A few thoughts on a desultory Wednesday afternoon...
Cash, Called Strikes and Never Missing a Flight
I think there is a tension underlying the running of a portfolio.
On the one hand, I want to keep the bar high for new names. When I look at all the things I want in a business – insider ownership, a clean balance sheet, high returns on capital, reinvestment opportunities, good price, etc. – it is hard to clear all these bars. That’s good. I want a strong filter. Keeps the quality high and, I hope, lowers the risk of losing money.
All my current investments cleared these hurdles when I put them in the portfolio. (And they keep clearing it, though valuation changes). And I like to think that whatever I add has to be clearly better than what I already own, or I might as well just buy more of what I already own. (There are some self-imposed limits here to manage risk, so it’s not like I can pile into three names or something).
On the other hand, one can be too tight, as expressed by various old sayings and insights. “Don’t let the best be the enemy of the good.” Or “don’t let perfect be the enemy of the good.”
These ideas have their own Wiki page, where I find further witty formulations of the idea: Robert Watson-Watt’s "cult of the imperfect," which basically says take the third best option because the second best comes too late and the best never arrives.
Or, one of my favorites, George Stigler's: "If you never miss a plane, you're spending too much time at the airport."
And, lastly, from Donald Knuth: "Premature optimization is the root of all evil."
Yes, yes… But then there is Warren Buffett. Everyone must be familiar, by now, with his baseball analogy for investing. But it is worth repeating here:
“The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘swing, you bum!'”
“Ted Williams described in his book, The Science of Hitting, that the most important thing – for a hitter – is to wait for the right pitch. And that’s exactly the philosophy I have about investing – wait for the right pitch, and wait for the right deal. And it will come… It’s the key to investing.”
Concerns over (short-term) performance can make you feel impatient. You know cash can be a big drag on your returns if you keep too much for too long. And if you’re behind performance-wise, maybe the pressure to invest and "catch-up" is greater.
All of the above ties in, too, with how you think about cash in the first place. Does it burn a hole in your pocket? Or are you okay holding cash? It’s an important question to think about.
I always liked what Chuck Akre had to say about managing cash:
“We do not part with your cash in order to 'stay fully invested' or out of concern for 'tracking error.' We only part with cash when we have something specific we feel good about doing with it. This is one of the means by which we strive to manage your money as if it were our own.”
And:
“We appreciate that cash compounds at a negligible rate. But we also believe cash can be an accelerant of long-term returns when it is reserved for 'highest and best' opportunities rather than sprinkled pro-rata up and down the portfolio. In short, we do not look at cash to determine whether to buy stocks; we look at stocks to determine whether to deploy cash.”
For me, that’s how I think about it. I don’t want to invest just because I have the cash. I want the opportunity set to drive the decision. So, I’m keeping the bar high – erring on that side of things, rather than lowering the bar a bit to get the cash invested.
After all, I’m looking for businesses I can own for a decade and will deliver strong returns. I think it’s okay if it takes me a few months of sitting on cash to make that commitment.
As a practical matter, I don’t usually have significant levels of cash (say 10% or more) unless I sell something, which doesn’t happen too often (or shouldn’t). Also, it usually doesn’t take me long to find something. There are plenty of businesses I like, it’s often just a matter of price. If you’re patient, Mr. Market almost always gives you a good chance someday. The question is more: “Will you have the courage to take it when it comes?”
The Futility of Trying to Get the Big Picture Right
Another thought I’ve been kicking around: There are so many people trying to make the big macro calls. What’s fascinating is that even when they are right on the big call, the market may not reward them.
For example, if you thought at the start of 2022 that inflation was going to be a problem, well, you got that call right. What’s a common thing you might have done if you thought inflation was going to be a big problem? Buy gold is one. Maybe buy bitcoin, too? And yet, year-to-date, both assets are down.
Another example that hit me was in a tweet by Nassim Taleb on July 17:
Wow. So if you thought the war in Ukraine would drive wheat higher – which seems perfectly logical – you didn’t get paid for that insight.
A friend of mine shared part of a research piece that documented, in a similar way, the errant forecasts that seem endemic to the oil industry. One particularly memorable forecast was by a professor named James Hamilton, who is an econometrician and studies the oil markets. In 2014, he came out with a strongly reasoned paper which reached the conclusion that “hundred-dollar oil is here to stay.” Six months later, oil went from $105 to $46 and wouldn't reach $100 again until 2022.
