Just as in investing and climate change, accurate models are difficult. It requires a lot of assumptions and judgment. Even if you are off a degree here and there, it can have a massive impact on the results. You need to understand its limitations. That’s why a margin of safety (error) is important.
If you follow Warren Buffett then Lawrence A. Cunningham (@CunninghamProf) doesn’t need an introduction. Lawrence is a lawyer, a professor at GW, a corporate director, and a Buffettphile. Mr. Cunningham is better known for documenting Warren Buffett and Berkshire Hathaway for decades. He’s the author of many books. His most famous work is the The Essays of Warren Buffett: Lessons for Corporate America. Investors that want to learn more about Buffett and BRK has turned to Professor Cunningham’s work.
Last night I participated to his virtual book launch of his new book: Dear Shareholder: The best executive letters from Warren Buffett, Prem Watsa and other great CEOs (pun on Dear Chairman, another great book, he asked Jeff Gramm for permission). Prof. Cunningham also provided slides to follow allow.
Dear Shareholder Talk Slide Deck April 14 2020 (feel free to share)
I’m looking forward to reading the book. Investors, entrepreneurs, and business leaders could learn from some of the best shareholder letters written. The book is separated in 16 chapters. Each chapter represents a company. Most letters have one author, but companies like Leucadia-Jefferies and Markel Corporations have two. This is truly some of the best people in business, separated in three categories: 1) Classic (Buffett, Goizuieta +), 2) Vintage (90s), and 3) Contemporary (SEACOR, Google, Constellation Software +). The only ones I never heard of on the list were Charles Fabrikant from SEACOR, Brett Roberts from Credit Acceptance Corp, and Robert Keane from Cimpress N.V. I will have to look them up.
Buffett is the dean of shareholder letters. They all learned the art from Buffett. They all tried to emulate him. But they have their own style, own personality, and all try to bring something different to the table. These guys (and two ladies) are great writers. There is something special about this group of authors. They focus on discipline, capital allocation, conservatism, being rational and the long-term. What makes a great shareholder letter? They treat shareholders as partners. They provide a comprehensive clear report.
This book is great business writing pulled together into a book. I’m waiting for my copy and will be great references on the book shelve.
Thank you Professor Cunningham for your work and being generous with your time.
Hey,
Are you in quarantine with two young children like me? We are all doing our best and trying to navigate the current crisis. Below are three different fun activity packs to keep your young children busy. They were free and fun. It worked for me. My kids are five and two. I’m supposed to be working and educating my kids at the same time. It’s sort of impossible. Formal home schooling is not working because the two year old like to crash the party. Plus, even without a toddler, it only works for so long. So you kind have to improvise as you go. My approach is learning while having fun. Basically they are having fun and they don’t know that they are learning. That’s the best kind.
Here’s the downside: You need a printer and lots of ink. (If there’s anything left after printing everything your teacher sent.)
Social isolation is playing defense. It’s a tool and it’s very effective. It’s the equivalent of taking a sledge hammer to a fight. It buys off time. The curve is starting to flatten in Italy and other parts of the world that have adopted social distancing measures. You can’t get infected if the virus doesn’t know where you are. But there is a problem. Social isolation is half of the battle. A battle has to be fought on multiple fronts. If you don’t know who has the virus, you can’t see where it is and where it isn’t. If you can’t see where it is, you don’t know how to fight it, except by shutting everything down and telling people to stay away from each other. In addition to a sledge hammer we now you need a scalpel. We need to get surgical. Testing in an outbreak gives you data. The data provides two functions. One is to diagnose those who are sick. The other is surveillance: to see where the virus may be lurking, especially in cases where symptoms are mild or don’t manifest at all.
Before we have a vaccine and a victory parade, we need massive testing. The key forward in this battle is testing, testing, and testing. We need to be aggressive on that front. That’s how we will know how wide spread the virus is. Test positive: Hide for fourteen days. Test negative: Go to work. The countries that have tested the most people are also the countries with a better handle on the virus. Why? Because they have data. South Korea and Singapore have been exemplar in their response. Italy is the “what not to do” example and the U.S. is providing serious competition for the title. In Italy the pandemic has turned into a disaster. Italy has only twice as many cases as Germany but almost 50 times the deaths. The Germans have tested huge numbers of people and the Italians have tested only people with serious symptoms. That is, some vast numbers of Italians has had the virus but were never tested, either because their symptoms never sent them running to the hospital or they never even knew they had it. In a matter of weeks (from February 21 to March 30), Italy went from the discovery of the first official Covid-19 case to 11,591 deaths. Within this very short time period, the country has been hit by nothing short of a tsunami of unprecedented force, punctuated by an incessant stream of deaths. This is the world’s biggest crisis since World War II.
