“The only reason people do not know much is because they do not care much. They are incurious. Incuriosity is the oddest and most foolish failing there is.” —Stephen Fry
— John Mihaljevic (@JMihaljevic)
Jan 13, 2023
Amazon: Value Hiding in Plain Sight (Best Ideas 2023 Preview)
January 13, 2023 in Best Ideas Conference, Equities, Global, LettersThis article is authored by MOI Global instructor Edward Chang, portfolio manager at Pledge Capital, based in New York.
Edward is an instructor at Best Ideas 2023.
Amazon needs no introduction in the value investing community. Berkshire bought a stake back in 2019. It may have one of the widest moats in the world.
After falling $100 from the highs, the stock now trades where it did in 2018. Since then, they have built Amazon Ads into one of the biggest digital ad players in the world. AWS has grown from twenty billion in revenue per annum to eighty. 3PL marketplace revenue has nearly tripled. They have added one hundred billion in 1PL ecommerce sales. Subscriptions, which is mostly the prime membership, has grown from fourteen billion to thirty-five.
If you value the cloud and the ad business separately, at four to five times revenue or sixteen to seventeen times EBIT, it will imply the rest of the company trades at the lowest valuation in history – around 0.6x sales. Including the Great Recession. You do not need to make herculean assumptions to project strong five-year investment returns.
Amazon bulls are battered. The debate is now centered around the quality of the ecommerce business. On the sell-side, analysts are beginning to question if the cloud is maturing. Many investors are even hoping Bezos will come out of retirement. It is not often a blue-chip company with Amazon’s moat declines 55% in a year. I believe this is a great long-term buying opportunity.
What attracts me to the stock, is in part the culture that Bezos has built during the tenure. The door desk mentality differentiates Amazon from the rest of the internet giants. Culturally, I believe they are better prepared for a sustained period of belt tightening. The company’s customer obsession will also get it through tough economic times and emerge out of the other side stronger. Andy Jassy, the CEO of Amazon, has gone through this before and had a front row seat as Jeff Bezos’ shadow during the tech bubble. He watched Amazon launch the 3PL business, which threatened 1PL sales but delighted customers with low prices and helped Amazon turn a profit. Amazon’s customer obsession can still be witnessed in the strategic changes being made to position the company for the next 5-years.
With Amazon’s core ecommerce business, customer obsession shows in the launch of Buy with Prime. This new service brings Prime benefits to the far corners of the web. While some of us have heard of some of the brands or sites in the long tail of built on Shopify, Wix, or WordPress, most of us have not. These sites lack the trust Prime and Amazon have developed with consumers. Amazon is now offering to share the trust it earned with prime members with external website. Amazon will provide prime services on other websites. This could greatly expand the value proposition of its popular membership program. It also helps merchants, by boosting their conversion and by providing ecommerce fulfilment and shipping services.
With AWS, customer obsession is showing in the company’s pivot from a builder (or developer) first mindset to a focus on both partners & builders. Earlier in the cloud transition, AWS could please the customer by adding more features and tools for developers to build cloud applications. As we move into the next stage, AWS’ large portfolio of tools and features confuse customers in the early majority. Fortune 500+ companies typically work with consultants or system integrators, and AWS is strengthening its go-to-market with these partners to help the end customer find the right solution.
AWS’ investments to strengthen its partnership with independent software vendors also fulfill the same purpose. It is another example of the company’s customer obsessed culture. The ISVs used to view Amazon as a competitor or frenemy, who offered low-cost versions of their software. Amazon and many ISVs had rocky relationships, because Amazon copied features or even offered services built on the open-source software of other companies. Over the last year, AWS has invested to strengthen these relationships. There is no one size fits all, and what works for one set of customers may not work for another set of enterprise customers. Customer obsessed strategic moves will help AWS capitalize on the next leg into the cloud.
Amazon has made extremely large investments into fulfilment and continues to invest heavily into AWS. Investments to enable next-day delivery of a greater number of SKUs around the world, have required them to densify their logistics network by opening sortation centers and delivery stations. Amazon has also needed to make a major investment in working capital, to fill these sites and get product closer to their end customer. AWS is amid a large capex cycle, as the company seeks to fulfill long-term agreements made with customers looking to move more of their IT infrastructure into the cloud. Ultimately, we believe these investments will pay off for shareholders.
Around ~15% of retail sales have moved online and ~10% of IT spending has moved into the cloud. Ecommerce and cloud will not capture 100% of their respective markets, but there is still plenty of room for both businesses to grow. Amazon’s customer obsession gives me confidence that management will make the right strategic moves to widen its moat and enable the company to capitalize on its long-term opportunities.
