New book out now! The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market

Tobias CarlisleAmazon, Tobias Carlisle1 Comment

From Amazon

The Acquirer’s Multiple is an easy-to-read account of deep value investing. The book shows how investors Warren Buffett, Carl Icahn, David Einhorn and Dan Loeb got started and how they do it. It combines engaging stories with research and data to show how you can do it too. Written by an active value investor, The Acquirer’s Multiple provides an insider’s view on deep value investing.

The Acquirer’s Multiple covers:

  • How the billionaire contrarians invest
  • How Warren Buffett got started
  • The history of activist hedge funds
  • How to Beat the Little Book That Beats the Market
  • A simple way to value stocks: The Acquirer’s Multiple
  • The secret to beating the market
  • How Carl Icahn got started
  • How David Einhorn and Dan Loeb got started
  • The 8 rules of deep value

The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market provides a simple summary of the way deep value investors find stocks that beat the market.

Excerpt

Media

(If you’d like to schedule an interview, please shoot me an email at tobias@acquirersmultiple.com)

Buy The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market is out now on Kindle, paperback, and Audible.

Other Books

Howard Marks: Markets Have Flipped From Being All Good to All Bad

Johnny HopkinsHoward Marks, Investing StrategyLeave a Comment

Here’s a great video with Howard Marks at Bloomberg. During the interview Marks says:

“I think, as it often does, the market has flipped from being all good to all bad. Prior to October the 4th it was ignoring some possible problem sites and now it’s obsessing about them. That’s the way it goes.”

You can watch the full video here:

Jamie Dimon: 11 Books That Every Investor Should Read

Johnny HopkinsInvesting Books, Jamie DimonLeave a Comment

We recently started a series called – Superinvestors: Books That Every Investor Should Read. So far we’ve provided the book recommendations from:

Together with our own recommended reading list of:

This week we’re going to take a look at recommended books from Jamie Dimon. Taken from his writings, interviews, lectures, and amazon reviews over the years. Here’s his list:

1. The World is Flat (Thomas Friedman)
2. Competitive Strategy: Techniques for Analyzing Industries and Competitors (Michael Porter)
3. Security Analysis – Classic 1940 Edition (Benjamin Graham) (David Dodd)
4. The Intelligent Investor (Benjamin Graham)
5. Execution – The Discipline of Getting Things Done (Larry Bossidy) (Ram Charan) (Charles Burck)
6. Jack: Straight From the Gut (Jack Welch) (John Byrne)
7. Sam Walton – Made in America (Sam Walton)
8. Double your Profits in 6 Months or Less (Bob Fifer)
9. Built from Scratch (Bernie Marcus) (Arthur Blank)
10. Only the Paranoid Survive (Andrew Grove)
11. Built to Last (Jim Collins) (Jerry Porras)

TAM Stock Screener – Stocks Appearing in Fisher, Greenblatt, Simons Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks.

The top investor data is provided from their latest 13F’s (dated 2018-6-30). This week we’ll take a look at:

MKS Instruments, Inc (NASDAQ: MKSI)

MKS Instruments Inc provides solutions to improve process performance and manufacturing productivity. Their products fall into three categories: instruments, control, and vacuum products; power and reactive gas products; and analytical solutions products. MKS generates the majority of its revenue from sales to semiconductor capital equipment manufacturers and semiconductor device manufacturers. The company’s operating segments comprise Manufacturing Capital Equipment, service, Asia Region Sales, and Other. The Manufacturing Capital Equipment segment contributes the majority of revenue. Over half of MKS Instruments’ sales occur in the United States.

A quick look at the price chart below for MKS Instruments shows us that the stock is down 24% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 7.37 which means that it remains undervalued.

(SOURCE: GOOGLE FINANCE)

Superinvestors who currently hold positions in MKS Instruments include:

Jim Simons – 1,393,902 total shares

Chuck Royce – 1,000,897 total shares

Ken Fisher – 574,609 total shares

Cliff Asness – 503,353 total shares

Joel Greenblatt – 84,234 total shares

Paul Tudor Jones – 47,686 total shares

The Large Cap 1000 Stock Screener (19.3%)

From January 2, 1999 to November 29, 2017, the Large Cap Stock Screener generated a total return of 2,797 percent, or a compound growth rate (CAGR) of 19.3 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 320 percent, or 6.3 percent compound.

This Week’s Best Investing Reads 10/19/2018

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

How the Many Sides to Every Story Shape our Reality (Farnam Street)

The Worst Kind of Bear Market (A Wealth of Common Sense)

Haste Makes Waste (Collaborative Fund)

These Are the Goods (The Irrelevant Investor)

The Laws of Medicine (Barel Karsan)

“There Ain’t Gonna Be No Core” (Jason Zweig)

Overfitting & Underfitting – Machine Learning in Equity Investing (Euclidean Technologies)

Did Uber Steal Google’s Intellectual Property? (The New Yorker)

Buyback Derangement Syndrome (Cliff Asness)

An update from the road (The Reformed Broker)

James Grant & Jason Zweig on WealthTrack (WealthTrack)

Dan Loeb – Watch four-minute critical video on Campbell Soup (CNBC)

The Allure of Private (The Bell Curve)

The Trouble With Using A One-Dimensional Investment Process (The Felder Report)

O’Shaughnessy Quarterly Investor Letter Q3 2018 (OSAM)

Investment value in an age of booms and busts: A reassessment (Edelweiss Journal)

Cheap Is Great, But Free Will Cost You (Bloomberg)

If You Can Keep Your Head When All About You Are Losing Theirs (Advisor Perspectives)

Sears Holdings Chapter 11 Filed Document (Dropbox)

Ray Dalio Spells Out America’s Worst Nightmare (Bloomberg)

Bezos Unbound: Exclusive Interview With The Amazon Founder On What He Plans To Conquer Next (Forbes)

What To Do When Stock Market Volatility Returns (Financial Samurai)

Blockchain Future; Create Your Own Case Studies (csinvesting)

Dodge & Cox Q318 Market Commentary (Dodge & Cox)

Won in Translation (Humble Dollar)

When Will Chasing The Hot Stock No Longer Work? (Macro Tourist)

Carl Icahn Interview (CNBC)

Vanguard Founder Jack Bogle’s Market Forecast (Morningstar)

Lessons from Annie Duke (Author of “Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts”)  (25iq)

What is Your Financial Tipping Point? (Of Dollars and Data)

Bill Nygren Discussing Netflix (YouTube)


This week’s best investing research reads:

How a Multi-factor Portfolio is Constructed Matters (Alpha Architect)

A Carry-Trend-Hedge Approach to Duration Timing (Flirting With Models)

U.S. Households Are Overly Invested In Equities (UPFINA)

Activist excess, incentives, and the undersupply of grievance (LT3000 Blog)

Part 1: Blowing up, The Minsky Moment, and A Turkey on Thanksgiving (Palisade Research)

Mr. Market’s Split Personality: Can Sector-Driven Factors Help? (CFA Institute)

Why decentralization could prove the most disruptive tech megatrend of the next decade (13D Research)


This week’s best investing podcasts:

Animal Spirits Episode 51: The Healthy Correction (Ben Carlson & Michael Batnick)

The Mental Habits of Effective Leaders (Shane Parrish)

TIP212: Billionaire Howard Marks and Credit Cycles (Stig Brodersen & Preston Pysh)

Bonus Episode: Wes Gray – Factor Investing is More Art, and Less Science (Meb Faber)

CoVenture Credit – Esoteric Credit with Ail Hamed, Brian Harwitt, and Marc Porzecanski (Patrick O’Shaughnessy)

Bruce Berkowitz: Top 10 Holdings, New Buys, Sold Out Positions

Johnny HopkinsBruce Berkowitz, Portfolio ManagementLeave a Comment

One of the best resources for investors are the publicly available 13F-HR documents that each fund is required to submit to the SEC. These documents allow investors to track their favorite superinvestors, their fund’s current holdings, plus their new buys and sold out positions. We spend a lot of time here at The Acquirer’s Multiple digging through these 13F-HR documents to find out which superinvestors hold positions in the stocks listed in our Stock Screeners.