We need mass testing for both the affected and the asymptomatic. Social distancing slows the disease to manageable level. That way we ensure hospitals have the equipment and resources they need. We’re going to need other kinds of testing, too, like serology — testing of people’s blood. That way, we can figure out who has already had the disease and is now immune and can safely return to be in contact with others in society. When that happens, we can move to a more sustainable mitigation strategy. Any sustainable strategy against Covid-19 has to balance public health and economics. It will need to be done in phases. You can’t just turn on the economic faucet to full and nuke the health care system. Low risk and younger people will be able return to work. Gradually allow “nonessential” businesses to reopen (prioritize reopening in industries compatible with physical distancing first).
With aggressive wide spread testing we can start to go back to our normal lives, or a new normal, while savings lives. It’s not the case that everything could go back to normal. A new normal includes some level of social distancing measure in place with tracking and isolating cases. No more handshakes and kisses. That’s over for a while.
Stay safe and thank you for reading,
Brian
Over the next couple days, I will publish a few posts on the current Covid-19 crisis. The first post is where I highlight some positive developments that deserve to see the light of day to keeps things in perspective.
Uncle Sam Wants You Home
At the time of this writing I’ve been ordered to shelter inside my home with my family because I’m fighting an invisible enemy called Covid-19. You too have been drafted in this war to stay home. Except for essential workers (which should be renamed brave workers), the most heroic thing I can do is stay home and watch TV. That’s how we are saving lives. Despite being in isolation for the last seventeen days, we are in this fight together, but not physically together, to prevent from killing each other. In theory, if everybody respected the rules for thirty days, the virus would be dead and we could declare victory. But that would be too easy. Yogi Berra said that “In theory there is no difference between theory and practice. In practice there is”. So practically speaking, the reason we are home is to slow down the spread of the novel coronavirus to avoid a public health care crisis.
Behavior has changed. You can tell just on walking down the street. A new etiquette manual is being rewritten as we go. People are keeping their physical distance. People are also making more of an effort with each other than I’d ever seen. Strangers are saying hello to each other. We now all have something in common. We all are in quarantine! And we talk about being stuck at home. I see people helping each other, especially the most vulnerable. I have a lot older neighbors that can’t go out in public and can’t believe the response they get from their neighbors willing to offer help. It’s fascinating how hard times bring people together.
The purpose of this post is to highlight some positive developments, current events, and a way forward.
I believe we will get out of this crisis sooner than later. I believe we will get out of this stronger. We are planting the seeds to combat the next epidemic. The world and the U.S. will never let this happen again. The world will adjust their response for the next crisis. They will treat this like a war. They need to be able to mobilize thousands of people and resources next time a threat is detected. We will be ready for Covid-20.
The Good News
We are flooded everyday with negatives news. It’s raining gold for the media industry. We can’t turn it off and the media is not turning off the tap. Covid-19 is a very sticky business for the media. Covid-19 is not only a lung killer, it goes after our brains. It activates a part of our brain call fear. Fear is more contagious than the virus itself. Fear is a powerful emotion that makes us act irrational. It makes human hoard toilet paper.
I want to shine some light on certain developments that might not see the light of day:
Even though we might not feel like it, we are heading in the right direction. Social distancing works. Better testing tools are coming. Everyday we are making progress. It will take time but we will win and come out of this stronger and better.
Thank you for reading,
Brian Langis
I made these two videos over the weekend that I shared over social media. Basically the message is if we stay inside for the next little while, we can defeat this virus, or at least slow it down. We can still have a handle on the situation. Staying inside is the best weapon we have right now. If it free up our ICUs, our resources, staff and equipment for the people that needs it the most. We have to get the best chances on our side.
*Update: I wrote this two weeks ago. This morning the Liberals gave the big 3 wireless providers two years to cut prices by 25%. If they don’t comply the government will look into further increasing competition (hint: foreign companies).
During the last electoral campaign, Prime Minister Justin Trudeau made a promise to reduce cell phone bills by 25%. According to the Liberals this would save a family of four about $1000 per year on average. Part of the plan is to bring more competition to the table via mobile virtual network operators (MVNO). With the CRTC hearings underway, Canada’s Big Three, Bell, Telus, and Rogers are showing resistance. Telus said they would cut 5K jobs and $1 billion in spending if CRTC approves MVNO. The head of Rogers says it may have to cut back $3 billion on planned investment in technology networks, including 5G, this year if it doesn’t like the government’s new rules.