At Pledge Capital, we look for companies that are investing to strengthen their position through some sort of fundamental inflection point. We typically invest in small and mid-cap businesses. However, the large declines in the FAANG stocks have created some compelling opportunities. We especially like Amazon’s long-term prospects given its culture and recent strategic moves. This is a great time for long-term investors.
Mohnish Pabrai on Intelligent Investing Globally in 2023 and Beyond
January 13, 2023 in Audio, Best Ideas 2023, Best Ideas 2023 Featured, Best Ideas Conference, Diary, Equities, Ideas, Invest Intelligently Podcast, Member Podcasts, The Manual of Ideas, TranscriptsIn a keynote Q&A with John Mihaljevic at Best Ideas 2023, superinvestor Mohnish Pabrai discussed his latest thoughts on intelligent investing around the world. Mohnish reiterated some of the key tenets of his investment philosophy and shared some of the opportunities he sees in global markets as we enter 2023.
The full session is available exclusively to members of MOI Global.
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About the instructor:
The Pabrai Investment Funds (PIF) were inspired by the original 1950s Buffett Partnerships and are a close replica of the original Buffett Partnership Rules. The Pabrai Funds Managing Partner, Mohnish Pabrai, is an ardent disciple of Warren Buffett and closely follows Buffett’s principles on value investing and capital allocation. From inception in 1999 through September 2022, a $100,000 investment in Pabrai Funds had grown to $1.1 million (after all fees and expenses). This equals to an annualized gain of 10.7% versus less than 6.2% for the S&P 500.
Mohnish was the Founder/CEO of TransTech, Inc. – an IT Consulting and Systems Integration company. Founded in his home in 1990, Mohnish bootstrapped the company to over $20 million in revenue when it was sold in 2000. TransTech was recognized as an Inc. 500 company in 1996. Mohnish has been profiled by Forbes and Barron’s and appeared frequently on CNN, PBS, CNBC, Bloomberg TV and Bloomberg Radio. He has been quoted by various leading newspapers including USA Today, The Wall Street Journal, The Financial Times, The Economic Times and The Times of India. He is the author of two books on value investing, The Dhandho Investor and Mosaic: Perspectives on Investing. The Dhandho Investor has been translated into German, Mandarin, Japanese, Thai, Korean, Vietnamese, and Spanish.
Mohnish is the winner of the 1999 KPMG Illinois High Tech Entrepreneur award given by KPMG, The State of Illinois, and The City of Chicago. He is a member of the Young President’s Organization (YPO) and a charter member of the IndUS Entrepreneurs (TiE).
Mohnish is the Founder and Chairman of The Dakshana Foundation which is a public US 501c(3) charity. Dakshana focuses on poverty alleviation through education. Dakshana alleviates poverty by identifying brilliant but impoverished teenagers and providing intensive coaching for 1-2 years for the IIT and medical entrance exams in India. Since inception in 2007, the IITs have accepted 3015 Dakshana Scholars. Since inception, 4095 of our scholars have been accepted by the IITs, AIIMS, and various medical colleges (out of a total universe of 6290), a success rate of 65%. Since 2017, various government medical colleges have accepted 1080 Dakshana Scholars, including 222 at AIIMS, the Harvard Medical School of India.
Mohnish loves playing duplicate bridge and received his first lifetime ban in 2019 from playing Blackjack at a Las Vegas Casino due to his winning blackjack system. He lives in Austin, Texas.
Thinking About Opportunities and Challenges in Developing Markets
January 12, 2023 in Africa, Best Ideas Conference, Equities, Global, LettersThis article is authored by MOI Global instructor Fred Steiner, managing director at BCCM Advisors.
Fred is an instructor at Best Ideas 2023.
Since 1960, only about a dozen countries out of 150 or so have managed to materially better themselves relative to their peers. About half of the dozen grew from building a manufacturing base and the remaining half comprised of small nations that either attracted beachgoer tourists or got lucky with an abundance of oil and gas or diamonds. What do they all have in common? Exports: Each of these countries experienced more than 10% annual USD export growth since 1960. So, the question is, what are the prerequisites to building an export led growth model? The answer lies primarily in literacy rates and electricity and an interrelated relationship between demographics and geography that can leave some economies hopeless in the pursuit of industrialization.[1]
Why Exports?
To date, the only proven way to create sustainable economic growth in developing economies is via exporting manufactured goods. This is because the development of a light manufacturing base employs a significant proportion of the population and foreign exchange revenues derived from the exports can be used to import requisite technology, materials and capital goods inputs to further expand export capacity. In that manner, you get a virtuous cycle wherein exports drive savings, savings enable investment in export capacity, which, if allocated well, translates into further exports (as illustrated in the above chart) and jobs, jobs, jobs. This circular process not only serves demand on a global scale, but also stimulates domestic demand for which capital is attracted to produce products and services that would otherwise not exist. This in turn further stimulates local job creation while diversifying the local economy. This is how an agrarian economy transitions into a successful developing economy and, over a long enough period, a developed economy.
