[The Weekend Bulletin] #73: Pricing Power and Other Aspects of a Good Business...
...Giverny Capital + Fancois Rochon, Aliens+Jedi+Cult, Fake Art, Incentives, 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
"The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business."
Those are wise words of the Oracle of Omaha. Clearly, the importance of pricing power cannot be undermined. This post looks at pricing power in the context of some businesses that have it in abundance.
While pricing power is a powerful tool to identify a good business, it is but only one of the many tools that help differentiate a good business from a not so good one. The following two part twitter thread lists a number of variables that make a business good, and also provide a nifty scoring model that can be used as a screener to shortlist good businesses [Part 1; Part 2].
The following infographic summarises some of the characteristics of a good business:
A quantitative scoring model measures the results rather than the inputs. In other words, while factors like high return ratios, strong cash flow generation etc characterise a good business, these numbers are outcomes that are driven by a number of soft factors that cannot be screened for. These are aspects of the business that shape it over a long period of time (think decades). In this post, Chris Mayers - author of the book 100-baggers, discusses some such soft factors that he has observed in his research.
Giverny Capital's Annual Letter to Investors make for an interesting read. Apart from great content, what I really like about their letters is the way they are structured - each letter has a section that compares long term returns with growth in intrinsic value of the business, another one that revisits some past decisions, and also one that celebrates three of their gravest mistakes each year. We could all do very well to adopt this format in evaluating our own investment decisions - publicly or privately. The other interesting aspect of the letter is usually its cover which carries an artwork from their corporate office and how it relates to the prevailing conditions each year. As for the current year, the letter draws some pertinent observations on the prevailing valuations in the market and also carries a fun (but educating) section on some stock market equations inspired from the physicist Maxwell's.
If you are looking for more thoughts from the man behind the firm, this recent interview of Francois Rochon will make for an interesting read.
Asymmetric investments - high returns or a total loss of capital - are extremely risky ventures and are generally not advised. However, using an interesting mental model and some innovative structure (replacing money with time), the author of this post was able to make a number of asymmetric investments. An interesting read, although think hard before you leap into something similar.
Section 2: Mental Models & Behavioral Biases
One of the objectives of this section is to understand how the human brain is capable of fooling itself. In a battle between emotions and rationality, emotions tend to have an upper hand. That is what this article demonstrates while narrating a true story from the world arts. The story also shows that there is very little difference between experts and novices when it comes to falling victims to the the tricks of the mind (and therefore should not fall prey to authority bias - but that is for some other time).
If you enjoy the above story, then you'll also like this recently released movie, 'Made You Look: A True Story About Fake Art' (available on Netflix).
“Never, ever, think about something else when you should be thinking about the power of incentives.”
“Well, I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.”
When one of the most well-read investors, Charlie Munger, appreciates a mental model, you cannot help but pay attention. More importantly, given that incentives drive most of our actions, they cannot be ignored. This short post explains this mental model using some interesting examples.
Section 3: Lessons From History
A lot of financial literature celebrates contrarianism. We love to hear stories of investors that took a stand against the market and eventually came out winners. While these stories make for very interesting read, and also sound inspiring, what they mask is the pain that investors suffer in taking such a stand. One of the most famous recent stories of contrarianism is that of Micheal Burry (The Big Short) who correctly predicted and profited from the 2008 housing crisis. Though he made his investors lots of money in the end, these same investors experienced excruciating losses in the short term while they waited for the housing market to collapse (some even threatened to sue). As a result, none of Burry’s investors said thank you when the dust finally settled. In order to understand the agony that an investor suffers in taking a contrarian view to the markets, I invite you to read this post that reproduces short paragraph's from Seth Klarman's letters preceding the tech bust. It is for going through this agony that Seth Klarman is the revered investor that he is. Respect!!
Unfortunately, not all endings are happy. Sometimes, the agony gets the better of the investor. This recent news was a very unfortunate such incident. RIP 🙏🏼.
Section 4: Personal Development
Carrying on from the previous section, sometimes life gets the better of us. We feel the pressure of the world on our shoulders. These testing times feel life they last a life time. Here are two different perspectives that will help ease the burden of the tough times:
The first one comes out of the diary of Marcus Aurelius. It is the internal system that he used to keep push himself to keep moving forward even when the tasks ahead felt like moving mountains.
The second one presents a very interesting lens through which we can see our lives with a fresh perspective. There is a certain loop that exists in our lives, and is similar to something that we have all played with. A long, but interesting read. You will definitely think about your life differently after reading this.
Section 5: Blast From The Past
We consume a lot interesting text in our quest for knowledge. However, with each new byte of data that we feed into our memory, we lose some bit of old information that was held. Even without the addition of new information, our memory regularly cleans our information that is held deep and not often retrieved. It is for this reason that re-reading old texts (books/articles/notes) is highly recommended.
There are other advantages to re-reading. Spaced repetition for one - when we revisit some old material, it is etched better into our long term memory. More importantly, as we gain more experiences in life, re-reading an old text can provide some fresh perspectives that we may have missed while reading earlier. It is to reap these benefits that, starting with this issue, we'll revisit a select few articles from an earlier issue.
This one is meant to be consumed slowly - like a good single malt or a well aged wine. And like with most good spirits, you'll keep coming back for more. A summary of over two decades of communication from a man who ran a business with 55 consecutive years of profits - yes, you read that right, 55 consecutive years!!
Quotable Quotes
* * *
That's it for this weekend folks.
If you enjoyed reading this issue → please hit the like button
If you have any feedback/interesting articles that you’d like to share → simply reply to this email/leave a comment below.
Have a wonderful week ahead!!
- Tejas Gutka
[May 01, 2021]