Post of the Day
November 16, 1999
Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light.
Survival of the Simplest
In reference to "what works" and to some of Bruce's comments (AND an attempt to invigorate this fantastic board):
"I just feel, going forward, that the models in the communications sector are changing the world in drastically positive ways. In ways far more important that can ever a beverage maker, a furniture manufacturer, an electric razor maker, etc."
I've been prone to similar lines of thought. To the intelligent mind, evolving/empowering things appear intrinsically more valuable than those that are static/trivial. Empty-calorie cola syrup which contributes to ghastly American obesity rates somehow seems less respectable than photon-based communications linking the disparate brains of human civilization. Probably, from a philosophical standpoint, that is defensible. Not necessarily, however, if we are debating on investing terms. I suspect that investment methodologies grounded in such high-minded ideals are bound for mediocrity more often than out-performance. It's easy to get swept up in that almost luminous sense that the world is changing...no, something greater than that: evolving. Philosophical/intellectual ideals lead many to believe that the forefront of adaptation, the cutting edge, is the sweet spot of prosperity. You know what, though? Ground zero of biologic evolutionary boom-times, metaphorically speaking, are littered with animal varieties that didn't survive the transition. You see, survival is the bottom line of the existence. Successful species (like successful companies) survive and thrive via competitive and durable advantages. Viruses, of course, are superlative examples. They're the coca-colas of animal kingdom.
Survival is not only key to animal perpetuation, it is a critical element of successful investing. Long-term mindedness would be useless if nothing retained permanent value. Today's prevalent long-term investing techniques roughly involve identifying "successful" companies, regardless of the presence of existing sustainable protective moats around their on-going operations, and buying them up when their sure-thing status is only skin-deep. Had Warren Buffett operated like this, it likely would have cost him a brilliant track record as well as a great deal of money that would have been sucked back into capital intensive means of preserving precarious ankle-deep wading pool barriers to entry.
It is well known that a blind eye to the past fates us to repeat our mistakes. Buffett addresses just this idea, as it ties into current modes of investment theory: "I thought it would be instructive to go back and look at a couple of industries that transformed this country much earlier in this century: automobiles and aviation�[two] industries whose plainly brilliant future[s] would have caused investors to salivate�If you had foreseen in the early days of cars how this industry would develop, you would have said, 'Here is the road to riches.' So what did we progress to by the 1990s? After corporate carnage that never let up, we came down to three U.S. car companies � themselves no lollapaloozas for investors�Here is an industry that had an enormous impact on America � and also an enormous impact, though not the anticipated one, on investors." The same plot applies to aviation, television, radio, plastics, and already, to a meaningful extent, computers. Every time, optimistic investors figured it was different.
"My purpose was only to get�them to give reasons WHY things are overvalued. It is like an absolute assumption on this board that the technology and communications sector is overvalued. I for one...hardly think giving a leader in wireless technology a $55 billion market cap is so outrageous when we give a maker of electric razors a $39 billion market cap."
When biological systems, like products and their life-cycles, become more entropic and fast-paced, the inherent evolutionary competitiveness creates uncertainty, and therefore, risk. Would biological speculators would have placed tech stock valuations on dinosaurs? How would they have reacted to mammal development? Ape-mania, anyone? Through most roiling expansions of biology, viruses, bacteria, bees, cockroaches, and sharks, for example, have been the consistent survivors. Warren Darwin (get it?) would probably have built a portfolio around these creatures. It's NOT to suggest that lions, tigers, bears, and apes � hell, neural systems, like a hot new technology � are not exotic and neat, but they ARE naturally more susceptible and quite possibly ephemeral. It seems a little too "make or break" to me, from an investment standpoint, because by the time decline is apparent, losses would have been exacted. Esteem for stable life, and hence their valuations, would tarnish when nature's R&D labs periodically bare new fruit. The relevance for investors is that risk � uncertainty � makes valuations justifiable or not. Life insurance companies demand huge margins of safety before writing policies to risky individuals. Investors, en masse, go exactly the opposite way � pick your explanation: greed, mis-education, New Era optimism, etc. They require no safety margin, instead paying best case scenario prices. A lucky few win lotteries while the masses are drainward-bound because their investing is rooted in emotional pipe-dreams.
One of Buffett's keys to success, and what has fundamentally separated him from the rest of the investing community, has been his comprehension of risk and his distaste for uncertainty. Risk, as it factors into Buffett's valuations, has nothing to do with volatility � rest assured he'll travel a bumpy, country lane, so long as it gets him to where he wants to go quicker than a highway. His horizon disregards the immediate likelihood for out-performance if he can foresee probable eventual fruition that justifies the price he's offered. His standard of certainty is head and shoulders (as well as torso, waist, and legs) above the benchmarks of others. This is his famed need to predict a company's place in the universe some years out. Nothing he invests in is guaranteed, but he has great skill recognizing probabilities and playing odds � little surprise, then, is his attraction to insurance. Buffett's investing prowess is primarily a combination of emotions suited to the task and an acutely analytical logic � like the Red Baron in an F15. This dynamic duo of sensibility and brainpower form a priceless set, because it will not stagnate or antiquate � capitalism ensures that. Curiously enough, critics dismiss Buffett's methods during both seventies-style bear markets � "equities are dead" � as well as nineties-style bull markets � because "momentum investing rules, the good times are here to stay, and value bows down to technology's impact."
Sailing the Calm Waters of a Sustainable Moat,