The labour intensive, low-end manufacturing export model is a process of then graduating up the value chain toward higher value capital intensive high-end electronics and light industrial goods to eventually heavy industrial goods. As a nation graduates one stage, other economies compete to take its place. This process, by our count, is on its third major iteration since the 1960s when the Asian Tigers[2] began their industrialization journey. Beginning in the 1980s, China steadily took market share from the Asian Tigers while the latter gradually moved upward in the value-add chain. Today, many of the Tiger Cub economies[3] and Bangladesh are well into the first stage of this industrialization process while China has migrated upwards. In short order, the Tiger Cubs too will be transitioning upward in the value chain, making way for a wave of new entrants.
The gains to be had as one of the new entrants are vast: Much like you often see winner takes most in many industries, the same goes for exporters. Paul Bairoch found that the Asian Tigers, “which represent less than 3% of the Third World market economies’ population, in 1990, provided almost two thirds of the total exports (excluding re-exports) of manufactured goods of the entire Third World.”[4] While this graduation process may be an impossibly long investment horizon in a world obsessed with daily, weekly, and monthly performance, the outputs are surely mesmerizing and tangible: In 1960, Ghana had a greater GDP/capita than Korea, and in 2000 Kenya and Vietnam were equals on the same measure.
Literacy Rates
The first prerequisite of developing a manufacturing base is for a nation to achieve a 70% literacy rate. Simply put, no economy has grown sustainably below this threshold and any attempt at industrializing prior to achieving 70% literacy rates has been futile. Egypt tried and failed in the 1950s, Ghana in the 1960s and Nigeria in the 70s and 80s.
As noted above, in 1990, the Asian Tigers effectively exported 2/3rds of emerging economies’ total exports. At the time, China’s literacy rates had just surpassed the 70% threshold. Fast forward thirty years and Korea has graduated up the value-added chain with Samsung shipping nearly 300 million mobile phones globally. Meanwhile, China has 25% of the world’s manufacturing exports and has already transitioned away from the sweat shops that might come to mind when thinking about Chinese manufacturing.
Electricity Capacity
The second prerequisite for industrialization is having sufficient power generation and distribution capacity. This is rather obvious: If you do not have a consistent supply of cheap electricity, it is impossible to compete in highly competitive low-margin light manufacturing.
Ironically, what China should have done over the past decade is build power plants and distribution networks in heavily dense cities throughout its One Belt, One Road recipient nations. China grew in large
part by attracting rural population to the cities where they manufactured goods with cheap electricity. Instead, China has built railways, roads and ports to many regions that do not have the export capacity to compete on a globally competitive stage. Ethiopia, for instance, has been a large recipient of Chinese investment, but its manufacturing sector is, contrary to beliefs, exceptionally small. So small that it is less than 5% of GDP. Why? Because despite having a fraction of the labour cost as, say Bangladesh, Ethiopian companies cannot manufacture textiles competitively due to the comparatively high cost of electricity.
Geographic & Demographic Handcuffs
Geography has played an overarching, decisive role in which nations can outperform or are handcuffed. Post-World War II, all the sustained high-growth success stories originated by having land or seafaring access to developed Europe or America, or by being geographically located between Japan and Singapore, which happens to be where almost all the world’s population growth occurred (see diagram in the appendix).
There is little doubt that the next leg in global population and urbanization will occur in Africa. This is a blessing and a curse. For one, as Charlie Robertson argues, countries that bear more than three children per woman will simply be too poor to develop because parents will not have any savings after providing care for their children. But what if your nation has fewer than three children? The answer is there is nothing to get too excited about. Countries with the highest labour growth rates do not necessarily translate into high GDP/capita growth rates. The same goes for nations with low labour growth rates. This is because, on average, labour’s contribution to real GDP growth is about two percentage points, give or take half a point.
Put differently, dispersion across countries’ GDP/capita results are simply too great relative to the minor dispersion in labour growth rates for any given country. Turns out this is how it works with urbanization rates, as well, and it is easier to portray with the twenty most urbanizing countries and region over the past thirty years, according to the World Bank.
