This week's interesting finds

June 29, 2019

Next will be net store closures? Real estate implications 

• The rise of online sales has triggered a re-allocation of capital from retailers
• Walmart, for instance, is only selectively expanding their network
• The company, however, is investing more in IT, supply chain and innovation
• Interestingly, it is also investing more to upgrade and transform its existing stores

Banks’ cash return yield

Most predictions turn out to be wrong.

In 1967, the Keuffel & Esser Co. commissioned a study of the future. Keuffel & Esser was a leading manufacturer of slide rules and was thought to be ahead of the curve in innovation. Their "visionary" study ended up being a huge dud, with most of their predictions being completely wrong. One thing they failed to predict was that within five years the company's own slide rule would be obsolete, falling victim to the electronic calculator. Keuffel & Esser would cease production only a few years later.

Steven Schnaars wrote a book “Megamistakes” that goes over the story of Keuffel & Esser and countless other examples of predictions that turned out to be very wrong. His message in the book was simple. Don’t be fooled by prevailing opinion, and don’t extend trend lines into the future. Instead, challenge your assumption and think for yourself. Work hard to distinguish fad from growth markets.

Today's low interest rates mean the risk is on and caution is old-fashioned. Companies selling at 20 times revenues instead of earnings (Beyond Meat is at 43 times its 2019 sales forecast, and Tableau Software recently sold for 16 times its 2018 revenue.) How long will this last?

Failed bond yield predictions

The makeup of the world’s largest companies from 1999 to 2019

Brand loyalty and online shopping trends: Shopify’s State of Commerce Report

• 73% of North American respondents agree that once they find a product or brand they like they stick with it. 
• 36% of North American respondents agree that they often buy things to cheer themselves up. 
• Americans shop most frequently, Germans the fastest, and Japanese shoppers are the biggest spenders. 
• November is the most popular shopping time worldwide. This is likely due to big retail events like Black Friday, Cyber Monday, Singles Day and pre-holiday shopping.

Investment Placebo Effect

• The placebo effect is both fascinating and real, with compelling evidence of its impact in both a medical and marketing context. What about in the investment context?
• An investment placebo is an activity or action taken to make us feel better when there is no evidence that it will have a positive impact. Often investors feel better over the short-term as they satisfy that urge to act and do something when the market makes its volatile swings. In the investment industry, there is a strong preference for action over inaction amidst the incessant news flow, erratic price fluctuations and obsession with the latest headline risk, the urge to do something can be irresistible. What if things go wrong and I have done nothing? How can I just sit here when all of this is happening?
• While placebos in other areas can actually deliver a positive end outcome, in investing these activities do not assist in meeting our end objectives and in fact, often come at a long term cost. 

Announcing the winner of the EdgePoint Photo Contest, Part III-Even Furrier: Olivia (and Winston)

This week's interesting finds

June 22, 2019

Check out our Investment team’s latest summertime reading & listening picks (Here) 


Early stages...but the value in Japan will start to get recognized if this continues

The Japanese stock market is one of the most inefficient in the world, largely because corporate governance has been bad for a very long time. But if the corporate governance reforms stay on the right track the value in Japan could start to get recognized.

Management and investors are slowly embracing dialogue as seen by the increase in the number of shareholder proposals at shareholder meetings. Another positive sign is the increase in the number of foreign activist funds in Japan which can push to continue corporate governance reforms.

Stability is being highly prized

The market is willing to pay higher prices for large-cap companies with the highest fundamental stability scores. Fundamental stability score is a measure of the volatility of the key financial metrics.

Advising professional athletes
Finding real financial advice can be difficult for professional athletes as many “yes men” only associate with these athletes for self-serving reasons.

One guy who seems to be doing right by his clients is a former Arizona college basketball player Joe Mclean. Joe manages the wealth of professional athletes, including big names like Klay Thompson. McLean’s main goal is to help his athletes achieve long-term financial stability and avoid the financial pitfalls many athletes with a lot of money fall into.

To retain his services, each player must agree to put aside at least 60% of every dollar he earns, with the rate climbing to 80% if he’s fortunate enough to land a long-term deal. Or they’re gone. Mr. McLean has fired two clients for ignoring the policy. He hates it, because “in my mind, it means I’m giving up on them,” he said. “But they didn’t buy into it.”

