Simple things matter

No one wanted the pandemic. It is, nevertheless, an opportunity to learn. In this post, I will reflect on one of my most important learnings from this experience: simple things matter.

There is a lot of angst around covid. Some simply seem not to care; others have fully holed themselves in. My approach is simple. We must endeavor to lead near-normal lives whilst doing simple things (following good hygiene and some social distancing) to contain the spread. Indeed, having spent a quarter on the UChicago campus, I can say with some degree of conviction that small measures can go a long way. If people wear masks, use hand sanitizer, and form well-defined social bubbles, we can not only contain covid, but can also lead fairly, albeit not entirely, normal lives while we are at it!

I see parallels to this in investing, which too is all about responsible risk-taking. Doing seemingly simple things like focusing on the long term, limiting oneself to one's sphere of knowledge, and emphasizing management quality can help avoid blowups, the equivalent of a covid outbreak perhaps. This is a lot of the job done! Indeed, as Howard Marks says, "If we avoid the losers, the winners take care of themselves." The reverse of this logic also holds true: if we fail to do the small things right, we are more likely to have a covid outbreak, or make a terrible investment. And a single blowup can negate the effects of several good decisions.

It's all about the little big things!

Betting on humankind

As the 2020 saga is coming to a close, I want to take a quick look at the world's scorecard:

Deaths? MILLIONS extra

GDP? DOWN

Mental health? SCREWED 

World? SHUT the hell DOWN

2020 was a bummer year for the world. Full stop!—no ifs, no buts. 

As the 2020-saga comes to a close, however, it seems the covid-saga is, at long last, near the beginning of its end too. I think the world is ready (almost!) to let out a muted "Phew": the economy has not been decimated, mortality has fallen, vaccines are being rolled out...there is light at the end of this dark tunnel. 

In March, fear engulfed the world. Now, our lips are poised, tongues are ready for that collective sigh of relief and sense of having made it out of the woods. We have shown great resilience and displayed a capacity to cope with and adapt to unforeseen and highly undesirable situations. Perhaps the age-old adage "this too shall pass" is indeed accurate. Humankind has survived two pandemics, two world wars, and a great deal more. The full weight of human history points in one direction: Betting on humankind is wise.

Time has a way...

To use the title of Aswath Damodaran's book on corporate valuation, investment decisions should be based on a combination of "Narrative and Numbers". In order to start developing an understanding of the numbers side, I recently took a super interesting Coursera course on financial accounting!

Near the start of the course I realized that non-cash items such as depreciation, amortization, and bad debt expense add artistic elements into accounting. Managers can legally get creative with accounting? What? My reaction exactly: the thought that the numbers published in an annual report present a twist on reality (and not reality itself) worries me.

But as I went through the course, I realized that this is partly because the future reality is unknowable till it happens. More importantly, I learned that provided the books are not cooked, time has a way of revealing and ironing out adventurous, aggressive accounting; if you don't account for non-cash items sufficiently, you will have to take write downs on assets in the future. (And similarly if you are too conservative, the expenses booked today will reduce future expenses.) Time just has a way...

So what did I take away? There are three things that were reinforced for me: 

• Time has a way of setting things right.
• One must carefully evaluate a long term track record. 
• You have to trust that the managers' interest is aligned with yours.

Invest with the Dao

I recently took a course on Daoist Thoughts. Daoism, for those who don't know, is a thought-process which emphasizes the importance of leading a simple life in harmony with nature, and not resisting the dao (the way of nature). The concept at the heart of Daoism is wuwei: action in inaction. This is somewhat like the idea of Going with the flow and involves taking only those actions, which are suited to the circumstances.

With the summary out of the way, I can get to the connection between Daoism and investing, which I wished to highlight. In the manuals on wisdom produced by Daoists, we are repeatedly told that rather than impose a plan or model on a situation, we should let others act frantically, and then lightly adjust ourselves as we see the direction that matters have evolved in. Investing is, above all, a test of our equanimity. So, it seems to me, that we investors must master the art of wuwei; the idea of achieving the greatest effects by a wise strategic passivity is at the heart of long-term investing. Hence the Mungerism: The big money is not in the buying and selling, but in the waiting. 

Dead Companies Walking

In Fortress Balance Sheets I said that I had exited my investment in Aston Martin at a 42.5% loss and I quoted one of my favourite adages: "When you don't get what you want, you get experience." Back then I had - and I still have - every intention of making this experience count. My Aston Martin foray made me very curious about business failure so I kept asking myself: why do some corporations seem to last forever, whilst others struggle to stay alive?

If we avoid the losers, the winners will take care of themselves.  -H. Marks 

In that spirit, I went on to read Scott Fearon's Dead Companies Walking, which is chock-full with anecdotes and insights acquired over an investment career spanning more than three decades. Fearon identifies six company leadership mistakes, which help him spot losers. In this post I want to touch on each of these fatal management errors:

1. They learned only from the recent past. 

We frequently - usually unwittingly - learn from the recent past rather than the entirety of history. This is somewhat analogous to relying on anecdotes in lieu of base rates (if you know the first thing about probability, you know that this is a recipe for disaster!). Business leaders, as well as investors, must guard against myopic vision, for it leads to error. Fearon also applies this to individuals': A successful track record and a degree from a good school...can create a kind of historical myopia, a mistaken belief that one's past successes guarantee similar results in the future. 

2. They relied too heavily on a formula for success.

Using a formula without thoughtfully considering its limitations and relevance to the situation at hand is a fool's errand. Maslow explained the law of the golden hammer best: I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail. It is also important to remember that a formula can be plain wrong even if it appears to have worked for a period of time. In fact, a formula is most dangerous when it has worked for a long time, because we have a tendency to forget that it is not gospelspeak. I would love to have a foolproof formula for success (who wouldn't!!!), but I'm not sure one exists.

3. They misread or alienated their customers.

The classic product-market-fit problem has wrecked countless companies. There is at least one of two key things at work in almost every case: (i) the product is targeted at the management, instead of the consumer; (ii) management failed to account for the way in which people in the real world actually behave. REMEMBER: A truly valuable company is one that provides a product or service, which possesses significant value in the eyes of its target customer.

4. They fell victim to mania.

Largely self explanatory... If management bets the ranch on the latest cool thing, they will almost certainly lose the ranch. Instead of bold bets, you want companies to invest in new initiatives and ideas by making small, calculated bets, which can be scaled up if and when they yield promising results. If this is done well and the organisation learns from past mistakes, this will allow the company to go from strength to strength and move forward (with caution!).

5. They failed to adapt to tectonic shifts in their industries.

When the entire industry changes and a business fails to adapt, the entity must die. This is because no business can outlive its utility; fewer customers will inevitably (at least eventually) mean that the corporation will be deprived of the lifeblood of any business: revenue growth. I would go so far as to say that tectonic shifts in their industries, which materially alter the economics of doing business can undo even the most nimble, well run company. Hence the sage Buffetism: turnarounds seldom turn.

6. They were physically or emotionally removed from their companies' operations.

This post is all about leaders' mistakes which can destroy a business. To me it is blindingly obvious that management matters!!! It is no surprise then, that this error rounds-off Fearon's list of fatal mistakes. If management is not actively engaged with trying to understand the business and getting a feel for its pulse, how can they steer the company in the right direction? In case you didn't realise, that was a rhetorical question: they can't!

For me, Fearon's book is a guide for becoming better at avoiding disastrous losers and maybe benefiting from their often self-inflicted and predictable deaths. I would unreservedly recommend this book to all other aspiring investors!