We’d wager few would have guessed Haiti coming in the top 10 most urbanizing countries since 1991 (we would have never guessed either!). The message, however, is clear. Take for example, Vietnam. Vietnam’s increase in urbanization ratio was 13 percentage points lower than Cost Rica’s, but its cumulative change in GDP per capita was roughly 5x. Thus, not all urbanization rates or labour growth rates are created equal, and by no means do either imply a positive impact on GDP/capita growth. This makes sense, Nigeria’s population is, on a relative scale, exploding and Lagos has attracted millions of migrants to its city, but many end up living in squalor. It comes down to what a non-geographically handcuffed nation does with those rates of growth and does the nation have the prerequisite literacy rates and electricity capacity to leverage an urbanizing and growing labour force.
This data explains the country level performance, but the regional performance relationship is difficult to refute. As pointed out before, the vast majority of the world’s population growth occurred in Asia, especially along the shipping lanes from Singapore to Japan. We argue, without being able to quantify an amount, this bodes well for Africa as a continent and several of its regions.
Africa’s Lions and Bedouins
The African countries that largely fit the above bill are Morocco, which is well on its way to industrialization, then Ghana and Egypt, followed by East Africa’s Kenya, Rwanda, Tanzania, and Uganda. South Africa has already industrialized, but it is in some respects slipping backwards as our readers will be aware of.
Morocco passes each of Charlie’s three tests. It also has direct access to Europe, where the majority of
its exports are shipped. Today, the country boasts burgeoning aerospace, automotive, electronics and offshoring industries. In the not-so-distant future, Morocco may double its entire existing installed energy generation capacity to send cheap, renewable energy to Europe.
Ghana may well chart the same path as Mauritius did beginning in the 1980s. At the time, Mauritius had recently experienced two major currency devaluations, was dependent on the IMF, and had a debt load that was effectively drowning the country. But it also had begun its transition toward industrialization supported by literacy rates and electricity. Today, Mauritius not only has a well-established textile industry, but also a developed financial services industry. There’s considerable evidence Ghana is well on its way, with USD exports growing ten-fold since 2000. The West African nation is also located in the same neighbourhood as Nigeria, which boasts a population of 200 million. One can easily envision Ghanaian made textiles replacing Chinese and Bangladeshi made garments hawked by street traders.
Egypt also passes the three tests and has the considerable geographic advantage of being able to serve the demand of the Far East as well as developed Europe via the Suez Canal. Further, the population density in the Cairo-Nile delta region is similar to that of the Guangdong-Hong Kong-Macao greater bay area. The North African Nation also has ample cheap electricity. It, currently, however, imports far in excess what it exports. As your manager has written in recent letters, however, the pandemic followed by the Ukraine war are forcing the country’s leadership to address structural changes that should help to grow exports significantly. The country has all the ingredients to be a major success, and quite literally can pave its own destiny.
Lastly, East Africa’s Kenya, Rwanda, Uganda and Tanzania look most alike Korea in the 1960s with literacy rates having surpassed 70% in the past decade. Like Korea at the time, they are all currently mostly agrarian economies, take in significant foreign aid, export very little, and are short of cheap electricity. However, industrialization is a common goal across region and while there have been missteps in building their power generation, each of the countries recognizes the importance of cheap electricity.
And what about the rest of the countries and the role of the internet in breaking down barriers? Without calling out individual names, the good news is nations can go from largely illiterate to literate in a matter of fifteen years as has been shown by Korea and building out an electrical grid takes years, not decades, and that’s to say nothing of solar in rural areas. Then there is the role of the internet economy, which many very bright investors argue could equal the physical economy. We think this is a bit of a stretch and is not as scalable as light manufacturing with regards to absorbing large amounts of labour, but the internet will undoubtably play a major role in absorbing, educating and enriching the lives of whole swathes of Africans.
THEY SAY A PICTURE IS WORTH A THOUSAND WORDS
Since 1960, all of the world’s developing markets that sustainably and dramatically improved GDP/capita did so via manufacturing exports and were located in Asia
[1]The role of education, electricity and fertility in economic development is a topic we have discussed in prior letters and are thankful for Charlie Robertson’s contribution in helping our understanding. His recently published book “The Time Traveling Economist” is a goldmine of supporting data and arguments. Thank you, Charlie.
[2]Taiwan, Hong Kong, Singapore, and Korea
[3]Thailand, Indonesia, Malaysia, Vietnam, Philippines
[4]Charlie Robertson, The Time Traveling Economist
Seizing the Opportunity in Energy and Industrial Businesses
January 11, 2023 in Best Ideas Conference, Equities, Global, LettersThis article is authored by MOI Global instructor Bob Robotti, president and chief investment officer at Robotti & Company, based in New York.
Bob is an instructor at Best Ideas 2023.
In the 1940s Alan Jay Lerner penned the musical, Brigadoon, in which two American friends get lost in Scotland on a hunting trip and end up in the magical village of Brigadoon, a euphoric village that only rises from the Scottish mist every one hundred years. The last twelve years have been a financial Brigadoon, especially in America. No recession, very low inflation and low, even negative interest rates — it was Shangri-la for capital.