As a new weekly feature, we’re now providing the top 10 holdings, new additions to the portfolio, and sold out positions from some of our favorite superinvestors based on their latest 13F-HR documents.

This week we’ll take a look at Bruce Berkowitz (6-30-2018):

The current market value of his portfolio is $744,207,000.

Top 10 Positions

Security Current
Shares
Current Value
($)
JOE / St. Joe Co. (THE) 27,444,119 492,622,000
VSTO / Vista Outdoor Inc. 5,055,300 78,307,000
T / AT & T, Inc. 1,227,300 39,409,000
VSTE / Vistra Energy Corp. 1,037,500 24,547,000
HRG / Harbinger Group Inc. 1,553,250 20,332,000
SPB / Spectrum Brands Holdings, Inc. 243,500 19,874,000
SHLD / Sears Holdings Corp. 14,061,957 17,296,000
C / Citigroup, Inc. 235,000 15,726,000
OAK / Oaktree Capital Group, LLC 181,000 7,358,000
CLPR / Clipper Realty Inc. 280,000 2,391,000

Top New Positions

Security Current
Shares
Current Value
($)
HRG / Harbinger Group Inc. 1,553,250 20,332,000
SPB / Spectrum Brands Holdings, Inc. 243,500 19,874,000
C / Citigroup, Inc. 235,000 15,726,000

Sold Out Positions

Security Previous
Shares
Previous Value
($)
SRG / Seritage Growth Properties 1,595,000 56,702,000
LUK / Leucadia National Corp. 66,000 1,500,000

 

Aswath Damodaran: Investors Have Three Choices When It Comes To Investing In Marijuana Businesses

Johnny HopkinsAswath DamodaranLeave a Comment

Aswath Damodaran has just released his latest video in which he discusses the businesses that are involved in the marijuana market and the three choices that investors have when assessing their investment choices in this space saying:

“If the marijuana market is likely to grow strongly, it should be a good market to operate a business in, right? Not all big businesses are profitable or value creating, since for a big business to be value creating, it has to come with competitive advantages or barriers to entry. If you are an investor in this space, you also have to start thinking about how companies will set themselves apart from each other, once the business matures. To see how companies in this business will evolve, it is important that you separate the recreational from the medical cannabis businesses, since each will face different challenges.”

Here is an excerpt from the video:

Investment considerations
So, should you invest in this business or stay away until it becomes more mature? While there is an argument for waiting, if you are risk averse, it will also mean that you will lose out on the biggest rewards. If you are exploring your options today, you have to start by assessing your investment choices and pick the one that you are most comfortable with.

The Investment Landscape

This is a young and evolving business, with the  Canadian legalization drawing more firms into the market. Not only are the companies on the list of public companies in the sector recent listings, but almost all of them have small revenues and big losses. While that, by itself, is likely to drive away old time value investors, it is worth noting that at a this early stage in the business life cycle, these losses are a feature, not a bug. Looking at just the top 10 companies, in terms of market cap, on the cannabis business, here is what I see:

Largest Publicly Traded Cannabis Companies- October 2018

Note that the biggest company on the list is Tilray, a company that went publicly only a few months ago, with revenues that barely register ($28 million) and operating losses. Tilray made the news right after its IPO, with its stock price increasing ten-fold in the weeks after, before losing almost half of its value in the weeks after. Canopy Growth, the largest and most established company on this list, has the highest revenues at $68 million. More generally, Canadian companies dominate the list and all of them trade at astronomical multiples of book value.

As new companies flock into the market, the list of publicly traded companies is only going to get longer, and at least for the foreseeable future, most of them will continue to lose money. Adding to the chaos, existing companies that have logical reasons to enter this business (tobacco & alcohol in the recreational and pharmaceuticals in the medical) but have held back will enter, as the stigma of being in the business fades, and with it, the federal handicaps imposed for being in the business. Put simply, this business, like many other young and potentially big markets, seems to be in the throes of what I called the big market delusion in a post that I had about online advertising companies a few years ago.

Trading and Investing

Like all young businesses, this segment is currently dominated by trading and pricing, not investing and valuation. Put differently, companies are being priced based upon the size of the potential market and incremental information. Put simply, small and seemingly insignificant news stories will cause big swings in stock prices. Thus, there is no fundamental rationale you can give for why Tilray’s stock has behaved the way it has since it’s IPO. It is driven by mood and momentum. If you are a good trader, this is a great time to play the game, since you can use your skills at detecting momentum shifts to make money as the stock goes up and again as it goes down. Since I am a terrible trader, I will leave it up to you to decide whether you want to play the game.

If you are an investor, you want to invest on the expectation that there is more value in these companies than you are paying up front, for your equity stake. As I see it, here are your choices:

  1. The Concentrated Pick: Pick a stock or two that you believe is most suited to succeed in the  business, as it matures. Thus, if you believe that the business is going to get commoditized and that the winner will be the one with the lowest costs, you should target a company like Canopy Growth, a company that seems to be pushing towards making itself the low-cost leader in the growth end of the business. If, in contrast, you believe that this is a business where branding and marketing will set you apart, you should focus on a company that is building itself up through marketing and celebrity endorsements. To succeed at this strategy, you have to be right on both your macro assessment and your company pick, but if you are, this approach has the potential to have the biggest payoff.
  2. Spread your bets: If your views about how the business will evolve are diffuse, but you do believe that there will be strong overall revenue growth and ultimate profitability, you can buy a portfolio of marijuana stocks. In fact, there is an ETF (MJ) composed primarily of cannabis-related stocks, with a modest expense ratio; its ten biggest holdings are all marijuana stocks, comprising 62% of the portfolio. The upside is that you just have to be right, on average, for this strategy to pay off, but the downside is that these companies are all richly priced, given the overall optimism about the market today. You also have to worry that the ultimate winner may not be on the list of stocks that are listed today, but a new entrant who has not shown up yet. If you are willing to wait for a correction, and there will be one, you may be able to get into the ETF at a much more reasonable price.
  3. The Indirect Play: Watch for established players to also jump in, with tobacco and alcohol stocks entering the recreational weed business, and pharmaceutical companies the medical weed business. You may get a better payoff investing in these established companies, many of which are priced for low growth and declining margins. One example is Scott’s Miracle-Gro, for instance, which has a growing weed subsidiary called Hawthorne Gardening. Another is GW Pharmaceuticals that has cannabis-based drugs in production for epilepsy and MS.