None of us will ever have to worry about how to make our 9-figure contract last a lifetime, but there are a few lessons from Joe McLean’s story that apply more broadly to financial management.

Making your money last
In the US, the average 65-year-old has enough savings to cover about 9.7 years of retirement income (8.3 years for men and 10.9. years for women). In Japan, this number jumps to 15 years for men and almost 20 years for women.

Japanese workers are good savers so why do they have the largest gap? First, they tend to live much longer than the rest of the world and second, they avoid return-seeking assets, so the amount they do save ultimately produces few gains over time.

GE's new CEO, Larry Culp is attempting the largest "turnaround" in American history
For the first time in its 126-year history, an outsider will lead GE to attempt to clean up a mess that took decades to create. Larry Culp is a proven leader and mostly known for transforming Danaher Corp. from an industrial manufacturer into a science and technology firm. Culp took the helm at Danaher at the age of 37 in 2001 and quintupled the company’s revenue over the next 14 years.

He now faces a monumental task to restore GE to its former greatness. Since taking over in October 2018 he has avoided the company’s Boston headquarters and opted for frequent visits to GE units around the world. Gary Wiesner, who runs GE’s wind-turbine-blade factory in Florida, was shocked to get an email from the new CEO. Larry Culp wanted to stop in and walk the factory floors, something that hadn’t been done by a GE executive in over 18 years.

Raptors and Noodle champions 

This week's interesting finds

June 15, 2019

What share of public companies have interest coverage below parity in China?

It's estimated that 15% of Chinese bank loans will be non-performing in the next credit cycle. This would be worse than any previous US crisis but on par with the late 1990s Asian debt crisis in Korea.

The diversity of the Chinese customer base

Chinese exports to all destinations are up 6% YTD in 2019 with exports to the U.S. down about 5%. The US is only 1/7th of all Chinese exports allowing overall Chinese export growth to hold up.

Howard Marks Memo: This Time It's Different

Howard Marks rarely attends a meeting these days where someone doesn’t propose a new theory of why this market cycle could be different. Mark’s latest memo broaches this very topic where he outlines nine of these hypotheses that have become far too prevalent among investors:

• There doesn’t have to be a recession
• Continuous quantitative easing can lead to permanent prosperity
• Federal deficits can grow substantially larger without becoming problematic
• The national debt isn’t worrisome
• We can have economic strength without inflation
• Interest rates can remain “lower for longer”
• The inverted yield curve needn’t have negative implications
• Companies and stocks can thrive even in the absence of profits
• Growth investing can continue to outperform value investing in perpetuity

What do all nine of these theories have in common? That’s easy: they’re optimistic. Each one provides an explanation of why things should go well in the future, in ways that didn’t always go well in the past. Mark argues that it should be very worrisome if these are the guiding principles of investors today. It’s important to keep up with current developments and those that will shape the future, but it’s also important to not unlearn the lessons of the past.

How elite NBA athletes handle pressure

From Larry Bird's nausea to Stephen Curry's butterflies, throughout history, the NBA’s brightest stars have had to manage and learn from pressure in a variety of ways.  The most elite basketball players are not immune to stress but instead mastered how to channel it, and in some cases thrived from it.

The truly great ones know there's pressure, so they don't consider consequences. If they did, they'd cave all the time. If you succumb to those consequences, you will never reach your potential. Just like with refining your shooting stroke, the more reps under pressure and stress, the more your body will learn to cope.

The second half of humanity is joining the internet

Today, over 50% of the planet’s population is online, a mere quarter of a century after the web first took off among tech-savvy types in the West. Most of the recent growth in users has come from the emerging world where 726 million people came online in the last 3 years. Countries like China are still growing fast, but much of the rise is coming from poorer places, notably India and Africa.

As these countries come online businesses now have access to a vast pool of new customers. The one challenge here is that most of these new users are too poor to spend very much.

For example, the average Facebook user in Asia generates only $11 of advertising revenue a year, compared with $112 for a North American user. The combined revenue of all the internet firms in emerging markets (excluding China) is perhaps $100 billion a year. That is about the same as Comcast, America’s 31st-biggest listed firm by sales.

Flocking climbers and investors

Climbers are flocking to Mount Everest, making for increasingly dangerous climbing conditions as inexperienced climbers crowd the peak.  In 2019 at least 11 people have been killed on the mountain, which is the highest death toll since 2015. Why the sudden rush? People didn’t suddenly become braver and the mountain didn’t become less steep.  What happened was a slow but steady amount of progress in the technology and equipment needed to make the climb, thus opening the way for more and more people to attempt it.