Throw in the attendant benefits of the strong US dollar, and you have a period where the average investor experienced a repeating trifecta: 16% returns for the S&P 500, 2% inflation, and a dollar which continues to buy more and more of the world’s goods and services. A 14+% real return for over a decade. A sustained 14% real return sounds too good to be true. So, how did it come to be?
We think two things led to this euphoric period:
1. Free money and low interest rates
2. China’s cost and scale advantages leading to low inflation
Free Money and Unrestrained Unicorns
After the 2008 World Financial Crisis (WFC), governments reacted in a distinctly different way than they did after the Great Depression. In 1929, governments learned that when they stood back and let the system cleanse itself, Wall Street failing led to Main Street failing. This time around governments were extremely active in staving off the collapse of the world’s banking and financial systems.
Monetary policy after the WFC is unique in that it was endorsed by both liberal and conservative administrations, even if it was often misdirected and ineffective. In its own way it was a new version of the Reagan years of ‘trickle down’ economics policies. The monetary policy of governments post-WFC made money free to do the same, trickle down and jump start the economy.
However, free money didn’t make a robust economy, but instead created one on life-support. While goods and services saw little inflation, financial assets inflated dramatically! These free money policies also suppressed interest rates to 5,000 year lows. I think that bears repeating. A 5,000 year low. With infinitesimal rates, financial assets began to be mispriced, and we saw plenty of capital ‘swimming naked!’
One major manifestation of this free money period was the rise of the Unicorn – another mythical animal that would feel at home in Brigadoon. Companies that could grow and receive huge amounts of new capital at little to no cost, and without needing to produce cash, just the promise of a “someday” that could conceivably create oodles of cash. The length of time this continued made it so anyone daring to point out holes in this business model were branded stuck in the past with an outdated understanding of economic progression. This belief was made harder to fight against as those doing the laughing were laughing their way to the bank.
It seems that today, the horns might be falling off these unicorns. A troubling development as they were trained as unicorns, and now that they can’t fly without the free money, they are having trouble walking or working the fields. With no use as horses, and no magic as unicorns, maybe they only have value to the glue factory?
China
In the meantime, on the other end of the globe, China continued to be a juggernaut, little affected by the WFC. Since 2008, China’s GDP has nearly tripled as the world continued to flatten. The interconnection of far-off lands through inexpensive transport, relative global peace and mostly open borders helped usher in today’s China. The economic integration of 1.2B Chinese people, successfully lifted hundreds of millions of people out of poverty and created an engine of consumable goods. This massive generator of low cost, high scale goods successfully devoured any potential for inflation to rise over the last 12 years, as it has for decades
To be clear, “China makes and the world takes” still holds true. Today China makes 50% of the worlds steel, chemicals, aluminum and even cannabis. Ross Perot was wrong in part, but right in sentiment. That giant sucking sound was NOT Mexico but China, hoovering up industries, jobs and, with it inflation for decades.
In recent years, rising costs, alternative sourcing and changing policies are evolving the 40-year reinvention of China into a more mature economy. Today there is plenty of talk about the possibility of ‘deglobalization’. We are already seeing real policies and investments being made to reshore production across the globe, and especially in America. The combination of China’s rising costs, depleting domestic resources, increasing dependence of inputs from abroad, and continued growth means rising costs for the world’s low-cost producer.
Years ago, Marty Tuckman saw the future and shared it with me. Marty ran Interpool, a container leasing business here in America. The manufacturing of containers had followed the migration of lowest cost. Initially these containers were made in the Midwest, close to American steel production, and then they migrated to the South, then to Mexico, then to Taiwan, and finally to mainland China, the lowest cost producer of everything on a scale that probably couldn’t be replicated. This was all in the hunt for reduced costs, mostly in the form of labor.
Today, three worldwide manufacturers control almost the entire market for new containers. They are all based in China (a slight caveat being some start up competition in Vietnam, but the scale is tiny, and they still import key components from China). Moving away from China will not have the scale efficiencies and therefore additionally sources of supply will cost more.
So how did we get the Brigadoon combo of high returns and low inflation? Free money boosted returns, and China ate inflation.
What Now?
“In Economics, things take longer to happen then you think they will and then they happen faster than you thought they could”
-Rudiger Dournbush, MIT Professor
As Brigadoon once again gets shrouded in the mist, what happens next? The above quote is one I have been using a lot recently, as I am constantly reminded of the difficulty markets have accepting true systemic changes.
That artificial, manipulated world has evaporated, and its return is as likely as that of Brigadoon…not in our lifetimes. In the new world, the winners and losers will be very different. The past patterns of this period will not provide useful tools for identifying future success. The investment world is largely in denial, the first stage of market rollover.