It may be indication of my age, but I really don’t have a strong enough handle on this market and what makes it tick to make an early bet on competitive advantages. So, I will pass on picking the one or two winners in the market. Given how euphoric investors have been since the legalization of weed in Canada in pushing up cannabis stock prices, I think this is the wrong time to buy the ETF, especially since sector is going to draw in new players.  That leaves me with the third and final choice, which is to invest in a company that is not viewed as being in the business but has a significant stake in it nevertheless. At current stock prices, neither Scott Miracle-Gro nor GW Pharmaceuticals looks like a good bet (I valued Scott Miracle-Gro at about $55, below its current stock price of $70.), but I think that my choices will get richer in the years to come.  I can wait, and while I do, I think I will take another walk on the boardwalk!

You can watch the full video here:

(Source: YouTube)

You can read the original article here – Aswath Damodaran, High and higher: The Money in Marijuana!

Warren Buffett Predicted The Fall Of Eddie Lampert And Sears Over 10 Years Ago

Johnny HopkinsEddie Lampert, Warren BuffettLeave a Comment

Here’s an article at Yahoo Finance discussing the bankruptcy of Sears and the prediction by Warren Buffett 10 years ago regarding the fall of Eddie Lampert and Sears.

Here’s an excerpt from that article:

The end for Eddie Lampert, the hedge fund manager in charge of Sears Holding Group, appears near. And Warren Buffett’s decade-old prediction is finally coming true.

Sears filed for Chapter 11 bankruptcy on Monday and announced the closing of 142 more stores, and Lampert also agreed to step down as CEO of the company. The announcement appears to be the final straw in a long decline for the once iconic retailer.

The fall from grace of both Lampert, once considered the “next Warren Buffett,” and Sears was laid out by the Berkshire Hathaway CEO 13 years ago.

In an interview between Buffett and a group of University of Kansas students that has been circulating since 2005, Buffett was asked about Lampert and his attempt to turn around Sears. In his reply, the famed investor laid out the road map for the retailer’s continued decline.

“Eddie is a very smart guy, but putting Kmart and Sears together is a tough hand,” Buffett told the Kansas crowd. “Turning around a retailer that has been slipping for a long time would be very difficult. Can you think of an example of a retailer that was successfully turned around?”

Buffett also compared it to his experience investing in retail in the 1970s. For him, the constantly changing winds of consumer preferences make it impossible for retailers to catch up to more forward-thinking stores after falling behind. From Buffett:

“Retailing is like shooting at a moving target. In the past, people didn’t like to go excessive distances from the streetcars to buy things. People would flock to those retailers that were nearby. In 1966 we bought the Hochschild Kohn department store in Baltimore. We learned quickly that it wasn’t going to be a winner, long term, in a very short period of time. We had an antiquated distribution system. We did everything else right. We put in escalators. We gave people more credit. We had a great guy running it, and we still couldn’t win. So we sold it around 1970. That store isn’t there anymore. It isn’t good enough that there were smart people running it.”

Buffett said other competitors such as Costco and Walmart could provide better deals while operating on smaller margins, making it hard for Sears and Kmart to compete.

“Costco is working on a 10, 11% gross margin that is better than the Walmarts and Sam’s,” Buffett said.

“In comparison, department stores have 35% gross margins. It’s tough to compete against the best deal for customers. Department stores will keep their old customers that have a habit of shopping there, but they won’t pick up new ones.”

This is what has happened. The focus on downsizing their store footprint and becoming resource light under Lampert didn’t translate into sustainable sales or profits. Instead, the stores hemorrhaged customers and other retail competitors have lapped both Sears and Kmart.

“How many retailers have really sunk, and then come back?” Buffett said. “Not many. I can’t think of any.”

He’s not called the “Oracle of Omaha” for nothing.

You can read the original article here – Warren Buffett predicted the fall of Eddie Lampert and Sears over 10 years ago.

Jonathon Tepper: Buffett Is The Antithesis Of Capitalism

Johnny HopkinsJonathon TepperLeave a Comment

We’ve just been reading the introduction and first chapter of Jonathon Tepper’s new book – The Myth of Capitalism: Monopolies and the Death of Competition, which are free online. The book tells the story of how America has gone from an open, competitive marketplace to an economy where a few very powerful companies dominate key industries that affect our daily lives.

Here are some excerpts from the book:

Warren Buffet is an icon for Americans and capitalists everywhere. For decades, his annual letters have taught and educated Americans about the virtues of investing. In many ways, Buffet has become the embodiment of American capitalism. He’s called the annual meetings of his investment firm Berkshire Hathaway a “Celebration of Capitalism” and has referred to his home town of Omaha as the “cradle of capitalism.” Yet Buffett is the antithesis of capitalism.

He has become a folk hero because of his simplicity. Even as he became America’s second wealthiest man, he has lived in the same home and avoided a lavish lifestyle. He makes billions not because of dirty greed but because he loves working. Books about him, such as Tap Dancing To Work, capture his jaunty ebullience.

As a person he is remarkably consistent. His daily eating includes chocolate chip ice cream at breakfast, five Coca-Colas throughout the day, and lots of potato chips. His investing is as consistent as his eating. For decades, he has recommended buying businesses with strong “moats” and little competition.

The results have shown how right he is. Warren Buffet gained control of Berkshire for around $32 per share when it was a fading textile company, and turned it into a conglomerate that owns businesses with little competition. The stock is now worth about $300,000 per share, making the entire company worth more than $495 billion.

For decades, Americans have learned from Buffet that competition is bad and to avoid companies that require any investment or capital expenditures. American managers have absorbed his principles. Buffett loves monopolies and hates competition. Buffett has said at his investment meetings that, “The nature of capitalism is that if you’ve got a good business, someone is always wanting to take it away from you and improve on It.” And in his annual reports. he has approvingly quoted Peter Lynch, “Competition may prove hazardous to human wealth.” And how true that is.

What is good for the monopolist is not good for capitalism. Buffett and his business partner Charlie Munger always tried to buy companies that have monopoly-like status. Once, when asked at an annual meeting what his ideal business was, he argued it was one that had “High pricing power, a monopoly.” The message is clear: if you’re investing in a business with competition, you’re doing it wrong.

***

If Warren Buffett is the embodiment of American capitalism, then billionaire Peter Thiel is Silicon Valley’s Godfather. They could not be more different. Where Buffett is folksy and simple, Thiel is distant and philosophical. Buffett quotes the actress Mae West, while Thiel quotes French intellectuals like Jean-Jacques Servan-Schreiber. Buffett is a dyed-in-the-wool Democrat, and Thiel is a libertarian who has procured a New Zealand passport so he can flee when the peasants with pitchforks come for Silicon Valley monopolies.

Buffett and Thiel have nothing in common, but they can both agree on one thing: competition is for losers.

Thiel founded PayPal and has funded a legendary roster of businesses like Linkedln and Facebook, which now has a monopoly on the key social networks and has a duopoly with Google on online advertising. He dislikes competition and redefines capitalism by turning it on its head, “Americans mythologize competition and credit it with saving us from socialist bread lines. Actually, capitalism and competition are opposites.” In Thiel’s view without fat profits, you can’t fund innovation and improve.

Thiel supported the Trump campaign, presumably because if you’re running a monopoly it is good to know your potential regulator. He wrote an entire book, titled Zero to One, praising creating businesses that are monopolies and defiantly declared that competition “is a relic of history.”

Competition is a dirty word, whether you’re in Omaha or Silicon Valley.

