Tuesday, December 23, 2014

Ray Dalio: Company Culture and the Power of Thoughtful Disagreement

This video probably summarizes what I have learned this year not only as an investor, but also as a human being. Do you want your company to make a difference? Create and nurture an outstanding culture. It might sound odd to most people, even from people within, but you have to put your beliefs in practice. That's how others companies also work. As Dalio puts its, the real difference is either on people or culture.

In his company's case, the ruthlessly transparent internal environment (forcefully) creates a trustful atmosphere, in which thoughtful disagreement foments knowledge creation. The possible issue: as people are smart in so many different ways, they must appreciate each other and make a team of them - the possible solution: the culture itself. It takes a genius to make it simple, and Dalio indeed did it by building an environment built on truth and thus, trust.

Culture is self-reinforcing.

"My biggest advantage is that I know what I don't know."

Sunday, October 5, 2014

The Culture of Learning as The Ultimate Competitive Advantage

'The end of work' has been quite of a debated theme, including by Brynjolfsson, McAfee, Drucker, Keynes, Andreessen, among others. As Nobel Prize winner Wassily Leontief has put it,
The role of humans as the most important factor of production is bound to diminish in the same way that the role of horses in agricultural production was first diminished and then eliminated by the end of introduction of tractors.
Fast forward, (robotic) engineering and automation in general have played quite a role in the last decade. As Mr. Gave put it in his book titled "Too Different for Comfort",
Thanks to functionality, and lower prices, the global 'labor-cost arbitrage' trend, which was the predominant macroeconomic feature of the past decade, may now be coming to an end.
Automobile manufacturers were the main beneficiaries of robotization wave #1, followed by electronic devices industry. More recently, we have seen other industries also benefit from the same trend.

The most staggering fact though is that we may be entering into a new revolution within this decade - a Robolution - as lower robots costs and inflationary labor costs converge, favoring robots adoption by industry participants.

But what types of jobs are at risk? Again recurring to Gave's book "Too different for comfort", he categorizes 4 kinds of jobs, being:

That said, categories 3 and 4 certainly fall at risk, while we (equity investors & research analysts) certainly follow under category 2 - non repetitive and complex tasks - and are likely shielded from robots. Thus, if we are indeed safe from robots, how could we lever our skills to better perform our jobs at the individual level, but more importantly, at the company level? Here kicks in Edward Hess and his recently published book "Learn or die: Using science to build a leading-edge learning organization".

Hess' motivation to write the book likely emanated from the conclusion that continually learning better and faster than the competition may be the only sustainable competitive advantage individually and organizationally. Take McGrath's thought-provoking book "The end of competitive advantage: how to keep your strategy moving as fast as your business" as the basis of this. If this assertion is correct, then to perform at a high level on job category 2 we must lever critical thinking, innovative thinking, emotional and social high engagement and other humans. As Hess put it,
the way to unify operational excellence and innovation in an organization is to have a learning culture, because learning underlies operational excellence and it underlies innovation.
In a recent interview with Hess conducted by Shane Parrish from Farnam Street blog, Hess lied a couple tenets of a learning culture, such as de-emphasized hierarchy, intellectual and leadership humility, curiosity, questioning, the right to debate freely, clarity, preparation, a praise for vulnerability, strong processes, accountability, empathy, compassion, humane relationships, no complacency, and so on.

At the end of the day, what we are talking about here is a CULTURE OF LEARNING. At Bridgewater, for instance, the culture is so strong we might call it a doctrine or a religion - if haven't read Ray Dalio's principles yet, please do! As companies with such a peculiar culture say it, "we are not for everyone!"

As I don't to spoil Hess' amazing book, I will finish this post with a couple quotes I got from his previous mentioned interview.
Number one, underlying innovation and operational excellence, go back to root cause analysis, or the five why's. Unpacking assumptions, good digging, the why, why, why, is underlying both processes.
Hierarchy as an elitism is de-emphasized, and there is a real push for highly engaging employees and leadership humility, and intellectual humility. (...) Does the CEO own the learning culture and walk the talk? (...) Has the organization put in place culture, structured leadership behaviors, HR policies, measurement and rewards to enable and promote learning behaviors? (...) You've got to start small and figure out and prioritize what you are really going to start working on.
Arrogance is a huge inhibitor to learning. Arrogance comes also from success in positional authority.
Where can I improve? What happened today? What would I do differently in how I think? What would I do differently in that conversation as to how I relate?
A leadership model that is very, very humanistic and people-oriented.
 The purpose of the whole system at Bridgewater is to overcome our humanness in a humane way. (...) The first thing they want to talk about is their vulnerability.
You don't put things off. You deal with them directly, honestly, openly. (...) everything about everybody is public record. 
Indeed, we are all work-in-progress until the last day of our lives. Thinking about how we are thinking is a never ending loop. We can't ever truly get comfortable. As this topic may look too 'soft' for for-profit companies, actually, it's not according to Hess:
There's this whole concept in the business world that if you're humanistic and engaging with people, you'll come across as soft. People will take advantage of you. (...) It's not the case. You can be humanistic and have high standards and high accountability. The companies I write about, every one of them are outstanding performers because they have the highest of standards that they hold themselves to. There is no softness in standards. There's a human element.