This is further sheds light on the need for active managers, specifically those with the skill set and ability to invest differently. In the value investing world this group has been winnowed down through fund migration, style drift and even general despair. The ability to pick the quality companies within sectors is again emerging as crucial today, especially as indexation is still the behemoth in the room, misdirecting capital flows
Our caution to investors was summed up in a quote often attributed to John Maynard Keynes a century ago. “When the facts change, I change my conclusions. What do you do Sir?”
Energy is the Driving Force of the Universe
What happens when free money leads to big returns? Capital flows in that direction, but the flipside of that is that it must be pulled from somewhere. One major area where capital was pulled from was conventional energy. This has always been the case for this cyclical industry, but there are also critical structural changes that have occurred concurrently which provide important differences: climate concerns and the maturation of the world’s oil supplies at current prices.
The world has entered a period of energy shortages largely due to that underinvestment… I’m not talking about an oil shortage, or even a natural gas shortage like currently exists in Europe. I’m talking about a comprehensive shortage of energy in all forms. We need not only more conventional energy for longer than is ideal but also more renewables for both energy needs and to mitigate carbon production.
In recent years every part of the world has focused on building out renewable energy production in all its forms: solar, wind, and hydroelectric. Now even further off alternatives are attracting attention and capital. Hydrogen and nuclear fission are garnering attention and investment dollars… We even see the reemergence of nuclear.
Simultaneously, the world has focused on becoming more efficient by reducing usage and increasing the ability to store energy to better distribute/use it at periods of peak demand. Success with high double-digit growth has facilitated reductions in the existing energy generation sources particularly sources causing environmental concerns like fossil fuels and nuclear.
The problem with these plans is renewables are a small percentage of total energy production. Even after a period of sustained investment it is less than 10% of worldwide supply and we seem unable to grow these alternatives fast enough to power the rest of the world’s needs. This problem is exacerbated not just by worldwide growth, but also the increasing demand from electrification and the shuttering of some of the world’s historic energy sources.
This metamorphosis is time consuming, capital consuming, resource consuming and as a result inflationary. We can and will continue to drive ahead, but at a cost. Our observation is that the drive from climate concerns has caused some unintended consequences and lead us into the middle of the “First Truly Global Energy Crisis.” That’s not my characterization., or even that of a major oil company, but the acknowledgement of Fatih Birol, head of the International Energy Agency (IEA), a Paris-based think tank focused on advancing sustainable energy security. This effort will take steel, cement, copper, silicone, rare earth minerals, other basic materials and lots of energy. Two steps back to make a giant, necessary leap forward as oil production is tapped out at anywhere near today’s oil prices.
Not all countries are created equal though. Over the last decade, America has become energy independent. Critically true when it comes to natural gas. Further, we are producing excess supplies which we can, and do, export to the rest of the world. In addition to powering the economy, many industrial companies in America use natural gas as a key raw material including chemicals and all the downstream products like, fertilizers, methanol, ammonia production, and many others. Further, available, plentiful, and affordable natural gas provides cost advantaged electricity which further powers North American industries and moderates costs to consumers.
China, You’ve Changed Man
While China has been the bastion of low-cost goods for decades now, that has shifted. China is more in line with the rest of the world, and because of that, their ability to devour inflation is limited.
Westlake Corporation (NYSE: WLK) is a critical producer of epoxy, a fundamental element for many light-weight manufactured goods. A good example is blades for wind turbines. Westlake is one of only three western producers of epoxies. In rough numbers, about half of epoxy is made in China, and half by Westlake and its peers. China’s quarantine in response to the COVID-19 pandemic has significantly slowed down activity and demand in the epoxy industry.
This has led to China dumping epoxy into the world market and dragging down the price. This dumped epoxy is mostly made from coal, and is therefore a high cost, high carbon producing way of making lower quality epoxy. Westlake has identified this and is convinced that the constrained Chinese activity is transitory and that Westlake’s cost advantage will grow as it comes back.
As countries begin to reshore production and build out new, clean energy infrastructures, meeting the demand for energy is going to be a huge undertaking, especially as we are starting out with limited availability worldwide.
Conclusion
All these macroeconomic observations are driven by aggregating the grassroots microeconomic observations which come from our bottom-up stock research focused for decades on industrial businesses in both America and around the world. Those industrial businesses are closely interrelated with commodities which are in a period of increasing demand once again after an extended period of being poor return businesses and therefore ignored by most capital market participants. They have also gone through a prolonged period of underinvestment logically due to those poor returns. Over this time most economic participants have formed strong views of this historic disappointment.
