in their relationship. So, there’s a reciprocity at a biological level.

Tobias Carlisle:
So, does that mean that your energy levels are dictated by your mom?

Jake Taylor:
It’s possible that the way that you process, the way that you convert chemical food into energy that your body uses, is largely determined by your mother’s lineage, yeah.

Tobias Carlisle:
Interesting.

Jake Taylor:
So, number three, large data set human history. We have 5,000 years worth of recorded history if we go back to Sumerian cuneiform, but above that, we have 2 million years worth of-

Bill Brewster:
I love your face Toby.

Tobias Carlisle:
I love this. I love this whole thing. It’s amazing.

Bill Brewster:
I do too, I do too.

Jake Taylor:
… So, you have 2 million years worth of, we’ll call it modern, what you and I would recognize as a human. We were largely hunter gatherers at that point. The hunter gatherer environment was very random. You would go out for a hunt and chances are maybe you’d come back with an empty stomach. However, if you did get a big kill, unfortunately the meat spoiled before you could eat all of it. So, you could actually store some of the meat in one of your friend’s stomachs, and if they got the kill they would then be reciprocal to you and feed you. So, that was the first insurance policies that we came up with was, come back with the kill and feed everybody in the tribe, and then when they get the kill will get fed.

Jake Taylor:
So, we are hardwired to appreciate reciprocity, to understand when someone is cheating us, when someone is a loafer and not delivering enough, we are very attuned to that biologically, and it’s from 2 million years of evolution of that playing out. So, all of these things, these three large data series tell us that reciprocity is a real thing that we can appreciate.

Jake Taylor:
What does this mean for investing? A business exists in an ecosystem and has to have reciprocity with all of the interactions that it has with its constituents. So, its constituents are the employees, it’s vendors, the environment, the communities that it does business in, its employees and then customers, and then lastly, its regulators. So, we have six primary constituents that there has to be some reciprocity for this business to operate and be sound in a longterm way, like biology would dictate.

Jake Taylor:
So, when you’re looking at businesses you have to look for, is there anywhere where that business seems like it’s getting over on one of these constituents? If it is, you have to ask yourself, is this going to… Is this a sustainable business over a very long term? We talk about wanting to be holding as a superpower. Well, if you’re going to hold for a really long time, you have to have a business that is going to be win-win across all of these stakeholders. Otherwise, eventually someone is going to defect because they feel like they’re getting over. Whether that’s employees unionizing, whether it’s an employee or the government cracking down on them for antitrust maybe, or whether it’s customers feeling they’re getting cheated, maybe a cable company and they’re like, “Screw those guys. I’m not going to-

Bill Brewster:
Hey, lay off. Lay off.

Jake Taylor:
I knew I’d throw that on Bill. So anyway, if we take some really long sweeps of data series, we can maybe apply that to our investing framework and look for those kinds of outcomes. What the beautiful thing to me about that is that, all of that is a win-win for society and all of us who are participating in this. I find that to be a really beautiful thing about capitalism, when it’s done well is that, it really does have to be win-win for everybody. It’s such a magical thing and it surprises me sometimes how we try to squish it away. But, that’s a different-

Tobias Carlisle:
Let me throw a couple of-

Bill Brewster:
My man went full Peter Kaufman on you all, just so you know.

Tobias Carlisle:
Let me throw a few names at you.

Jake Taylor:
I didn’t want to say that because he doesn’t like attribution, but-

Bill Brewster:
No, that’s the stuff he preaches, right?

Tobias Carlisle:
I want to just throw a couple of names at you and get you to talk a little bit about the ecosystem applying those rules. Amazon.

Jake Taylor:
A little bit problematic in how they treat suppliers probably. Probably a little problematic on-

Tobias Carlisle:
Employees in the warehouses.

Jake Taylor:
Yeah. That’s, I mean-

Tobias Carlisle:
They also did this thing today where they’ve reduced commissions for affiliates from 8% to 3%, a good time to do it.

Jake Taylor:
Right.

Bill Brewster:
They only do it so you can get diapers cheap and quick. So, somebody’s got to lose.

Jake Taylor:
Well, that would… Eventually, somebody will figure out a way to revolt against that if they’re getting pinned down for long enough.

Tobias Carlisle:
How about Google?

Jake Taylor:
In general, pretty clean, but some of the data-

Bill Brewster:
What’s funny is, everybody calls them fads.