Monday, September 1, 2014

Berkshire Beyond Buffet: Excerpt from Chapter 8

Lawrence Cunningham's new book Berkshire Beyond Buffet is scheduled to be released on Oct 21st, though you can find here the chapter 8 from the book. Below, notice Berkshire's tenets for its subsidiaries' CEOs praising independence, trust and an owner's mindset:
"Berkshire corporate policy strikes a balance between autonomy and authority. Buffett issues written instructions every two years that reflect this balance. The missive states the mandates Berkshire places on subsidiary CEOs: (1) guard Berkshire’s reputation; (2) report bad news early; (3) confer about post-retirement benefit changes and large capital expenditures (including acquisitions, which are encouraged); (4) adopt a fifty-year time horizon; (5) refer any opportunities for a Berkshire acquisition to Omaha; and (6) submit written successor recommendations. Otherwise, Berkshire stresses that managers are chosen because of their excellence and are urged to act on that excellence."

Wednesday, August 13, 2014

It's All About the Top-line

The panel below depicts crystal clear how activists' investing philosophies may widely differ. ValueAct demonstrates how it works collaboratively with executives and board members focusing on top-line initiatives, while others would rather use financial engineering techniques such as spin-offs, reverse merges and fiscal maneuvers and interact more aggressively with management.

At the end of the day, I feel myself prone to the former approach: driving sustainable top-line growth.

Thursday, August 7, 2014

Mafia Insights Into Quality Investing: No Kidding!

In one of Gladwell's latest articles entitled "The Crooked Ladder" he puts that old mafias were simply an attempt to be accepted by the society. Moreover, one of the biggest misconceptions in movies and also by us is that the really dangerous guys are those street drug dealers. Actually, those are not. As Gladwell puts it,
That’s why the crooked ladder worked as well as it did. The granddaughter could end up riding horses because the law—whether from indifference, incompetence, or corruption—left her gangster grandfather alone. The idea that, in the course of a few generations, the gangster can give way to an equestrian is perhaps the hardest part of the innovation argument to accept. We have become convinced of the opposite trajectory: the benign low-level drug dealer becomes the malignant distributor and then the brutal drug lord. The blanket policing imposed on 6th Street is justified by the idea that, left unchecked, Mike and Chuck will get worse. Their delinquency will metastasize. The crooked-ladder theorists looked at the Mafia’s evolution during the course of the twentieth century, however, and reached the opposite conclusion: that, over time, the criminal vocation was inevitably domesticated.
At the same time, one of the most insightful takeaways for me is that the real 'bad guys' were the ones who made illicit things at the society's face. On top of that, they focused on niches and represented a really tiny slice of the cost structure of the entire value chain. With that, they had pricing power, outstanding returns on capital and no one bothered about them.
"James Jacobs, a New York University law professor who was involved in anti-Mafia efforts in New York during the nineteen-eighties, points out that the Mafia had every opportunity to take over the entire carting industry in the New York region—just as they could easily have monopolized any of the other industries in which they played a role. Instead, they stayed in the background, content to be the middlemen. At New York’s Fulton Fish Market, one of the largest such markets in the country, the Mob policed the cartel and controlled parking—a crucial amenity in a business where time is of the essence and prompt delivery of fresh fish translates to higher profits. What did they charge for a full day’s parking? Twelve dollars. And when the Mob-controlled cartel was finally rooted out, how much did fish prices decline at the Fulton Fish Market? Two per cent."
“This is one of the most interesting things about the Mafia,” Jacobs went on. “They did business and cooperated. They weren’t trying to smash everybody. They created these alliances and maintained these equilibriums. . . . You’d think that they would keep expanding their reach.
At the end of the day, isn't that kind of business we are looking for? Companies that aren't bothered by either suppliers or clients, that are really focused on a niche and don't need to put a lot of capital to work while reap a disproportionate part of the profit pool?

Tuesday, June 3, 2014

Seth Klarman's version of Ben Horowitz' "The hard thing about hard things"

According to Klarman, the hard thing about hard things is that
"As long as I've been alive, there are structural imbalances. Most of the time they don't matter. Once in a while they really matter. That's what hard, that if you run a portfolio to to be fine in an upward market, if you're in the game, you will have exposures that you wish you didn't have in a worse market." - from The Graham + Dodd Luncheon Symposium Transcript from Oct. 2008

Thursday, May 22, 2014

Simon Sinek: Great Leaders Eat Last

As the old saying goes leaders are chosen by the people. In a highly competitive environment, employees tend to be egoistic and afraid. Why not create a great and complementary team based on trust and cooperation? It's not a coincidence that Patagonia's owner Yvon Chouinard hired friends and friends of friends to his company in its early innings. It's all about creating a great environment so people feel comfortable to give their best efforts for the company and his co-workers.

If you have the time, watch the complete speech.

If you are still interested, check his most recent book Great Leaders Eat Last.

Monday, April 21, 2014

Learning By Thinking

"By three methods we may learn wisdom: First, by reflection, which is noblest; Second, by imitation, which is easiest; and third, by experience, which is the bitterest." - Confucius
According to a very recent HBS paper titled Learning by Thinking: How Reflection Aids Performance, Di Stefano, Gino, Pisano and Staats argue that by "reflecting on and articulating the key lessons learned from experience, a person boosts her self-efficacy, which in turn has a positive effect on learning. In this respect, (...) the process of transforming a tacit into codified knowledge requires a cognitive investment that generates a deeper understanding of this knowledge."

