ChatGPT & DALL-E 2

It took a while but I managed to get an account. You have to be patient at times because the servers are maxed out. ChatGPT and its sister product DALL-E 2 is amazing and scary at the same time. As in any new technology, comments range from acclamation to criticism. Where do we go from here? Love it or hate it, the genie is out of the bottle. The beast is out. There’s no turning back. We have to adapt and learn how to live with it.

Quick primer. What is ChatGPT & DALL-E 2? They are text-to-image generators that let you type in almost any phrase and get an image or some kind of smart answer. Go check it out. I can spend 5 minutes writing what it’s about, or you can go try it yourself. The “wow” factor is in playing with it, not reading what it is, just like it’s more fun to drive a car than looking at a picture of it. This thing is an assistant, a doctor, a lawyer, a coach, a co-chef, an artist, and an advisor of all sorts. It’s not perfect and it make mistakes, but I’m not perfect either.

A fat American baby eating candies and floating in space.

Both products are creations of OpenAI (wiki). OpenAI is now a for-profit organization. It started as a non-profit in 2015. It was funded by Elon Musk, Peter Thiel, Sam Altman and others. The business is currently run by Altman. Musk resigned from his board seat in 2018. OpenAI is now backed by Microsoft. The partnership with Microsoft allowed them access to the computing resources it needed to train and improve its artificial intelligence algorithms. Microsoft now wants to incorporate the OpenAI tools in its products. More on this later.

For decades, we’ve been hearing about how AI is going to change how we interact with the world. We see AI in action, mostly in the background, when we use Netflix, our email, when we shop on Amazon. But I think this is the first time we actually use it to create something. It’s the first time most of us recognize it in action. Almost every time I put in a prompt and see what’s returned I’m amazed, entertained and scared, all three combined. 

It had that “feel.” The first time I used the Internet. I knew. I just knew that it was a game changer. Not exactly how, but I knew that it wasn’t just a trend. There was no going back. It’s hilarious to write this, but at the time many experts didn’t think the Internet would live last, or work. I’m serious. Look it up. Or what about when the iPhone came out. You knew it was a game changer. 

Clip from the a 1995 article in Newsweek, Why the Web Won’t Be Nirvana

First thoughts on ChatGPT: “Wow this is crazy amazing, and…..Is anybody ever going to do work anymore? Who wants to write papers?”

The technology is fun but full of potential unknowns. And there’s this whole question of ethics (I’ve seen called an “ethical fiasco”). I grew up watching Terminator. My brain wasn’t shaped into thinking about a rosy future about AI robots. What if down the lane the robot overrides its programming and becomes independent? It’s not helping that I’m watching Westworld. In a sense, you can argue that the machines have already won and they didn’t have to fire a shot. We are on our cell phones all the time. 

Back to ChatGPT/DALL-E. New game changing technology creates opportunities and lots of incertitude. There’s no going back. What does it mean for your job? If you are an artist, this is a nightmare. I mean the thing is cranking out poems. If you are not an artist, like me, this is awesome because I don’t have to learn how to use the Adobe slate of products. If you are a copyright lawyer, this is a goldmine. But I’m also worried about what it means for my career in the future. I’ve seen ChatGPT being used for legal advice and it’s not bad.

The current version of ChatGPT is 3.5.  It’s embryonic right now (beta). ChatGPT is more than a flash in the pan. We are in the first inning. It will need to scale. But as it develops, as it races to build it so that it could fully mirror the intelligence and capabilities of humans, who knows what we are getting into.

ChatGPT 4.0 will come out this spring and I heard it will be a massive improvement. And you know this will have 5.0, 6.0….10.0….

And you know the competition, like Google, and mainly Google, is not just sitting around doing nothing. A NYT article reported last month that ChatGPT’s launch triggered Google’s management to declare a “code red” internally (so they had a meeting).

Got it somewhere on Twitter

Search Engine War 2.0

I remember the search engine war of the 90s-early 00s, when you could choose between Altavista, Yahoo, Excite, Goto, AskJeeves, and many others? Well Google won (duh). Like crushed it. It now has a monopoly on search. Google killed all the search engines. Who’s in 2nd place? Bing? Nobody says “Let me Bing this up.”

I like Google and its slate of products. It works fine. But maybe it’s time for a little competition. A little shake up, a little pressure, a little there’s something big coming in the rearview mirror called ChatGPT. When you are in 1st place for 20+ years, you can get complacent. It’s just what happens. Google did introduce LaMDA, a rival AI chatbot.

Microsoft, with its Bing search engine, is going all in. Microsoft said it’s expanding access to OpenAI tools. DALL-E 2, ChatGPT, and other AI-powered software will soon become available to Azure OpenAI customers.

It’s early and Google is safe, for now. But as the AI industry takes off, there will likely be a battle between Microsoft and Google. Search engine are a high fixed cost businesses. Once you built the infrastructure, it’s all about scale. Right now, a product like ChatGPT is very computationally intensive. It cost ChatGPT “pennies” per query. Every search is burning cash. It wouldn’t cost or hurt Microsoft much to integrate ChatGPT to Bing because it’s much smaller. But for Google that’s a different story. Search users are very profitable. Deploying ChatGPT like feature (AI tools like Large Language Model (LLM)) is going to be very expensive and eat in their margins, and that’s just to keep market share. And I’m not sure ad revenue would be more profitable (less if you lose market share).

So, at the moment, the economics of deploying LLM isn’t quite there yet. It’s one thing to demo it. It’s another to try to integrate it deeply in a system with billions of request a day. Think of the cost and the latency. Those are two major bottlenecks I read that cost would need to go down at least 10x, or more, before it starts making sense. It will take some time.

Don’t fight the tide, swim with it

AI is a massive wave. Don’t fight the tide. Swim with it. Jobs and lives will be disrupted. Nothing is static forever. You need to adapt. As for artists, maybe it is a chance to use and adopt new tools. Just like they did with the PC, photoshop, and the Internet. Any new technology can be seen as a threat at first. The PC didn’t kill the artist. It probably made the artist better. Lawyers will be better. Doctors will be better. 

Fighting this won’t help. You have to embrace it. Remember when MP3s came out? It did kill the CD industry. But it didn’t kill music. MP3s disrupted music. Some artists were fighting it. In the end who won? The companies that adopted MP3s (Apple/iTunes), artists and the consumers. More music is being created than ever. More music is being consumed than ever.

ChatGPT is a deflationary force in an inflationary economy. What it means for productivity, competitiveness, efficiency is incalculable. Every organization in every industry will need to infuse this sort of AI technology in every business process and function so they can do more with less. It’s what I believe will make the difference between organizations that adopt changes and those that get left behind. There is an opportunity to apply technology to make a real difference has never been greater. You get to leapfrog. Imagine if you have nothing in the middle of nowhere, but you have access to this tool, it’s powerful. It will empower the people at the bottom. It will allow them to achieve more.

