Reading our previous ramblings, it would be of no surprise that we love founder led businesses.

Historical data will show that they often perform better, and it’s not hard to draw inferences as to why. Long-term perspective, greater commitment and dedication, more focus on sustainability and survival, less bureaucracy… it is often a source of significant a competitive advantage.

This brings us to Mainfreight.

Two weeks ago, I had the pleasure of traveling to Auckland for the company’s AGM.

For those of you who haven’t seen their blue trucks on the road, Mainfreight are a New Zealand based logistics business with operations across 331 branches in 26 countries. Its services included domestic transport (road and rail), warehousing, and air & ocean freighting — they offer a complete supply chain management solution summarised by “delivered 99% on time”.

The journey to the successful company we see today is hard to comprehend. With just $7,200, a borrowed forklift, and a friend’s help in securing space on the government owned freight ship, Bruce Plested founded Mainfreight in 1978. Price cartels, government regulations, economic pressures, earthquakes, large international competitors… Bruce and Mainfreight have dealt with them all. Now 82 years old, Bruce holds the role of chairman and has retained 16% of the company.

Getting to talk to Bruce, ask him questions, listen to his old business stories, and to see him interact with his family and Mainfreight’s loyal shareholders left a lasting impression. “Special company, special people” isn’t just a slogan.

Passion

The best entrepreneurs that we know are driven by more than larger pay-packets. Take Warren Buffett or Mark Leonard (Constellation Software). If they were driven by money, we dare say we would never have heard about them. They would have sailed off into the sunset once they reached a comfortable retirement.

These individuals have a deep seeded passion for what they do. I observed this in Bruce.

As he told us old business stories, his face lit up.

Bruce spoke fondly about working under Don Rowlands at Fisher & Paykel. He spoke of the joy he had when he got his first job in freight. “I just love order, and I couldn’t believe how every freighting branch ran different processes and systems. There was such an opportunity in just fixing simple things up,” (I’m paraphrasing here). Apparently, Bruce’s garage is a good endorsement for his love of order.

In Don’s CEO address, he shared that the board and senior management team had recently met with one of their largest US competitors (Old Dominion Freight Lines). This competitor gave them a tour of their biggest site in Chicago and showed them exactly how they do things. When Don said to them, “you do realise we are a competitor right?”, they replied “we shouldn’t worry about that because it’ll take 20 years before you compete with us.”

Don continued, “if you want to understand how much runway is in America, the 3rd biggest operator has just gone broke (Yellow Freight). The biggest operator has revenue of $34bn and they only move LTL domestic freight in the US… we have revenues of $5bn and we think we are doing pretty good… there is opportunity there for us.”

Talking with Bruce about this tour of Old Dominion after the AGM, you could just see in his eyes how excited he was. The challenge of attracting great people and building out their network and brand in the US energised him. He stressed that Old Dominon’s comment had zero ego attached to it, and that he was just so inspired and impressed by their operations, “we just have so much to learn from them.”

Bruce’s affection and commitment to continuing to find better for Mainfreight’s people, for Mainfreight’s customers, and for Mainfreight’s shareholders — it was infectious.

And if it was that impressionable on me for the brief few hours I had with him, I can only imagine what it is like to work for him.

Legacy

“There are two reasons companies behave well. Because they want to, and because they have to. Our preference is to invest in those that want to.” — Nick Sleep.

Bruce’s speech at the AGM was centered around water supply, and the importance of Mainfreight playing its role in preserving it.

These were not just words spoken to entertain those who have recently become ESG conscious. Bruce believes it. And he has put the company’s money where his mouth is for years.

“In recent years we have begun using water collected from our terminal roofs for truck washing. Our latest stunning new 10,000sqm freight facility due for completion in Hamilton in June 2003 goes a stage further. Rainwater is used in all toilets as well as for truck washing, and office heating is provided with an enclosed fire fueled by broken pallet wood.” — Bruce, 20yrs ago in the 2003 Annual Report.

After the AGM he spoke proudly about their new facility in Dandenong South that can run 87% off the grid when operating. We spoke about the challenges in getting supply of electric trucks. We spoke about how they can bring customers along with them.

My impression of Bruce was a man deeply aware of his legacy, and of Mainfreight’s role in society for the next 100 years.

Long-term vision but focused on today

Speaking of 100 years, that is exactly the compass that guides decision making. They invest for tomorrow but look no further than making this week better than last.

As CEO Don Braid displayed the trading update slide, my jaw dropped. Revenues down 19%, profits down 43%, US profits down 81%. It was ugly reading.

As the meeting concluded, the analysts in the room surrounded Don to express their concerns, especially around the profit falls in the US — they suggested Mainfreight close the US business and focus on their strong Aus and NZ businesses. Don said to us with a smirk, “they said all the same things about Australia 20-years ago”. Profits in Aus have gone from $2m to $159m since then.

He wasn’t shying away from the challenges they were facing and spoke of the lessons learnt. But the messaging was very much, “we’ve been through this before, we’ll keep investing, we’ll try take market share, we’ll build greater maturity in the customer base… all our people are now out there selling.” A recessionary environment was viewed very much as an opportunity to re-focus, double down on providing a great service and take market share.

“The last two years of growth have given us a taste of what’s available.”

As Bruce reiterated to us, Mainfreight doesn’t manage the company on the short-term movements of the share price. This is a man whose net wealth would fluctuate by the tens of millions of dollars every day, but I got the impression he doesn’t even look at the share price.

“Special People, Special Company”

When we look for quality business, it always starts with assessing those whose hands are on the wheel. It’s even more important with founder led businesses as their stories and behaviors remain imprinted on the culture.

Bruce, Don, and the rest of the Mainfreight people I met were just incredibly authentic, honest, warm, and open to answer my questions and help me understand the business of freight.

“Care and Quality are internal and external aspects of the same thing. A person who sees Quality and feels it as he works is a person who cares. A person who cares about what he sees and does is a person who’s bound to have some characteristic of quality.” — Robert M. Pirsig.

If you’d like to read more about Mainfreight, feel free to reach out for our long-form research note. Below is the video of the AGM addresses.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.

Mainfreight AGM — Ready Fire Aim was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

Not all buybacks are created equal. But the good ones do incredible things.

Mohnish Pabrai has a good slide on the magic of the math and how they can act a spring coil to share prices.

As a shareholder, management can give us three types of buybacks as a present.

1. The flowers buyback

We all love receiving flowers. They smell nice, look pretty, but unfortunately they don’t last very long.

In this first type of buyback, management has no opinion or conviction on the valuation of their shares. This means the buyback is generally small, insignificant and sometimes purely cosmetic in an attempt to support the share price with a vote of confidence from management.