Jake Taylor:
… How are they using the data, there may be ways of-

Tobias Carlisle:
Facebook seems a lot more offensive to me than Google, even though Google probably has just as much, maybe more on me.

Jake Taylor:
Yeah, definitely. Probably a lot more actually across wider things.

Tobias Carlisle:
Yeah, that’s interesting.

Bill Brewster:
My beef with this is, I’ve had this discussion as it pertains to airlines, so get your drinks out. But, somebody told me that they thought that Southwest was very customer focused and Delta wasn’t. I have heard from a lot of people that love Delta and say like Delta actually is.

Tobias Carlisle:
I fly both, Delta’s great.

Bill Brewster:
I know. Well, I think that you can get into pretty subjective stuff here. But, I don’t disagree with theory and I think that the thinking it through is super important, but Toby to your point, I hate Facebook and everything that it represents to me. That said, you talk to somebody Marcelo P. Lima, and I think he has pretty compelling arguments on the other side for what it can do for society.

Jake Taylor:
When is it going to start doing those things?

Bill Brewster:
Well, the thing is the internet in general… I think the problem with Facebook is they privatize the internet and when you privatize the internet, you get its ugly corners too. That sucks, especially when stupidity can ring louder than rational thought.

Jake Taylor:
I do think there are definitely some shades of gray to all this. You can’t just say like… It’s not binary if someone is clean or dirty. But, there are some that are more obvious that people are probably ignoring a lot of times, and I think eventually it will bite them in the ass, it may take a long time.

Bill Brewster:
Here’s one, what about Disney?

Jake Taylor:
Well, I’m sure it doesn’t seem like they’re treating their employees particularly well in this time of need.

Bill Brewster:
What about their customers?

Tobias Carlisle:
They’re also a bit nasty on the copyright front. They’ve got little deals in there, they come after you for copyright. And that’s silly thing on Twitter where they said, “Tell us what you feel about…” whatever it was. Then they put straight underneath, “By the way, if you respond to this email, you’ve given us the rights to use your likeness in this tweet in perpetuity.” Totally binding agreement.

Bill Brewster:
I mean, they’re one that I would say, and I have friends that are along it and I’m sorry to say, I don’t think that they are particularly concerned with treating everybody well. They just have a really, really unique experience in IP, so they can charge you enough that you have to take out a credit card loan to go there, or a second mortgage or whatever and people do it.

Jake Taylor:
How about from the owner’s standpoint, which is another one of the constituents that I forgot to say, and having such, maybe I’d call it egregious cop for the management. That’s a little chiseling of the owners, isn’t it, to pay some of these guys so much money.

Bill Brewster:
Yeah.

Tobias Carlisle:
Did you see that SBC thing that I tweeted out yesterday?

Jake Taylor:
Yeah.

Bill Brewster:
Yeah.

Tobias Carlisle:
It’s not my chat, somebody else’s chat, but holy cow, some of those companies have just been blasting up 20% plus-

Jake Taylor:
Stock based compensation by the way.

Tobias Carlisle:
Sorry, stock based compensation, pardon me, it’s stock based compensation, just through options and so on, like 20% a year.

Bill Brewster:
Yeah.

Tobias Carlisle:
That’s crazy.

Bill Brewster:
Only thing I’ll say real quick on the comp with Disney particularly, Iger has added a lot of value. He set that company up. That could be a dying company right now if it wasn’t for some of the moves he made.

Tobias Carlisle:
Did he also quit and then come back? What was all that about?

Bill Brewster:
He can’t let go.

Tobias Carlisle:
He wasn’t just the sidestep-

Bill Brewster:
I thought that was really funny. It’s like, here’s the new CEO and he’s super prepared, and Oh by the way, shit just hit the fan. I need to take this job back.

Tobias Carlisle:
I read it the other way around.

Jake Taylor:
You’re out.

Tobias Carlisle:
I read it like, well-

Bill Brewster:
Well, I meant you could run it when everything was good. I didn’t mean you could run it, run it.

Tobias Carlisle:
I thought that was the other way around. I thought he was like, “This is all sweet,” and then air pocket, I’m out. He pulled the parachute and then it was like, “Oh, we righted that ship surprisingly quickly. It’s not an 18 month rip up. I want to get back into play and you’re out brother.”

Jake Taylor:
This is like when you give your little brother the controller that’s not even plugged in and he thinks he’s playing.

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