I’m not saying I like it. I’m not pro or anti AI. It’s just is. Just like I don’t hate or love steel. I do my have concerns. There’s a lot of incertitude. But that’s mostly because we don’t understand it. There are already books published by ChatGPT. I’m not sure what to make out of that. You don’t have to buy it. You don’t have to read it.

Or maybe this won’t age well, like the Newsweek article above. I’m just trying to be optimistic.

A bowl of soup that looks like a monster, knitted out of wool.
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Memo on Interest Rates, Inflation, the Economy and Bonds

If you are investing, you read so much gloom and doom. The recession, the inflation, the coming market crash, the job losses, the hardship, the war, supply chain this, energy issues, climate change, higher interest rates etc…Then I step outside it feels like a very different world. Restaurants are packed and can’t hire enough people. Hotel room prices are still crazy expensive, if you can get one. I’m still trying to reconcile what I’m reading and what I’m seeing. Maybe that’s the lag effect economists are talking about, the time gap between decision and effect. The shock will probably come at mortgage renewal, or the day you need to change your car. With great credit, you can finance a new car at 9%.

There’s a lot of talk about recession. With rates where they are at, it’s hard not to think there won’t be a slow down. If there’s a recession, the key question is how deep and for how long? But I’m puzzled at the recession guessing game. During a recession, unemployment goes up and economic activity drops. And right now we have a very tight labor market. And yet the World Bank predicts that GDP will grow 1.7% in 2023.

Interest rates have risen a lot in 2022. 7 times in fact, that took the Fed Fund target rate from 0.12% to 4.25%. Inflation is the root cause of rising interest rates around the world. The goal is to crush inflation back down to 2%. Inflation is trending down but there’s still work to do. The good news is that the December CPI advanced at a 6.5% annual clip, matching the economist’s consensus, down from 7.1% in November and a high of 9.1% in June. It was the sixth consecutive month of slowing annual inflation. With weaker inflation, interest rates are expected to go up a little bit more in 2023.

Fed Fund Rate 2022
Fed Fund Rate 2006-2022

You can argue that central bankers should take a pause on the rate hike, but policy makers have suggested it’s better to overtighten since it is easier to loosen policy than to tame inflation. If they take their foot off inflation’s throat too early, it can come back roaring to life, like we saw in the 70s. If Powell follows through what he’s saying, he’s going by the Volker playbook of the 1980s.

If investing teaches you anything, especially in a year like 2022, it is that low-probability events sometimes materialize. Many funds had a very disappointing year in 2022, some well known names had drawdowns of 50% or even higher. A megacap like Amazon was down 50%. Yes that Amazon, the one that tries to deliver packages to your house the same day, not the rainforest, which I’m sure is not doing too well too.

For the newer generation of investors, 2022 was the year they realized that stocks can go down. Everyone knew that.  But to actually live it, the pain of a loss, to see your money melt away, that’s the real lesson. 2022 was the year where everything stopped working. Whatever worked for the last 15 years, stopped working. The link between equity and bonds broke. Normally when stocks are down, bonds go up. Bonds provide the buffer in case of panic. That’s why the 60-40 portfolio is popular. But that stopped working too, because normally was the keyword, and nothing is normal anymore. That 60-40 portfolio was down 16% in 2022. 

What worked in 2022? Energy, commodities, mining. But that’s not exactly conservative. Commodities are very volatile. Take oil, a WTI barrel of oil is trading near its 52 week low, around $79 a barrel. down from $123 back in July. 

Here’s the key returns of some of the main indexes:

  • S&P: -19.24%
  • Dow: -8.8%
  • Nasdaq: -33.63%
  • TSX: -8.5% (consists of a lot of energy, mining, commodities)
  • MSCI World Index: -17.7%
  • Emerging Markets: -22%
  • Bloomberg U.S. Aggregate Bond Index: -13% (dernier rendement négatif remonte à 1994, -2.9%)
  • US 10-yr went from 1.5% to 3.9%
  • Investment grade: -13%
  • High Yield: -12.7%
  • REITS -29%
  • Portefeuille 60-40: -16%
  • Amazon: -50%
  • Apple: -26.6% 

According to the Financial Times, the market value of companies traded across all global stock exchanges dropped approximately $25 trillion in 2022.

Source: JPMorgan

A lot of talk about a potential soft landing this week. We saw equity and bonds rallying this week. With the 10-yr Treasury Bill dropped from 3.9% to 3.5% since the year started. What does a soft landing this even look like? Look at the returns above. That doesn’t sound like a soft landing to me. Risk assets got decapitated. As for what will happen, I’ve no clues. Nobody has any idea what the earnings will look like. Without that, how do you even make predictions. However valuation looks more reasonable. The S&P 500 ended 2021 selling for over 21x earnings but was trading for just 16.7x (forward) as of December 31, 2022. Essentially at its 25-year average of 16.8x.

The main question is the bond market right? It’s usually right. Almost always correct—especially the 2-yr Treasury note. Well what does the US Treasury market tell us about the path of rates? We have an inverted yield curve (short-term rates are higher than long-term), which suggests problems in the economy and that rates will fall. Right now there’s a gap between where the bond market says interest rates are heading, and where the Fed says they’re going. The bond market is saying that we are the top of monetary tightening, and towards the end of 2023 it will start easing. Markets are expecting interest rates to be cut by the end of the year, down to 4.5%, while Fed officials see rates holding above 5% with no reduction until 2024.

Look I know the bond market is usually right, but I think we are destined for failure if the Fed tries to tighten and immediately loosen. Unless there’s a crash or some massive liquidity event that breaks the system, I don’t see it happen. Inflation is still too far off its target of 2%.

The good news is that you have a restoration of decent fixed income yield after 15 years of ultra-low interest rates. Fixed income is finally competitive. You can get a safe 4%-5%. We haven’t seen that in a very long time. On the other hand, the the days of “free money,” in the form of ultralow interest rates are gone, maybe for quite some time.

Have a good weekend.

2022 Predictions Review

2022 

That was one hell of a year. And not in the “it was totally rad” sense of hell. No, actually it was hell in the sense of hell. Or maybe not. My year was actually all right considering everything that is going on. I shouldn’t complain. Pain is relative. My country wasn’t invaded by Russians. I didn’t lose money in FTX. I’m not in an Iranian jail for breaking the dress code. I didn’t die from Covid. Will Smith didn’t slap me on national TV while hosting the Oscar. The FBI didn’t raid my house for classified documents. I didn’t waste $44 billion on Twitter. I didn’t get ban from Twitter. And despite a tough year in the market, my portfolio didn’t lose as much as the market. I remain optimistic. In chaos and disorders, there are opportunities. The attitude and mindset you bring when you approach a problem matters. You can decide to be a victim or not. That’s a choice.