Other times it could be purely to offset option and share based compensation dilution, e.g. “Given the macro environment and our strong free cash flow generation, we believe that using a portion of our free cash flow to manage dilution is a strategic use of capital”, ServiceNow CFO May 2023.

While admirable, its not all that strategic if you’re buying at silly prices.

2. The $20 Kris Kringle buyback

It happens once a year, maybe. It’s a gift, it might be fun, but you’ll probably throw it out in 2-weeks. They rarely have any value.

Again, management have no opinion on the valuation of their shares, but this time they are simply returning money to shareholders via repurchases as opposed to a dividend. It is more common in the US where there are greater tax advantages, as opposed to Australia which has franked dividends.

However, that doesn’t stop Aussie companies buying back shares willy nilly when they have excess cash. For a recent example, lets look at National Australia Bank (NAB).

In the panic of COVID in May 2020, the bank raised $4.25bn from issuing 300mil new shares at $14.15 per share. This was a 10% dilution.

Just over a year later, in July 2021, the bank started a $5bn buyback, retiring 172mil shares across nearly 2-years of on-market buying. The lowest price it paid was $25.44, and the highest price it paid was $32.14.

NAB effectively sold low and bought high. It’s hard to create shareholder value employing this strategy.

In this second bucket of buyback vs. dividend, it is also worth cross checking what management are incentivised to do.

“The further $2.5 billion on-market buy-back announced today supports our ambition to reduce share count and increase sustainable ROE (return on equity) benefits for our shareholders.” — NAB CEO Ross McEwan, March 2022.

Have a guess what the first financial metric is that determines Ross’ long term incentive bonus payout. ROE.

And other than increasing profits, what increases ROE? Buying back shares, as it reduces the denominator of this ratio (equity).

3. The valuable buyback

It might have been your 21st present, a special wedding gift, or you know those people that are really good at gift giving? These presents have value.

This is the type of buyback program where managements have correctly identified a mispricing of their company and by retiring shares, they are going to leverage returns to the long-term shareholder. This is a very rare skill.

As Ross showed us, managers, much like investors, struggle to follow the adage of “buy low, sell high”.

“Overconfidence can lead executives to buy back shares even at the peak share price — and a bias for caution can restrain them from buying shares when prices are lowest. The result is that companies seldom consistently pick the right time to buy back their shares at advantageous prices. Indeed, for the years 2004 through 2010, our analysis finds that a majority of companies repurchased shares when they and the market were both doing well — and were reluctant to repurchase shares when prices were low relative to their intrinsic valuations. Few stopped repurchases even as the market peaked in 2007. And when the market bottomed in 2009, few companies were buying back shares.” — McKinsey

Few have been successful, so lets look at the king of buybacks, Henry Singleton. He generated an incredible 20.4% p.a. of shareholder returns across his nearly 30-year tenure of the conglomerate Teledyne.

Prior to the 1990s, buybacks were seen as a sign of weakness. It indicated that your business lacked investment opportunities internally, and the conventional thinking was why on earth would you want to shrink your business? But Henry Singleton ignored Wall Street’s opinions.

In 1972, with a growing cash balance and Teledyne’s share price collapsing (in line with the market) from $40 to $8, Singleton saw an opportunity where no one else did. He proposed to the board that they could earn a better return buying their shares at these levels than doing anything else. So, between 1972 and 1984, in eight separate tender offers, he bought back an astonishing 90% of outstanding shares.

These buybacks were super aggressive and timed with low stock prices. As opposed to sipping from a straw for two-years, buying back shares gradually on-market, Singleton took to buybacks like a suction hose.

What’s even more incredible is that in the decade prior, Singleton grew shares outstanding by 14x as he rapidly acquired 130 companies. His ability to flip from this mentality and understand the value of his business was incredible.

“Great investors (and capital allocators) must be able to both sell high and buy low; the average price to earnings ratio for Teledyne’s stock issuances was over 25x. In contrast, the average multiple for his repurchases was under 8x.” — From the book Outsiders.

In general, we love our companies to be buying back their stock. It increases our ownership interest, and as we repeatedly say, we are focused on the growth of free cash flow per share.

But buybacks are just one tool in a manager’s capital allocation toolbox. They can be a significant source of value creation, but they can also destroy shareholder value if made at silly prices.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.

Buybacks was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

LCM announced another case win during the month, this time totaling A$132m. While it hasn’t been announced what proportion of the claim LCM will receive, we estimate it to be around ~A$20m. For context, LCM’s revenue for 2022 was A$47m.

LCM is a leading provider of funding for the pursuit and recovery of legal claims. They have an unparalleled track record driven by disciplined project selection and robust risk management. CEO Patrick Moloney, has been a director of the business since 2003 and owns 8.8% of the company.

Disputes finance, also known as litigation funding or third-party funding, is essentially a finance product whereby a funder assumes some or all of the financial risk of a legal claim in exchange for a share of the amount recovered from that proceeding. They essentially cover the claimants legal costs (solicitor fees, barrister fees, independent experts, court fees) and only recover the costs and funding premium if the claim is successful.

Much like a fund manager picking stocks, LCM’s investment managers review hundreds of applications for funding each year and allocate capital to the best investment opportunities — in this situation, legal cases that they believe they are highly likely to win. Over their 24-year history, LCM has invested in 244 separate disputes and only suffered a financial loss on 11.

LCM operates two complementary business models.

The first is direct investments made from LCM’s balance sheet. This invested capital has an 11-yr track record of 163% returns on invested capital. Unlike other listed peers though who do what is called “fair value accounting”, LCM conservatively carry their invested capital at cost until a case is closed.

The 2nd business model is a funds management business. LCM’s stella track record and the uncorrelated nature of this asset class has allowed them to raise money from pension funds, university endowments and family offices. Across two funds, LCM has deployed A$118m and has over A$330m of capital committed.

Since starting the funds management business in 2020, cases are being funded 25% from LCMs balance sheet and 75% from the 3rd party funds. The returns are then split accordingly, but LCM earn additional performance fees as a manager, with extra kickers for IRR’s >20%.

Typically, investments have taken 27 months to reach a resolution. However, because of the backlog in the courts during the pandemic, and the increased size and complexity of LCM’s cases, their portfolio maturity has elongated to 36–42 months. They’ve deployed a lot of capital in the past 2–3 years, with not much to show for it yet. The graph below highlights how the maturity of their portfolio has lengthened.

What this means is that we are starting to see an increased velocity of case wins over the coming 12-months, and with that, cash starting to flow back into the business. The recent announcement is a timely example.

Ordinarily too, you’d think that a longer investment period would decrease your return on capital (because of the time value of money). However, the underlying contractual funding agreements are typically structured with rising multiples over time, so returns are often enhanced as a result of delays.

