In an interview a few years ago, Elon Musk responded to a question on what had enabled him to innovate so effectively by saying: "I think it's important to reason from first principles rather than by analogy. The normal way we conduct our lives is we reason by analogy. [With analogy] we are doing this because it's like something else that was done, or it is like what other people are doing. [With first principles] you boil things down to the most fundamental truths... and then reason up from there". (He might also have added that, unlike many others, he has not been constrained by the need to generate a positive return on capital, but I digress).
Thursday, 29 August 2019
Thursday, 15 August 2019
It is fashionable amongst the value investing community these days to hold a concentrated portfolio of high conviction ideas. Indeed, any other approach is usually greeted with suspicion, if not outright disdain. And yet, in my experience, often some of the very best investment opportunities exist in areas of the market where one is intrinsically capable of only low levels of conviction, extending to situations where a zero is a reasonable possibility. Obviously, smaller position sizes and a more diversified approach is warranted with such situations, but on a portfolio basis, they can yield a portfolio with very agreeable risk/reward characteristics - indeed uniquely so I would argue, given how few value investors are adopting such an approach in today's world.
Wednesday, 14 August 2019
The history of financial markets makes it abundantly clear that empirically, P/E multiples have sharply compressed during periods of high inflation. This has confounded many observers, who argue that stocks are real assets, and therefore that P/E multiples ought not change during periods of high inflation. Indeed, seemingly confirming the theory, nominal EPS growth has been significantly higher during periods of high inflation. US Market EPS growth, for instance, was much higher in the inflationary 1970s than the relatively low-inflation 1980-90s, despite much poorer economic and financial market performance. The latter occurred because multiples sharply compressed. Is this a major inefficiency?
We have currently reached the point in this (unusual in many respects) cycle where many investors/commentators have started to question whether profits no longer matter, and also whether value investing is dead. As is often the case, the arguments put forward in the affirmative derive mostly from recent market experience/outcomes, rather than reasoning from first principles. Hyper-growth (and generally loss-making) tech companies have seen outsized share price gains (or when privately-held, significant valuation up-marks), with many recent IPO vintages also seeing triple digit gains, despite the absence of any profits either in the past or foreseeable future, in echos of the dot.com bubble. Meanwhile, many profitable and cash-generative companies with low growth, and especially with (even marginally) falling earnings/revenues, have been absolutely massacred.