Let’s go back to my 2022 predictions. First, let me say straight up that it’s a fool’s errand to predict anything. I knew that and I know that. But I thought it would be fun to try and see how it held. It’s the time of the year where you get to read about “experts” predictions. I read some stuff, try to stay informed and all of that. But did you ever notice how they never go over their past predictions? But I will go over mine and let’s see how embarrassing it is.

Second, I remember spending maybe 5 minutes making predictions, because I figured it was a total crap shoot.

Third, I had to go back to my 2022 post because I didn’t remember what I predicted.

The first thing that jumped at me was the date of the post. February 22, 2022. Two days before Russia invaded Ukraine. More on that war prediction at the end.

Source: Me last year. And I just noticed a typo.

Let’s review,

S&P 500 2022 prediction: Target: 4500

Wrong. Really wrong. The S&P finished at 3832. I was off almost 15%. In hindsight, it was a very stupid prediction knowing that 1) interest rates were going up and 2) the S&P just had a massive 26% return in 2021, and 16% in 2020 based on massive stimulus that was going away. Looks like I wasn’t the only one that’s wrong: The 2022 consensus for the S&P 500 was 4,800 at year end 2022.

Interest Rate 2022 prediction: Interest Rate, 5 rate hikes max. The 10-year T-Bill will finish at 2.5%.

Wrong. 7 rate hikes and the T-bill finished at 3.8%. The Federal fund rate is at 4.25%.

Inflation 2022 prediction: Inflation will come down in the 2nd half.

I’m giving myself a “W” for that one. I nailed the trend. But the inflation number is higher than I expected.

Oil 2022 prediction: The classic safe answer of “between $50 to $100 per barrel”. The narrative is that market dynamics will keep pushing prices higher, well above current levels around ~$93 a barrel. I’m going to go against the grain on this one.

This one makes me laugh. It’s a win that doesn’t feel like a win. The WTI ended the year at $73. Yeah I took the contrarian bet, but the journey! I feel like Apollo in Rocky I. Yes Apollo won, but it didn’t feel like a win. 12 rounds and a beating for the win. Oil hit a peak of $123 a barrel and analysts said that it was only the beginning. And yes energy was the only sector that performed well in 2022, and oil is 50% off its peak and trading at a 52-week low. 

Gold 2022 prediction: Gold will finish the year below $2000/oz. Why? The central bank will raise interest rates and “restore” a little bit of trust in the dollar.

Win. Gold finished at $1800/oz. Goldman Sachs called for a $2500/oz by the end of 2022. I crushed Goldman Sachs. I don’t know how to value gold. It was a lucky guess. With everything that’s going on in the world, war, inflation, and the money printing, I don’t know why gold is not higher.

Cathie Wood 2022 prediction: More carnage for ARK

Nailed it. The ARK Innovation ETF was down -69% (-80% at peak). I tried to remember why I made a prediction on Cathie Wood, or why would I even care. I wrote:

As a valuation professional it’s frustrating to watch. People have invested their retirement money and their kids’ education money in her ETFs.

Look I don’t like to see somebody losing money. It can happen to anybody. But there’s a little bit of “I told you so” in ARK’s debacle. We have seen this tape played many times in the past. Her MO is concentrated investments in companies with neat ideas and zero earnings, with astronomic valuations (if they can be measured at all). This is a recipe for disaster because 1) when companies don’t live up to their prospects (e.g. Peloton, Roku…) and  2) when rates rise, and they will, it will hurt the present value of future cash flow. And all of Wood’s investments rely on the future profits in years to come.

At the end of the day valuation matters. Fundamentals matter. Cash flow matters. Profit matters.

I still stand behind that statement.

Russia-Ukraine War 2022 Prediction: Russia won’t do a full invasion of Ukraine. The cost is too high. Instead it will support the separatist regions and will never stop harassing Ukraine through different means (cyberwar, coup, rigged election, propaganda etc…). (Update, a few hours after writing the previous lines Russia sent troops in the breakaway regions of Ukraine. I still don’t think a full invasion will happen.)

Really wrong with brutal timing. And not like I would had I wish Russia invaded just to be right. I still can’t believe Russia invaded. Nobody gave Ukraine a chance. Russia was so confident that the first wave of troops arrived with dress uniforms ready for a victory parade and without nearly enough food. The Ukrainians stood and fought. The Ukrainians have proven themselves.

Record: 4 wins, 3 wrong. It’s not bad. Because I didn’t remember what I predicted, I thought going in that it was would have been a disaster.

As for 2023, I may or may not make predictions. Not because I’m afraid to be wrong. But because I had fun last year making them. It’s impossible to predict the future. But you can plan for it.

We will see.

SA Interview: Investing With A Margin Of Safety With Brian Langis

I was interviewed by Seeking Alpha Pro. I think it’s only available to PRO subscribers but I’m not too sure. Maybe you can read some of it or get limited free access. I know some people without PRO were able to read.

Here’s a preview. There are 9 questions total, the first two are below. Full interview.


SA Interview: Investing With A Margin Of Safety With Brian Langis

Summary

  • Brian Langis is an investor and a Chartered Business Valuator (CBV). He manages Cape May Capital, a private investment company, and specializes in business valuation.
  • How to build a margin of safety, key questions to answer in the research process and how to identify catalysts are topics discussed.
  • Brian Langis shares a long thesis on Spectrum Brands, Lumen Technologies, Stella-Jones, Haleon, Activision-Blizzard and Primaris Real Estate Investment Trust.

Feature interview

Brian Langis is an investor and a Chartered Business Valuator (“CBV”). He manages Cape May Capital, a private investment company, and specializes in business valuation. He has been publishing articles on Seeking Alpha for almost ten years. You can learn more about Brian at brianlangis.com and on Twitter @absolut_brian. We discussed best practices for a SOTP valuation analysis, the opportunity in stocks that “fell off the orbit” and an under the radar company that should benefit from a key demographic trend.

Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?

Brian Langis: When I look at a new business for the first time, I go straight to the balance sheet. I do a quick read of the balance sheet. By just reading the balance sheet you can learn a lot about a business without actually knowing anything about it. I can tell if it has enough money to pay the bills for the next 12 months. It’s akin to doing a blood test on a stranger. You can learn a lot about a person’s health without ever talking to them.

A quick read of the balance sheet tells me right away if it’s a company that’s worth spending more time on. It tells me how much cash, assets and debt is behind the business. The retained earning line is a number that reflects what happened in the past. You get a feel if this business can stand on its own or not. If the balance sheet doesn’t feel right, I don’t waste time.

The reason I look at the balance sheet first is because I have scars from some of my early days of investing as a teen when I got in trouble with penny stocks. I had no clue what a balance sheet was and that was an expensive lesson. So balance sheet first. It accomplishes two things: 1) It’s time well spent. For 5 minutes it prevents me from wasting my time and 2) It potentially keeps me out of trouble.