In other words, reflection is as important as experience and is often underrated. If you haven't read the post on sense-making, you should, as both subjects (learning and sense-making) are correlated.

Learn smarter, not harder.

Wednesday, April 16, 2014

Is Patient Capital The Ultimate Competitive Advantage?

"Recently, when Page was challenged on an earnings call about the sums he was pouring into R&D, he made no effort to excuse it. "My struggle in general is to get people to spend money on long-term R&D," he said, noting that the amounts he was investing were modest in light of Google's profits. Then he chided the financial community: Shouldn't they be asking him to make more big, risky, long-term investments, not fewer?"
The struggle to build a long term capital base coupled with patience and the right incentives might be the ultimate competitive advantage.

Monday, April 14, 2014

Barry Schwartz Framework Re-framed: Profile Of An Outstanding Investor

"A wise person knows when and how to make the exception to every rule… A wise person knows how to improvise… Real-world problems are often ambiguous and ill-defined and the context is always changing. A wise person is like a jazz musician — using the notes on the page, but dancing around them, inventing combinations that are appropriate for the situation and the people at hand. A wise person knows how to use these moral skills in the service of the right aims. To serve other people, not to manipulate other people. And finally, perhaps most important, a wise person is made, not born. Wisdom depends on experience, and not just any experience. You need the time to get to know the people that you’re serving. You need permission to be allowed to improvise, try new things, occasionally to fail and to learn from your failures. And you need to be mentored by wise teachers". - Barry Schwartz
Substitute the term "wise person" for "investor". There you go!

Tuesday, April 8, 2014

Dare to be Great - Howard Marks

Howard Marks latest piece made a commonsensical though forgotten in our day-to-day: overperformance requires differentiation. He breaks down this tenet in 3 more basic principles:

  1. Define an explicit investment creed with sound principles;
  2. Define what success is for you;
  3. Are you willing to be different? And wrong?
As a Brazilian investor, I`m used to hear from potential investors that portfolios of local funds look too similar despite somewhat different investment thesis on the same company. At the end of the day, skill defined as intellectual capability is on average very similar across different investment firms. 

Although, as Marks cleverly puts it, "there's only one thing in the investment world that isn't two-edged, and that's alpha: superior insight or skill." Even not being a big fan of what the term 'alpha' coins as my principle guides me towards great absolute long term performance, i.e., mid-teens, insight or skill as he frames it is perspective for me, not higher IQ (or EQ). This "eternal preparation" B.S. definitely works, though in the longer term. Our minds are biased towards shorter timeframes, so it's nearly impossible for human beings speak out they are long term investors and indeed become one. As the old proverb says, "easier said than done". 

Another way to be different is through concentration. Without preparation though it is nearly impossible (imprudent would be the best fit here) to have a concentrated portfolio. With experience and mental models lacking, one can't overperform in the long run. So if you want to dare to LOOK wrong, better be prepared.

Monday, April 7, 2014

What Does Sense-making Can Teach Investors?

Sense-making is a qualitative, multi-disciplinary approach to make something sensible, i.e., how we structure the unknown as so to be able to act in it. In other words, it consists in constructing, filtering, framing, creating facticity and rendering the subjective into something more tangible. According to Karl Weick,
sense-making is about plausibility, pragmatism, coherence, reasonableness, creation, invention and instrumentality.

In this synthesis exercise in which accuracy is secondary, I found a couple parallels and antithesis to equity research, investing and managing an asset management firm.

On equity research and investing:
  • Sense-making is a synthesis exercise which usually benefits from mental models utilization to simplify complex and open-ended problems – it does not rely on extensive analysis and accuracy as enactment is needed in the learning process. This one is partially correct for investing in my point of view, since extensive analysis is a pre-requisite before synthetizing what the analyst has learned. A complete due diligence is required to mitigate risks, although it will never be complete due to the ever changing landscape and eternal unknown unknowns;
  • As I’ve just watched the True Detective TV series, I’ve learned from detectives this time (instead of Munger) that reading and studying different topics from a variety of sources helps us arm our brains with bits & bytes which can be combined later on our professional and personal lives. Although, we need previous knowledge and context to successfully use them “to consolidate bits and pieces into a compact, sensible pattern frequently requires that one look beyond those bits and pieces to understand what they might mean. Often, it is necessary to move outside a system in order to see the patterns within. (…) Of course, there is always more than one metaphor that can capture a situation, which means that any given metaphor is likely to be contested.”
  • And when we are unprepared, the man-with-a-hammer syndrome unleashes:  "operators who have specialized expertise do not see the big picture as crises develop and therefore miss key events." We will try to frame the problem within our pre-existing models, unfortunately;
  • We are more likely to uncover unanticipated and potentially valuable viewpoints and information armed with open-ended questions. Moreover, in this way we avoid confirmation bias;
  • Marcel Proust helped me out in this one: “The real voyage of discovery consists not in seeking new landscapes but in having new eyes.” Again, it's all about having perspective;
  • Sense-making benefits from past data (quant, social, etc.) in a given context to extrapolate necessary actions – just like investors learning from post mortem analysis/financial markets history to be better prepared for decision making;
  • Consequences are difficult to forecast in advance, though scenario planning could help out with this one;
  • Sense-making opposes scenario planning as “explanations that are developed retrospectively to justify committed actions are often stronger than beliefs developed under other, less involving, conditions." This one is screaming for me since I live in Brazil and we are used to see growth embedded in 99% of potential investments here, thus we aren't THAT creative imagining different scenarios. Unfortunately, we usually classify then as improbable as a preconception;
  • Learn not only what financial statements represent, but what is behind it: “e very sensitive to operations. Learn from those closest to the front line, to customer, and to new technologies.
On risk:
  • “Human errors are fundamentally caused by human variability, which cannon be designed anyway - so our function is to be risk mitigators which must be embedded in the capital allocator job description;
  • Compounding mistakes: "Small events are carried forward, cumulate with other events, and over time systematically construct an environment that is a rare combination of unexpected simultaneous failures."
  • Constant learning, perspective and team complementarity as a knowledge growth vector and risk mitigator: "Capacity and response repertoire affect crisis perception, because people see those events they feel they have the capacity to do something about. As capacities change, so too do perceptions and actions. This relationship is one of the crucial leverage points to improve crisis management." As investors, we should only act or react when we are prepared and comfortable with what we know and what we don’t know;
On governance:

  • “The dark side of commitment is that it produces blind spots" – This one I’ve learned from Malcolm Gladwell article in The New Yorker Magazine: do not engage in negotiation with fanatics, nor trust entrepreneurs living their dreams in listed companies. In other words, do not them live their dreams with your money;
  • "Turnover is as much a threat to capacity as is understaffing, but for a different reason. Institutional memory is an important component of crisis management"
  • "Perception, however, is never free of preconceptions, and when people perceive without institutional memories, they are likely to be influenced by salient distractions or by experience gained in settings that are irrelevant to present problems."
  •  “In a globally competitive environment our reward structures are geared toward rewarding immediate action and hence we may be signaling that sense-making is not a valued activity.”
  • “Sense-making is inherently collective; it is not nearly as effective to be the lone leader at the top doing all the sense-making by yourself. It is far better to compare your views with those of others – blending, negotiating, and integrating, until some mutually acceptable version is achieved. Soliciting and valuing divergent views and analytic perspectives, and staying open to a wide variety of inputs, results in a greater ability to create large numbers of possible responses, thus facilitating resilient action." - Sutcliffe & Vogus, 2003
At the end of the day, no single discipline or tenet will solve any problem alone, although sense-making might be useful when analyzing the past performance or story of a company in order to understand how things went out. It is like a mapmaking process. Sensemaking also uses mental models from previous experiences and disciplines. 

I do not agree though that it necessarily is a better exercise than scenario planning because it relies on past facts, as (i) facts are not as clean as they see, afterall someone made the fact up and you don't know in what context and motivation and (ii) in a constant changing landscape it's better to elucubrate about the future and try to foresee through group simulations what scenarios can come up.


Enacted sensemaking in crisis situations - Karl Weick

Sensemaking in organizations - Karl Weick

Wednesday, April 2, 2014

How Do We Learn The Most?

“That is the way to learn the most, that when you are doing something with such enjoyment that you don’t notice that the time passes.” - Albert Einstein

Tuesday, April 1, 2014

Incentives & Financial Shenanigans

After talking a little bit about incentives, nothing better than debating some of the possible outcomes. As we've learned in the previous entry, high paychecks with misaligned terms may be an issue: CEOs feeling pressured about beating analysts' short-term quarterly estimates may 'play dumb' destroying shareholder value in detriment of his own paycheck. As one CEO has put it,
"The most important thing we do is meet our numbers. It's more important than any individual product. It's more important than any individual philosophy. It's more important than any individual cultural change we're making. We must stop everything else when we don't make the numbers." - Joseph Nacchio, speech at January 2001 employee meeting, disclosed in a U.S. SEC complaint (March 2005)
Aggressive accounting may take its form in different ways, such as booking revenues too soon, recognizing undue revenue (nevermind PoC accounting method!), misclassifying items so they don't pass through the P&L, shifting current expenses to the next period, boosting operating income by one-offs and so on.

Since executives are well regarded, competent and competitive people, they do not like to lose - I get that. But how could both (i) investors analyze companies financial results in a proper timeframe and (ii) executives be aligned with the right incentives and KPIs so performance evaluation for both parties would be fair and accretive for the three entities in question, namely investors, executives and the company itself?

As Munger put it in one of his speeches,
“The system is responsible in proportion to the degree that the people who make the decisions bear the consequences.”
I do not aspire to share a proposal, but things such as
  1. A shareholder base aligned with the strategic planning horizon of a company;
  2. A well calibrated compensation package, with the vesting period aligned with the strategic planning timeframe (even in Brazil there are companies with 10-year vesting periods);
  3. A more spaced financial results release (half yearly, maybe?); 
should be steps in the more correct direction. That's my 2 cents. What do you think?

While below you may find the transcript of this another talk, right here you can find the video.

