[The Weekend Bulletin] #120: Robert Wilson, Ted Weschler, Quality Businesses, ...
...Resulting, Exercising, Rich vs Wealthy, and more.
A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.
Section 1: Investing Wisdom
Investing in high quality - wide moat - businesses has become a very popular strategy. This is especially true in a country like India where an entire decade of low growth and low inflation pushed everyone towards high quality consumer businesses (as that was the only segment that grew at a reasonable rate). Today, investing in quality businesses is being touted as the only investment strategy by some. While it is indeed a good investment strategy, it remains misunderstood. As this article explains: high quality businesses can generate high returns under the right conditions, but their best feature is safety.
Robert Wilson falls under the title of “the greatest investor you’ve never heard of.” He turned $15,000 into $230 million from 1958 to 1986 - a stunning 41% CAGR. Wilson was a long/short investor who wasn’t afraid to use leverage. His is an interesting journey that culminates in to an important lessons for all investors - never let success go to your head. This article discusses one of his biggest losses, and also reproduces an interview that he gave towards the end of his career. (Interestingly, the interview also featured John Templeton and Warren Buffett. It's interesting how each of them had a different investment philosophy and yet found success - an important lesson for younger investors. You can watch the whole interview here).
Here is an interesting conversation with Ted Weschler, who along with Todd Combs manages the investment portfolio at Berkshire Hathway. The podcast talks about Ted's two lunches with Warren Buffett leading to the offer to work at Berkshire. It also traces Ted's earlier investment journey, and later talks about his reading habit. A well rounded conversation. (If you are pressed for time, this thread has some highlights from the conversation).
Section 2: Mental Models & Behavioral Biases
We often weigh the same information differently. For instance, if a lesser known investor gave you a stock idea, chances are you'll not pay much attention. However, if a well known investor explained the same idea to you, you'd want to act on it. The idea is the same, however, where it comes from matters. This is because we believe that the well known investor's process is superior to the lesser known investor, simply from the fact that the former is more successful and hence well-known. This belief in the strength of a process based on the outcome is a behavioural bias called Resulting. This short article explains it very well using the example of Netflix.
Section 3: Personal Development
We seems to be the most focused on exercise compared to history. And rightfully so - the importance of exercise cannot be overstated. However, maybe we have the concept of exercise wrong in our head, claims this article. It quotes the example of Japan - a country with low obesity rates and a leader in longevity - that has not much of a workout culture. Does this mean that exercising has no impact on life span or weight loss? Read on to find out.
The distinction between rich and wealthy is increasingly gaining popularity. Rich is a narrow definition of one's status based upon the money that she possesses. Wealth on the other hand has a more philosophical bent. Wealth has more to do with independence and freedom, rather than just money. Going by these definitions, you could be wealthy but not rich, or vice versa. This article looks at the history of one of the richer families to drive this point.
Section 4: Blast From The Past
Revisiting articles from a past issue for the benefits of refreshing memory and spaced repetition, as well as for a fresh perspective. Below are articles from #46:
In last week’s issue, we looked at Henrik Bessembinder’s research around the performance of tech companies. He followed up that paper with an even more interesting one. For this paper, he looked at some so of the best and worst performing stocks over a decade (in terms of percentage returns as well as absolute wealth created) and tried to identify factors that separate the good ones from the not so good ones. As far as research papers go, this one is really simple to read, not very lengthy, and tabulates the findings for easy reference. I would therefore encourage you to read the whole paper here, or you can read a short article around it here.
As to why great businesses do not always turn into great investments, there are two issues that Henrik’s research identifies.
The first is that while the certain common characteristics are indeed observed in well performing stocks over a decade, these characteristics are more backward looking than forward. In order to study the predictive power of some of these characteristics, Henrik studies the characteristics of these firms in the decade prior to them being high return firms. He then compared them with the not-so-well-performing firms, and found that:
It can be observed that firms with the highest annualized shareholder returns in a given decade are often broadly similar to those that appear in the “Non-200” list in terms of average prior-decade characteristics. In particular, the firms that go on to deliver Top-200 returns in the following decade are, on average, within ten percent of “Non-200” firms in terms of growth in total assets, organic asset growth, as well as growth in current, fixed, and other assets, asset turnover, debt-to-asset ratio, and market-to-book equity ratio at the end of the prior decade…
…While the observable characteristics studied here had statistically significant forecast power for extreme positive and negative decade-horizon returns between 1960 and 2019, more than 98% of the variation in outcomes remains unexplained. The key open question is what portion of the unexplained variation can in principle be predicted by other (perhaps subjectively assessed) characteristics such as management quality, and what portion is purely random and therefore will prove impossible to predict?
You can read the paper here
The second issue is what Henrik started this series of papers with. His research found that the best performing firms also had large draw-downs during short periods, both during the decade of their performance and the prior decade. Investors in great businesses thus not only need a long investment horizon, but also need to stomach sharp drawdown in shorter periods. His research can be found here. You can also read it in an article form here.
Moving from first principles to second order thinking, there is a fine line that differentiates a good business from a great one. If 10% of all businesses are good, then the greats ones are probably just 1%. This article talks about what makes a company great, and why good is not good enough.