Then I look at the statement of cash flow. I like to see how the cash flow moves around. I want to see if it’s generating free cash flow. I want to see if it’s growing and sustainable. I want to see what they do with their FCF. I reject most companies that cannot show enough cash income to care for growth and expansion, capital returns, without resort to continual new financing (there are few exceptions). The statement of cash flow gives you a good idea of their capital allocation strategy.

And then I look at the income statement. I try to answer simple questions like 1) Is it growing? 2) How are the margins? 3) Is it profitable?

Then you piece all of it together. I want to be able to see the cash flow flowing through the business. All I am doing is getting a “feel” for the business. If it feels good, it might warrant that I spend more time on it. If not, or it’s too complicated, I move on.

There’s some classic value investing to my approach. I’m buying a business. That’s the mindset. It’s important that I understand the business. It’s important I understand how it makes money and what it does with it. I try to visualize the cash from the sale, to the expenses, and to the bottom line. If I can’t, I move on.

There’s a test that I need to pass. I try to answer key questions like 1) Would I like to own the whole business? 2) How would I feel about holding it for a really long time, like 10 years? 3) How much would I pay for the whole business? The purpose of the test is to get me in the right mindset when I analyze the business. This forces me to focus on the fundamental drivers of the business and think long-term. It helps you avoid costly errors.

As for the rest of the process,

  1. I want companies that are profitable, FCF generators with decent return on capital.
  2. I want great management. It’s a point I used to overlook. For the past couple years it has taken more importance in the process. Business is about people. If it’s not about the people, then what is it about? I’m looking for a business that is run with honest talented managers that think and act like owners. That’s very important.
  3. I’m looking for capital allocation discipline. What are the reinvestment opportunities? A great business takes money in, invests it, and turns it into more money.
  4. Valuation. Can I get the business at a fair price? I want a business that is trading at a significant discount to its intrinsic value. At the end of the day, I’m counting cash and I need to make a decision on how much to pay for it.

When it comes to opportunities, I don’t discriminate. I’m not restricted by sector or asset class. I’ve a pretty wide hunting ground. An opportunity is an opportunity, why would I care if it’s bonds, stocks, or real estate? The only restrictions are things outside my circle of competence. All you want is getting more than you paid for. You are looking for the mismatch between price and value. You often find it where nobody is looking. And if nobody is looking it’s because it’s generally hated. And if it’s hated it might present opportunities for bargains.

SA: How do you identify catalysts, and more importantly, how do you tell if they are priced in already or not? What is the difference between a hard and soft catalyst, and which one is better and why?

Brian Langis: Value investors like me like to focus on fundamentals, come up with a value, and say “look I’m getting all that other stuff for free.” And you know what happens? It stays that way forever. Because the perceived value is trapped.

A catalyst is anything that can lead to a drastic change in a stock’s current price trend. It could be good or bad (i.e. buyout, bankruptcy). You are looking for an event or action. Identifying an asset that’s undervalued or not recognized by the market probably won’t lead to much. The market will discount it until action is taken to unlock that value. Otherwise it will most likely stay trapped. Basically you try to take advantage of companies undergoing change.

As for the question “how do you tell if the catalysts are priced in?”, the catalyst investing practice is mostly geared towards undervalued situations.

If a stock is trading on a high multiple basis, it’s hard to tell if any potential catalyst is already priced in. You can assume it is. Let’s say you identify a catalyst that you think the market has ignored, what’s the upside if the stock is overvalued? Unless it’s a massive catalyst, the upside is likely to be marginal. In situations where valuation is overstretched, it is safer to avoid.

As for companies that are perceived to be undervalued, I work with what the market gives me. I reverse engineer the stock price. I try to answer the question “What is the market saying?” The price is the collective view of the market. I might use a reverse DCF. A traditional DCF forecast cash flows to determine value. A reverse DCF starts with the end, the stock price, and works backward. You try to estimate the level of expected performance embedded in the current stock price. For a company with many different assets and businesses, a Sum-of-The-Parts (“SOTP”) approach can help. You are looking for mismatches, a gap between price and value.

Not all catalysts are equal. I don’t know if there’s a preset definition of a hard and soft catalyst (I didn’t find any). Below is my own spin on the meaning:

Soft catalysts are more internal. It could be a change of management, a new strategy, a new product, cost cutting, better execution, hidden or misvalued assets, unique intangibles, key people, tax losses. It could be real estate or excess land just sitting there. For example MSG Entertainment has unused air rights/development rights that could be unlocked. Or a company that’s net cash and it’s just sitting in the bank account doing nothing. That will be discounted by the market. Soft catalysts can have a wider range of outcomes and may be more nuanced in nature.

Hard catalyst is more of an external event. It could be a company getting sold, carved out, a spin-off, an asset sale. It’s very specific. I don’t know if hard catalysts are better, but they are easier to value. A hard catalyst has a more defined outcome and timeline (i.e.merger, spinoff). We know what is getting sold, for how much, and we have a timeline. So they are easier to work with.

For the rest of the interview click here.

Quality at the Right Price

In this post, there are two factors that I will address: 1) Quality 2) and Price. In the investment world, there’s a lot of talk about quality and not enough about how much to pay for it. Even though how much you pay for an asset is the biggest factor of your future returns

You want to invest in quality businesses at a reasonable price. Overpaying for a quality business is not a quality investment. It’s when you overpay that you get in trouble. Even if you buy the best company in the world, you can lose money if you overpay. Quality is not the equivalent of a good investment. What you pay and what you get in returns is what matters. If the market views a particular stock as a high-quality business, it’s unlikely going to be cheap and it’ll be priced for low returns. So it’s really the search for quality that has been unrecognized or unpriced by the market that’s critical.

The “Quality” Marketing Cliche 

You need to watch out for that “quality” word. You will hear it a lot. It goes without saying that quality is something we seek, whether in people, goods, services, or in investments. But in the investment business the word “quality” has been so over used and diluted that it has become meaningless. So when we seek a quality business, you have to make sure it’s not just another marketing cliche that fund managers put in their presentation.

Investment professionals will often say to just buy “quality”. “You can’t go wrong if you buy high-quality businesses”. “Ignore junk and just focus on quality stocks.” Or “quality companies lose less money in a downturn.” They will also bring up Warren Buffett to justify anything; “Buffett transitioned to quality investing from the cigar butt approach and look at how successful that was.”

You should be wary of broad generalizations like “just buy quality” that oversimplify investing into a certain thing. To focus on quality alone is not bad advice, it’s just incomplete. Quality is a good thing. But it’s good advice to an extent. The problem is not quality, the problem is overpaying for quality. If you go through fancy fund presentations, you can pick out the marketing-cliche beats the managers are trying to hit: “economic moats,” “investment opportunity,” “massive total addressable market,” “barrier to entry”, “scalable platform”. 

But for all the talk surrounding quality, there’s barely any talk about how much to pay for it. And I’m of the opinion we need to think about valuation just as much, if not more, than the time spent on assessing quality.