You can read the entire introduction here:

You can read the entire first chapter here:

Mohnish Pabrai: The Ten Commandments of Investment Management

Johnny HopkinsInvesting Strategy, Mohnish PabraiLeave a Comment

We’ve just been watching a recent presentation with Mohnish Pabrai at the Carroll School of Management – Boston College. Pabrai is discussing his ten commandments of investment management as follows:

1. Thou shall not skim off the top [fees]

2. Thou shalt not have an investment team

3. Thou shalt accept that thou shalt be wrong at least one-third of the time

4. Thou shalt look for hidden PE of 1 stocks

5. Thou shalt never use Excel

6. Thou shalt always have a rope to climb out of the deepest well

7. Thou shalt be singularly focused

8. Thou shalt never short a stock

9. Thou shalt not introduce leverage

10. Thou shalt be a shameless cloner

You can watch the entire presentation here:

Nassim Taleb: 17 Books That Every Investor Should Read

Johnny HopkinsInvesting Books, Nassim TalebLeave a Comment

We recently started a series called – Superinvestors: Books That Every Investor Should Read. So far we’ve provided the book recommendations from:

Together with our own recommended reading list of:

This week we’re going to take a look at recommended books from Nassim Taleb. Taken from his writings, interviews, lectures, and amazon reviews over the years. Here’s his list:

1. Seeking Wisdom: From Darwin to Munger (Peter Bevelin)

2. The Opposing Shore (Julien Gracq)

3. The Tartar Steppe (Dino Buzzati)

4. Why Stock Markets Crash: Critical Events in Complex Financial Systems (Didier Sornette)

5. A Guide to Econometrics (Peter Kennedy)

6. The (Mis)behavior of Markets (Benoit B. Mandelbrot) (Richard L. Hudson)

7. Statistical Models: Theory and Practice (David A. Freedman)

8. Information: The New Language of Science (Hans Christian von Baeyer)

9. The Hour Between Dog and Wolf: Risk-taking, Gut Feelings and the Biology of Boom and Bust (John Coates)

10. Mathematics: Its Content, Methods and Meaning (A. D. Aleksandrov) (A. N. Kolmogorov) (M. A. Lavrent’ev)

11. Probability, Random Variables and Stochastic Processes (Athanasios Papoulis) (S. Unnikrishna Pillai)

12. The Science of Conjecture: Evidence and Probability before Pascal (James Franklin)

13. The Kelly Capital Growth Investment Criterion: Theory and Practice (Leonard C. MacLean) (Edward O. Thorp)

14. Modelling Extremal Events: For Insurance and Finance (Paul Embrechts) (Claudia Kluppelberg)

15. The Tyranny of Experts: Economists, Dictators, and the Forgotten Rights of the Poor (William Easterly)

16. Birth of a Theorem: A Mathematical Adventure (Cédric Villani)

17. The Paradox of Choice (Barry Schwartz)

James Montier – The World’s Dumbest Idea – Shareholder Value Maximization

Johnny HopkinsJames MontierLeave a Comment

Some years ago, James Montier wrote a great paper called – The World’s Dumbest Idea, that explored the problems surrounding the concept of shareholder value and its maximization saying:

“Before you dismiss me as a raving “red under the bed,” you might be surprised to know that I am not alone in questioning the mantra of shareholder value maximization. Indeed the title of this essay is taken from a direct quotation from none other than that stalwart of the capitalist system, Jack Welch. In an interview in the Financial Times from March 2009, Welch said “Shareholder value is the dumbest idea in the world.”

Here’s an excerpt from that paper:

The World’s Dumbest Idea

When it comes to bad ideas, finance certainly offers up an embarrassment of riches – CAPM, Efficient Market Hypothesis, Beta, VaR, portfolio insurance, tail risk hedging, smart beta, leverage, structured finance products, benchmarks, hedge funds, risk premia, and risk parity to name but a few. Whilst I have expressed my ire at these concepts and poured scorn upon many of these ideas over the years, they aren’t the topic of this paper.

Rather in this essay I want to explore the problems that surround the concept of shareholder value and its maximization. I’m aware that expressing skepticism over this topic is a little like criticizing motherhood and apple pie. I grew up in the U.K. watching a wonderful comedian named Kenny Everett. Amongst his many comic creations was a U.S. Army general whose solution to those who “didn’t like Apple Pie on Sundays, and didn’t love their mothers” was “to round them up, put them in a field, and bomb the bastards,” so it is with no small amount of trepidation that I embark on this critique.

Before you dismiss me as a raving “red under the bed,” you might be surprised to know that I am not alone in questioning the mantra of shareholder value maximization. Indeed the title of this essay is taken from a direct quotation from none other than that stalwart of the capitalist system, Jack Welch. In an interview in the Financial Times from March 2009, Welch said “Shareholder value is the dumbest idea in the world.”

A Brief History of a Bad Idea

Before we turn to exploring the evidence that shareholder value maximization (SVM) has been an unmitigated failure and contributed to some very undesirable economic outcomes, let’s spend a few minutes tracing the intellectual heritage of this bad idea.

From a theoretical perspective, SVM may well have its roots in the work of Arrow-Debreu (in the late 1950s/early 1960s). These authors demonstrated that in the presence of ubiquitous perfect competition and fully complete markets (neither of which assumption bears any resemblance to the real world, of course) a Pareto optimal outcome will result from situations where producers and all other economic actors pursue their own interests. Adam Smith’s invisible hand in mathematically obtuse fashion.

However, more often the SVM movement is traced to an editorial by Milton Friedman in 1970. Given Friedman’s loathing of all things Keynesian, there is a certain delicious irony that the corporate world is so perfectly illustrating Keynes’ warning of being a slave of a defunct economist! In the article Friedman argues that “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits…”

Friedman argues that corporates are not “persons,” but the law would disagree: firms may not be people but they are “persons” in as much as they have a separate legal status (a point made forcefully by Lynn Stout in her book, The Shareholder Value Myth). He also assumes that shareholders want to maximize profits, and considers any act of corporate social responsibility an act of taxation without representation – these assumptions may or may not be true, but Friedman simply asserts them, and comes dangerously close to making his argument tautological.

Following on from Friedman’s efforts, along came Jensen and Meckling in 1976. They argued that the key challenge when it came to corporate governance was one of agency theory – effectively how to get executives (agents) to focus on maximizing the wealth of the shareholders (principals). This idea can be traced all the way back to Adam Smith in The Wealth of Nations (1776) where he wrote:

The directors of such [joint stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to  consider attention to small matters as not for their master’s honour, and very easily give them a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Under an “efficient” market, the current share price is the best estimate of the expected future cash flows (intrinsic worth) of a company, so combining EMH with Jensen and Meckling led to the idea that agents could be considered to be maximizing the principals’ wealth if they maximized the stock price.

This eventually led to the idea that in order to align managers with shareholders they need to be paid in a similar fashion. As Jensen and Murphy (1990) wrote, “On average, corporate America pays its most important leaders like bureaucrats.” They argued that “Monetary compensation and stock ownership remain the most effective tools for aligning executive and shareholder interests. Until directors recognize the importance of incentives and adopt compensation systems that truly link pay and performance, large companies and their shareholders will continue to suffer from poor performance.”

***

Conclusions

So what is one to conclude from this tirade? Three things stand out to me, each addressing a different constituency:

Shareholder’s Lesson

Firstly, SVM has failed its namesakes: it has not delivered increased returns to shareholders in any meaningful way, and may actually have led to poorer corporate performance!

