#21 - The Underrated Capability Of Tinkering
On whales as a natural solution to climate change, a new framework for value investing, few rules by Morgan Housel and key ideas by Buffett in 1984 letter to shareholders
Hello,
Greetings from the Curious Cat.
The most common adjective used by journalists to describe successful businessmen is ‘visionary’. Journalists want their readers to believe that businessmen acquire something like a vision which helps them foresee things and that they position themselves accordingly in sync with that future. This positioning helps them reap economic benefits and create value. Very few businessmen would attribute their success to a heady combination of luck, randomness, strategic thinking, good execution, experimenting, listening to feedback, and tinkering. The combination sounds boring and removes the elements of heroism which the adjective ‘visionary' brings to the description.
On similar lines, Nassim Nicholas Taleb in his book, The Black Swan, suggests constant tinkering as a way to benefit from Black Swans, or rare events, because they are hard to predict. He writes,
“The strategy for the discoverers and entrepreneurs is to rely less on top-down planning and focus on maximum tinkering and recognizing opportunities when they present themselves. So I disagree with the followers of Marx and those of Adam Smith: the reason free markets work is because they allow people to be lucky, thanks to aggressive trial and error, not by giving rewards or ‘incentives’ for skill. The strategy is, then, to tinker as much as possible and try to collect as many Black Swan opportunities as you can.”
Tinkering, thus becomes an important capability that professionals need to develop to confront an uncertainty laden world.
So what aspects of your process or product or behavior are you planning to start tinkering?
In today’s edition, we look at -
Nature’s Solution To Climate Change - The Whale
A Few Rules
Value Investing - Requiem, Rebirth or Reinvention ?
Key Ideas from Buffett’s letter to shareholders - 1984
Happy Reading.
Nature’s Solution To Climate Change - The Whale
Read the article here (Read Time ~ 8 mins)
Scientific research now indicates more than ever that our carbon footprint—the release of carbon dioxide (CO2) into the atmosphere where it contributes to global warming through the greenhouse effect—now threatens our ecosystems and our way of life. But efforts to mitigate climate change face two significant challenges. The first is to find effective ways to reduce the amount of CO2 in the atmosphere or its impact on average global temperature. The second is to raise sufficient funds to put these technologies into practice.
Many proposed solutions to global warming, such as capturing carbon directly from the air and burying it deep in the earth, are complex, untested, and expensive. Marine biologists have recently discovered that whales—especially the great whales—play a significant role in capturing carbon from the atmosphere. Whales accumulate carbon in their bodies during their long lives. When they die, they sink to the bottom of the ocean; each great whale sequesters 33 tons of CO2 on average, taking that carbon out of the atmosphere for centuries.
Wherever whales are found, so are populations of phytoplankton. These microscopic creatures not only contribute at least 50 percent of all oxygen to our atmosphere, they do so by capturing about 37 billion metric tons of CO2, an estimated 40 percent of all CO2 produced. More phytoplankton means more carbon capture. In recent years, scientists have discovered that whales have a multiplier effect of increasing phytoplankton production wherever they go. It turns out that whales’ waste products contain exactly the substances—notably iron and nitrogen—that phytoplankton need to grow. Whales bring minerals up to the ocean surface through their vertical movement, called the “whale pump,” and through their migration across oceans, called the “whale conveyor belt”. At a minimum, even a 1 percent increase in phytoplankton productivity thanks to whale activity would capture hundreds of millions of tons of additional CO2 a year, equivalent to the sudden appearance of 2 billion mature trees.
International financial institutions, in partnership with other UN and multilateral organizations, are ideally suited to advise, monitor, and coordinate the actions of countries in protecting whales. Whales are commonly found in the waters around low-income and fragile states, countries that may be unable to deal with the needed mitigation measures. The IMF is also well placed to help governments integrate the macroeconomic benefit that whales provide in mitigating climate change, as well as the cost of measures to protect the whales, into their macro-fiscal frameworks. The World Bank has the expertise to design and implement specific programs to compensate private sector actors for their efforts to protect whales. Other UN and multilateral organizations can oversee compliance and collect data to measure the progress of these efforts.
International institutions and governments must exert their influence to bring about a new mindset—an approach that recognizes and implements a holistic approach toward our own survival, which involves living within the bounds of the natural world. Whales are not a human solution—these great creatures having inherent value of their own and the right to live—but this new mindset recognizes and values their integral place in a sustainable ocean and planet.
A Few Rules
Read the article here (Read Time ~ 3 mins)
Morgan Housel writes few rules which are useful to remember and reflect upon -
Reputations have momentum in both directions
It is way easier to spot other people’s mistakes than your own
Progress happens too slowly to notice, setbacks happen too fast to ignore
History is driven by surprising events, forecasting is driven by predictable ones
History is deep. Almost everything has been done before. The characters and scenes change, but the behaviors and outcomes rarely do.
Don’t expect balance from very talented people
Self-interest is the most powerful force in the world.
Simple explanations are appealing even when they are wrong.
The only thing worse than thinking everyone who disagrees with you is wrong is the opposite
Most fields have only a few laws.
People learn when they are surprised.
Being good at something does not promise rewards
The world is governed by probability.
Something can be factually true and contextually nonsense
Tell people what they want to hear and you can be wrong indefinitely without a penalty
Behaviour is hard to fix.
and the best
The person who tells the most compelling story wins.
Value Investing - Requiem, Rebirth or Reinvention?
Read the article here ( Read Time ~ 8mins)
Professor Aswath Damodaran argues that value investing has lost its way at three levels and points to ways in which it can be reinvented to gain a new life. As per Prof Damodaran, value investing has lost its way at three levels -
It has become rigid - Rules like focusing on dividends and not investing in companies with significant tangible assets appear to be a throwback in time.