How to Get in Trouble With Quality

Quality at any price can get you in trouble. The “Nifty Fifty” comes to mind when talking about quality and price. The Nifty Fifty was a group of 50 large-cap stocks in the 1960s that represented the best and fastest growing in America. They became known as “one-decision” stocks. That decision was to buy and let it ride. No price was too high. Buy them and hold them. Like any mania their valuation reached nosebleed level and they eventually crashed. Depending on the stock, if you held them during the crash you would have lost 60%-90% of your money. The sin: Overpaying for quality.

Microsoft is another example of a high quality company. In the 1990s their Windows and Office flagship products were on every computer in the world. Microsoft was a monopoly, made massive amounts of money, and co-founder Bill Gates was the world’s richest man. The future looked bright. The Dotcom bubble took the stock to a different orbit. Then the bubble burst. It took Microsoft 15 years for its share price to come back to their bubble height, despite growing and being profitable every year. The sin: Overpaying for quality.

Another Dotcom high-flier was Cisco. Cisco is another solid business with a high-quality moat around it. Cisco does important things like providing the technology that “makes the Internet work.” It’s been twenty three years since its Dotcom peak and Cisco is still not close to their Dotcom peak despite being profitable every single year. The sin: Overpaying for quality.

Depending on your timing, Microsoft and Cisco are two examples of high-quality companies you could have bought and not make you money for a very long time. Both Cisco and Microsoft were highly profitable (still are), with steady earnings growth and low debt. And yet many people holding them would have been in the red. The price of these stocks got ahead of themselves. Their stocks were so hot that their valuation lost all touch with reality. The mania sent them to levels that were unjustified in relation to their earnings and growth prospects. Investors bidded them up to prices that weren’t sustainable.

You want the price of a security to be cheap relative to its value, to its cash flow, to its assets, to its perceived quality attributes. Buying quality at an extremely high price is not a quality decision. If you pay too much, you will realize that quality is not going to perform as defensively as you think it would. If you overpay, quality doesn’t provide bulletproof performance. There’s limited upside if you overpay.

What is Quality?

What does quality investing really mean? What constitutes a quality business? It’s subjective. It can be vaguely defined. Quality lies in the eye of the beholder as they say. 

So what factors do investors consider that constitute a high-quality stock? It’s a confluence of factors. Some focus on quantitative metrics, such as high return on capital, a low debt ratio, low capital need, steady earnings growth, profitability, and the capacity to generate sustainable free cash flow. Things that you can measure and put a number to it.

There are qualitative factors that are harder to define and to measure. These are things such as the capacity to survive a recession (super resilient business), a long runway for durable growth, high product “stickiness” (e.g. bank account), a strong economic moat, competitive advantage, lack of competition, pricing power, high margins, capital discipline, great capital allocation skills, rich re-investment opportunities, a great enduring brand, economies of scale, and exceptional management. And there’s more.

You recognize quality when you see it. But it can’t always be measured with precision. In a business, quality is a confluence of attributes. My point is you need to study the business and you need to determine what makes it great. Quality can’t just be another tick the box on the checklist and move on without thinking hard about the confluence of attributes that you think make the business great. 

Once you find that high-quality business, the next questions you should ask are 1) How much is it worth? 2) How much am I willing to pay for it? Unfortunately if you do find this gem of a company, it trades at a premium, and sometimes at prices that aren’t sustainable. Only in times of distress high-quality companies trade at bargain levels. This situation usually occurs when there’s a recession, a market crash, or the company has run into some trouble. And when that happens, nobody wants to buy them.

The Price is Right

By now I think I made the point that price is the essential factor in every investment equation. Does quality warrant a price premium? Of course it does. It’s rare to find quality at a cheap price. That’s why I suggest paying a reasonable price for quality. But how much? Well that’s the art of valuation. It’s subjective. Each business needs to be studied on an individual basis.

Any asset no matter how low the quality is, can be cheap enough to be a good investment. At the right price, every asset is a buy. No matter how terrible it is, at the right price it can become a positive investment. And no matter how great the asset is, at the wrong price, you can get in trouble. Any share you buy, you have to ask yourself what you will get in return. You are looking for mismatches, a company that is of great quality that the rest of the world thinks is crappy. That’s what a great investment is.

Since I brought up Warren Buffett earlier to justify anything, I’m going to close this letter with him. Buffett once joked that “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

Midterms Elections, DePolarization & Democracy

I’ve been following the US midterms elections, mainly for entertainment purposes. US elections are over the top. Americans are the king of show business. They can take something as mundane as the temperature and make it entertaining. It probably shouldn’t be that way, but it’s entertaining. We just had an election in Quebec. It had to be the most boring election ever. We had a Federal election last year, that was a sleepy affair also. Maybe boring is good. You campaign for a month, then move on other things. 

Also it’s been a week since people voted in the midterms and it’s still not done. Are they still counting votes? Anywhere else in the world you know the night off or the day after. Like I said, we had an election last month and I think we knew the winner by 8pm. Same in Brazil.

One big difference between our Canadian-Quebec politics and the US is the degree of polarization. Yes our domestic politics is getting more polarized, but nothing to the extent you see in the US. I think the one big difference I find here is that people don’t identify themselves with a political party. Sure some do, but most people just vote.

While in the US it’s common for people to say I’m a Republican or a Democrat, I don’t know anybody here walking around saying “I’m a New Democrat” (you might vote for the NDP but you don’t identify by that). Some might identify as a separatist, conservative, liberal, or green, but you have more than one option to vote for. Somebody with conservative views has two parties to choose from (Conservative and the People’s Party). Somebody that leans liberal has 3-4 parties to vote for (Liberals, NDP, Bloc, Green).  As for myself, I’m more a la carte, I vote all over the place. As for my interest in American politics, it stems from me having lived there and investments.

DePolarization

The polarization of politics is toxic. Going extreme on anything is never good. It’s pretty much shooting poison in the system.

This whole “Left” vs “Right” is stupid. Everything that the Right says about the Left, they are right. Everything that the Left says about the Right, they are right too. They are correct about each other. The Left is right about Trump. Trump is right about the Left. They are right about pointing out each other’s craziness. There are crazies on both sides.

The “Left” hates the “Right” and the “Right” hates the “Left”. Everyone is in their silos. We don’t trust each other anymore. There’s no conversation. There’s no debate. There’s no exchange of ideas. People are just peddling nonsense.

I live in a democracy. The leader only sometimes reflects my values. My values are not the whole country. I’m a small part of this country. Alberta and Quebec will never share politics. Just like Alabama and California won’t. Forget cross-country politics, people don’t even share politics in the same household. Go ahead, try to convince your wife to vote a particular way. The point is if you live in a country where you love the leader everyday, he’s not doing his job. He’s not there to serve just you and to represent only your views. I only agree with a minority of the people normally. The leader needs to be a representative of people’s will. He’s serving the people, the whole country, from tree huggers to pipeline roughnecks.