This is a lumpy cash flow business. It is hard for the market to place a PE multiple on the stock, or for sell side analysts to plug short term earnings expectations into their models (they’ve actually given up). This suits us. We aren’t concerned about the short-term. This business has proven its unique ability to compound its cash flows significantly over long-periods and we expect that to continue.

While this growth is fantastic, we wouldn’t be there if not for sufficient downside protection — our margin of safety.

We take comfort from the fact that LCMs current market cap of A$165m is largely covered by the company’s net asset position.

With the joys of compounding, we believe that Patrick and his team will continue to progress this into a multi-billion dollar asset-management business with a multi-hundred million dollar balance investing alongside.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.

Litigation Capital Management was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

Serial acquirers are companies that purchase and hold businesses for the long-term, building a portfolio of firms that operate under a holding company structure. Ordinarily on their own, these businesses would reinvest their cash flows back into their businesses or pay out dividends to their owners.

Under a serial acquirer model, these cash flows are instead collected by head office and reinvested to acquire more businesses. The idea is to reinvest the cash at a higher rate of return than could otherwise be achieved. This phenomenon creates a powerful compounding effect over time. A collection of “boring” or small businesses are suddenly worth more together than they would be apart.

This isn’t a new business model. Companies like Berkshire Hathaway and Constellation Software have paved incredible paths, and their lessons are well laid out.

This article is also timely as we look forward to watching Berkshire Hathaway’s annual meeting on Saturday (I’ve been going back through past editions recently and they really are timeless and full of gold).

“You don’t need to create your own ideas — you can clone them.” — Mohnish Pabrai

The concepts and strategy are the easy part. Execution is what matters.

Here are some of the key traits we look for when assessing serial acquirers.

1. Aligned Incentives

This is critical. Both the head office capital allocators and the individual business managers must be aligned in ways that service the overall strategy.

“Show me the incentive and I’ll show you the outcome” — Charlie Munger

Constellation Software has structured this best. They pay their company CEO’s base salaries that service their needs. However, their bonus incentives, which are very lucrative and usually involve equity, are linked to metrics like returns on capital invested and organic growth.

If instead a CEO’s pay was linked to sales growth or the size of their profit, they might instead champion internal bolt on acquisitions to grow the size of the division they manage. They would disdain sending cash back to head office.

Constellation’s executive officers are also required to invest 75% of their after-tax incentive bonus into common shares in the open market (note not newly issued shares or options, diluting existing holders). The shares are then held in escrow for a minimum average period of four years.

In Berkshire’s 1995 meeting, Buffett explained how they charge/credit their manager’s bonuses based on how much capital they retain/release back to Berkshire.

“We believe in managers understanding that money costs money… most managers when its their own money, understand that money costs money, but sometimes managers when using other peoples money, start thinking about it as though its free money, and that’s a habit we don’t want to encourage in Berkshire.”

It’s also incredibly important that head office capital allocators are significant shareholders and think like owners. This too focuses them on growing cash flows per share, not just the size of the firm.

2. Limited Synergies — maintain as much independence as possible.

If a deal’s success is dependent on the achievement of synergies, we think that’s a bad deal. Every purchase and business should stand successfully on its own.

It can be tempting to use the collective bargaining power of the group of businesses to negotiate favorable Salesforce contracts, or develop group wide HR/Marketing divisions or the like.

When asked about if Berkshire ever looked for synergies across its businesses, Charlie Munger said it was almost never worth it. This was for one simple reason. It would break the trust of their CEOs.

To them, this trust was 100x more important than any incremental margin that could be achieved by combining business units.

We believe if you have highly capable managers, it’s best to get out of their way.

3. Differentiated shareholder offering allowing cheaper purchase multiples.

This is especially relevant in the private space where you could be competing against private equity firms. If you are a permanent and passive shareholder, this is much more appealing for founders. Private Equity generally has a limited holding period. Even when they are buying, they are planning for the eventual exit in 3–6yrs.

For founders, this means they might initiate radical change in their business in order to drive their desired exit outcome. Staff restructuring (either cutbacks, or more management layers), adding debt into the business, bolt-ons with other rivals. There are various ways in which PE strives to “add value”.

Founders want to trust the people they are selling their “baby” to. They’ve worked incredibly hard to build the business to where it is. They have deep connections to the employees who have helped them along the way.

We want our serial acquirer to have a differentiated offering as a shareholder.

As the acquirer builds a reputation for being a fair and trustworthy partner, it attracts better deal flow and hopefully cheaper purchasing multiples.

4. Limited leverage

There are very few things that can kill a great business. Leverage is one of them.

We prefer serial acquirers that aren’t relying on excessive leverage to fund their strategy as this can quickly snowball them into oblivion after one or two poor deals.

5. Scaling and the law of large numbers

Generally, most of the best deals of a serial acquirer are done in the early days when they can purchase fantastic smaller businesses at great prices.

As the holding company gets bigger, it becomes harder to allocate a larger pile of cash at the same economics. This means they are forced to do one of two things to continue scale and avoid mean reverting:

Increase the velocity of deals. Rather than doing 2 purchases a year, the head office needs to do 4 a year, then 8 a year, then 16… quickly, you reach a point where you need to delegate capital allocation and purchase decisions down the managerial chain. This can be dangerous when much of the success up to this point has been a result of a few astute decision makers at the top.

Constellation Software is about the only one to successfully do this. They are buying hundreds of tiny companies every year. Mark Leonard only gets involved in larger deals and has built an incredibly well-oiled M&A machine. Staff are taught to be almost excessively disciplined.

If a deal is expected to generate a 24.8% IRR, and the hurdle is 25%, all the way down the ranks they know they have to say no.

Increase the size of deals. Bigger deals can mean bigger risks. It also means greater competition for deals which increases the purchase multiples.

This is how Berkshire Hathaway ended up buying more public equities like Coca Cola and Apple. It became near impossible to move the dial by acquiring other brilliant private business-like Nebraska Furniture Mart.

Not everyone is the next Berkshire, so it’s important the serial acquirer has a relatively long runway before they are forced into larger deals.

6. The F1 driver

The final critical element is in accessing the people whose hands are at the wheel.

It is an incredibly unique individual who posses both the skill of capital allocation and the emotional intelligence to build trust with managers and founders. There is a reason we put the successful ones up on a pedestal.

If any clients are interested in the name we have been building a stake in, please feel free to reach out.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.

Serial acquirers was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

For context, Mayer’s research shows that to achieve 100x returns on a stock, the journey is likely to take 20–25 years. To hold a stock for that long, you need to “defeat your own worst instincts — the impatience, the need for action, the powerful feeling that you need to do something.” This is where the 10-year coffee can question comes in. It forces you to extend your time horizon.

It’s a fascinating question to ponder, and you can approach it in a myriad of ways. Mayer’s book highlights some of the important qualities to look for, but ultimately you will never find a company that has all the boxes ticked.