Corporate’s Lesson

Secondly, it suggests that management guru Peter Drucker was right back in 1973 when he suggested “The only valid purpose of a firm is to create a customer.” Only by focusing on being a good business are you likely to end up delivering decent returns to shareholders. Focusing on the latter as an objective can easily undermine the former. Concentrate on the former, and the latter will take care of itself. As Keynes once put it, “Achieve immortality by accident, if at all.”

Everyone’s Lesson

Thirdly, we need to think about the broader impact of policies like SVM on the economy overall. Shareholders are but one very narrow group of our broader economic landscape. Yet by allowing companies to focus on them alone, we have potentially unleashed a number of ills upon ourselves. A broader perspective is called for. Customers, employees, and taxpayers should all be considered. Raising any one group to the exclusion of others is likely a path to disaster. Anyone for stakeholder capitalism?

You can read the original paper here – James Montier – The World’s Dumbest Idea.

Seth Klarman’s Protege David Abrams: Top 10 Holdings, New Buys, Sold Out Positions

Johnny HopkinsDavid Abrams, Portfolio ManagementLeave a Comment

One of the best resources for investors are the publicly available 13F-HR documents that each fund is required to submit to the SEC. These documents allow investors to track their favorite superinvestors, their fund’s current holdings, plus their new buys and sold out positions. We spend a lot of time here at The Acquirer’s Multiple digging through these 13F-HR documents to find out which superinvestors hold positions in the stocks listed in our Stock Screeners.

As a new weekly feature, we’re now providing the top 10 holdings, new additions to the portfolio, and sold out positions from some of our favorite superinvestors based on their latest 13F-HR documents.

This week we’ll take a look at David Abrams (6-30-2018):

The current market value of his portfolio is $3,594,895,000.

Top 10 Positions

Security Current
Shares
Current Value
($)
TEVA / Teva Pharmaceutical Industries Ltd. 19,743,123 480,153,000
WU / Western Union Co. (The) 21,351,798 434,082,000
AET / Aetna, Inc. 1,575,000 289,013,000
YHOO / Yahoo! Inc. 3,822,305 279,831,000
BEN / Franklin Resources, Inc. 7,945,023 254,638,000
ORLY / O’Reilly Automotive, Inc. 883,194 241,615,000
UHAL / AMERCO 576,045 205,158,000
ESRX / Express Scripts Holding Co. 2,653,101 204,846,000
WLTW / Willis Towers Watson Public Limited Company 1,183,287 179,386,000
PCG / PG&E Corp. 3,911,357 166,467,000

Top New Positions

Security Current
Shares
Current Value
($)
ESRX / Express Scripts Holding Co. 2,653,101 204,846,000
GOOGL / Alphabet Inc. 124,117 140,152,000

Sold Out Positions

Security Current
Shares
Current Value
($)
TWX / Time Warner, Inc. 3,346,103 316,474,000

This Week’s Best Investing Reads 10/12/2018

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

You Never Know (A Wealth of Common Sense)

Time Horizon vs Endurance (Collaborative Fund)

U-G-L-Y (The Irrelevant Investor)

And then they came for the tech stocks… (The Reformed Broker)

Lessons from Howard Marks’ New Book: “Mastering the Market Cycle – Getting the Odds on Your Side” (25iq)

Delivering Happiness (Barel Karsan)

Economic Bears Throw In The Towel (The Macro Tourist)

Hedge Fund Test: Are YOU Smarter than a Chimp? (csinvesting)

Why The Best Predictor of Future Stock Market Returns is Useless (Of Dollars and Data)

Valuation: How to Value Financial Services Companies (Rob Abbott)

A Bad Day in the Market: Is It a False Alarm? (Advisor Perspectives)

How Much is Too Much to Pay for a Great Business? (Focused Compounding)

Saving Your Retirement from a Stock Market Crash (Safal Niveshak)

BANG: The Ultimate Anti-Passive Investment (The Felder Report)

Why Warren Buffett still wins if Sears goes bankrupt (Yahoo Finance)

Activism Insight: An Interview With Bruce Goldfarb, CEO of Okapi Partners (ValueWalk)

Jack Bogle’s Bogleheads Keep Investing Simple. You Should Too. (Jason Zweig)

Third Point’s Loeb says Campbell Soup’s existing board should not choose next CEO (CNBC)

Jack of Hearts (Humble Dollar)

Wedding Spending Rules To Follow If You Don’t Want To End Up Broke And Alone (Financial Samurai)

What’s Wrong, Warren? (Brian Langis)

The Cost of Having a Taper Tantrum (Pragmatic Capitalism)

Richard Bernstein – What’s the Biggest Risk in the Markets Today? (WealthTrack)

Weitz Investment Management Q318 Market Commentary (Weitz)

When Better Profit Margins Aren’t Better (Validea)

Bill Ackman reveals $900 million bet on Starbucks, sees shares doubling in three years (CNBC)

Bill Nygren Q318 Market Commentary (Oakmark)

My Self-Improvement Journey (Vitaliy Katsenelson)

The last day of the quarter (Tesla edition) (Bronte Capital)


This week’s best investing research reads:

Investment Factor Timing: Challenging, but Not Impossible (Alpha Architect)

New Research Paper – Insider sales are positively associated with future crash risk (efmaefm.org)

Factor Investing in Micro and Small Caps (CFA Institute)

The Reason Behind Rising Yields (UPFINA)

As Stocks and Bonds Crash (A Rare Event) – Gold Surprised With A Rally (Palisade Research)

The Post Financial Crisis Decade: Unusually low factor returns and an investment drag (mrzepczynski)

Is the green rush fool’s gold or will marijuana prove one of this decade’s great investment opportunities? (13D Research)


This week’s best investing podcasts:

Animal Spirits Episode 50: A Committee of Geniuses (Ben Carlson & Michael Batnick)

Saifedean Ammous – The Bitcoin Standard (Patrick O’Shaughnessy)

Daniel Gross: Dreams and Determination (David Perell)

TIP211: Artificial Intelligence and Finance w/ Dr. Wes Gray (Stig Brodersen & Preston Pysh)

Episode #125: Tom Barton, “The Biggest Problem Investors Have is Things Change…and They Don’t Change”(Meb Faber)

TAM Stock Screener – Stocks Appearing in Munger, Watsa, Chou Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks.

The top investor data is provided from their latest 13F’s (dated 2018-6-30). This week we’ll take a look at:

POSCO (NYSE: PKX)

Posco is the largest steel producer in South Korea and one of the top steel producers globally. It mainly produces flat steel and stainless steel from its two integrated steel facilities. It is exposed to the auto, shipbuilding, home appliance, engineering, and machinery industries. Posco controls around 40% of South Korean domestic market share and exports around 45%-50% of its steel products overseas, mainly to Asian countries. Through diversification, around 15%-20% of its revenue comes from nonsteel and trading-related businesses.

A quick look at the price chart below for Posco shows us that the stock is down 14% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 7.54 which means that it remains undervalued.

(SOURCE: GOOGLE FINANCE)

Superinvestors who currently hold positions in Posco include:

Sarah Ketterer – 387,351 total shares

Charles Brandes – 274,091 total shares

Prem Watsa – 189,000 total shares

Richard Pzena – 106,653 total shares

Jim Simons – 98,200 total shares

James O’Shaughnessy – 46,830 total shares

Francis Chou – 21,000 total shares

Cliff Asness – 14,652 total shares

Charlie Munger – 9,745 total shares

The Large Cap 1000 Stock Screener (19.3%)

From January 2, 1999 to November 29, 2017, the Large Cap Stock Screener generated a total return of 2,797 percent, or a compound growth rate (CAGR) of 19.3 percent per year. This compared favorably with the Russell 1000 Total Return, which returned a cumulative total of 320 percent, or 6.3 percent compound.