Tuesday, March 25, 2014

Governance & Culture: Munger, Peter Thiel & Netflix Combined

Combining Munger takes on Governance, Peter Thiel's insights and Netflix HR presentation was fun to delve into intelligent governance frameworks sourced from an equity investor, a venture capitalist and a company. So, what are them?

  • The fundamental principle: good character - when in doubt, there's no doubt. Do not hire;
  • Strive for a trust-based environment;
  • Provide context to people (why, why, why?), over-communicate - candor & clarity are musts;
  • Inspire responsible behavior through freedom and independence, though reinforce accountability;
  • Less formal processes, DOs and DON'Ts: "Act in Netflix's best interest". Yes, that's it. It's a principle-based approach that works with minimal good sense and intelligence; 
  • Offer modest fixed salary, roughly equal to fixed costs. Align with equity ownership;
  • Control is for beginners: “When we don’t give our people the space to take calculated risks, learn, apply, and iterate, we are really risking our future. While there is a risk to improvising and spontaneity, control brings its own insidious dangers. In our push for perfection, we over-engineer. We add so many bells and whistles that it takes a Ph.D. to use the product. Just because we can doesn’t mean we should. Just because we can practice to perfection doesn’t mean that’s best.” - HBS Article

Wednesday, February 19, 2014

Peter Thiel and His Version of Moats: Durability

"More important than being the first mover is being the last mover. You have to be durable. In this one particular at least, business is like chess. Grandmaster José Raúl Capablanca put it well: to succeed, "you must study the endgame before everything else"."
Have you ever tried to philosophize on what would be the end-game of a company? Try to play it backwards.

Wednesday, February 12, 2014

Graham & Doddsville: Lee Ainslie Interviewed + Post Holdings Investment Case

This issue was nice, indeed. I decided to share it because Lee makes interesting points on his firm and its investment philosophy. I don't agree with everything he said, although I share most of his thought. So, here are a couple quotes from the interview:
"What truly made Tiger a special place was that you were surrounded by so many individuals who were not only very talented and dedicated investors, but also just really nice people." 
This reminds me of the "brilliant jerk" topic as Seth Klarman has already put it. When we work in such a small company, we need to get along - the team has to be your second family.

"We all had different pockets of knowledge about investing, not only in terms of sectors and industries, but also different ways of looking at and thinking about stocks. We spent a lot of time comparing notes and playing devil's advocate to each other, and so the collective talent of the team ended up being a great benefit to my investing education.(...) We believe that having responsibility for both longs and shorts sharpens analytical judgement and helps a team build a more complete understanding of a particular industry. In my experience, people that are solely focused on shorts tend to become extreme pessimists." 
This quote yields two interesting comments: (i) team complementarity might be the definitive edge to perspective/learning and (ii) the insertion of the contra case when an investment idea is provided might enlighten blind spots on the long thesis.
"We have tried to develop a culture where we have a group of people who view themselves as peers, who are not afraid to challenge one another, who enjoy working together and who are driven by common goals and values."
That one is interesting. It caught my eye the values since in the asset management business this is not common ground. Also, it becomes clear by this statement that Maverick's associates have to be vulnerable - it's part of their learning culture.
"There's a certain trade-off with having very narrow expertise. If one focuses on just a very small number of names they can develop a deep understanding of certain companies but may lose perspective of how that opportunity set compares to a broader universe.(...) Today, we generally hold about four investment positions per investment professional. At most hedge funds, this ratio seems to average somewhere between 10 and 20. This gives us a significant advantage in terms of the quantity and depth of our due diligence behind each investment decision and how familiar we are with the companies in which we invest. (...)"
Definitely, working on few names wouldn't give an analyst perspective/the broad picture. At the same time, who said the analyst would focus solely on the one company? When studying a company, one should compare it to others. While trying to understand the market structure and the value chain - which should be part of the due diligence process - the analyst will eventually stumble upon other companies which might be future competitors (upstream/downstream/consolidation strategic movements), giving the analyst the broader picture. The deal is: for that kind of due diligence, one needs TIME. And this is the scarcest asset we have and damn, it's hard to allocate it well.

Another tidbit is how envy I am as a Brazilian investor when looking to the tiny Brazilian investment universe.
"The most important components we gauge [in candidates] include competitiveness, mental flexibility and emotional consistency - that last trait is surprisingly important. This is a very stressful business. We are all human, and we all make mistakes. How one responds to those mistakes and whether someone can keep a level head and make thoughtful decision is critical. Conversely, how does one respond to a few big wins? With some folks, early success leads to inflated confidence that may slow the recognition of a mistake."
That is sharp. Psychology plays a big role in the investment business. When you buy a stock you are implicitly stating that the guy who sold it to you is dumber than you. At the same time, you know you might be wrong, but you believe the odds are in your favor. It's an eternal humbleness x arrogance duel. Also, resilience - not like the common physical athletes have, but mind resilience - is key to sobriety.
"So while we place great emphasis on valuation in our investment decisions, valuation alone should never the driver of either a long or a short investment. (...) As investors, it is critical that we have a strong understanding of the quality and the objectives of every management team in which we invest."
Avoid value traps. Moreover, check formal and informal incentives. Businesses don't run alone, they're run by real people. Don't trust numbers at face value - there are a lot of assumptions embedded and perhaps some dark incentives. Capital does not allocate itself.
"(...) when we evaluate a management team, we're much more focused on analyzing past decisions and actions than simply reviewing their responses to our questions."
This is key. Generally executives are aligned with stock prices, so they don't necessarily have to be uttermost upfront. I'm not saying they lie, what I'm saying is that they are in a conflict of interest. In order to avoid this kind of situation, ask for what happened in the past in the type of situation you are trying to analyze. You shall gather a way better answer.