Politics is the art of compromise. You have to give something up. Everybody does. It’s the only way it works. German leader Otto von Bismarck said, “Politics is the art of the possible.” So compromise seeks the “best possible” solution. It’s hard. It’s tough. You need civility and courage. The answer to the MAGA right shouldn’t be Woke left, and the answer to Woke left shouldn’t be the MAGA right. For democracy to work you have to talk to people you don’t agree with. 

Democracy is messy. Changing the country is difficult. Change takes forever. It feels like nothing ever happens. It’s a grind. It’s slow. It’s unsatisfying. It’s ugly. It’s difficult. It’s boring. It’s bureaucratic. But it’s better than the other systems out there. Just ask countries that don’t have it. They want what we have.

Here’s a few suggestions to depolarize politics:

– The art of compromise. You have to give something up.

– Need to take money out of politics. Take corporations out of politics. Take super pac out of politics. That way politicians answer to their citizens, not the donors or whoever finance their campaign.

– Need to stop identifying with a political party. Don’t outsource your thinking. That’s tribalism. Think for yourself. Plus every party has a stupid side, why would you want to identify with that?

– Stop reading news just from sources that tell you what you want to hear. Because that makes you retarded. It keeps you in your world. A small shrinking world. Instead of learning and growing you are becoming retarded. Read different stuff. Learn. Talk to different people. Ask questions. Don’t outsource your thinking to a political party.

– Stop talking about politics. There’s other stuff to talk about.

Midterms Review

Everybody is pointing to the Republican’s bad performance. But I think the Democrats sucked even more.

The media likes to highlight the crazies running, like Herschel Walker running for a Senate seat. There’s now a runoff election in Georgia and he has a good chance of winning. Walker has repeathly proven himself to be stupid. Herschel Walker is “observantly stupid” as Dave Chapelle said. But that’s beside the point. Herschel Walker’s voters aren’t necessarily stupid. That’s too easy. They are not voting for Walker, they are voting against the Democrats. Just like it’s a mistake to think that every Trump voter likes the guy.

My question is; What does that say about the Democrats? What does that say about the Democrats policies that a joke candidate like Hershel Walker gets 50% of the vote in Georgia? That’s the Democrats’ failure. When a guy like Hershel Walker says certifiable crazy stuff all the time, how can you not get 90% of the vote? That failure is on the Democrats. Who cares about Herschel Walker? It’s not about him at this point. At this point just put anybody up against the Democrats, because it clearly doesn’t matter.

I’m well aware that I’m harsh on Herschel Walker the politician. But Herschel Walker the athlete? I would pick him on my fantasy team any day. Walker is a former superstar running back, Heisman Trophy winner, Olympian, and UFC fighter. He’s a phenomenal freak athlete. But Herschel the politician? No. Fantasy sports. Yes. He’s just in the wrong lane right now.

Instead of reaching out to voters, Democrats have been pushing them out. They shit on Republican voters. They shit on people that voted for Trump. The “basket of deplorables.” They look down on Republican voters. Democrats are condescendant with “this country would be perfect if the stupid people would stop acting so stupid” attitude or “Republicans voters are stupid”.  And they can’t stop doing it. And it’s the stupidest thing you can do. You are making half the country hate you. What you are doing is assigning people to the other side. You tell a certain group that you belong to Trump. You push people away. You give him votes. You are turning half the country against you. If you trash somebody, or ridicule them, how are you going to lead? What you have is half the country digging their heels and it’s hard to ever get them back. Why would you piss off half the country? You need to reach out. And this goes for both parties.

The Democrats need to address that crazy left wing, the Woke side. I know I’m bashing the Democrats, but the same arguments can be made about the Republicans. When was the last time the Republicans put forward a policy that was appealing? I don’t even know what the Republican party stands for anymore. There’s no real conservative running. It’s just a shit show.

I always said you get the politicians you deserve. Trump is the result of where we are politically. He’s not the cause. He’s the result of the Left being totally crazy in certain places, so out of touch with the general population. It’s so unattractive that you are pushing people away. If you tell people that men can get pregnant and give birth, and that you will get canceled for not endorsing that, I can see why people would look at a guy like Trump. You have to understand why they voted for him. And it’s not because they are stupid. Trump was the only candidate to ever reach out to them. A large segment of the population feels disaffected, that the rest of the country left them behind, and Trump spoke to them. Even though Trump is full of shit, and they know it, Trump became their guy, because he made them feel important.

I mention all of this here to make the point, if it needs making, is that you need to reach out. You need to speak to people with different views. As a politician you are supposed to convince people to come to your side. Not shit on them. You are supposed to say “I’m like you and you are like me more than you understand”. We might not agree on everything or have the same values, but we have the same concerns (economy, education, healthcare, security etc…) We can work together to make this country better. The way out of this mess is compromise.  Both sides need to give up something. We need to come together. 

Putin’s Disastrous Gamble

Anatolii Stepanov / AFP – Getty Images

Putin took a gamble and lost. The bet: Ukraine would fall once Russia invaded. They would meet scant resistance. It was supposed to be so easy that Russian soldiers brought their victory parade uniform. What fueled that thinking was that Russia had a secret network of pro-Russian agents that infiltrated the Ukrainian state at different levels. Putin believed that, aided by these agents, Russia would require only a small military force and a few days to force Ukraine to capitulate. But the agents overstated their influence. The problem in a dictatorship is you always say what the leadership wants to hear because otherwise you won’t get paid, or you will be out of the job. And with bad intel comes bad decisions. We know the rest of the story. Zelenskiy did not capitulate. Zelenskiy said something that will go down in history as one of the most gangster things ever said by a leader. Once offered by the US to get out of Dodge, Zelenskiy reportedly said “I need ammunition, not a ride.” 

If Putin would have won his bet, the ultimate payoff would have been the revival of the USSR. A victory would have fuel that idea that Putin is the only one who can restore the greatness of Russia. We would have a very different conversation today. An easy victory would have made Putin overconfident, pump up his ego, the approval of the Russian people, and the smaller countries in Russia’s orbit would have followed like fallen dominoes. What are you going to do? Take on a nuclear power over Moldova? The thinking was the US lost its way and Europe is too dependent on Russia’s gas to do anything. Nobody has the stomach for a fight. I can’t blame Putin for thinking that. That’s what everybody thoughted. But the Ukrainian’s will to fight for their land and sovereignty convinced everybody otherwise.

Quick detour: Food for thoughts, let’s say, theoretically speaking, that everything Putin said about Ukraine was true, that Ukraine was a country full of Nazis on drugs that needed to be eliminated, don’t you think he would have support of the the whole planet? He wouldn’t have to do any convincing. Israel would have been the first to invade. Anyway…

Putin lost the gamble. Instead of being the next Peter the Great, he’s looking more like Nicholas II. He was the last Czar of the Romanov family. Long story short, it didn’t end well, and history is not too kind to Russian rulers that don’t deliver, and Putin is a historian.