It’s safe to say that most mobile consumer wouldn’t mind the government shaking down big telecoms to lower bills but there’s a probably a long term cost, where Canada falls behind in innovation and technology. Telecoms provides critical infrastructure to the economy. It should be in the nation’s interest to have the best network. A lack of investment in the space could outweigh lower cell phone bills over time. The main question is how do we get lower bills and higher investments to fuel innovation?
Part of the answer is grant 5G spectrum for free or at a low cost in exchange for lower bills. Spectrum is the airwaves used to carry mobile phone and other electromagnetic signals. Spectrum is essential for companies to be able to grow, to provide data to consumers, to connect consumers. It’s what makes a smartphone smart. So this is a very valuable resource and how we deploy that resource will enable the ability for companies to invest and grow going forward.
The Canadian government is expected to auction wireless spectrum in 2020 and 2021, which could be a significant expense for wireless network operators. 5G is the next generation of wireless that is supposed to be better and faster. 5G will be fundamental in ushering our economy into the next generation (autonomous cars, smart cities, smart factories, IoT etc…) 5G will have a major impact on the next stage in the development of the digital economy.
For government, the spectrum auction is an opportunity to raise a lot of money. But do how to strike a balance between raising billions from a sector already straining to reduce costs while stimulating investment in the rapid deployment of 5G services. If the spectrum is too expensive, it becomes a way of taxing the industry instead of helping new technologies. It’s possible that high spectrum costs have a knock-on effect for consumer prices, which would reverse what the Liberals want to achieve.
This idea is not new. China has granted spectrum licenses to the country’s telecoms networks in rather than selling them off. It’s part of China’s attempts to win the 5G race and to have a national rollout of 5G. This is an opportunity for Canada to become a leader instead of playing catch up.
There’s a win for everyone. The Liberals fulfills an electoral promise. The consumer gets a lower bill. And the telecoms invest in infrastructure and innovation to provide access to the next wave of technology.
I understand it’s attractive for the government to auction off licences for potentially billions on an industry largely built on thin air. Instead of chasing quick money, I recommend playing the long game. We should approach this space with a large ambitious vision. Let’s think big here. Let’s be the model that other countries want to emulate.
Thank you for reading,
Brian
I like the statement below. The point is that the capital market are currently subsidizing your Uber ride. This works until it doesn’t. One day the capital markets won’t be as generous and Uber & company will be in a bind. The business model of looking outside for cheap money won’t work. One of the biggest reason these companies are where they are is access to mountains of cheap cash built on a promise that one day you will be profitable one day. I have a serious question: If you can’t generate internal positive cash flow after so many years of growth, let’s say like Uber and Wework, how successful are you?
If you wake up on a Casper mattress, work out with a Peloton before breakfast, Uber to your desk at a WeWork, order DoorDash for lunch, take a Lyft home, and get dinner through Postmates, you’ve interacted with seven companies that will collectively lose nearly $14 billion this year. If you use Lime scooters to bop around the city, download Wag to walk your dog, and sign up for Blue Apron to make a meal, that’s three more brands that have never recorded a dime in earnings, or have seen their valuations fall by more than 50 percent.
Source: The Atlantic, The Millennial Urban Lifestyle Is About to Get More Expensive by Derek Thompson
It’s hard to make sense of what’s happening in the stock market. There’s no simple explanation to why certain profitable companies can trade at 10x Price-Earnings (PE) or why money-losing companies are trading at 100x. The automobile industry is an example. There has been little appetite for traditional auto makers like GM and Ford. Tesla (TSLA) captures all the electric-vehicle (EV) enthusiasm. Tesla is trading at $930 a share, up 200% in a year and 121% less than two months in 2020.
Below is the market capitalization of some of the main auto manufacturers with total car sold in 2019:
How has Tesla surpassed Volkswagen which sells 30 times more cars? How does Tesla’s valuation dwarfs the combined market value of Ford, General Motors, and Fiat Chrysler? Globally, the only competitor Tesla trails is Toyota Motor at $196b.