I have more examples in my book How Do You Know? Drawing from work by Michael O’Higgins. Here is an excerpt:
Suppose that at the start of 1973 you knew that the earnings of the Dow Jones Industrial Average would rise 50% over the next two years. Seems you would bet on the Dow, right? Well, the Dow got cut in half.
The premise: rising earnings lead to rising stock prices. Wrong. Again, too many real world variables were left out of the premise. The valuation on those earnings could fall, for example, as they did.
Say you could know ahead of time which companies would make money and which would lose money. You’d likely invest in the former. In 1999, the stocks of companies that actually made money declined 2%. Profitless tech startups soared 82%.
Premise: Stocks of companies that make money do better than stocks in companies that lose money. Not so. At least, not all the time...
And here’s one more example.
“In 2016,” O’Higgins wrote in July of that year, “Brazil’s senior leadership has been embroiled in a vast corruption scandal, President Dilma Rousseff’s powers have been suspended due to impeachment proceedings, Finance Minister Joaquim Levy has been forced to resign, and inflation is in double digits. Brazil suffered its worst GDP contraction since 1990.”
If you had known all that was going on, you probably would’ve stayed away from Brazilian stocks. Yet, the Brazil iShares ETF was up nearly 60% through July.
“Even if we had a crystal ball,” O’Higgins concludes, “the investment implications of future events and conditions are unknowable.” (Remember this next time you hear one of those market pundits telling you what the future holds.)
And yet people keep trying. And other people keep listening to them. I don’t know why.
Speaking of the future...
Buckminster Fuller: Inventor of the Future
To Buckminster Fuller
friend of the universe
bringer of happiness
liberator
- Ezra Pound
Buckminster Fuller is one of my favorite figures from history. There are a bunch of quotes of his that stick in my head – “Dare to be naïve.” “There is nothing in a caterpillar that tells you it's going to be a butterfly.” “I seem to be a verb.” – among others. I have almost all of his books – he wrote around 30 – plus more than a dozen about him. I’ve watched hours of him speaking on Youtube.
And so I was excited to learn about a new biography of the man by Alec Nevala-Lee, titled Inventor of the Future. There are several shorter biographies on Bucky, but he’s never gotten the full “presidential treatment.” This one – weighing in at 600+ pages – will probably wind up being the definitive biography.
So who was he? It is hard to describe what Bucky is all about because he did so many things. He doesn’t fit into anybody’s neat bucket. (I refer you to his Wikipedia page here, for a taste).
Sometimes I introduce him to friends as a "systems thinker." Bucky was fascinated by the behavior of systems unpredicted by the behavior of the parts taken separately. He called this “synergy.” It’s poetically expressed in the quote at top about the caterpillar and the butterfly.
One of Bucky’s favorite examples to illustrate synergy: alloys. Bucky talks about the chrome-nickel steel alloy used to improve the strength of cannon barrels in World War I. Individually, the chrome, nickel and iron would melt under the high heat of cannon fire. Combined, they could withstand it. Thus, alloys exhibit synergy, a behavior unpredicted by a study of its parts.
Nevala-Lee writes in his prologue that Fuller “emphasized whole systems, interdisciplinary thinking and intuition.” That’s as fine a summary as I’ve read of Bucky’s thinking. Among the many things I have learned from Bucky is to think in terms of whole systems: Everything is connected to everything else.
There are many corollaries of this simple idea. For one thing, it means you can never change just one thing. Yet, people do this all time. Economists like to change one variable, “ceteris paribus” as they say. But there is no such thing. When you change one thing, other things change too.
You can think of businesses as whole systems. Copart’s business is a great illustration of why it isn’t wise to try to change one thing. (I own it). Copart describes itself as "a global leader in 100% online car auctions featuring used, wholesale and repairable vehicles." There are several key factors that drive demand, which management captured well in a 2016 presentation with a slide titled (imaginatively enough) “Demand Drivers”:
You can see how different trends impact different demand drivers in different ways – and how they connect. For example, technology reduces accidents (a negative), but increases vehicle complexity which drives up salvage rates (a positive). You can’t just change X… because changes in X will lead to changes in Y and Z. Everything is related to everything else.
Anyway, there is a lot more I could say about Bucky and systems thinking, but this post is overly long already. I just wanted to point out this new biography to you, which I am enjoying so far. (I’m only about 50 pages in). Time with Bucky is time well spent, though he is hard to get into; his books are not accessible. But this biography seems like a good entry point into his world.
Thank you for reading and I hope you enjoyed today's notes.
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Published: August 3, 2022
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