We identify this investor limitation as the “myopia of linear thinking”. They refuse to even think to revisit this area. Investors ignore strong results as transitory or value traps. Past experiences have fixed these views in investors’ minds. Investors see no need (and have limited experience and knowledge) to identify and appreciate structural changes that have transformed these businesses and their return generating abilities. Not only changes in return generating abilities but the sustainability of those earnings. Barriers now exist to new entrants and combined with limited interest from the remaining participants to add capacity that profitability should be more sustainable. This is why we believe we are invested in what Buffett characterized as “better businesses” available at Ben Graham cigarbutt prices.
Intelligent Investing in a Markedly Different Investment Environment
January 11, 2023 in Best Ideas Conference, Equities, Global, LettersThis article is authored by MOI Global instructor James Davolos, vice president and portfolio manager at Horizon Kinetics, based in New York.
James is an instructor at Best Ideas 2023.
Financial markets thrive on predictability, as greater certainty about the future permits greater risk tolerance, which promotes economic growth, ergo growth in wealth. The past decade, if not decades, of modern central economic planning have sought to reduce economic uncertainty, largely by intervening in free markets by providing liquidity support through monetary (interest rate) and fiscal (spending) measures.
The requisite magnitude of financial support to stimulate the economy has grown in excess of nominal economic growth and financial leverage within the system, creating reliance on a rapidly increasing amount of stimulus. This cycle of ever greater financial stimulus may have recently culminated (temporarily), after U.S. money supply[1] grew approximately 45% between January of 2020 and April 2022. This translates into approximately 31% of the total U.S. Dollars in existence having been “created” within the past 26 months.
It should come as no surprise that an unintended consequence of decades of policy aimed at supporting asset and economic growth is inflation. “Inflation” first came in the form of financial asset inflation (i.e. stocks, bonds and private assets), followed by consumer and producer goods (e.g. CPI, PPI), and now, seemingly, everything.
The U.S. Federal Reserve is no longer denying that inflation is extremely unlikely to abate on its own, and it has begun raising interest rates aggressively in order to combat rising price levels. Tighter money can only combat inflation by reducing demand, as interest costs consume more of businesses’, individuals’ and governments’ cash flows[2].
Contractions in demand are often associated with economic contraction, i.e. recession. Fear of economic/demand contraction is driving irrational price action in financial markets, as investors underestimate structural trends and rely on heuristic analysis of past cycles. It may shock many people to learn that commodity prices and broader consumer prices can, in fact, rise during a recession.
To quote Zolten Pozsar of Credit Suisse, “You can print money, but not oil to heat or wheat to eat.” This quote summarizes the dilemma that central banks face, as decades of underinvestment in indispensable raw materials are coinciding with growing demand, specifically from emerging (non-OECD[3]) markets.
Further, there is a growing risk that aggressive central bank policy aimed at reducing inflation via curbing demand will achieve its goal in reducing growth, but without impacting structural inflation, thus resulting in stagflation.
This leaves the global economy in a very uncertain position, where restrictive bank policies are in direct conflict with slowing global growth. We do not have any unique insight into what will catalyze this dynamic to shift, or how or when it might occur, but we do believe we have an informed opinion about what the ultimate economic and investment implications are. In short, the current paradigm of investing, which has reigned for decades is shifting – and at warp speed due to the policy mismatch.
This change will be uncomfortable, and many individuals and institutions will surely reduce exposure due to the uncertainty, which will pressure asset prices. However, this short-term orientation fails to recognize the difference between cyclical and structural inflation, hence missing investment opportunities in secular inflation beneficiaries.
The past 40 years can be characterized as an era of abundance, driven primarily by globalization, technological innovation, and declining interest rates. These supporting trends simply cannot be sustained, and most are either stalling or outright reversing. This will result in a markedly different investment environment for the next decade as compared to the past – yet most investment “models” rely on historical performance and correlations based on 10, 20 or 30 years of data, which is no longer a valid analog.
Specifically, we believe that the changes in these trends, in conjunction with underinvestment in raw materials, will result in a new era not of abundance, but of scarcity. In short, the new era will place a primacy on existing high quality, hard assets – which stands in stark contrast to the prevailing primacy on intangibles and cheap investment capital.
[1] M2 Money Supply
[2] Cash Flow: Cash Flow is the increase or decrease in the amount of money a business, institution, or individual has.
[3] OECD: Organization for Economic Co-operation and Development
A Stock for a Grandchild: Applying a Long-Term Mindset to Investing
January 10, 2023 in Best Ideas Conference, Equities, Global, LettersThis article is authored by MOI Global instructor Bogumil Baranowski, founding partner at Sicart Associates, based in New York.
Bogumil is an instructor at Best Ideas 2023.
Now, that’s an idea!