Howard Marks: The Pendulum of Investor Psychology

Johnny HopkinsHoward Marks, Investing PsychologyLeave a Comment

We’ve just been reading Howard Marks’ new book – Mastering The Market Cycle. In it there’s a great chapter titled – The Pendulum of Investor Psychology which discusses the impact of investor psychology on markets. Marks writes:

One of the most time-honored market adages says that “markets fluctuate between greed and fear.” There’s a fundamental reason for this: it’s because people fluctuate between greed and fear. In other words, sometimes people feel positive and expect good things, and when that’s the case, they turn greedy and fixate on making money. Their greed causes them to compete to make investments, and their bidding causes markets to rise and assets to appreciate.

But at other times, they feel less good and their expectations turn negative. In that case, fear takes over. Rather than enthuse about making money, they worry about losing it. This causes them to shrink from buying — eliminating the upward impetus beneath asset prices — and perhaps to sell, pushing prices down. When they’re in “fear mode,” people’s emotions bring negative forces to bear on the markets.

Here’s part of the discussion of the swing between greed and fear, from “The Happy Medium” (July 2004):

When I was a rookie analyst, we heard all the time that “the stock market is driven by greed and fear.” When the market environment is in healthy balance, a tug-of-war takes place between optimists intent on making money and pessimists seeking to avoid losses. The former want to buy stocks, even if they have to pay a price a bit above yesterday’s close, and the latter want to sell them, even if it’s on a downtick.

When the market doesn’t go anyplace, it’s because the sentiment behind this tug-of-war is evenly divided, and the people – or feelings – on the two ends of the rope carry roughly equal weight. The optimists may prevail for a while, but as securities are bid up they become more highly priced, and then the pessimists gain sway and sell them down. The result is a market that rises or falls moderately if at all – not unlike the experience so far this year. For example, as The Wall Street Journal wrote on May 17,

The Dow Jones Industrial Average has been down for three weeks in a row, . . .
Still, a determined group of optimists has refused to throw in the towel, stepping in to buy what they view as cheap stocks whenever prices began to plummet. On Wednesday, when the Dow Industrials fell as low as 9852.19 during the day, these people began to buy, pushing the blue-chip average back above 10000.

Two forces continue to compete in the market: those who believe that the current skittishness will end once investors get used to the idea of rising interest rates, and those who think further stock declines are inevitable.

It didn’t take long in my early days, however, for me to realize that often the market is driven by greed or fear. At the times that really count, large numbers of people leave one end of the rope for the other. Either the greedy or the fearful predominate, and they move the market dramatically. When there’s only greed and no fear, for example, everyone wants to buy, no one wants to sell, and few people can think of reasons why prices shouldn’t rise. And so they do – often in leaps and bounds and with no apparent governor.

Clearly that’s what happened to tech stocks in 1999. Greed was the dominant characteristic of that market. Those who weren’t participating were forced to watch everyone else get rich. “Prudent investors” were rewarded with a feeling of stupidity. The buyers moving that market felt no fear. “There’s a new paradigm,” was the battle cry, “get on board before you miss the boat. And by the way, the price I’m buying at can’t be excessive, because the market’s always efficient.” Everyone perceived a virtuous cycle in favor of tech stocks to which there could be no end.

But eventually, something changes. Either a stumbling block materializes, or a prominent company reports a problem, or an exogenous factor intrudes. Prices can even fall under their own weight or based on a downturn in psychology with no obvious cause. Certainly no one I know can say exactly what it was that burst the tech stock bubble in 2000. But somehow the greed evaporated and fear took over. “Buy before you miss out” was replaced by “Sell before it goes to zero.”

And thus fear comes into the ascendancy. People don’t worry about missing opportunities; they worry about losing money . Irrational exuberance is replaced by excessive caution. Whereas in 1999 pie-in-the-sky forecasts for a decade out were embraced warmly, in 2002 investors chastened by the corporate scandals said, “I’ll never trust management again” and “How can I be sure any financial statements are accurate?” Thus almost no one wanted to buy the bonds of the scandal-plagued companies, for example, and they sunk to giveaway prices. It’s from the extremes of the cycle of fear and greed that arise the greatest investment profits, as distressed debt demonstrated last year.

You can get Howard Marks’ latest book here – Mastering The Market Cycle.

You can read the entire 2004 memo here – Howard Marks Memo – The Happy Medium 2004.

John Hussman: Fish Don’t Know They’re In Water (Investors In A Market Bubble)

Johnny HopkinsJohn HussmanLeave a Comment

We’ve just finished reading a great article by John Hussman at Hussman Funds called The Music Fades Out in which Hussman discusses current market conditions and provides a great illustration of the changes in investor psychology during market bubbles.

Here’s an excerpt from that article:

Fish don’t know they’re in water

A fish swims up to another fish and asks “How’s the water?” The other fish replies, “What the heck is water?”

The problem with financial bubbles is not that they are objectively difficult to recognize, but that they can only emerge if the majority of market participants become so immersed in them that they are willing to excuse or dismiss the extremes.

Intuitively, if overvaluation alone was always immediately followed by market losses, it would be impossible for the market to reach valuation extremes like 1929, 2000 and today, because the market advance would have been halted by much lesser overvaluation. Instead, periods of speculation can persist for some time, despite extraordinary valuations.

By the peak of every market bubble, investors come to imagine that historically reliable valuation measures are useless and no longer “work,” because they don’t understand how valuations work in the first place. As a consequence, they are repeatedly brutalized by the market collapses that follow.

At market extremes, investors become so impressed by the recent and glorious outcomes of their own speculation that they don’t even recognize the bubble surrounding them. After the bubble collapses, it becomes easier for investors to step back objectively, allowing them to conclude that the bubble was “obvious” in hindsight.

One of the best examples of this was July 2000, when the Wall Street Journal ran an article titled (in the print version) “What were we THINKING?” The article reflected on the “arrogance, greed, and optimism” that had already been followed by the collapse of dot-com stocks. My favorite line: “Now we know better. Why didn’t they see it coming?” Unfortunately, that article was published at a point where the Nasdaq still had an 80% loss (not a typo) ahead of it.

Again, the only way to produce bubbles like 1929, 2000 and today is for speculation to continue despite lesser extremes. That doesn’t mean that valuations have failed. It means that speculation has persisted for longer than usual, and that the devastating consequences of hypervaluation are still ahead. Someone has to remain willing to say that out loud. The financial markets are in a bubble. It will end badly.

Given current valuations, even a return to average run-of-the-mill historical norms would result in a loss of about two-thirds of U.S. stock market capitalization. Meanwhile, any significant recession will likely be accompanied by a wave of corporate bankruptcies in a system where corporate debt is easily at the highest percentage of corporate gross value-added in history, and the median corporate credit rating is already just one notch above junk.

The likelihood of collapse will be smaller in periods when market internals are uniformly favorable across a very wide range of securities, because indiscriminate behavior is a hallmark of speculation. The likelihood of a collapse will increase dramatically in periods when market internals are weak or divergent, as they are now, because selectivity is a hallmark of growing risk-aversion.