Do you want reliability? I would be shocked if Telstra, Nike, or Berkshire Hathaway and its collection of businesses (Apple, Coca-Cola, Bank of America) didn’t exist in 10-years’ time.

Do you want earnings growth? Consequently, you might pick a technology firm that you think has a decade of tailwinds behind it. My mind went to Microsoft and how well placed they are for the AI wave, others may go to faster growing software firms.

Do you go for innovation and a company that you think will continue to reap the rewards of its research and development pipeline? CSL or Idexx Laboratories comes to mind.

Do you want an owner-operator that you know will run the company with a focus on the long-term? L’Oreal and LVMH are front and center. With children of each of the founding families still leading their businesses, it’s fair to assume that these companies will be run in a way to protect the family’s wealth.

After thinking it through though, we both ended up landing on two of perhaps our most boring but special compounders.

Markel and Brookfield Corporation.

In their simplest form, both companies are value-based compounders of capital. Markel came to it as a specialty underwriter of insurance. Brookfield has done it off the back of an asset management earnings stream. They both share similar philosophy’s, both have long and successful histories and both have similar competitive advantages.

BRANDS

While Markel will rarely be the cheapest provider on an insurance brokers lists, they will generally provide the most coverage, and brokers know they are reliable, approachable, and able to solve for complex risks. This reputation has helped them attract many top fortune 500 companies as clients.

No asset allocator at a pension fund or family office is going to lose their job for investing in Brookfield’s funds. Their trusted reputation and track record attracts more assets, which generates more fee revenues, which brings in better talent, better deal flow and partners, and ultimately leads to better performance. That’s a tangible fly wheel.

EFFICIENT SCALE

By design, Markel are not the biggest writer in any particular market, but they’ve still managed to compound to a size that gives them a number of advantages. Its their diversity across their books. It allows them the funds to invest in technology. But ultimately, it gives them a bigger float to invest as they choose. Markel Ventures, their collection of private businesses, is reaping the rewards of this scale.

In the market of trophy real assets that Brookfield owns and controls, there are only a select few that have the financial firepower ($124bn of “dry powder”) to compete and bid for them. Additionally, managing an additional $1bn once you are at $800bn of AUM doesn’t require any extra staff or resources. That fee revenue just drops straight to the bottom line.

QUALITY MANAGEMENT

This page is taken from Markel’s IPO documents in 1986.

These 6 paragraphs of guiding principles remain as relevant today as they did nearly 40 years ago, and not one sentence mentions insurance.

Saurabh Madaan summarises it (we will share the podcast episode below), “you could describe Markel as a collection of systems and values.” Ultimately, the Markel style is what is going to dictate what you find when you open your coffee can in 10-years’ time.

CEO Tom Gayner, who has been at the helm since 1990, has mainly directed the investment operations of the business. He describes Markel as a publicly traded family office. Importantly, his track record has outperformed the S&P500 over this period.

Similarly, Brookfield and its CEO Bruce Flatt have been guided by a set of principles that has led to its 19% p.a. of total shareholder returns over 20-years.

When Flatt entered Brookfield (then called Brascan) in the early 1990’s, the company was over leveraged and left exposed by rising interest rates. “That was quite impressionable on us to how we run the business today — never put yourself in a situation where you have to sell something in an environment where you should be buying.”

After gaining control of the company, Flatt has done just that, accumulating many of the firm’s trophy assets in periods of market stress. Peers like Blackstone and KKR have more traditional private equity buy to sell approaches. We think Brookfield’s long-term value investing philosophy gives them an edge.

Brookfield also own 64% of Oaktree Capital Management who embody a similar philosophy of contrarian and value-based investing. It too is run by similarly impressive managers, co-founders Howard Marks and Bruce Karsh.

In answering the coffee can question, on the front of our mind was the fact that you want to sleep well for the next 10-years, and you want to start from a reasonable valuation.

If Mayer’s 100 baggers book teaches you anything, it’s the power that comes from the combination of starting from a cheap multiple and then having excellent growth. This way you get the extra boost that comes from a valuation re-rating as well.

We believe Markel and Brookfield both offer that. You can buy both at discounts to net asset value, and we trust management to continue to harness the power that comes from milking an earnings stream and compounding a capital base.

In its simplest form, Brookfield Corporation consists of:

1. An Asset Management Business (BAM) with a high margin recurring revenue stream. This is now a separately listed entity, so their 75% interest has a clear market value.
2. A collection of extremely high quality investments across renewables, infrastructure, private equity, real estate, insurance, cash and other financial assets.

BAMs listing allows us to separate its value from the corporation’s market capitalisation. This leaves us with an implied value of only 3.9x / 26% FCF yield for the remaining balance sheet assets.

We think this is an incredible margin of safety for a compounder of the highest quality.

We have just finalised a round of work on Brookfield and are happy to share our long form research memo if you were interested.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL №508934.

Coffee can stocks was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

There are a multitude of variables which impact the outcome of an investment. It makes sense for us to focus on those variables we can control. Wasting time and energy on things we can’t influence is ineffective.

The problem is that much of the uncontrollable have a lure about it. Things like the noise of sensational news flow, hearing of other investors big ideas, or observing other investors impressive returns. It’s hard not to compare ourselves or be influenced by them.

“Focusing is about saying no” Steve Jobs

There is a plethora of causes of human misjudgement and how we spend our time is our primary protector. Carefully considering what we read; who we talk to / seek advice from; how often we check stock prices. These are all activities which can help or hinder our ability to focus on our process.

In a recent interview, historian Jaime Catherwood shared a study of 4,000 brokerage accounts in the early 1900s. “They found that account holders who did not live near a brokerage office where they could go trade did better than local traders to a brokerage office because they just couldn’t over trade on short-term news.”

Munger says that investing “is not supposed to be easy. Anyone who finds it easy is stupid”. All we can really control is how we spend our time. As we know — that’s harder than it sounds.

Share Prices

This notion that investing is difficult is well illustrated in how day-to-day changes in a share price can distract us. We don’t invest in a share price; we buy a share of a business. Our focus should be on monitoring the performance of that business.

“At almost every all-hands meeting I say: ‘Look, when the stock is up 30 percent in a month, don’t feel 30 percent smarter. Because when the stock is down 30 percent in a month, it’s not going to feel so good to feel 30 percent dumber,’” Jeff Bezos

Its difficult but I generally try to avoid any day-to-day market watching, as Nick Saban would say — that is rat poison.

Process not outcomes

“Don’t think about winning the SEC Championship. Don’t think about the national championship. Think about what you need to do in this drill, on this play, in this moment. That’s the process: Let’s think about what we can do today, the task at hand.” Nick Saban

The success of an investment decision is not always defined by its outcome. Despite our best efforts, sometimes we don’t achieve the desired result — it’s going to happen. Investing is an uncertain game and sometimes all of that uncertainty goes against us at once.