Of course profits, cash flow, and valuation are important. But in the short-term what matters the most is story telling. Tesla and Elon Musk are pushing are very interesting story: Tesla is the car of the future. They are revolutionizing the car industry and saving the planet along the way. Tesla’s cars are cool and high-tech. It’s a computer on wheels. They are a status symbol. Now compare that story to Ford’s “have you driven a Ford lately?” (I have no clue if that’s still their thing). The point is one car company are making investors excited and the others are not.
The belief in Tesla is cult like. You can throw anything at Tesla and the stock just keeps going up. Just last week there has been a car recall, a SEC subpoena, $2b of new shares issued, explosion in warranty expenses, and yet the market doesn’t care. That’s on the top of losing over $700m in 2019. The SEC revelation, that alone, can spook investors. They check up on company accounting and financial practices and nobody seems to care.
The value of a stock is based on future expectations. In this case, the market believes that Tesla will become the biggest and most profitable car company in the world. Over the long term, the expectation is that revenue growth will translate into growth in profits and free cash flow. The value of any investment is the present value of future free cash flows. The market also believe that Tesla’s rise reflects investor expectations that the company will remain at the cutting edge of technological change in the auto industry.
It’s important to note that growth does not always create value. A company can grow, but if it doesn’t earn above the cost of capital, that growth destroys value. In order for growth to create value, a company must earn returns above its cost of capital.
What’s going on with Ford? It hasn’t been an easy year or five years for Ford. The stock has been an absolute dog for years despite seeing their trucks everywhere. The F-series is one the best selling vehicle every year. They are nice. They are a symbol. They are fun. And they are expensive and very profitable. The upcoming Bronco has a nice buzz around it and the Mustang Mach-E has a big reservation list. Still none of that seems to matter. The stock is around $8, half of what they were a couple years ago. It has a juicy dividend of 7.4%. But…the most important question is will they cut it? The current dividend commitment is $2.4 billion annually and guided $2.4-$3.4b for 2020 in free cash flow. Ford does have a strong balance sheet with a cash position of $22 billion and its liquidity, which includes lines of credit, totaled about $35 billion. Ford has to fund the dividend, its capital plan and a restructuring.
They are in a $11b turnaround that never seems to end. Ford disappointed investors with its earnings and guidance.The current CEO seems to be on the right path despite the never ending issues. He adopted the playbook that other companies, like GM and Fiat Chrysler, are now using which is a larger focus on profitably vs market share. These companies were trying to be everything for everyone and it’s not working.
The car industry is changing fast and Ford is in the middle of that struggle. The last five years hasn’t been good for Ford. The main question is what will the next five be like?
There’s no love for GM. The story here is that GM is an old traditional auto maker, not one that is taking a plunge in the future.
Every year the stock seems to get cheaper on an earning basis, but cash flow ultimately came up short for one reason or another. GM trades for less than 6 times estimated 2020 earnings and Ford sells for 7 times. The comparable figure for Tesla stock is about 88 times. Is 2020 the year for GM?
GM does have a plan for an all-electric future featuring leading-edge autonomous-driving technology with their Cruise division (valued at $19b alone but that’s because of Softbank’s investment, so they probably paid too much like everything else). GM is saying the right things by addressing climate change and decarbonization.
The market gives little credit to the huge amount of cash GM generates. For 2020, it forecast almost $7 billion of free cash flow. At that level, GM stock, trading at $35, would have a free-cash-flow yield of almost 13% (vs the S&P 500 index’s FCF yield is about 3.7% and Toyota of 0.8%).
Something needs to happen. The stock hasn’t done anything since its IPO except the nice dividend of 4.3%. Nevertheless I’m confident in GM.
I don’t have much to say on Fiat Chrysler (FCAU). It’s a favorite for certain part of the value investing community. I know Mohnish Pabrai likes it a lot was an important holding of his for years. I think Sergio Marchionne was a good CEO. He was focused on capital allocation and has a famous presentation on the topic: FCA Presentation – Confessions of a Capital Junkie. Basically the message was the industry has not earned its cost of capital over a cycle and consolidation is the answer. Which explains why he was always trying to sell itself to GM, Ford, and whoever was interested, which confuses me. Spin this, buy that, sell that, split this etc…they are not mergin in Peugeot. Will Americans buy French cars? Peugeot and Fiat trade for just 5.8 times and 4.9 times estimated 2020 earnings because nobody cares.
Fiat Chrysler has some good brands. I think the RAM and Jeep are strong and could be stand alone. But the main problem with Fiat is that they are behind in the EV game and R&D. They are behind in playing catch up.