After reading the full interview, don't miss the Post Holdings investment case on page 50. The company is run by Stiritz (79), who ran Purina and was profiled in The Outsiders book, having compounded at a 20% return over 19 years, ultimately repurchasing 60% of total outstanding shares! You should also take a look at his last annual report.

Friday, January 31, 2014

What Does An Astronaut Has To Teach Investors? - Part II: An Ode to Preparation

Mastering skills and knowledge while crafting research, i.e. analysis then synthesis in order to be the best informed non-insider ready to call the shot at the right price - be the price taker. If I had to summarize the book in an 'one liner' it would be "An Ode to Preparation". Throughout the book the topic is present in many ways, from straight-to-the-point to obliquely. There are several nuances we can learn from the same topic:
“Growing up on a farm was great for instilling patience, which was necessary given our rural location. Getting to the enrichment program involved a 2-hour bus ride each way. By the time I was in high school and on the bus only 2 hours a day, total, I felt lucky. On the plus side, I’d long ago got in the habit of using travel time to read and study – I kept trying to do the things an astronaut would do, though it wasn't an exercise in grim obsession.” - patience and willpower;
“My goal in the pool was to practice each step and action I would take until it became second nature.” - perfect the craft;
“The ratio of prep time to time on orbit is many months to a single day in space.” - intense preparation;
“To me, it’s simple: if you've got the time, use it to get ready. (…) I picture the most demanding challenge; I visualize what I would need to know how to do to meet it; then I practice until I reach a level of competence where I’m comfortable that I’ll be able to perform. It’s what I've always done, ever since I decided I wanted to be an astronaut in 1969, and that conscious, methodical approach to preparation is the main reason I got to Houston. I never stopped getting ready.” - time is what we allocate in the first place and our most precious asset;
“It’s never either-or, never enjoyment versus advancement, so long as you conceive of advancement in terms of learning rather than climbing the next rung of the professional ladder. You are getting ahead if you learn, even if you wind up staying in the same rung.” - constant evolution;
“But I’m not terrified, because I've been trained, for years (…)” // “Preparation is not only about managing external risks, but about limiting the likelihood that you’ll unwittingly add to them. When you’re the author of your own fate, you don’t want to write a tragedy. Aside from anything else, the possibility of a sequel is nonexistent.” - preparation as a mean of risk mitigation;
“Our training pushes us to develop a new set of instincts: instead of reacting to danger with a fight-or-flight adrenaline rush, we’re trained to respond unemotionally by immediately prioritizing threats and methodically seeking to defuse them. We go from wanting to bolt for the exit to wanting to engage and understand what’s going wrong, then fix it.” - a way to put psychology/human biases away from decision making;
“Take your simulation seriously and engage as fully as you would in real life – but be prepared that the sim itself may be wrong. This happens to us most often with simulators that are used to train not for disasters but for skill development.” - craft scenarios, use your imagination and take them seriously when assessing them;
“This is why, individually and organizationally, we have the patience to sweat the small stuff even when – actually, especially when – pursuing major goals. We've learned the hardest way possible just how much little things matter.” - details matter (and a checklist helps a lot);
After preparation phase I, i.e. analysis, it's time for the investment conjecture. Here, knowledge combined with imagination gives form to the investment conjecture. In this phase, scenario conjecturing gives birth to pre-mortem analysis:
“We spend our days studying and simulating experiences we may never actually have. It’s all pretend, really, but we are learning. And that, I think, is the point: learning.” - we should be deja vu seekers; understand incentives (formal and informal) and business environment scenarios in order to foresee possible moves, just like chess players;
“For a sim to work, you really have to buy into it. (…) A sim, on Earth, is the right place to expose these kinds of philosophical disconnects and resolve them.” - if you plot a worst case scenario, you gotta buy into it;
“Sometimes a sim is a proving ground where you demonstrate how well-rounded your capabilities are, but more often, it’s crucible where you identify gaps in your knowledge and encounter domino effects that simply never occurred to you before.” - while scenario planning, you'll spot some blind spots in your knowledge base then you turn back to preparation phase I again;
“These sims are all about prioritizing risks, understanding how they interrelate and deciding which ones must be dealt with immediately – all of which you need to figure out well before you get to space, where hesitation could be fatal.”
The worst thing to compound is mistakes:
“Part of preparing for the worst is keeping in mind that your sim itself may be based on the wrong assumptions, in which case you’ll draw the wrong, perfectly polished conclusions.”
Post-mortems are also useful to learn from mistakes:
“The main point is to learn – and then to review the experience afterward from every possible angle.” 
Our job is an eternal humility versus arrogance game:
“(…)what I loved about racing was the same thing I loved about flying: learning to manage speed and power effectively, so that you can tear along, concentrating on making the next turn or swoop or glide, yet still be enough in control that you don’t wipe out.”
“(…) one of the most important lessons I've learned as an astronaut: to value the wisdom of humility, as well as the sense of perspective it gives you.”  
Assessing risk:
“In my experience, fear comes from not knowing what to expect and not feeling you have any control over what’s about to happen. When you feel helpless, you’re far more afraid than you would be if you knew the facts. If you’re not sure what to be alarmed about, everything is alarming.” - keep in mind you are buying an interest in a business, not gambling at Las Vegas, so you better know it well;
“To me, the only to take a risk, is that there’s a decent possibility of a reward that outweighs the hazard. Exploring the edge of the universe and pushing the boundaries of human knowledge and capability strike me as pretty significant rewards, so I accept the risks of being an astronaut, but with an abundance of caution: I want to understand them, manage them and reduce them as much as possible.” - risk/reward framework, always looking for asymmetrical wars;
“A lot of people talk about expecting the best but preparing for the worst, but I think that’s a seductively misleading concept. There’s never just one ‘worst’. Almost always there’s a whole spectrum of bad possibilities. The only thing that would really qualify as the worst would be not having a plan for how to cope.” - again, scenario planning comes into play in a form to assess worst cases and think of the big picture;
“Having hard and fast rules, and being unwilling to bend them, was a godsend on launch day, when there was always a temptation to say: ‘Sure, it’s a touch colder than we’d like, but… let’s just try anyway’.” - generally we don't like strict rules, but they prevent us from taking excessive risks and doing stupid things;
"Group-think is a good thing when it comes to risks. If you’re only thinking about yourself, you can’t see the whole picture.” - I've never framed it that way, so that's interesting. Investors generally say 'stay away from the crowd', etc. but actually when thinking about risks, group creativity might be a good thing;
“50% of the risk of a catastrophic failure during a long-duration space mission occurs in the first 10 minutes after liftoff. Per second, it’s the most dangerous phase of a space flight. So many complex systems are interacting that changing a single variable can have a huge ripple effect, which is why we rain so long and hard for launch: you have to know how the dominoes might fall, and be ready to do the right thing, in all different kinds of scenarios.” - I'd argue that the same occurs in our analyst job. If you haven't built a great knowledge base (the first 10 minutes), that's where you might compound mistakes going forward;
On thinking on the downside:
“We’re trained to look on the dark side and to imagine the worst things that could possibly happen. Okay, what’s the next thing that will kill me?” 
“My optimism and confidence come not from feeling I’m luckier than other mortals, and they sure don’t come from visualizing victory. They’re the result of a lifetime spent on visualizing defeat and figuring out how to prevent it. Like most astronauts, I’m pretty sure that I can deal with what life throws at me because I've thought about what to do if things go wrong, as well as right. That’s the power of negative thinking.” 
On competence:
“Competence means keeping your head in a crisis, sticking with a task even when it seems hopeless, and improvising good solutions to tough problems when every second counts. It encompasses ingenuity, determination and being prepared for anything.”
“Over time, I learned how to anticipate problems in order to prevent them, and how to respond effectively in critical situations. I learned how to neutralize fear, how to stay focused and how to succeed.” - sharpness comes with experience. Have you imagined yourself with 80 years old: how's gonna be your skill set?
On focus: 
That kind of intense focus is less about what you include than what you ignore.”
I'd like to end the post talking about the one of the most important and often ignored topic: people-based business requires time devoted to the team, either collectively or individually. 