Climbing Mount Everest still has cache, of course, but compared to ten years ago? Or 30 years ago? Not really. More and more are reaching the peak every year.

We see this phenomenon play out in the investment markets all the time. The first people to discover something exploitable and profitable are treated better than the subsequent people that come rushing in. This is what crowds do to opportunities. No matter how good you are, if what you’re doing is very profitable, others will copy you and will be “good enough” to impinge on your game. Which is why the best investments are those with moats – companies that are so good at something that their abilities and assets literally act as a barrier to those who would follow and imitate.

EdgePointers celebrate the Toronto Raptors' unbelievable NBA championship!

Weekend catch-up

We heard your feedback and we don’t want to clutter your inboxes. We’ll proceed with posting our collection of reads on Inside Edge on a weekly basis. On Saturday mornings, pour yourself a mug of coffee, get comfortable and enjoy a few of the most interesting pieces that we came across during the week.

Interview insights from Graham & Doddsville quarterly issue 

Yen Liow discusses compounding and durable businesses. 
Compounding is the most important framework in investing. Your business model, portfolio and structure should be built around it. You must find durable compounders which are businesses with a substantial and repeatable advantage that allows them to grow more briskly than the broader market.

How do you find these durable compounders? Many believe that they need the largest possible investment universe to find opportunities when in fact the opposite is true. You need to find a rich vein of repeatable inefficiency in a finite universe that you can focus on, so when price dislocation occurs you can exploit it.

Most of the market will revert to the mean over time as excess profit gets eroded away by competition. Focusing on the small percentage of stocks that resist the mean-reversion forces is where you should spend all our time and resources. These are called durable growth businesses. Durable growth businesses are often more predictable businesses because history often holds when faced with new dynamics. Businesses or industries where there is a loose link between history and the future are often defined as lower quality, as your ability to find repeatable situations is low. 

Our job is to find situations where history does hold and to constantly ensure that new dynamics and threats do not jeopardize the durability of that moat. When the moat breaks down, our ability to predict breaks down.

When your ability to predict breaks down, it is hard to know what to do with volatility. Is it an opportunity or is it risk? When your portfolio is highly durable and volatility hits, at worst you know to hold through, and at best you know to exploit it.

Q&A with Howard Marks

What are qualitative measures you use to take the temperature of the market? 
You want to assess the emotion that is prevalent in the market. When investor optimism is high, assets tend to sell above their intrinsic value.

When people are more concerned about FOMO then the fear of losing money then you must assume that prices will be high relative to intrinsic value.

When bullish prognosticators are in high demand on TV, when bullish books are written, when financial articles tout the last great time to buy before things go to the moon or when first-time fund managers easily raise funds. All these things are strong qualitative indicators of a hot market and that investor emotion is running high.

Timing the market is impossible, so to what extent can you predict market cycles if the timing is unknown?

The pattern of a cycle can be understood. We can have a sense of when we are high in a cycle or low in a cycle. We can have a sense that something will happen, but we will never know when.

If we believe a security is overvalued, we will either underweight it or eliminate it entirely from the portfolio. When a security is overvalued in our estimation it is more likely to go down then up, but we will never know when it will go down.

If overpriced meant that a stock will go down tomorrow, then nothing would ever become overpriced. In the real world, we see things go from overpriced to more overpriced to maximally overpriced. That’s how we get bubbles which proves that prices are not self-correcting.

We sometimes understand what’s going on in the market and understand its implications for the future, but we never know when these implications will take effect.

Returns are almost never average
It seems rational to assume that stock and bond market returns would be clustered around the average with a few outliers. If we go back to 1926 we clearly see this is not the case. The average return for stocks during the 92-year period from 1926 to 2017 was 10.3%. How many times during those 92 years do you think the annual return fell between 8% and 12%? Incredibly, that only happened 6 times based on the chart below.

Why do investors underestimate their vulnerability to bias?
Below are five (of many) possible explanations:
Overconfidence: Our belief that we are better than others is probably the most obvious explanation; this issue is exacerbated for professional investors as there is undoubtedly a selection bias into fund management roles toward those with exaggerated levels of confidence in their own capabilities.