In the post-mortem of a poor investment we need to ask ourselves what would happen if we repeated that same decision 100 times over. If the process is still sound long-term, if you are confident the result will be positive most of the time, have the resolve to push forward.

Charlie Munger says that the worst thing that can happen to someone is that they make money from Bitcoin. Putting aside the ‘bitcoin’ aspect of his statement, Munger is suggesting that a positive outcome from a poor process is likely to instil the poor process and potentially amplify the eventual misfortune in the future.

Success is not a single investment. In fact, very few investments in history have created generational wealth on their own. Success (to me at least) is compound growth of capital over many years. It’s the repetition of good practices which ultimately leads to avoiding disasters and consistently picking good investments.

“Survival is the only road to riches” Peter Bernstein

Internal scorecard

One of the main causes for distraction is comparing ourselves to others, whether it be the investments their excited about or their impressive performance numbers. Envy is one of the seven deadly sins, it’s a real problem as it creates a bias and influences our actions. It’s also difficult to avoid.

In the investing game, if we see someone else overly excited about an investment or doing particularly well we are inclined to want to follow them.

“Nothing so undermines your financial judgement as the sight of your neighbour getting rich”. John Pierpont Morgan

We can only be the best version of ourselves. We can’t beat anyone else at their game and conversely, no one can beat us at ours. I’m a big fan of cloning but anyone’s best investment style is unique to them. It is a match of their own emotions, intellect, patience, tolerance, interests, and networks (opportunity set).

Stick to your knitting

We all have investments we adore — the ones we never lose sleep over. It is likely that these are those which fit perfectly within our style, they are well within our circle of competence. The other investments? The ones we are little uneasy about, they are probably someone else’s idea.

For the benefit of our investors, the fund has been closed to new applications for a little while now. This has coincided with an opportunity rich environment and so we have been forced to think a lot more carefully about what we own. We had a mix of investments that perfectly match our criteria and some which don’t.

These ‘less comfortable’ investments were often smaller ones. They came into the portfolio via some hubris, envy, or just plain carelessness. Now, these are largely gone. Some were quite profitable but on reflection they had potentially large downsides. Hence the danger of good outcomes from bad processes.

The returns we publish are our own. They will be different to the index, they will be different to other investors. They reflect us executing our own investment style, in the approach we know best, according to the unique opportunities provided to us.

We are most comfortable staying within our circle of competence — sticking to our knitting and are extremely grateful in your support to allow us to continue to do that.

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Acknowledgements: Steve Jobs, Charlie Munger, Jeff Bezos, Nick Saban, Peter Bernstein, Jaime Catherwood, John Pierpont Morgan.

Focus was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

Given the attention this has received in the media and the consequential discussions that involve many of our compounders including Google, Microsoft, and Meta, we thought it was worth investigating what is going on.

If you don’t know what we are talking about, late last year OpenAI released “ChatGPT3”, a language artificial intelligence (AI) model which interacts in a conversational way. Think of it as a calculator, but for words, information and pieces of text.

The dialogue format makes it possible for ChatGPT to answer follow up questions, admit its mistakes, challenge incorrect premises, and reject inappropriate requests. It is a truly incredible innovation that is quite mind blowing to play around with, we recommend you try it yourself before we divulge.

https://chat.openai.com/

Firstly, who is OpenAI?

Founded in 2015 by Elon Musk and Sam Altman, it was originally a non-profit research company created in part because of its founders’ existential concerns about the potential for catastrophe resulting from carelessness and misuse of general-purpose AI. They wanted to create “safe AI” for the benefit of humanity and set about freely collaborating with other organisations and individuals in tech. Research and patents made by the company are intended to remain open to the public except in cases where they could negatively affect safety.

Elon ended up leaving the company in 2018 due to its conflicts with Tesla but is still a shareholder. LinkedIn co-founder Reid Hoffman was also an early backer, as were many other prominent technology VC funds like Tiger and Khosla.

Co-Founder Sam Altman is CEO and in 2019 he created a for-profit arm so it could more easily raise money to fund the computing power needed to train its algorithms. Enter Microsoft, who gave OpenAI $1 billion in funding and a sweetheart deal allowing them to use their cloud infrastructure in Azure to train their models.

OpenAI currently generates revenue from selling APIs to its image and language models. This allows developers and ancillary companies to build products or solve problems using their systems, and OpenAI clip the ticket each time they are used.

While it is unclear how much revenue OpenAI has generated, it is rumoured to be in talks with selling existing shares in a tender offer that would value the company at $29 billion, up from $14 billion when it last raised in 2021.

The company has also limited some venture investors’ profits to about 20 times their investments, with the ability to earn greater returns the longer they wait to sell their shares. OpenAI has said such capped investment structures were necessary to ensure that the value from OpenAI accrued not only to investors and employees, but also to humanity more generally.

It is certainly a unique new player in the technology universe.

After a few private demonstrations and releases to tech journalists and research partners, OpenAI’s first public release was Dall-E 2, launched in September 2021. This product enables users to create realistic art from strings of text like “an Andy Warhol-style painting of a bunny rabbit wearing sunglasses.” It is quite clever and fun to play around on. But it is just that, fun. It was hard to see what the real-world use cases would be for this tool, other than to demonstrate the language model’s skills and to show it off as a party trick.

Then came ChatGPT 3.

Large Language Models

Firstly, it is worth having a basic understanding of how a large language model (LLM) works. As apposed to supervised models, LLM’s training is done by the models themselves. These models are given an enormous amount of text and are then allowed long-periods of time to borough through it. The LLM then plays a game where the model takes away one word, and then it tries to guess that word it just removed. It will play this game trillions of times over, guessing right or wrong and consequently, teaching itself the statistical structure of the text. As it gets better, it is then able to predict what the next word could be given all the words seen before. This is how it constructs language.

A simple version of this that you can already relate to using is autocorrect on word, or when you write text on Gmail, and it will predict the ends of your sentences as you type.

You would also be familiar with using chat bots for customer service queries, but again, these are painfully limited.

ChatGPT is just the next iteration of this technology and is solving problems in ways that do baffle the mind. From simplifying complex university text, to writing poems in the style of Shakespeare, to giving detailed “how to” guides… it really is amazing what it can do. It even scored 52% on the SAT test.

It does have limitations though.

Firstly, and most importantly, it will give wrong answers. Perhaps more worryingly, it will do so in a very confident manner, meaning you might not suspect it is wrong.

Secondly, the data that it has learnt off is only up to 2021. Additionally, given that LLMs are not databases, they are text predictors, the inputs and models are harder to update and re-learn on the fly.

Thirdly, as these models are a function of the data and text they are given, there are inherent biases in their results. However, this is a challenge that almost all AI tools face.