On teams: 
“On the Soyuz, there’s simply not room to fly someone whose main contribution in expertise in a single area. The Russian rocket ship only carries three people, and between them they need to cover off a huge matrix of skills.”//“Crews were put together a little bit like a ports team: it was all about the mix.” - the complementarity of the investment team is an important feature;
“I've never know an astronaut who doesn't believe that the work we do is far more important than we are as individuals.” - team play should be seen more often;
“All the people who are involved in the sim have a chance to comment on how things looked from their consoles, so if you blundered in some way, dozens of people may flag it and enumerate all the negative effects of your actions. It’s not a public flogging: the goal is to build up collective wisdom.” - that's a benefit of a team with diversified background;
“At NASA, where the organizational culture focuses so explicitly on education, not just achievement, it’s even easier to frame individual mistakes as teachable moments rather than career-ending blunders.” - making decisions with incomplete information will yield mistakes. Our jobs is to try to mitigate then, and when not possible, learn from them; 
“There was definitely a sense that we were all in this together, but the environment was also highly competitive, without the competition ever being explicitly acknowledged.” - we work with highly capable, competent, smart people. They are competitive by nature, but do not let this feature blur team play;
“No one wants to go to space with a jerk.” - old and well known 'brilliant jerk' theme, always worth remembering it;
“Over the years I've learned that investing in other people’s success doesn't just make them more likely to enjoy working with me. It also improves my own chances of survival and success. The more each astronaut knows how to do, and the better he or she can do it. The better off I am, too.” // “It’s not enough to shelve your own competitive streak. You have to try, consciously, to help others succeed.” // “It’s counter-intuitive, but I think it’s true: promoting your colleagues’ interests helps you stay competitive, even, in a field where everyone is top-notch.” - help others be better investors and human beings;
On personal development: 
“In any field, it’s a plus if you view criticism as potentially helpful advice rather than as a personal attack.” - the lower your guard, the more you will learn;
“Early success is a terrible teacher. You’re essentially being rewarded for a lack of preparation, so when you find yourself in a situation where you must prepare, you can’t do it. You don’t know how.” - usually talented people are lazy, and that's what kills their prospects;
“How can I help us get where we need to go? You don’t need to be a superhero. Empathy and a sense of humor are often more important (…).” - be emphatic; 
“Sometimes the motivation is over-eagerness rather than arrogance, but the effect is the same.” - try not to overshoot your will, it might kill you as well;
“No astronaut, no matter how brilliant or brave, is a solo act.”
“Ultimately, leadership is not about glorious crowning acts. It’s about keeping your team focused on a goal and motivated to their best to achieve it, especially when the stakes are high and the consequences really matter. It is about laying the groundwork for other’s success, and then standing back and letting them shine.”