The chart below shows our margin-adjusted CAPE, which now stands beyond even the 1929 and 2000 market peaks.

You can read the original article here – John Hussman – The Music Fades Out

Robert Vinall: RV Capital 10 Year Anniversary Letter

Johnny HopkinsRV CapitalLeave a Comment

We’ve just finished reading RV Capital’s 10 Year Anniversary Letter. In it Robert Vinall discusses his ‘aha’ moment as it relates to value investing, and the key determinant of an investment outcome, which he discovered while analyzing his previous investments.

Here are some excerpts from that letter:

The Aha Moment

Recently, I was asked by a fellow value investor when I had my “Aha Moment”. I thought it was a great question and a good place to start a memo at the 10th anniversary of the Business Owner Fund.

In my case, the logic of value investing – a share is a part ownership in a business, the metaphor of Mr. Market, and the concept of Margin of Safety – hit me like a bolt of lightning as opposed to slowly dawning on me. The question implies it is the same for all value investors. I suspect that is true.

Lightning struck in my case one morning in the early 2000s in a nondescript office in one of the skyscraper’s punctuating Frankfurt’s skyline. At the time, I was a telecom’s analyst at DZ Bank. In the debris of the Dot Com crash, I had started tentatively investing in companies listed on the Neuer Markt (Germany’s now-defunct Nasdaq clone) in collaboration with my two roommates, Vidar Kalvoy and Wolfgang Specht. The former Neuer Markt darlings had fallen so much in value that many were trading at discounts to the net cash they carried on their balance sheets.

On this morning, Vidar came bouncing into our office excitedly carrying Benjamin Graham’s “The Intelligent Investor”. He opened the book at Chapter 5 of the first (and best) edition, in which Graham describes the speculative boom in new issues that preceded the Great Crash of 1929, then read out the following sentence:

“Some of these issues may prove excellent buys – a few years later, when nobody wants them and they can be had at a small fraction of their true worth.”

This sentence blew me away. I was amazed that a book written over 50 years earlier, prior even to the mass adoption of the telephone, could so precisely describe what I was seeing in the Internet economy of the new millennium. I was hooked on value investing and have been ever since. It is not an exaggeration to say this sentence changed my life.

The Key Determinant Of An Investment Outcome

After Business Owner started, I had a strong appreciation for the managers I invested in, but they were not central to my investment hypotheses. My goal was primarily to avoid the bad guys. Having satisfied myself this was the case, price and business quality drove the investment decision.

I only changed my mind on this several years later when I, again, noticed a funny thing when I looked back on past investments.

Fortunately, most of my investments had worked out reasonably well – by focusing on business quality I avoided the complete investment disasters that occasionally marred my earlier investing career – but a handful of my investments had worked out spectacularly well.

When I dived deeper into why, I saw that it was generally due to factors that I had not specifically forecast at the initiation of the investment, such as an opportunistic acquisition, a product launch, or a new market. It became clear to me that no matter how deeply I studied a company, ultimately, I only saw the tip of the iceberg. The prime determinant of an investment outcome was below the waterline, out of sight.

As someone who prided himself on being a thorough and diligent analyst, it was a painful and humbling realization that my company analyses may, in fact, not be all that good.

But it freed me to recognize a far more important truth: If the key determinant of an investment outcome is what I do not see, the most important thing is to invest in managers I trust.

I have found time and again that the surprises with managers I trust are generally positive, whereas those with managers I do not are nearly always negative.

Today, I only feel motivated to do the hard miles and build an understanding of an investment case if I get a visceral sense that the company’s manager is someone I could deeply admire. Invariably, this is someone for whom the company constitutes his or her life’s work or has the potential to be.

I described why I think people are the key factor in my 2015 letter and held a talk on the same topic at Bob Miles’ Value Investing Conference in Omaha in 2017.

You can read the entire letter here – RV Capital 10 Year Anniversary Letter.

David Einhorn: There Are Many Parallels Between Tesla And Lehman Brothers

Johnny HopkinsDavid EinhornLeave a Comment

In his latest shareholder letter, David Einhorn makes some very interesting comparisions between Telsa and the Lehman Brothers collapse saying:

“In thinking through TSLA more, it brings us back to Lehman, which went bankrupt 10 years ago. One of our key insights into Lehman was that the company had faced a credit crunch in 1998, bluffed its way through and got away with it. In fact, rather than facing regulatory, legal or even market consequences for failing to own up to reality in 1998, the company was rewarded when its business turned.”

“This emboldened management to be even more aggressive during the next credit crunch in 2007 and 2008. Lehman threatened short sellers, refused to raise capital (it even bought back stock), and management publicly suggested it would go private. Months later, shareholders, creditors, employees and the global economy paid a big price when management’s reckless behavior led to bankruptcy. The whole thing might have been avoided had the authorities cracked down on Lehman in 1998. There are many parallels to TSLA.”

Here is an excerpt from that letter:

While it hasn’t led to great returns so far, our opinion expressed in 2016 that General Motors (GM) will likely earn its market capitalization before Tesla (TSLA) makes its first annual profit seems well on its way to coming true.

Speaking of GM and TSLA, during the market discussion about whether TSLA should go private, Catherine Wood of ARK Investment Management, one of TSLA’s most vocal shareholders, explained why TSLA could be worth $4,000 a share or $900 billion and provided an analysis to back it up.

The interesting thing about the analysis is that 84% of the value came from the assumption that TSLA would be operating a platform of three million robo-taxis in 2023. As of today, TSLA hasn’t even announced a plan to enter the robo-taxi business, nor is it possible for the company to develop the manufacturing capability to make 3 million robo-taxis within five years. Setting that aside, GM Cruise has made significant progress towards developing robo-taxis and expects to launch commercial service in 2019. All of GM is worth $48 billion or about 6% of what ARK claims to be the value of TSLA’s robo-taxi opportunity.

Recently, Honda invested $750 million into GM Cruise at a headline valuation of $14.6 billion. However, when you peel back the deal, Honda plans to contribute an additional $2 billion over 12 years for non-exclusive technology rights – e.g. the right to be a customer. To the extent Honda’s support could be thought of as equity, Cruise’s implied valuation could reach up to $50 billion.

As a result, GM Cruise’s development is in the traditional sense: funding secured! In thinking through TSLA more, it brings us back to Lehman, which went bankrupt 10 years ago. One of our key insights into Lehman was that the company had faced a credit crunch in 1998, bluffed its way through and got away with it. In fact, rather than facing regulatory, legal or even market consequences for failing to own up to reality in 1998, the company was rewarded when its business turned.

This emboldened management to be even more aggressive during the next credit crunch in 2007 and 2008. Lehman threatened short sellers, refused to raise capital (it even bought back stock), and management publicly suggested it would go private. Months later, shareholders, creditors, employees and the global economy paid a big price when management’s reckless behavior led to bankruptcy. The whole thing might have been avoided had the authorities cracked down on Lehman in 1998.

There are many parallels to TSLA. In 2013, TSLA was on the brink of failure as customers who had paid deposits weren’t taking delivery of the Model S. TSLA’s cash reserves fell to a dangerously low level and CEO Elon Musk secretly and desperately tried to sell the company to Google. Rather than communicating the truth to shareholders, Mr. Musk bluffed his way through the crisis. There were no regulatory, legal or market consequences for failing to own up to reality. The business survived, and Mr. Musk was celebrated for his successful bluffing. In our opinion, this has emboldened the TSLA CEO to embark on ever more aggressive deceptions. In 2016, Mr. Musk bluffed his way through the TSLA bailout of SolarCity by demonstrating a very exciting but fake product called Solar Roof.

