The "Real World" - more Meta?

For the past year, I have been emphasizing a movement from "physical" real estate to "digital" real estate. When I originally studied and valued Home Depot stock, I spent time studying the locations, the structures and the private valuations of those. This "physical" real estate anchored my understanding, valuation and analysis.

Since then, I have moved to the value of "digital" real estate, preferring digital real estate because of its scalability. Physical real estate became valuable due to its toll road nature, but that limitation also became a limitation in value. Digital real estate is expandable with little limitation on scale. This scalability creates an amazing "winner take all" characteristic powerful network effects drive a financially virtuous cycle of growth.

All of this converges with a growing sense that the "real world" is made up of an interplay between the two. This convergence has hit me as recently I have been considering the sale of my home. I received a beautifully written note from a realtor expressing interest in my "stunning, magical and picturesque" property and, based on her poetically stated interest, agreed to meet. 

I originally selected the property because of its connectivity in an active and busy area of town. However, as I watch the development of the digital world from Zoom to Instagram to LinkedIn to emails, I find that my main connectivity, especially during Covid-19, to be through the digital venue and my physical location was less significant. Perhaps the flight path of the jets of Love Field as well as my neighbor's daily obsession with gas-powered leaf dampened my ardor. Now I grapple with what is my best life?

I'm not sure yet, but I believe that physical real estate patterns will be affected on individual basis in the same way as retail space has been disrupted by Amazon. It seems as if the primary shift in residential will be a greater sprawl when suburban concepts are appealing. For those who are attracted to inner cities, the metrics are altered to an increase in space as office dedicated space is important. But it looks like the grind of daily suburban commutes are likely to be reduced.

A capstone of this trend is Facebook's recent pivot to the metaverse. As the physical and the digital converge, it seems clear to me that the metaverse will play a multidimensional approach like the facetime dynamic. The convenience factor will be important. Over time, there are signs that zoom, google meeting and skype are tiresome and awkward. Why not simply write a lovely note like this realtor? However, if the newly named Meta can drive interactions as easy as those between iPhone owners, then physical reality may become even less relevant and allow for an expanded suburbia.

Wage Push Inflation Sustainable?

Everyone sees the inflationary spike post-Covid (assuming that day arrives) and I think pretty much everyone assumed that it was likely to occur. However, the key phrase became "transitory" versus "permanent." I have been and am in the "transitory" camp, but have noted one flaw in my analysis.

Basically, I viewed a post-Covid world as one which returned to a pre-Covid world with significant tech improvements. These improvements are generally deflationary - greater communication, less travel and better technology (like docusigning etc). I recognized that there would be some inflationary impacts as some distancing measures and productivity losses held. 

However, my biggest blindspot was the reluctance of workers to simply return back to work. I was skeptical that subsidy checks would cause people to be reluctant to go back to work. Here I was wrong. In the 80s, I saw a strangely similar pattern. When realtors made six figure incomes in the real estate boom in the 80s, they were reluctant to work for anything less when the boom busted. Forever more, they saw themselves as six figure people.

Now a similar pattern seems to be showing up where people have received funds for no work and shifted a self-image to a much higher income to return to work. In response, businesses have simply stepped up wages and passed those on to customers - who assume these prices are temporary. I still believe that these prices are temporary and that higher wages will only drive higher productivity and a loss of some services jobs. If a wage push inflation is sustainable, bond and stock markets will be dislocated. In japan, there have been more jobs than workers for years, but inflation has not been sustainable.

Quality = Low Turnover

Increasingly I have focused my attention on the "own forever" principle. By evaluating such a permanent commitment, I am forced to focus on "quality." Quality companies are distinguished by several factors: 1) a business model that is durable, 2) an industry that is durable, 3) a strong balance sheet and 4) a willingness to suffer by making long term investments in the business. Such companies make for wonderful investment marriages when combined with a reasonable price. 

However my life is littered with a very different history. Having been trained in the school of Ben Graham, I have tended to look for that which is on sale. This excitement is the same as anyone might observe at a TJ Maxx. There is real pleasure in getting something that is genuinely needed at a significant discount. This warmth has a downside as the value is remembered long after the price is forgotten. By accumulating "sale price" goods, the investment portfolio is built of companies which grow slowly once the price has gotten to intrinsic value. The decision pathway becomes unattractive - either sell and pay taxes or keep and grow slowly. No good solution. 

I'm finding that such a pathway towards quality and low turnover is also important in every other area of my life. First of all, as a veteran of two divorces, clearly there are a set of characteristics for a quality spouse. Second, in the area of employees, there are also characteristics that make for a quality employee. Third, in terms of selecting a client base, the same can be held true. The emphasis should be the same: pay attention to the drivers of low turnover and high quality while avoiding short term excitement.

"Margin of Safety" Investment Stack

The three most important words for investing are "margin of safety." Benjamin Graham, who coined this phrase was essentially focused on the investment itself. For example, he liked an stock investment which cost less than the actual net cash of the underlying investment. This "tangible" value approach to investing was a way to preserve value through such disruptions as the Great Depression. Since then, the world has evolved away from "tangibles" to "intangibles" but the underlying principle has not changed.

Yet within investing there are several layers which create an "investment stack." The investment stack at the most fundamental is the business itself. There are a wide variety of estimating the the values, but the principle is to pay less than the value of the investment by a "margin of safety." In today's world, this is increasingly difficult and requires some conviction about the ability for rates to stay lower for longer.