Thursday, January 23, 2014

What Does An Astronaut Has To Teach Investors? - Part I

Actually, a lot. First off, these guys spend their whole lives preparing themselves to go to a space mission - unfortunately, not always all of them go on a space mission (just like an investor studying a company until it finds out it isn't suitable for an investment). Not only their lives alone, but also their families lives. They go through extensive physical and mental training, mastering their engineering skills, conducting pre-mortem and post-mortem analysis, learning how to be a team player and so on.

According to Col. Chris Hadfield,
“An astronaut is someone who’s able to make good decisions quickly, with incomplete information, when the consequences really matter. I didn't miraculously become one either, after just eight days in space. But I did get in touch with the fact that I didn't even know what I didn't know. I still had a lot to learn, and I’d have to learn in the same place everyone learns to be an astronaut: right here on Earth.” 
Who investors are after all but professionals making good decisions quickly and with incomplete information, mastering their knowledge base for years?

Thinking about how an investor has to be prepared through learning, here is Col. Hadfield take on learning:
“I was in an enrichment program that year and the next, where we were taught to think more critically and analytically, to question rather than simply try to get the right answers. (…) Really, we learned how to learn." 
Also, there's no boring investment case task:
“I viewed it as a plum assignment, one learning opportunity after another.”
Definitely someone must compare things when thinking critically and analytically, otherwise how could someone judge if it's either a good or bad thing? Col. Hadfield shares his experience on that:
“Astronauts have these qualities not because we’re smarter than everyone else. It’s because we are taught to view the world – and ourselves – differently. My shorthand for it is “thinking like an astronaut”. But you don’t have to go to space to learn that. It’s mostly a matter of changing your perspective.”
“Operational awareness – being able to see the big picture and focus on what could kill me next – is what kept me safe after I regained consciousness. (…) If you’re focused on the wrong things, you are likely to miss the very narrow window of opportunity to correct a bad situation.”
And yes, separating the signal from the noise comes with a large enough knowledge base, which comes with experience:
“Training in Houston, I hadn't been able to separate out the vital from the trivial, to differentiate between what was going to keep me alive in an emergency and what was esoteric and interesting but not crucial. There had been so much to learn, I’d just been trying to cram it all into my brain. During the mission, too, I was in receive mode: tell me everything, keep teaching me, I’m going to soak up every last drop.” 
“I spent a lot of time on PTTs looking at the symptoms of false alarms versus actual system failures: pressure regulation, atmospheric constituent controls, the rendezvous sensing system – the list is long. Through this process I started to figure out what to pay attention to and what to disregard, which risks were the greatest and which would trigger the most negative consequences, and then I was ready for the actual Soyuz simulator, to see what the whole picture looked like.”
In order to learn, naturally, investors need to be great questioners, even for the obvious ones since you work with incomplete/biased information:
“What were the best answers to the obvious questions?”
Many times investors are "1st-level-correlated" to money-making opportunists, although
“It takes years of serious, sustained effort, because you need to build a new knowledge base, develop your physical capabilities and dramatically expand your technical skill set. But the most important thing you need to change? Your mind. You need to learn to think like an astronaut.”
Simply change "physical" for "mental" and "astronaut" for "investor".

And when you get what's needed to go "all-in", have a sizable position in your portfolio in your great idea, it's when you know
“Knowledge and experience have made it possible for me to be relatively comfortable with heights, whether I’m flying a biplane or doing a spacewalk or jumping into a mountain of corn. In each case, I fully understand the challenge, the physics, the mechanics, and I know from personal experience that I’m not helpless. I do have some control. (…) But in order to stay calm in a high-stress, high-stakes situation, all you really need is knowledge.” 
Another interesting metaphor is how austronauts' (g)ravity is correlated to investors' (g)rowth. As the space rocket is coming down to space (a 54-minute long trip!), (g)-force receives a multiplier attached to it, so astronauts get dizzy and feel so weak they can't even stand up when they get down to Earth. After they arrive home again, they spend months with physicians monitoring their recovery. Isn't it pretty much how investors feel with high multiples attached to companies with strong (g)rowth prospects when they are de-rated? High-growth indeed is foggy.

There's a lot more we can learn from astronauts, which I shall share with you in the next coming post.