I was sipping my coffee one morning, and I got a phone call from my partner, François Sicart. He likes to surprise me with interesting questions, and that day was no different. He said: “if you were to pick one stock to recommend to a client as a gift to a grandchild, what would it be?” I gave him an answer immediately, and we had a long conversation about it, which planted a seed for this article.
The client’s request was not the only source of inspiration, though! Once a year, I get asked by a dear friend, John Mihaljevic, to share one stock with the MOI Global community of investors. It’s an invitation-only global group of thoughtful lifelong investors of which I’m privileged to be a member.
It’s a challenge I take on every winter, and I pick one out of all the stocks we bought in the recent year. I take it very seriously, I usually immediately write down a handful of tickers, and then I boil it down to one idea over the next few weeks. I always remind my MOI listeners that it’s just one stock out of 30-50 that we might be holding at any given time. We will hold it for a while, maybe forever, but it can play its own unique role in the portfolio. One might pay a healthy dividend and offer a limited downside; another can still grow fast and potentially have a much bigger upside.
The third source of inspiration was my conversation with another dear friend Christopher Tsai, a fellow MOI Global member. He was a recent guest on my podcast Talking Billions, where I have intimate conversations about money, investing, and more with friends and friends of friends. He brought up the idea of aiming for a big, huge upside in investments. We concluded how chasing a 10-20% gain is not worthwhile, but making our money 20-50-100 times over in a particular stock (likely over many years!) is something we aspire to!
Picking one stock for a larger audience reminds me of yet another good friend Antony Deden. Whenever he is asked to recommend one stock, he feels like a doctor asked to recommend a good medication without knowing the patient or ailment. Hence, I always recommend my MOI Global listeners to research the idea and see if it may belong in their portfolios.
Here, picking one single investment, I was influenced by my partner Francois Sicart’s question: I had the stock for a grandchild in mind. One of our clients became a grandparent and wanted to gift a single stock. I like that idea a lot – as I do any idea that can turn someone into a lifelong stock investor.
Since I already had a great chat with Christopher Tsai, and I had John’s request on my mind, I had an idea ready to share!
I immediately knew it had to be an investment that would not only be around for the next two decades but has a chance to become a much bigger company. I thought of a relatively new company, yet established enough so it won’t go away and vanish before the grandkid goes to school!
Obviously, the company had to be already public, with a few years of financials and, ideally, a profit. I needed to have some reasons to believe it was already mature enough to defend itself against any competition.
Ideally, this company would operate in a fairly new industry or, if it’s in an old one, at least have a new way of doing things, a disruptor.
Equally important to me was the market potential. I preferred a company that could become global or, even better, already was global. I tend to find more of them in the US market than elsewhere, but it’s just my personal bias since it’s the market I’m the closest to and the most familiar with.
With a two-decade or longer investment horizon, the entry point, the price we pay, could be seemingly less important, but being a disciplined value contrarian investor at heart, I love a good deal. I’ll pay up for quality, but I still want to know that I got more than I paid. Hence, preferably, I’d like my investment candidate to be down, cheap, and out of favor with the market at the time of purchase.
I know it’s still a relatively young company in a promising industry with a big wide long runway ahead, but if I can buy it half off or even cheaper, my odds of turning it into a successful investment immediately rise.
When my partner called, he was a little surprised by how quickly I gave him the answer. What he didn’t know was that, unknowingly to both of us, I had been preparing for this question for a few weeks now. Between John’s request and Christopher’s wise words, I knew exactly what kind of stock a grandparent could gift to a newborn grandchild.
This made me think, why wouldn’t we buy more stocks with that mindset? We’d trade even less, keep the long-term horizon in mind, and possibly even do just fine with very respectable returns in the process!
Next time you think of buying a stock, pause for a minute, and ask yourself, would it be a good stock for a grandchild?
I can think of at least one (if not more) that could!
Get your mindset right and everything else will follow. In investing, approach every idea as if you will own the entire company forever. Ask yourself, if that is the case, am I getting a good deal? If the answer is no or don’t know, move on. That’s it. It really is that simple.
— John Mihaljevic (@JMihaljevic)
Jan 8, 2023
Henry Ford lowered the price of Model T from $900 to $300, while staying profitable. Model T propelled to 70% market share.
From @FoundersPodcast episode on Henry Ford’s autobiography
— Rishi Gosalia (@RishiGosalia)
Jan 8, 2023
“I am just a child who has never grown up. I still keep asking these ‘how’ and ‘why’ questions. Occasionally, I find an answer.” -Stephen Hawking
Happy 81st birthday to one of the most inspirational scientists of the 21st century
— Rishi Gosalia (@RishiGosalia)
Jan 8, 2023