Putin’s powerbase is fuel by the social contract he made with his people. Give me power and in exchange I will stabilize the country. That contract is now broken. He destabilized Russia. The economy is taking a hit, the war in Ukraine is not going well, the losses are heavy, Russia is losing young people, mothers are losing their sons, and his mobilization is a total mess. Some reports estimate 75,000 to 80,000 dead Russian soldiers. That’s a lot of grieving parents. For what? The future looks bleak. They have taken young men off factories and farms. Many talented people left the country. Inflation will hit Russia hard. Instead of turning Ukraine into a failed state, it’s Russian that’s turning into one.

Putin totally discredited himself in the eyes of his own people when he said that his “special military operation” was going to plan to then call for a mobilization. Because now the war hit home. Putin now finds himself in a protracted, full-scale war, fighting for every inch of territory at huge cost. Putin is not making any gains in Ukraine and domestic dissent to Putin is growing more vocal by the day. I’m pretty sure the Russian elite, its bureaucrats, the establishment and inner circle are thinking about life after Putin.

Putin lost the gamble and he’s trying to cut his losses. Putin is probably trying to hold on to as much occupied territory as possible to turn it into a Russian state. My guess is that he’s looking for a way to bring the big power (USA+NATO+Europe) to the table to negotiate some kind of deal. Putin needs to save face. The threat of nuclear weapons will bring the powers to the table, like they did in 1963 during the Cuban Missile crisis. Unless Putin is removed from power, his only leverage is edging closer to brink. I hope it doesn’t get to that, but he doesn’t have a lot of cards left to play.

Putin can’t pull out of Ukraine. Doing so will shatter is strong leader image. It would make him look so weak a home. A defeat might well lead to the collapse of the Putin regime. Remember Putin built his brand around being a source of stability and strength. So he can’t get out and he can’t win. And Ukraine said they want all their land back. My guess the best option for Putin is statis, a long gradual losing war of attrition.

If Russian soldiers keep dying, with the failure of the war, with the economy is disarray, with the sense of failure and imminent disaster everywhere, Russia will be on the verge of total collapse of morale. You need one major regiment to mutiny and other regiments will follow. Why not? The troops in Ukraine are poorly motivated, poorly trained and undersupplied, and their officers had no reason to be loyal to the regime. The biggest threat to Putin is not the West or Ukraine. It’s inside Russia.

Part I – Thoughts on the Ukraine Crisis (pre-war)

Part II – It’s War

Part III – War. War Never Changes

Part IV – Russian-Ukraine, World War III?

Part V – G20 Biden-Putin and the Nuclear Threat

The Rise of the SuperBots

From a previous post, Twitter & Musk

Could paying $8 per month give rise to the SuperBots? Let’s say you are a foreign actor with malicious and deceptive intentions, and you have a bot farm in Macedonia or Russia, that’s $8/month is the easiest play in the world. For $8/month your bot is now verified and credible. You now have a farm pumping verified SuperBots soldiers. Do that with thousands of accounts and you are beating the system. If you are a foreign power like Russia, that’s nothing. It’s cheaper than training and building an army. And a lot cheaper than invading a country. So if invading a country is too expensive or not feasible, but for $8/month you can mess with your enemy so much. For $8/month you have taken your good old bot farm and transformed it into a verified army working at influencing, election meddling, and dividing people. Get a few SuperBots working together and now have viral content on hot topic issue that triggers people. You might not be able to beat your enemy, but it’s a cheap way to get the country to turn on itself. Why invade when you can get the country to turn on itself? My point is that instead of taking care of the bot problem, you have making them stronger.

Iran Protests

No souce. Just a picture I found on Twitter

The Iran protest continues across the country. The unrest was sparked by the death of 22 year old Mahsa Amini in the custody of the country’s morality police. Her crime: Strands of hair showing because of a loose hijab. That was enough for the country’s morality police to beat her to death. Her death quickly grabbed the world’s attention.

The more the Islamic Republic tries to suppress the protests, the more they pop up. It’s like a bad game of Whac-a-Mole. Each time you kill a protestor, they multiply. Iran is blaming the White House and the Zionist regime for the protests. I’m not sure anyone is buying that. Iran has enough problems on its own that it doesn’t need outside influence to destabilize it.

The protests first focused on the strict Islamic dress code for women but quickly grew into calls for the downfall of Iran’s theocracy itself. As I’m writing this, it’s the 50th day since her death and protests are not slowing down. What is unique about today’s protests is that they have united nearly every section of society.  Normally the regime stages counter-demonstration. This time, it’s not happening.

Protesting in Iran requires courage. The protestors, the majority women, face getting arrested, shot, and tortured. According to Reuters, they estimate 356 people die protesting. It’s fascinating what they are doing. They risk death for a cause that’s greater than them.

Source: Mahsa Amini Family

Mahsa Amini is not the first woman to die at the hands of the morality police. But her death lit a spark. (Just like George Floyd wasn’t the first black man to get killed by the cops, for some reason, most likely the graphic video, led to unrest and demand for change and justice.) In 2003, Zahra Kazemi was an Iranian-Canadian photographer that died after being tortured by Iranian authorities. I remember how it was a big deal and relations between Canada and Iran deteriorated afterward.

We have seen episodes of protests in Iran in the past, notably in 2009 (rigged election) and 2019 (high gas prices), and shooting protestors put an end to them. But this feels different. This is one of the most important events in Iran in more than four decades and suggests this could be a turning point for the country’s future. The protests have become one of the most serious threats to Iran’s ruling clerics since the 1979 Islamic Revolution (which was also corrupt and brutal).

The protestors are not demanding more welfare or the loosening of some regulation. No, they want an end to the regime. The demands are very clear. They are chanting “Death to the dictator”. 

Iranians involving every ethnic group, led by women, are fed up. This is not about a hijab or a faith. It’s about basic human rights, women’s rights. It’s about accountability, it’s about freedom. The current theocracy doesn’t represent the Iranians. They want a better future. Iran’s economy is in the tank. Inflation is making everyone poor. It doesn’t help that they are spending vast fortune waging proxy wars or trying to get nukes, when bread is unaffordable. Their allies are North Korea, Russia, and China (the point is you can have better friends or at least less enemies). They are cut off from the world. They want a better world. They want a better future. And the students look at the current regime, and they see the 83 year old sick and out of touch Ali Khamenei.

It is impossible to tell if or when a spark sets the system on fire. But for Iran, it’s been boiling for a long time. You could sense it. I always wondered how regimes that are so out of touch, so inefficient, and just terrible, can last for so long. I guess you have to be brutal. But that will turn on you eventually because you are planting the seeds of your own destruction. It took a long time for the system in Iran to come to this boiling point, but suddenly it has.