So, will ChatGPT take my job?

This sort of technology is likely to disrupt many parts of our daily lives. But to calm concerns over it taking your job, it is more likely to be used as a tool.

To give you some idea of the impact that this type of tool can have though, 13% of jobs in the USA involve writing as their main task. That’s $675bn of value, or 3% of US GDP. Given it can help you write your essay, your news article, or your letter to Santa, it is already becoming very hard to distinguish whether a human or computer wrote a piece of text.

As these models have improved though, we are learning that they are capable of even more applications than was first imagined. For example, OpenAI discovered that this tool was really good at coding.

Microsoft’s CTO Kevin Scott shared that their programmers are already using LLM Co-Pilot to write basic code. This is a joint venture between GitHub (owned by Microsoft) and OpenAI that already has >100k daily users now. Co-Pilot is producing more than 30% of the code in the commits from Microsoft right now, freeing up time for these skilled developers to think more deeply about the problems and what they are trying to build and solve for.

The other important question that we are considering is… whether ChatGPT will disrupt Google Search?

Implications for Google

Firstly, it must be said that scale really does matter in this game. The bigger you can make the model, the more generalisation you get from them, and the broader the applications you can solve. OpenAI’s deal with Microsoft was pivotal to their success.

As a result, companies like Amazon, Microsoft and Google are at an advantage to smaller scale companies looking to replicate what OpenAI has done. These big tech firms hold significant market share in terms of cloud computing infrastructure and produce large cash flows that enable them to continue to invest heavily without outside funding.

Isolating Google, Search already uses AI models to improve its results and better imbed advertising. The latest is what they call the “Multitask Unified Model”, or MUM, which was 1,000x more powerful than BERT, their 2019 AI model. However, the human has always been the arbiter in these models, clicking on the links that it finds the most helpful, or clicking on the ads that are most relevant (and thus teaching the machine).

There is a distinct difference between search engines and a chat based LLM too.

Search engines are like indexes to the internet, which is like an endless database which updates constantly. You can’t ask ChatGPT for live scores in the Australian Open.

Additionally, the sort of searches where Google makes the most money — travel, retail, insurance, etc. — may not be well-suited for chat like interfaces. As we mentioned above, ChatGPT only uses data pre-2021, and thus it becomes out of date very quickly.

It’s not like Google have been sitting on their hands though.

They spend 12–14% of revenues on Research & Development, which is ~$160bn of accumulated spend in the last 6 years. That’s a lot of money, even if only a slice of it was going directly into AI.

They also acquired DeepMind in 2014 for ~$500mil, which has become their own AI “research institute”. Its Founder and CEO Demis Hassabis told reporters this week that they would potentially release the “Public Beta” of its reply to ChatGPT called Sparrow later this year.

CEO Sundar Pichai was also on the PR front foot this week, spruiking all of Google’s internal advancements.

Sundar Pichai on Twitter: "Summary of great research progress on #GoogleAI, including language models, computer vision, multimodal models, generative ML. We're building it all into current and upcoming products + APIs, look forward to sharing more with everyone soon. Stay tuned! https://t.co/bGzLSfxZ0A pic.twitter.com/xAJql9WH4h / Twitter"

Summary of great research progress on #GoogleAI, including language models, computer vision, multimodal models, generative ML. We're building it all into current and upcoming products + APIs, look forward to sharing more with everyone soon. Stay tuned! https://t.co/bGzLSfxZ0A pic.twitter.com/xAJql9WH4h

However whether or not Google have a reply to ChatGPT is not really the question.

Over the past seven years, Google’s primary business model innovation has been to insert ever more ads into Search, a particularly effective tactic on mobile. However, this business model doesn’t work in a ChatGPT like product.

Thus, even if they have a superior version, releasing it might be killing their own golden goose. And herein lies the innovators dilemma.

So what happens next?

While we do not have an answer for Google’s strategy or plans with AI (no doubt they’ll be the focus of the next investor call though), we do have some thoughts about MOATs and technologies evolution.

Google is the default in almost every browser and on every phone, and over two decades, people have formed habits of using Google for everything. No matter how good alternatives may end up being, this competitive advantage takes time to disrupt.

The thing with disruption is that if left ignored, slow change can become quick change. Even though ChatGPT has many flaws compared to Google Search today, this technology is moving fast and may be radically better again in 6-months’ time.

Given the media attention and recent performance of the share price, Google’s management are no doubt wide awake to these questions.

Implications for Microsoft

While Google rightly has taken most of the spotlight in the debate, it is also worth briefly mentioning Microsoft’s role in this, because they seem to be the best placed of all big tech.

They have already integrated much of OpenAI’s technology into Azure and have flagged that ChatGPT will be available soon too. The announcement made this week has a great video of how this technology can be used today by developers.

There are also further rumours of an additional $10bn investment into OpenAI. If this were the case, we suspect there are further strategic partnerships involved. Perhaps OpenAI has worked out that Microsoft has the scale, vertical eco-system, and capabilities to monetize its innovations better than it ever could. Thus, OpenAI would be better off just focusing on maintaining its culture, developing new models and holding itself to the core mission of safe AI.

So, while being the sole cloud provider for OpenAI has probably been expensive for Microsoft, it has set them up to provide the infrastructure that could underpin so much of silicon valley’s next phase of product creation.

It has also given Microsoft a front row seat into remarkable innovations. Perhaps better than anything the same amount of internal R&D spend could generate. The bonus is being able to integrate these AI models into their product suite at scale before their peers.

Returning to the Google question — Microsoft’s search engine Bing is 2nd to Google with only ~8% share and is relatively small in terms of revenue contribution to the group. If incorporating ChatGPT-like results into Bing risks the advertising business model but provides the opportunity to gain massive market share… that could be a bet well worth making.

The information provided in this newsletter is for general information purposes only and does not take into account your personal circumstances. It is not intended to be a substitute for professional advice, so please seek the advice of a licensed financial advisor before making any investment decisions. The author and publisher of this newsletter may hold positions in the stocks mentioned. The author is a representative of Lugarno Partners Pty Ltd AFSL № 508934.

ChatGPT was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

An investment is usually a challenging journey with plenty of ups and downs. Making it particularly difficult is that we do not know what the destination looks like or precisely where we are headed. Sounds contrite, but while pundits like to make bold predictions around precise prices and timeframes, a more useful exercise for me has been to focus on preparing for the journey itself.

The planning fallacy is the tendency where most of us underestimate the time required to complete a task. Our optimism blinds us to the multiple variables which are often out of our control.

Fresh from our holiday travels, I’m learning (slowly) that travelling with young children is made dramatically easier when a fixed timeframe is removed. It allows us to deal with the inevitable toilet stops, food cravings, variable sleep patterns, car sickness (if we’re unlucky) in the moment.

