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My new formula predicts a 73.2% move by Friday - your details inside


ScottHall
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So I got stoned again and I had this great idea. It is largely accepted as belief that being as dispassionate and emotionless as possible in your analysis of securities is the right way to go about it, because you're less likely to fall for your own mental hangups and biases regarding various companies and/or the people who work there and/or the products.

 

Of course this is actually ALL BULLSHIT the teacher's pets like to say to sound smart and get Scooby Snacks from their PMs & Fintwit friends. Everybody knows emotion is unavoidable as a moist robot, and we like to shun away from it in favor of clear and rational decision making.

 

I think that is incredibly stupid. Humans have evolved with emotion for good reason, and instead of shunning our heritage we should allow it its own time to take center stage. Just as the devil standing on Donald Duck's shoulder inevitably gets his day, I think there are times when we should allow emotion to as well.

 

The reason is that emotion helps us empathize with each other, and some of us are better at that than others. By attempting to lock our emotions in the closet, we start to lose the ability to empathize with the customer of many of the companies that we invest in. If we do not understand him, it somewhat obscures the true prospects of the companies we're watching. Are they fads or legitimate? Is there anything this company can do to upsell to its existing customers by serving even more of their needs, emotional or otherwise?

 

Some of that gets picked up in financial analysis and the sort of thinking Munger encourages us to participate in. Namely, the power of understanding incentives. But many incentives are not financial. They may be social, moral or from latent emotions the customer has brewing inside them.

 

I think Berkshire is better at this than most; I imagine most of us have read Munger's analysis of how to make the perfect company (Coca-Cola), and his use of understanding the imprint Coke's advertising has left on the mind of the American (and at this point, world) consumer. By attempting to understand the emotions they feel towards the product, you can sometimes hit home runs.

 

I think that's a very useful way of thinking. I also think that the concept more broadly can be added to by a sense of immersion, when possible. I would wager Buffett & Munger were able to understand the Coke consumer so well because they are (were?) Coke consumers themselves, and it's been around them and targeted to people like them all their lives. If they were investors born in some remote region of the world, because of its ubiquity, they'd still probably be able to understand the emotions of Coke consumers... but would they be able to understand it as well as they do, having been consumers?

 

I applied this sort of thinking in my own life once, outside of investing. I was working at a company where my job was mostly to write quarterly earnings reports for publicly traded companies, and this company had a marketing department.

 

I did not fully understand the value of advertising or how to do it effectively, and thought many (not all) of the established techniques used in the advertising industry were wrong... largely for the moral lack of regard for manipulation. But I wanted to learn why the industry works the way it did, and why copywriters wrote the way they wrote, so that I could attempt to improve upon it.

 

So I asked one of the senior copywriters who was a friend of mine to let me work on some projects with him. He ended up assigning me a copy of Tested Advertising Methods and entered me into an internal copywriting tournament, which I ended up winning by using the same techniques that had been standard in the industry for 70 years. Techniques I never would have learned without attempting to gain some level of empathy with marketers.

 

I think the same thing can apply in investing, and though Peter Lynch gets a lot of shit for it, I think his concept of investing in what you know goes a long way in that regard. What better way to understand the allure of a company's products than method act as if you are one of the company's customers?

 

I think this has additional implications, too.

 

It's often said that price is what you pay, value is what you get. That in the long term the market is a weighing machine, not a voting machine. And that a company's intrinsic value is independent of the price it trades at. I don't think I've ever heard something so stupid in my entire life.

 

Which is that you cannot be a good analyst of companies that exhibit certain types of reflexivity without first understanding emotion. And there are a lot of companies that share this trait. REITs and MLPs for years have increased shareholder value by issuing equity to acquire or build new assets, and have largely had the benefit of having equity that trades at lower yields than the assets acquired.

 

If you can raise equity at 20x earnings to acquire assets trading at 10x earnings, you're creating significant value for your shareholders all else being equal. Your intrinsic value per share is being increased from the fact that you can sell at 20 and buy at 10.

 

That can create this weird sort of feedback loop where a company can be overvalued on the merits of its own financial performance, but when you account for the fact that it can issue equity at overvalued levels, it is actually undervalued because of the value those overvalued equity issuances can create when invested at relatively more attractive rates.

 

All of this is a means of saying that in investing, emotions aren't bullshit and can be self-fulfilling. Look at the long term track record of the Kinder Morgan entities - up, up, up in a virtuous cycle - until it was faced with the threat of being cut off from the capital markets. The stock tanked, and consequently the value of the company was lowered because the spread in multiples contracted.