I know in Canada and in Western Democracies we complain a lot about our politics and government. I do it all the time.” It sucks. It’s slow. They are wasteful. Why can’t they get anything done? It doesn’t work blah blah etc…” But a quick look at other countries and it quickly humbles you. Suddenly what we have looks very attractive. What we have is what they want. I can complain about my crappy politicians. They can’t.

As for Iran, I’m terrible at making predictions, but I think this is the beginning of a revolution. If the students keep going, cracks will appear in the system. Business and the army will follow. The dictatorship will fall. The army will take over (they have business interest to protect). If they feel that the supreme leader is sinking, they have no incentive to go down with him. Iranians just want a normal country. If that happens, we should embrace it.

Twitter & Musk

Some are outraged that Musk bought Twitter. Some are happy. I don’t have a camp. I can care less. Well I do care a little bit, in the sense of how much influence it has on people and Twitter is a great vehicle for disinformation, hate speech and conspiracies theories and the real-world consequences that comes with it. Of course that conversation is not limited to Twitter. And I’m not going to get into it because it comes with the rabbit hole of cancel culture, politics, freedom of speech, conspiracy theories…

After identifying himself as a free speech absolutist Musk hasn’t announced how he would patrol Twitter but it’s a one man show now. He’s the only board member and CEO. Twitter is his personal asset. He can do as he wishes (not exactly true, he took on a lot of debt that needs to service and he has other shareholders, so he’s going to need advertisers and they won’t spend if Twitter is the wild west.)

I like Twitter, but it’s a crazy place. The amount of trolls, psychos, and bots far outweigh the number of “real” people (probably not but it just feels that way). My take is that the less time you are on it, or any of these social media platforms, the better.

Back to Twitter. It will be interesting to see how Musk tries to monetize his investment. Musk paid $44b for Twitter. And he way overpaid with his $54.20 per share bid (a play on when he said he was taking Tesla private at $420). What seems to have started as a joke became reality when he couldn’t get out of the purchase agreement. How do I know he overpaid? He paid 8x forward revenue. Compared to 2.2x for Facebook (I know it’s now called Meta) and 3.3x for Snap. Put another way, Musk is paying more than double the current valuation of Twitter’s main rivals. At a sales multiple in line with Facebook and Snap, Musk would be paying more like $24 per share for Twitter, and I would argue that’s still too much. Generally, if you are going to pay 8x sales, it needs a hyper growth profile and that’s not Twitter. Twitter is not a startup. It was founded in 2006 and after all these years it’s barely profitable and it’s not growing. 

Musk has a lot of work to do to make this investment work. He paid too much and took on debt. Now he has to service that debt which some estimate to be $1 billion in interest expenses. Musk can cut costs to boost cash flow and profit. He’s already doing that by firing 50% of the workforce. Cutting fat off is a good thing, but shaving costs to the bone might hurt the product, revenue, and growth potential. And he has to grow revenues a lot to make this investment work.

Source: Elon Musk

Musk said Twitter will charge $8 monthly to Twitter users who want a blue tick by their name indicating a verified account. Like many things Musk says, I can’t tell if he’s joking, trolling, or being serious. It’s probably a combination of the three. “Power to the people! Blue for $8/month,” Musk said on Twitter. Maybe I would have paid a one-time upfront fee just for verification. But $8 every month? Do people care that much about a blue tick? And only have to suffer through half as many ads as those of us who won’t be paying. And of course trolls will have a field day.

The whole point of the blue tick was to separate authentic people from fake accounts. It brings credibility to your platform. So you know you are getting your opinions from the real Kim Kardashian.

I also get the feeling that by charging money for the blue tick he’s making his bot problem my problem to fix. “Hey we have too many bots, so pay up to clean up the place.”

Could paying $8 per month give rise to the SuperBots? Let’s say you are a foreign actor with malicious and deceptive intentions, and you have a bot farm in Macedonia or Russia, that’s $8/month is the easiest play in the world. For $8/month your bot is now verified and credible. You now have a farm pumping verified SuperBots soldiers. Do that with thousands of accounts and you are beating the system. If you are a foreign power like Russia, that’s nothing. It’s cheaper than training and building an army. And a lot cheaper than invading a country. So if invading a country is too expensive or not feasible, but for $8/month you can mess with your enemy so much. For $8/month you have taken your good old bot farm and transformed it into a verified army working at influencing, election meddling, and dividing people. Get a few SuperBots working together and now have viral content on hot topic issue that triggers people. You might not be able to beat your enemy, but it’s a cheap way to get the country to turn on itself. Why invade when you can get the country to turn on itself? My point is that instead of taking care of the bot problem, you have making them stronger.

The new subscription might bring in new revenues Musk needs. I think Twitter has about 240 million daily users. If you get 5% of users to sign up, that’s 12m subscribers. 12m * $96/yr = $1.15 billion in new revenue. That covers your estimated interest expenses.

People spend $8 on stupid things all the time, like for a cup of coffee. LinkedIn charges $29.99 per month for its premium subscription. Twitter itself has its own Twitter Blue subscription service, for $4.99/month and I have no clue what it does. I know Musk has big Twitter bills to pay and I wouldn’t bet against Musk. He’s the guy building EVs and sending rockets to space. So maybe there’s some genie to his madness.

From an investor’s point of view, in the Twitter value chain, all the value goes to the consumer. That’s why Twitter never really figured out how to make money. It’s hard to extract anything out of it when all the value goes to the consumer. But some companies have figured it out, like Costco and Amazon. These companies have thrived in giving as much value as possible to the consumer. If you take Costco, all of their money is in that membership card. Their margins are razor thin on the retail side. It’s a similar situation with Amazon with their Prime membership. I guess by now you realize they don’t make money off books. They both put the consumer first and worship him. As for Twitter, it does have the potential to be the best platform.

Twitter is a social network. The more people, the better. Each additional user adds value to the existing user. The worst thing for Twitter is that the network effect collapses–because no one wants to be at a party where other people aren’t there. You don’t have a social network if there’s no people. Remember Google Plus? Nice place, but it was a ghost town.

I said this in a previous post. I’m not a Musk fanboy. I’m not a Musk Hater. I’m fascinated with Elon Musk, the person, the character. Just like how historians study people from the past. I’m also envious of his schedule. He’s the CEO of way too many important massive companies (Tesla, SpaceX, Twitter, Boring Company, Neurolink and I’m missing some). He has 9 or 10 kids. And he’s very active on Twitter. Look, I don’t even have time to read my emails. 

I had a moment a couple years ago. I was trying to put some clothes on my toddler and she wasn’t having it. And you know as a parent, when a kid says no, it’s a hard no, and it’s impossible to do anything. It was at the same moment Musk was launching rockets and landing them. And I couldn’t even get my kid to get dressed. I remember asking myself “how does he do it?”

I think the playbook here is to try to “fix” Twitter, generate revenues, pay down some debt, and turn it into some superapp that does everything like they have in Asia with WeChat. And once Twitter is all shiny again, make it public as some extravagant valuation.