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.

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.

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.”

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.

Scaling Laws in Biology and Other Complex Systems & the Read-through for Investing

It seems the whole universe is designed based on the principle of economy of scale, from metabolic rates, to vascular systems, cancer growth, aging, mortality, etc. Those are log (x) correlated (<1.00) - metabolic rates, for instance, stand at 0.75. When it comes to cities, economies of scale still apply. Examples are less paved roads and gas stations per capita. Those are super-linear correlated (e(x) or >1.00) at 1.15 on average.

The question which pops out thus is "Is our system sustainable?!". Society and companies have to innovate in a regular, but accelerated, fashion. Clearly this isn't sustainable, at least not in the required pace for the long term. This is straightforwardly applied to the technology sector and that's why disruptive innovation exists. The curious part is that the below speech took place at Google!

But what about Coca-Cola company? What make those companies "moats", as Buffett would put it, large enough for generations to see? In hindsight it would be an easier call, but what can we look for when trying to identify ex ante such a great 100-year business? Food for thought.