Cognitive dissonance: Whilst the overconfidence explanation focuses on how we perceive ourselves relative to others, cognitive dissonance is focused on how we judge ourselves internally.

Too complex / too difficult: It may simply be a case that dealing with personal biases is too difficult.

Personal narratives: When objectively and dispassionately observing another person’s investment decisions it is often easy to identify the potential biases that are likely to be influencing their judgment.

The sales message: Perhaps the reticence of professional investors to engage with their own bias is related to a general reluctance to acknowledge mistakes.


None of these potential justifications are a reasonable excuse for understating our own behavioural limitations or failing to actively mitigate them. Given how few genuine edges are available in the investment industry, it is baffling that this one remains widely neglected.

What Buffett’s short-termism critics don’t tell you 

There are still critics today claiming Buffett's old-school style won't last in today's “new era” of investing and that Mr. Buffett has lost his edge.

In today's climate of short-termism, the demand for immediate results makes it hard to preach Buffett's long-term style of investing. Lagging the S&P 500 Index in recent years just gives those pundits something to talk about but their arguments don’t hold any truth when evaluating Berkshire’s performance over the longer periods. If you had purchased $100 worth of Buffett’s stock in 1987 it would be worth more than $8,000 today. The same investment in an ETF tracking the S&P 500 Index would have earned you $1,700. Almost 80% less in 32 years.

Many compare Buffett's performance against bull market cycles and willingly leave out how Buffett performed during bear markets. The graph below shows that Buffett outperformed the S&P 500 Index in all of the last three bear-bull market cycles.  Berkshire lost only 41% in the 2007–2009 financial crisis, while the index fell 51%. In the 2000–2002 dot-com debacle, when the S&P 500 Index collapsed 45%, Buffett pulled off a gain of 28%. Without loading up on tech stocks, his portfolio outperformed.

Jeff Bezos - Big ideas

What we’re really focused on is thinking long-term, putting the customer at the center of our universe and inventing. Those are the three big ideas to think long-term because a lot of invention doesn’t work. If you’re going to invent, it means you’re going to experiment, you have to think long-term.

We don’t take a position on whether our way is the right way, we just claim it’s our way. Bezos quotes one of Warren Buffett's sayings, “You can hold a ballet and that can be successful and you can hold a rock concert and that can be successful. Just don’t hold a ballet and advertise it as a rock concert. You need to be clear with all of your stakeholders, are you holding a ballet or are you holding a rock concert and then people get to self-select in.” 


You can’t skip steps, you have to put one foot in front of the other, things take time, there are no shortcuts but you want to do those steps with passion and ferocity.

From the Bond desk: 
New all-time low in 10-year German bund yields at -0.20%

Long-term thinkers

May 31, 2019

What Buffett’s short-termism critics don’t tell you 

There are still critics today claiming Buffett's old-school style won't last in today's “new era” of investing and that Mr. Buffett has lost his edge.

In today's climate of short-termism, the demand for immediate results makes it hard to preach Buffett's long-term style of investing. Lagging the S&P 500 Index in recent years just gives those pundits something to talk about but their arguments don’t hold any truth when evaluating Berkshire’s performance over the longer periods. If you had purchased $100 worth of Buffett’s stock in 1987 it would be worth more than $8,000 today. The same investment in an ETF tracking the S&P 500 Index would have earned you $1,700. Almost 80% less in 32 years..

Many compare Buffett's performance against bull market cycles and willingly leave out how Buffett performed during bear markets. The graph below shows that Buffett outperformed the S&P 500 Index in all of the last three bear-bull market cycles.  Berkshire lost only 41% in the 2007–2009 financial crisis, while the index fell 51%. In the 2000–2002 dot-com debacle, when the S&P 500 Index collapsed 45%, Buffett pulled off a gain of 28%. Without loading up on tech stocks, his portfolio outperformed.

Jeff Bezos - Big ideas

What we’re really focused on is thinking long-term, putting the customer at the center of our universe and inventing. Those are the three big ideas to think long-term because a lot of invention doesn’t work. If you’re going to invent, it means you’re going to experiment, you have to think long-term.

We don’t take a position on whether our way is the right way, we just claim it’s our way. Bezos quotes one of Warren Buffett's sayings, “You can hold a ballet and that can be successful and you can hold a rock concert and that can be successful. Just don’t hold a ballet and advertise it as a rock concert. You need to be clear with all of your stakeholders, are you holding a ballet or are you holding a rock concert and then people get to self-select in.” 