 

And guess what? Market prices are driven in large part by... emotion. Getting cut off from your financing b/c investors are scared shitless? Emotion. Celebrities giving Nordstrom millions of dollars in free advertising since they cut Ivanka? Emotion.

 

I think it's dangerous to try to check your emotion at the door every day, because nobody else is going to.

 

 

P.S. There is no formula.

 

 

 

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Wow. Great thought provoking stuff.

 

I think a separate tangent can take us to the debate of emotion vs the collection psychological efforts of mass emotions. By this I am referring to the aggregate emotions of crowds that ultimately create market dislocations. You have investments that people feel good about. Investments people buy because others are buying. Investments because people are convinced they will only go up.

 

Think about VRX and the roller coaster. Guys like Chanos were tooting the short horn in the $60s. The stock chugged along for years to a high north of $250.  Now, the pendulum has swung so far back the other way, people are having a hard time ponying up anything more than a fire sale liquidation number. Without getting into the fundamental calamity of the VRX story, the psychology behind what drove the stock was incredible. Kind of like a current AMZN or TSLA.

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You may just be talking about the 'delight your customers' idea. Very true. Also delight the investor - you. If you get turned on by the business and the management is having fun, that's a team you want to play on. My little measure is to look at a small action or acquisition a company makes. Once in a while I'll see a deal that makes me say, 'wow that's creative'. Or that is something of high quality, quite unique. You have to see many deals to get a feel for what is above average. Managements that do creative, superior things may be what turns you on. That often translates into a good result too.

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Wow. Great thought provoking stuff.

 

I think a separate tangent can take us to the debate of emotion vs the collection psychological efforts of mass emotions. By this I am referring to the aggregate emotions of crowds that ultimately create market dislocations. You have investments that people feel good about. Investments people buy because others are buying. Investments because people are convinced they will only go up.

 

Think about VRX and the roller coaster. Guys like Chanos were tooting the short horn in the $60s. The stock chugged along for years to a high north of $250.  Now, the pendulum has swung so far back the other way, people are having a hard time ponying up anything more than a fire sale liquidation number. Without getting into the fundamental calamity of the VRX story, the psychology behind what drove the stock was incredible. Kind of like a current AMZN or TSLA.

 

I think that is true. For a long time people believes that VRX could make great acquisitions, and as a result the stock went on a rampage. I owned it for part of this ride; sold recently for tax purposes b/c I had to offset some big gains this year.

 

The interesting thing to me about VRX is that I think Mike Pearson was basically right regarding his outlook about the drug industry. The incremental returns on capital are total dogshit and have been trending down for many years. Most of the money that goes into research is blown, and it's an industry where you have to run just to stand still when a hit product goes generic.

 

I think the thing that killed him is he basically assumed he could fuck payers indefinitely without there being repercussions. If not for the revelation and shut down of Philidor, I'd guess VRX would be a $400 stock now and potentially a more robust enterprise by issuing stock for a big acquisition. If they'd pulled one off, even with the revelation of Philidor, there'd probably be no doubt about VRX's solvency, enabling even more deals.

 

But that's not what happened, and the rest is history. I think this is actually a really good example of where understanding emotion is very useful, and I've talked about this on Twitter before. So I agree with you on that. On both the way up and the way down, Valeant's swings in share price were changing the range of outcomes for this company.

 

My big mistake here was probably not properly understanding the extent of the rage that VRX, Shkreli, etc. whipped people into, and what other actors in the industry and government may do to counter them. It'll be interesting to see what will happen to it from here; my guess is it's either worth a lot more than the current price or it's worth zero. I have no skin in the game anymore, so I don't really care. But it was probably worth a lot more at $250, in either case.

 

You may just be talking about the 'delight your customers' idea. Very true. Also delight the investor - you. If you get turned on by the business and the management is having fun, that's a team you want to play on. My little measure is to look at a small action or acquisition a company makes. Once in a while I'll see a deal that makes me say, 'wow that's creative'. Or that is something of high quality, quite unique. You have to see many deals to get a feel for what is above average. Managements that do creative, superior things may be what turns you on. That often translates into a good result too.

 

I think that's related, but not the entire extent of it. I think emotion can be quite useful in figuring out just how much companies can fuck their customers and have them take it, as well. I think many people got comfortable with the cable companies because they were customers themselves and knew that the service was fucking awful, but that there was no realistic alternative.

 

I agree with you about creative businesses. It's a big reason why I own shares of IDWM, even though it's a bit difficult to put a valuation on it. Creative people can create some really unexpected outcomes sometimes. After a certain amount, additional experience in a field may in fact be detrimental to your performance in it because you can internalize the existing assumptions really quickly. I think maintaining a growth mindset is critical to success in most things.

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