Links... and What can go wrong?

"The best way to get what you want is to deserve what you want." --Charlie Munger

Daniel Kahneman on Expertise, Bias, and the Investment Industry [H/T Phil] (video) (LINK)

Ray Dalio at the Aspen Ideas Festival -- Success in Leadership and Life: A Function of Principles (video) (LINK)

Aspen Ideas Festival -- Deep Dive: Leading Transformational Change (video) (LINK)

Little Money Rules - by Morgan Housel (LINK)

Twists and Turns in the Tesla Story: A Boring, Boneheaded Update! - by Aswath Damodaran (LINK)

Rocket Men Precision - by Ben Carlson (LINK)

Related book: Rocket Men: The Daring Odyssey of Apollo 8 and the Astronauts Who Made Man's First Journey to the Moon

The Knock-On Effect Podcast: Rising dollar to unleash unusual ice cream flavors? (LINK) [Interesting topic of vanilla beans, which have risen in price from $20/kilo to about $600/kilo since 2016. It looks like there is also a recent article in the The Globe and Mail (Canada) on the topic.]

How One Number Could Change the Lives of People With a Rare Disorder - by Ed Yong (LINK)

Book of the day: Social Value Investing - by Howard W. Buffett and William B. Eimicke

Also, for Audible members, Pre-Suasion by Robert Cialdini is the Daily Deal today ($3.95).

*****

Posting may be light over the next 7-10 days, so before the weekend, I'll leave you with a little more wisdom from Warren Buffett (via Alice Schroeder) and Tony Deden. I enjoy learning something from one great investor that reminds me of a lesson from another, as it gives one a new perspective on which to build the mental model in one's mind. Deden's discussion in regards to the question "What can go wrong?" reminded me of a story Schroeder told about Buffett's investment in Mid-Continent Tab, when she described Buffett's first filter as being "What can go wrong?" First, the excerpt from Deden, where he made the point using his firm's investment in a salmon business (which I believe is Bakkafrost):

So we have a relatively important stake in the business of salmon farming, for argument's sake. Well, not just myself, perhaps, but we have a team that knows, more or less, everything there is to know about salmon farming literally everywhere in the world. We know what can go wrong. We know where the strengths are. We know where the abilities, where the skill is.    

And not just merely from what will happen in the price of...salmon today or tomorrow, the demand or supply of it, but in terms of those ingredients that contribute to the long-term viability of a business. But we also pay to understand what can go wrong. What can go wrong is really more important than what can go right, because over time, even a marginally good business will profit, will do well.    

So you really need to understand, you don't know what anything is worth until you know what can go wrong. Because we value things differently because we weigh components differently. There's no such thing as valuation metrics based on some standardized formula, unless you see it in connection with other issues.

And then Schroeder's story, from a 2008 talk, about Buffett and Mid-Continent Tab (from a file I have compiled on investing wisdom over the years, but I believe the original source for this excerpt is the CS Investing blog):

So when Wayne Ace and Warren Cleary who were two friends of Warren’s saw that IBM was going to have to divest in this business, and they thought, “We are going to buy a Carroll Press which was a press that makes these cards. And we are going to compete with IBM because we are based in the Mid West, we can ship faster. We can provide better service. And they went to Warren and they said, “Should we invest in this company and would you come in with us? And Warren said, “No.” 

Well, why did he say no? He didn’t say no because it was a technology company. He said no because he went through the first step in his investing process. This is where I think what he does is very automatic but it isn’t well understood. He acted like a horse handicapper. The first stop in Warren’s investing process is always to say, “What are the odds that this business could be subject to any type of catastrophe risk—that could make it (the business) fail? And if there is any chance that any significant part of his capital would be subject to catastrophe risk, he just stops thinking. NO. He just won’t go there. 

It is backwards the way most people think because most people find an interesting idea and figure out the math, they look at the financials, they do a projection and then at the end, they ask, “What could go wrong?” 

 Warren starts with what could go wrong and here he thought that a start-up business competing with IBM can fail. Nope, pass, sorry.  And he didn’t think anymore about it. But Wayne and Cleary went ahead anyway and within a year they were printing 35 million tab cards a month. At that point, they knew they had to buy more Carroll Presses so they came back to Warren and said, we need money—would you like to come in? 

So now, Warren is interested because the catastrophe risk is gone.  They are competing successfully against IBM. So he asks them the numbers, and they explain to him that they are turning their capital over 7 times a year. A Carroll Press costs $78,000 dollars and every time they run a set of cards through and turn their capital over, they are making over $11,000.  So basically their gross profit on a press (7 x $11,000 = $77,000) is enough to buy another printing press. At this point Warren is very interested because their net profit margins are 40%. It is one of the most profitable businesses he has ever had the opportunity to invest in. 

Notably people are now bringing Warren special deals to invest in—it is 1959. He has been in business for 2.5 years running the partnership. Why are they doing that? It is not because he is a great stock picker. They don’t know that. He hasn’t yet made that record.   It is because he knows so much about business, and he started so early he has a lot of money. So this is something interesting about Warren Buffett—people were bringing him special deals like they are today with Goldman Sachs and GE. 

He decided to come in and invest in the Mid-Continent Tab Company but, interestingly, he did not take Wayne and John’s word for it because the numbers they gave him were very enticing. But, again, he went through, and he acted like a horse handicapper. 

Now here is another point of departure. Everyone that I know or knew as an analyst would have created a model for this company and projected out its earnings or looked at its return on investment in the future. Warren didn’t do that. In going through hundreds of his files, I never saw anything that looked like a model. What he did is he did what you would do with a horse….he figured out the one or two factors that determined the success of the investment. In this case, it was the cost advantage that had to continue for the investment to work. And then he took all the historical data, quarter by quarter for every single plant and he obtained similar information as best he could from every competitor they had, and he filled several pages with little hen scratches with all this information and then he studied that information. 

Then he made a yes/no decision. He looked at—they were getting 36% margins, they were growing over 70% a year on a $1 million of sales—so those were the historical numbers. He looked at them in great detail like a horse handicapper would studying the races and then he said to himself, “I want a 15% return on $2 million of sales and said, Yes, I can get that.” Then he came in as an investor. 

OK, what he did was he incorporated his whole earnings model and compounding (discounted cash flow or DCF) into that one sentence.  He wanted 15% on $2 million of sales (a doubling from $1 million current sales). Why does he choose 15%? Warren is not greedy, he always wants 15% day one return on investment, and then it compounds from there. That is all he has ever wanted and he is happy with that.  …You are not laughing, what’s wrong? (Laughs)  

It is a very simple thing, nothing fancy about it. And that is another important lesson because he is a very simple guy. He doesn’t do any DCF models or anything like that. He has said for decades, “I want a 15% day one return on my capital and I want it to grow from there-ta da! The $2 million of sales was pretty simple too. It had a million in sales already and it was growing at 70% so there was a big margin of safety built into those numbers. 

It had a 36% profit margin—he said I would take half that or 18%. And he ended up putting in $60,000 of his personal, non-partnership money which was 20% of his net worth at that time. He got 16% of the company’s stock plus some subordinated notes.   And the way he thought about it was really simple. It was a one step decision. He looked at historical data and he had this generic return that he wants on everything. It was a very easy decision for him. He relied totally on historical figures with no projections.  

I think that is a really interesting way to look at it because I saw him do it over and over again in different investments.