The company started taking $1,000 deposits in May 2017 and launched the product in August 2017, but as of May 31, 2018, reports indicate that only 12 Solar Roofs have been fully installed – 11 of which are owned by Tesla employees.

But, like Lehman, we think the deception is about to catch up to TSLA. Elon Musk’s erratic behavior suggests that he sees it the same way. In August he told the New York Times, “But from a personal pain standpoint, the worst is yet to come.”

Given that prediction, we can’t understand why anyone would want to own TSLA shares. It really doesn’t get much clearer than that. Here is our take on why we think Elon Musk is so despondent: In 2016, the Model S had already become an iconic car selling for about $80,000. However, the market for $80,000 cars is small. TSLA announced the Model 3, which looked to be a stripped down version of the Model S, starting at $35,000 before a $7,000 tax credit. If the Model 3 was even 80% as good as a Model S, this was an incredibly exciting offer. Hundreds of thousands of people sent in $1,000 as a refundable deposit to get a spot on line. At the same time, TSLA promised it could make a 25% margin at that price point.

Why did TSLA think it could make the car so cheaply? At the 2016 shareholder meeting Mr. Musk said, “We realized that the true problem, the true difficulty, and where the greatest potential is – is building the machine that makes the machine. In other words, it’s building the factory. I’m really thinking of the factory like a product.” He thought he could improve car manufacturing by an order of magnitude and claimed that manufacturing would be TSLA’s competitive advantage.

Fast forward one year, and Forbes wrote about Mr. Musk’s vision, “In fact, robots will move so quickly and so efficiently that humans won’t be safe on the factory floors. So, just a skeleton staff of engineers will be on hand – and they will merely monitor production.”

The faster speed would mean much more productivity and much lower manufacturing costs. In July 2017, TSLA turned on the machine that was to build the machine… and it didn’t work. Instead of producing TSLA’s forecast of 5,000 Model 3s a week in the month of December, TSLA produced only 2,425 for the entire quarter. Elon Musk realized that full automation is impractical. Humans replaced some robots. Adding humans into the production process means that TSLA can’t improve the factory speed to achieve its vision of improving manufacturing by an order of magnitude. As Musk said in 2016, “You really can’t have people in the production line itself, otherwise you’ll automatically drop to people speed.”

In 2016, TSLA thought its Fremont plant could make 5,000, 10,000 and 20,000 vehicles a week in late 2017, 2018 and 2020, respectively. This can’t happen at people speed. Consequently, the cost structure of the Model 3 is much higher than Elon Musk expected when he took deposits from hundreds of thousands of people for a $35,000 car.

It’s a promise he can’t keep. UBS did a teardown analysis and estimated that the cost to make a stripped down version of the Model 3 is $41,000. That’s a long way from $35,000, let alone $26,250 – the level needed for TSLA to make a 25% margin. In May, Elon Musk tweeted that the $35,000 version would be launched 3-6 months after the company achieved 5,000 cars a week. That milestone was hit with great fanfare in June. However, investor relations has leaked that the company now expects the $35,000 version in the second quarter of next year.

Tellingly, TSLA has stopped taking orders for the $35,000 version, as it may already know that it won’t be releasing a $35,000 version anytime soon or ever. The company has changed its policy on refunding deposits so that customers who are tired of hoping TSLA makes a car that doesn’t exist and want their money back have to wait 45 days. It reminds us of Jane and Michael Banks in Mary Poppins: https://www.youtube.com/watch?v=xE5klz0yUT0

We think this may explain Mr. Musk’s erratic behavior.

He can’t make the car without losing too much money and he can’t bring himself to cancel the program and refund everyone’s deposits. His conduct suggests that he is doing his best to be relieved of his position as CEO to avoid accountability. Quitting isn’t an option because it prevents Mr. Musk from claiming he could have fixed the problem had he stayed.

But, it’s a Mexican stand-off: the Board is too close to him to fire him and also doesn’t want to be blamed.

The same can be said for the SEC, which backed off on its threat to bar him as an officer. Thus far, TSLA has produced several more expensive variants of the Model 3 with an average price of about $60,000. The addressable market at that price point is no more than one third of the addressable market at $35,000.

A fraction of the customers who placed deposits for the Model 3 have been willing and able to buy one of the premium versions. To date, TSLA has made about 95,000 Model 3s, and given that some versions are now available for immediate sale to people who weren’t on the wait list and that TSLA is offering promotional discounts like free supercharging, it seems clear that the backlog for premium versions is nearly exhausted.

TSLA is expected to make and deliver more than 65,000 Model 3s in the December quarter. It might be able to make them, but without an order backlog there is very little chance that there is enough demand to sell them.

We expect a large revenue and earnings disappointment in Q4. The exposed demand shortfall should ruin a key pillar of the bull case. Next year, TSLA loses the government Zero Emission Vehicle subsidy, which will make it even harder to attract demand. The September results are likely to be as good as it gets for TSLA. Meanwhile, the brand is in trouble. The blocking and tackling of the Model 3 rollout is leaving customers unhappy. There have been lots of reports of delivery snafus and poor quality cars.

There are anecdotes about TSLA accepting full payment for cars and then not delivering them. There are many stories of cars (even Model S and Model X) in service shops for months for lack of spare parts. With so many new TSLA cars on the road, the problem is overwhelming TSLA’s limited service infrastructure. The Model 3 is the least reliable car on the market.

If you add in the pending disappointment of customers who paid deposits and may find themselves as involuntary unsecured creditors, TSLA appears on the verge of losing all but its most dedicated fans.

This section of the letter has run more than a bit long, which doesn’t leave space to address the infamous “funding secured” market manipulation tweet and a number of apparent accounting red flags at TSLA. But, we would be remiss to fail to note that in August TSLA hired a well-respected finance executive to be its new Chief Accounting Officer. He was to receive $10 million worth of stock over four years. Suffice it to say, that is not the going rate for accountants. He lasted a month and quit before ever being associated with a reported financial statement. TSLA may be in accounting hell.

Our TSLA short was our second biggest winner during the quarter. The biggest was Brighthouse Financial (BHF), which announced a satisfactory quarter, but more importantly announced a $200 million buyback, thereby commencing capital return a full 2 years sooner than projected at the spin-off road show.

You can read the entire shareholder letter here (H/T ZeroHedge):

Michael Burry: 6 Books That Every Investor Should Read

Johnny HopkinsInvesting Books, MIchael BurryLeave a Comment

We recently started a series called – Superinvestors: Books That Every Investor Should Read. So far we’ve provided the book recommendations from:

Together with our own recommended reading list of:

This week we’re going to take a look at recommended books from superinvestor Michael Burry. Taken from his writings, interviews, lectures, and shareholder letters/meetings over the years. Here’s his list:

1. The Intelligent Investor (Benjamin Graham)

2. Common Stocks and Uncommon Profits (Philip Fisher)

3. Why Stocks Go Up and Down (William H Pike)

4. Buffettology (Mary Buffett, David Clark)

5. Value Investing Made Easy (Janet Lowe)

6. Security Analysis – 1951 Edition (Benjamin Graham, David Dodd)