Like investing, a healthy dose of patience brings us to our destination with greater calm and less risk of irrational decisions.

“Blessed is he that expecteth nothing, for he shall not be disappointed,” GK Chesterton

A recap on our strategy

We aim to purchase investments for less than 50% of what we think they are worth. Just to be safe, we prefer net tangible assets owned by the underlying business to cover (at least) what we are paying for it. To maximise our search for these gems, we place no constraint on asset classes, investment type (private or public), region, or size.

While we have no fixed timeframe, experience tells us it takes 3–5 years for the gap between price and value to close. We are willing to wait longer so long as we are confident the value is there.

“We don’t get paid for activity, just for being right. As to how long we’ll wait, we will wait indefinitely.” Warren Buffett

I’m often asked where we find our ideas. Funnily enough, the finding and buying is the easy part of the process. I find the greatest difficulty in the holding (the waiting) and keeping my emotions in check while others disagree with us.

Why is patience easy to say but hard to do?

Patience is one of those characteristics that everyone acknowledges is useful but so few are realistically comfortable delaying gratification. Investors are obsessed with action, we all struggle to sit still. Why is that? I think there are two primary ideas.

a. Investors have a misguided belief that they can predict things — especially timeframes

b. Investors struggle to deal with the emotional impact of volatility

Predicting specific prices (and timeframes) has a huge margin of error

Knowing when a stock will eventually rerate toward its fair value is a question near impossible to answer. What moves share prices in the short term is a vote with many hundreds (if not thousands) of other investors. Knowing how the collective market will feel in any given day or week relies on an accurate understanding of feelings and emotions.

“The market is a voting machine, not a weighing machine. It registers and reflects the thousands upon thousands of personal opinions about tomorrow. It swings high and it swings low on the facts and fancies that move men to investment action” Benjamin Graham

I’m busy trying to handle my own feelings, so to attempting to forecast how thousands of others are going to feel about a specific stock in the near future feels like a fool’s errand. Needless to say, while we do look for catalysts which may assist in shortening an investment’s timeframe, we spend zero time estimating specific timeframes.

“The investor’s chief problem — even his worst enemy — is likely to be himself.” Ben Graham

Getting comfortable with volatility

Investor behaviour plays a big part in the volatility of the market. Loss aversion bias is a big one. We all hate losing money and we all have an urge to sell a stock when it is falling.

The opposite is true of rising prices. As a type of herding behaviour, investor’s pile into investments when everyone else is loving them. The feeling of belonging is a driving force, we are inclined to join/follow our peers and then look to others for confirmation through the process. This is a fuel for rising prices, it helps to create asset bubbles and volatility.

But why do we do this? We all know we should be buying low and selling high. All else being equal, the merit of an investment increases as its price falls — but our emotions force us to feel the opposite.

Being comfortable with the price of your investments falling is a difficult exercise. A study of the best performing investors tells us that extended periods of poor returns is an essential ingredient to outstanding long-term returns (quote from study below).

Volatility represents the collective view of the market. It affects me. It’s hard to imagine it not affecting everyone to some extent. But we know that independent and rational thought is a key determinant of great returns. An idea carries very little merit if it is not (to some extent) different. So like anything worth striving for — learning to deal with volatility is hard. So work on it we must.

“An outperforming manager can expect to experience a continuous drawdown lasting two years or more every 10 years and a drawdown of at least 20 percent over time” Chris Tidmore & Andrew Hun.

Our investments sometimes fall in value — that is a predication destined to be correct

As a contrarian investor, I need to be aware of these fallacies and manage them more than most. The thing about buying cheap stocks is that they are cheap for a reason. Buying a stock that has fallen 70% usually has a good chance of falling further.

The stocks we invest in have (most often) fallen either because no one is looking at them or because some bad news has impacted the sentiment toward them. In other words, the ‘market’ either isn’t aware of the company or disagrees with our thesis (until they begin rising of course).

Investing as a contrarian is difficult, but it works. So we are sticking to it and commit to continuing to improve our craft.

“Sometimes buying early on the way down looks like being wrong, but it isn’t” Seth Klarman

Treating our investments like they are private businesses

Our recent experience investing in private companies has highlighted how detrimental the minute-by-minute pricing mechanism of the ‘stock market’ can be to both investing and management. With our private investments, we do not have the ability to sell quickly. This forces us to think much more strategically and longer term.

Of the many issues businesses face, most are transient. They are fixed and forgotten very quickly. Where listed company issues are exacerbated by a melodramatic stock market, a private company and its investors are allowed to be more focussed and rational. Generally, they just get on with running the business. My recent experience as a board member of one of our investee companies has reinforced the idea that time heals most issues.

“This too shall pass” Abraham Lincoln

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Acknowledgements: GK Chesterton, Warren Buffett, Ben Graham, Howard Marks, Chris Tidmore & Andrew Hun (Patience with Active Performance Cyclicality: It’s Harder Than You Think), Seth Klarman, Abraham Lincoln

Patience was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

In Dec 1999 Microsoft traded at a high of $59.62 but didn’t reach that price again for almost 17 years. Adjusting for dividends, shareholders earned a return of just over 1% per annum for 17 years.

One would think this performance is a reflection of a poor business, NO. While they had some challenges, Microsoft’s revenues still grew by an impressive 9.6% pa (avg).

Investing is not as simple as buying good companies. Buffett has suggested that paying too high a price for a great company has the ability of the undoing the effect of the next decades worth of favourable developments.

A share price reflects the expected future performance of its underlying business. Great returns will only be achieved if the business performs better than expected. This performance might be due to growing faster than expected or might even be that the business declined less than expected.

Point being, the share price does not necessarily follow revenues or earnings, especially over short and medium time frames.

The share price is the often overlooked element which determines if the investment is a bargain or a rip-off. Paying too high a price leaves us no margin of safety. It leaves us exposed to losses in an all too common scenario where the business performs poorly relative to our expectations.

On the contrary, a low share price might afford us a wide margin of safety to protect us when the business performance is poor. If the margin of safety is wide enough, it isn’t uncommon to earn a positive return even when the business performs poorly — so long as its performance is better than the implicit negative expectations.

“This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” Warren Buffett

Some might say they are a long-term investor and observe that the Microsoft share price eventually recovered. Some may be patient enough to hold for 16 years poor returns, most wouldn’t. In 2009 (10 years later) the stock was down 74%!! One would be forgiven for giving up — no doubt many did around this time.

In 1999, Microsoft’s share price implied a multiple of 85x current earnings. A multiple in this region is common these days and to me is an aggressive price for any business. A price in this region assumes almost perfect execution, an impossible benchmark. It is far safer to only pay for what there is today not what we hope for the future. Let the upside be the upside, not the justification for the high price.