Driving the point of legacy moats further, is Mark Walker of Tollymore Investment Partners in this interview on finding great stocks. He also reiterates Henrik’s findings that moats are often difficult to identify pre-mortem, and that past business performance need not sustain in the future. Some of his best investments, he says, are in businesses that were written off by investors as low moat businesses.
So if I look at the contributors to Tollymore's results and the detractors from Tollymore's results, the major contributors are from businesses which at first sight are written off as low quality businesses and that is due to usually a faulty heuristic and an inability or unwillingness to interrogate the business quality from first principles.
So for example you know investors have written off you know Tropanion as an insurance company with a heuristic associated with insurance companies that they are capital intensive strategy, mature businesses with limited opportunities to internally redeploy capital and constrained addressable markets. And I think that that heuristic has led to a really outsized investment opportunity and really if you think about the components of that company's value chain and how they cumulatively manifest in this really phenomenal business then you can kind of avoid that heuristic.
Likewise you know one of our largest holding Gym group is an old economy operationally geared financially leveraged business selling discretionary services with very high churn in a world which is enamored with high multiple of sales SAAS companies and big tech. And so if you succumb to being a victim of this sort of potential bubble and buzzwords by becoming overly enamored with these labels, if you're not interrogating from first principles what a good business is and what a poor business is.
So those types of opportunity have contributed strongly. Then what we've done badly in two main areas:
one is where we've identified obvious excellence and we've become enamored by this beautiful you know financial history going back 10/20/30 years of extraordinary consistent super normal profit generation;
and the second area is in what's often called legacy-moat type companies.
Section 5: Readworthy Passage
Let's read together a random, but read-worthy, passage from a randomly picked book.
If you were living in 1950 and had chest pain, your cardiologist might well have suggested a procedure for angina pectoris called internal mammary artery ligation. In this operation, the patient is anesthetized, the chest is opened at the sternum, and the internal mammary artery is tied off. Voilà! Pressure to the pericardiophrenic arteries is raised, blood flow to the myocardium is improved, and everyone goes home happy.
This was an apparently successful operation, and it had been a popular one for the previous 20 years. But one day in 1955, a cardiologist in Seattle, Leonard Cobb, and a few colleagues became suspicious. Was it really an effective procedure? Did it really work? Cobb decided to try to prove the efficacy of the procedure in a very bold way: he would perform the operation on half his patients, and fake the procedure on the other half. Then he would see which group felt better, and whose health actually improved. In other words, after 25 years of filleting patients like fish, heart surgeons would finally get a scientifically controlled surgical trial to see how effective the procedure really was.
To carry out this test, Dr. Cobb performed the traditional procedure on some of the patients, and placebo surgery on the others. The real surgery meant opening the patient up and tying up the internal mammary artery. In the placebo procedure, the surgeon merely cut into the patient’s flesh with a scalpel, leaving two incisions. Nothing else was done.
The results were startling. Both the patients who did have their mammary arteries constricted and those who didn’t reported immediate relief from their chest pain. In both groups, the relief lasted about three months—and then complaints about chest pain returned. Meanwhile, electrocardiograms showed no difference between those who had undergone the real operation and those who got the placebo operation. In other words, the traditional procedure seemed to provide some short-term relief—but so did the placebo. In the end, neither procedure provided significant long-term relief.
....
IN GENERAL, TWO mechanisms shape the expectations that make placebos work. One is belief—our confidence or faith in the drug, the procedure, or the caregiver. Sometimes just the fact that a doctor or nurse is paying attention to us and reassuring us not only makes us feel better but also triggers our internal healing processes. Even a doctor’s enthusiasm for a particular treatment or procedure may predispose us toward a positive outcome.
The second mechanism is conditioning. Like Pavlov’s famous dogs (that learned to salivate at the ring of a bell), the body builds up expectancy after repeated experiences and releases various chemicals to prepare us for the future. Suppose you’ve ordered pizza night after night. When the deliveryman presses the doorbell, your digestive juices start flowing even before you can smell the pie. Or suppose that you are snuggled up on the couch with your loved one. As you’re sitting there staring into a crackling fire, the prospect of sex releases endorphins, preparing you for what is to come next, and sending your sense of well-being into the stratosphere.
In the case of pain, expectation can unleash hormones and neurotransmitters, such as endorphins and opiates, that not only block agony but produce exuberant highs (endorphins trigger the same receptors as morphine). I vividly recall lying in the burn ward in terrible pain. As soon as I saw the nurse approaching, with a needle almost dripping with painkiller, what relief! My brain began secreting pain-dulling opioids, even before the needle broke my skin.
- From PREDICTABLY IRRATIONAL by Dan Ariely
Quotable Quotes
"The most important battles must be fought anew each day.
Exercising today does not render tomorrow's workout unnecessary.
Supporting your spouse today does not mean you can mail it in tomorrow.
Learn to love the endless nature of things and life gets easier."
- James Clear
“We are like books. Most people only see our cover, the minority read only the introduction, many people believe the critics. Few will know our content.”
- Émile Zola.
* * *
That's it for this weekend folks.
Have a wonderful week ahead!!
- Tejas Gutka
[May 07, 2022]