You can’t skip steps, you have to put one foot in front of the other, things take time, there are no shortcuts but you want to do those steps with passion and ferocity.

Interview insights

May 27, 2019
_________________

Interview insights from Graham & Doddsville quarterly issue 

Yen Liow discusses compounding and durable businesses. 
Compounding is the most important framework in investing. Your business model, portfolio and structure should be built around it. You must find durable compounders which are businesses with a substantial and repeatable advantage that allows them to grow more briskly than the broader market.

How do you find these durable compounders? Many believe that they need the largest possible investment universe to find opportunities when in fact the opposite is true. You need to find a rich vein of repeatable inefficiency in a finite universe that you can focus on, so when price dislocation occurs you can exploit it.

Most of the market will revert to the mean over time as excess profit gets eroded away by competition. Focusing on the small percentage of stocks that resist the mean-reversion forces is where you should spend all our time and resources. These are called durable growth businesses. Durable growth businesses are often more predictable businesses because history often holds when faced with new dynamics. Businesses or industries where there is a loose link between history and the future are often defined as lower quality, as your ability to find repeatable situations is low. 

Our job is to find situations where history does hold and to constantly ensure that new dynamics and threats do not jeopardize the durability of that moat. When the moat breaks down, our ability to predict breaks down.

When your ability to predict breaks down, it is hard to know what to do with volatility. Is it an opportunity or is it risk? When your portfolio is highly durable and volatility hits, at worst you know to hold through, and at best you know to exploit it.

Q&A with Howard Marks

What are qualitative measures you use to take the temperature of the market? 
You want to assess the emotion that is prevalent in the market. When investor optimism is high, assets tend to sell above their intrinsic value.

When people are more concerned about FOMO then the fear of losing money then you must assume that prices will be high relative to intrinsic value.

When bullish prognosticators are in high demand on TV, when bullish books are written, when financial articles tout the last great time to buy before things go to the moon or when first-time fund managers easily raise funds. All these things are strong qualitative indicators of a hot market and that investor emotion is running high.

Timing the market is impossible, so to what extent can you predict market cycles if the timing is unknown?

The pattern of a cycle can be understood. We can have a sense of when we are high in a cycle or low in a cycle. We can have a sense that something will happen, but we will never know when.

If we believe a security is overvalued, we will either underweight it or eliminate it entirely from the portfolio. When a security is overvalued in our estimation it is more likely to go down then up, but we will never know when it will go down.

If overpriced meant that a stock will go down tomorrow, then nothing would ever become overpriced. In the real world, we see things go from overpriced to more overpriced to maximally overpriced. That’s how we get bubbles which proves that prices are not self-correcting.

We sometimes understand what’s going on in the market and understand its implications for the future, but we never know when these implications will take effect.

Investor behaviour

May 27, 2019
_________________

Returns are almost never average
It seems rational to assume that stock and bond market returns would be clustered around the average with a few outliers. If we go back to 1926 we clearly see this is not the case. The average return for stocks during the 92-year period from 1926 to 2017 was 10.3%. How many times during those 92 years do you think the annual return fell between 8% and 12%? Incredibly, that only happened 6 times based on the chart below.

Why do investors underestimate their vulnerability to bias? 

Below are five (of many) possible explanations:
Overconfidence: Our belief that we are better than others is probably the most obvious explanation; this issue is exacerbated for professional investors as there is undoubtedly a selection bias into fund management roles toward those with exaggerated levels of confidence in their own capabilities.

Cognitive dissonance: Whilst the overconfidence explanation focuses on how we perceive ourselves relative to others, cognitive dissonance is focused on how we judge ourselves internally.

Too complex / too difficult: It may simply be a case that dealing with personal biases is too difficult.

Personal narratives: When objectively and dispassionately observing another person’s investment decisions it is often easy to identify the potential biases that are likely to be influencing their judgment.

The sales message: Perhaps the reticence of professional investors to engage with their own bias is related to a general reluctance to acknowledge mistakes.

None of these potential justifications are a reasonable excuse for understating our own behavioural limitations or failing to actively mitigate them. Given how few genuine edges are available in the investment industry, it is baffling that this one remains widely neglected.