What is the stock today most at risk of mimicking Microsoft’s performance in the early 2000’s? Which of our market darlings will perform below expectations? Impossible to say for sure but I’m fairly confident there will be a few run backs.

Our experience tells us that bad businesses can make great investments and vice versa. Price matters to us. It determines value — the most essential ingredient to our decisions.

Variant perception

“Invert, always invert: turn a situation or problem upside down. Look at it backward. What happens if all our plans go wrong? Where don’t we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead. Tell me where I’m going to die, that is, so I don’t go there” Charlie Munger

You invest with us to receive greater than average returns. Our fees are structured to ensure we are only rewarded when we deliver above returns.

Variant perception is just a fancy investment phrase for thinking differently.

It seems logical that in order to deliver above average returns, we cannot invest like the average investor. My practical experience has supported this notion that in order to achieve a different return — we have to invest differently.

We are attracted to the ideas which are unique. The market will often overshoot at its extremes. It makes sense to us that a popular investment idea is reflected in a higher (more expensive) price. Vice versa for unpopular or contrarian ideas where value is often created by an overreaction to the downside.

In our experience, it very difficult to find value in a stock everyone seems to like.

Variant perception can come in two forms.

1. Out-of-favour (contrarian) investments. Investments where the consensus view is overwhelmingly negative. This is usually reflected in the media and a large share price decline.
2. Out-of-sight investments. Investments which are fairly obviously attractive but are outside of the lens of most other investors. Large investment firms generally focus their search on the top 200–500 companies in any given stock market. This leaves the overwhelming majority of companies available to us to consider without major competition. Private businesses (especially smaller ones) are also a fertile ground for us because we are often bidding without ANY competition. No competition makes for buyer favoured price discovery.

We are looking for value. It makes sense to us that we are more likely to find them in investments which the market has either hated for some time or hasn’t yet found.

Charlie Munger often talks about the importance of inversion. We try to look at mainstream perspectives and take the opposing view to see what is there. A fertile ground for this at the moment is in and around the environmental debate.

Public sentiment and capital flows is heavily against coal and fossil fuels. This is the right call long term but it has created a significant under-investment in coal and oil projects well before what is prudent. You only need to look at the energy crisis in Europe & the UK to see the unintended consequences of sentiment driven investment policy.

The variant perception in the climate debate makes for some interesting investment opportunities today which we are current taking advantage of.

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Acknowledgements: Charlie Munger, Warren Buffett.

Price matters was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.

Humans have a habit of overweighing recent experiences, this is particularly true of investment results. Jason Zweig’s recent article in the WSJ suggests that US investors expect to make a whopping 17.3% over the next 12 months.

I’m sure we can all recall a recent conversation with someone expressing over-confidence around their investment ability. This is typical during bull markets and vice versa following a market correction.

“After seeing a movie that dramatizes nuclear war, they worried more about nuclear war; indeed, they felt that it was more likely to happen. The sheer volatility of people’s judgement of the odds — their sense of the odds could be changed by two hours in a movie theatre — told you something about the reliability of the mechanism that judged those odds.” Michael Lewis

Being over-confident at any time is dangerous especially when it is founded on recent success. Given the cyclicality of investment markets, is it not more logical that a winning streak brings us closer to a period of weaker returns?

Focus on what we can control

A share price is simply the result of a vote. A short-term forecast is tantamount to guessing the opinions, moods and unique circumstances of thousands of other people. Investors (especially new ones) struggle to recognize the immense margin of error in short-term forecasts.

So if we have little (no) control over short-term results, why place any specific expectations on them? “Expectations outside of reasoned choice leave you fragile, rigid, and reactive” Alex J Hughes in the Daily Stoic.

Jeff Bezos is well-aware of the psychological impact of investment returns. He advises his staff to ignore short-term movements in Amazon stock… “When the stock is up 30% in a month, don’t feel 30% smarter. Because when the stock is down 30% in a month, it’s not going to feel so good to feel 30% dumber.”

By removing expectations we are better able to focus on repeating the types of decisions which we are confident will deliver us our objective, that is, to max out returns while avoiding any permanent capital losses.

I know this statement is on repeat but it’s important. We measure our effectiveness over a 3–5 year period and we are grateful that you (our investors) provide us the slack to do so. Your patience is our competitive advantage.

Now is the time for caution — not over-confidence

It is true that we would love this streak to continue. Strong returns provide a utopic sensation that is addictive. Have you ever noticed that you check your share prices more often when your portfolio is up?

We humans have a tendency to be over-confident anyway. Charlie Munger quotes Demosthenes “what a man wishes, that also will he believe”. There is a force that drives people to believe the stock market, casinos or lotteries is a source of quick riches. Being aware of our inclination to be over-confident is helpful — especially today.

Strong returns are a trap. Because they feel so good, we get a false sense of security which can blind us. It is well understood that investors are far more risk averse following a large correction. It’s important we recognise the opposing effect of a bull market. Now, more than ever, we need to be cautious.

Despite the short lived (COVID) correction, we have enjoyed a 12 year bull market. Given we are clearly at the market’s historical extremes, it seems reasonable to us that we are nearing the end of this fabulous run (at the very least we are closer to the end than the beginning).

Despite this we are witnessing an unprecedented bias to risky investing. This optimism is being fuelled by low interest rates and an expectation the good times will just keep on rolling. News flash — they won’t.

A colleague suggested he would gladly borrow at 8% to invest. They suggested that generating a return of +15% is ‘easy’. Humans have a habit of confusing returns achieved in the short-term, with long-term incompetence.

“Only when the tide goes out do you discover who’s been swimming naked” — Warren Buffett

We have all had a great time over the past decade being rewarded handsomely for almost any financial decision we make. Instead of extrapolation, let us do more consolidation.

On a ride last weekend I didn’t pack my spare tyre. My saddle bag had broken and it was inconvenient to hold the spare on me. I hadn’t had a puncture in a year so I was feeling lucky. Needless to say, I got a puncture and my lacklustre approach to an obvious risk cut my ride short.

Warren Buffett’s success was not determined by any single result, rather his ability to protect and compound over decades. It’s relatively easy to make money in the good times but extremely difficult to do it across multiple cycles.

This period of easy returns has attracted all kinds of people to the investing game. The proportion of the population owning shares is the greatest it has ever been — a typical feature of any late stage bull market. What is also typical is that when the tide eventually turns, there will be less investors.

The question I regularly ask myself is whether we will be one of those washed away, or, one of the few left standing? Our priority is to protect and grow. One objective doesn’t survive without the other.

I’m confident that the principles set out in these letters will achieve that for us.

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Acknowledgements: Shane Parrish, Charlie Munger, Alex Hughes, Jeff Bezos, Michael Lewis.

Bias to recent events was originally published in Look Down, Not Up on Medium, where people are continuing the conversation by highlighting and responding to this story.