It has become ritualistic - The rituals involve an annual trek to Omaha to reading Ben Graham and an unquestioning belief that whatever Buffett or Munger say has to be right.
It has become righteous - Some investors feel they have a right to high returns because they have followed all the rules and rituals.
Prof Damodaran proposes a new framework for value investing
Be clear about the distinction between value and price - Value is a function of cash flows, growth and risk. Price is determined by demand and supply, and moved by mood and momentum.
Rather than avoid uncertainty, face up to it - Uncertainty is a feature of investing and investors should embrace it rather than trying to avoid it. Value investors need to expand their tool boxes to include statistical tools like decision trees, probability distributions and Monte Carlo simulations to deal with uncertainty.
Margin of safety is not a substitute risk measure - Value investors view traditional risk and return models with disdain, but there is nothing in intrinsic value that requires swearing allegiance to betas and modern portfolio theory.
Don’t take accounting numbers at face value - Value investing has an accounting focus central to its strategy. Companies have become aggressive in using pro forma income statements to skew numbers in their favour and a paradigm shift from manufacturing to technology and service companies has made accountants struggle to keep up with the valuation of intangible assets.
You can pick stocks and be diversified at the same time - In a market where even the most mature of companies are finding their businesses disrupted and market momentum is augmented by passive trading, having a concentrated portfolio is foolhardy.
Don’t feel entitled to be rewarded for your virtue - Investing is not a morality play and there are no virtuous ways of making money. To hold any investing philosophy as better than the rest is a sign of hubris and an invitation for markets to take you down.
Damodaran concludes by saying that to rediscover itself, value investing needs to get over its discomfort with uncertainty and be more willing to define value broadly, to include not just countable and physical assets but also investments in intangible and growth assets.
Key Ideas from Buffett’s letter to shareholders - 1984
While we summarize the key ideas in the letter, we encourage the readers to read the entire letter to capture the context in which the thoughts were expressed by Warren Buffett.
On stock repurchases: The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two important reasons - one that is obvious, and one that is subtle and not always understood. The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended. The other benefit of repurchases is less subject to precise measurement but can be fully as important over time. By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value. These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.
On the secret of Nebraska Furniture Mart: I have been asked by a number of people just what secrets the Blumkins bring to their business. These are not very esoteric. All members of the family: (1) apply themselves with an enthusiasm and energy that would make Ben Franklin and Horatio Alger look like dropouts; (2) define with extraordinary realism their area of special competence and act decisively on all matters within it; (3) ignore even the most enticing propositions failing outside of that area of special competence; and (4) unfailingly behave in a high-grade manner with everyone they deal with.
On how bankrupt insurers can survive: In most businesses insolvent companies run out of cash. Insurance is different: you can be broke but flush. Since cash comes in at the inception of an insurance policy and losses are paid much later, insolvent insurers don’t run out of cash until long after they have run out of net worth. In fact, these “walking dead” often redouble their efforts to write business, accepting almost any price or risk, simply to keep the cash flowing in. With an attitude like that of an embezzler who has gambled away his purloined funds, these companies hope that somehow they can get lucky on the next batch of business and thereby cover up earlier shortfalls. Even if they don’t get lucky, the penalty to managers is usually no greater for a $100 million shortfall than one of $10 million; in the meantime, while the losses mount, the managers keep their jobs and perquisites.
On retained earnings: In judging whether managers should retain earnings, shareholders should not simply compare total incremental earnings in recent years to total incremental capital because that relationship may be distorted by what is going on in a core business. During an inflationary period, companies with a core business characterized by extraordinary economics can use small amounts of incremental capital in that business at very high rates of return (as was discussed in last year’s section on Goodwill). But, unless they are experiencing tremendous unit growth, outstanding businesses by definition generate large amounts of excess cash. If a company sinks most of this money in other businesses that earn low returns, the company’s overall return on retained capital may nevertheless appear excellent because of the extraordinary returns being earned by the portion of earnings incrementally invested in the core business. Many corporations that consistently show good returns both on equity and on overall incremental capital have, indeed, employed a large portion of their retained earnings on an economically unattractive, even disastrous, basis. Their marvelous core businesses, however, whose earnings grow year after year, camouflage repeated failures in capital allocation elsewhere (usually involving high-priced acquisitions of businesses that have inherently mediocre economics.) The managers at fault periodically report on the lessons they have learnt from the latest disappointment. They then usually seek out future lessons. (Failure seems to go to their heads.)
What We Are Reading
We decided to publish few links to interesting articles that we have found across the Internet. We hope you find them interesting.
Can Video Games Treat Mental Illness? [Input Magazine]
The World Henry Ford Made [Boston Review]
Investing And The Convergence Of Public And Private Markets [Medium]
Why Facts Are Overrated [Areo]
Storytelling Can Make Or Break Your Leadership [Harvard Business Review]
The Epigenetic Secrets Behind Dopamine, Drug Addiction and Depression [Quanta]
Fighting Coronavirus With Behavioural Economics [Bbias Blog]
The Psychology Of Fact Checking [Scientific American]
Software Is Eating The Markets [Substack]
Why Turkey Has Turned Against The West? [The Spectator]
Afterthought
“Show me a man who thinks he is objective and I’ll show you a man who is deceiving himself”
-Henry Luce
And that is a wrap for the week. We hope you enjoyed binge reading this edition. If you found this newsletter useful and worth your time, do share it with your friends.
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Take care, stay safe and have a nice weekend. We shall see you next Saturday