The next level within the investment stack is at the portfolio level. This involves an asset class decision, such as an appropriate amount of cash, bonds and stocks. At this level, the portfolio has to exhibit a "margin of safety" so that the volatility of the portfolio performs adequately against required draw rates.

The final level within the investment stack is at the investor level. The investor is likely to experience changed requirements, such as those related to healthcare or other issues, as well as psychological issues during periods of extreme duress. If an investor is likely to get caught up in larger societal reactivity, the investor needs a "margin of safety" to address this. Reason does not win when faced with the overwhelming power of emotions. Here Socrates gave the two most important words "know thyself." 

When a "margin of safety" is the principle of construction at each level of the stack, the investment process is likely to be enjoyable as well as profitable.

India's Economy Buried by Gold?

For years, I have wondered how India has been the home of spiritual, material, aesthetic and architectural highs (not to mention gorgeous women) but managed to evidence such extreme poverty. When I asked about it growing up, my rural Midwestern community's answer was "they don't eat their cattle." Another great example of our frame of reference driving perceptions. More recently, many of the public traded companies that I follow are lead by Indians. And it's not just leadership as apparently per capita income exceeds any other identifiable American group. So what in going on?

Later, I was reading a book on the history of India. The historian discussed a common perception from the Roman writings. India was already the go-to place for fabrics, art, jewelry, building materials and all things man-made. However, the Romans found that the Indians desired nothing but gold in return. Indians could care less about weaponry, swords and shields - only gold did the trading trick.

In reading BRK's 2011 annual report, a light went on. It states "Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B? Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices. A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond."

It's sad to think about. Indians have tied their national wealth up with an inert object rather than focus on productive assets. The tragic result is that gold is the likely cause for poverty in India as gold ownership really became a form of high social consumption (for dowries etc) rather than capital as an investment for productivity and employment. 

Big Tech is really Digital Real Estate

I have gone to Aspen Colorado for over 25 years. It's a lovely place with beautiful scenery, mild winds and attractive infrastructure. The buildings are from the Silver Boom in the late 19th century and provide a wonderful Western flair. As a coffee junkie, I initially fell in love with a shop called Zele. Soon enough, I found what happens with many shops. The business was so successful that the owner of the real estate kicked them out and put in one of their own. It turns out that this phenomenon has a name: wholesale transfer pricing.

Wholesale transfer pricing is the bargaining power of company A that supplies a unique product XYZ to Company B which may enable company A to take the profits of company B by increasing the wholesale price of XYZ. In this case, the Aspen real estate owner supplied Zele with a perfect location that ultimately the real estate owner could take by either jacking up rents or kicking out the business. Nothing evil here, but it's a crushing dynamic if you're on the wrong end.

As current suits stack up against Google, Facebook, Apple and Microsoft, it just reminds me of the Aspen Zele dynamic. These Big Tech companies have simply created and own the critical real estate. Businesses can come in and build very successful businesses on top of that real estate, but to quote the labor union at UPS, Big Tech can simply say to those businesses "you make more, we take more." Rules of the road. The critical part is not to be invested to heavily that relies on another company with such bargaining power.

Value Redefined?

Historically, a "value" manager was in a category that adhered to a numerical basis for the valuation of an investment. This process was typically balance sheet-driven in which assets were purchased for less than their valuation. The positive estimate between the value received and the price paid constituted a "margin of safety." The results were driven by downside protection and some percentage of upside capture.

In contrast, a "growth" manager was in a category that followed structural disciplines in which indicators of growth were identified. This indicators might vary from gaining market share from cost or disruptive technology all the way to simply price movements. The results were driven by capturing the gains of expansion followed by a quick exit if any signs of maturity or decline set in.

Seasonally, value and growth managers alternated leadership with the best in each category generating superior results to market averages. However, for the past ten years (excepting the past two quarters), "growth" has trounced "value." While many pundits argue for a "reversion to the mean," I think that something else may be at work. 

Generally speaking, an investment does well if there is scarcity of supply relative to demand. After the vigorous efforts to restore markets damaged by the Great Recession of 2008-9, capital became abundant. Rates were low. This trend accelerated during the Great Infection of 2020. With government fiscal spending and central bank monetary support strongly committed, this abundance of capital could thwart the "reversion to the mean" thesis.

Business cycles are characterized by cycles in profits. When profits sink, unproductive assets drop in value, capacity is closed and capital is withdrawn. Later when profits recover, capital flows back into assets, capacity is expanded and assets increase in value. Critical to this cycle is scarcity of capital. If capital is abundant, then as profits drop, capital is not withdrawn and capacity is not closed, but instead continues to compete at lower levels of profitability. As a result of capital abundance, industries may experience prolonged competition and a decreased ability to cyclically get to "the good old days."

If this is so, then "value" managers may still capture results numerically, but need to focus on income statement items in which reasonable assumptions of growth are secured by some durable competitive advantage. Durable competitive advantages offset the impact of capital abundance. By discounting future earnings of such companies at today's lowered rates, value managers may discover a "margin of safety" through growing earnings rather than recovering assets. Such an approach may not yield the same combination of downside protection and upside capture, but it may generate superior results due to owning assets less subject to commoditization.