Streaks

I am not sure when do you know doubling down on a decreasing stock price is akin to "Gambler's Fallacy" and I will go broke doing that. I do know that in one study of 6,500 stocks from 1985-2024, the median drawdown was 85% and peak to trough took 2.5 years. Then again half of the stocks never recovered. In order to finish first, you must first survive.

Stories

Everyone likes a good stockstory. Go to any small town in the US and there will be plenty of DG stores. AZO and ORLY also seem prevalent. There are always those TSCO and plenty of ogliogopoly/monopoly lying in their wake. The real question is what is the next story.

Financials

The financial sector is the 2nd biggest sector in the SPX. I am not sure if I am fighting the last war though when trying to avoid it as the circle of competence does not include any of it. I lived through the 2008 and it seems everything can dissappear even if it's not your fault. The leverage is always necessary making the quality of earnings low. Then again, CM's two biggest positions at Daily Journal was BAC and WFC. The sub-categories I would brand financials into are Big banks: BAC, WFC, C, ALLY, Credit Cards/Payment Processsors/Fintech: V, MA, SYF, AXP, COP, DFS, PYPL, FISV, GPN, FOUR, Insurance divided into PC, reinsurance, specialty insurance, diversified into life/annuity, It is too hard to understand all the risks it has with its mismatching of assets/liabilities of borrowing long and lending short, counterparty risks, and unknown unknowns.

Original Sin

One of investing's original sins is summed up perfectly by the phrase: “past performance is not indicative of future results." That remains true in every facet outside of the value vs. growth one too. I lean too much towards "value" even if they are attached to the hip and fail to understand how important ROIC/ROC is vs. FCF. I know the Munger quote:

"Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."

But knowing is not understanding. I am finally understanding with a thought bringing the numbers to an understandable limit. If a company has a fcf of 10% and just pays it all out in dividends, the return is 10%. If the company has a fcf yield of 10% and is rebuying stock with the free cashflow, you can compound at 1.1^n. If a company only has a fcf yield of 5%, but it manages to retain 50% while deploying at a ROIC of 30%, the return is 20%. Its fcf will grow .75% a year (30% of 2.5%). Its return is theoretically 5% fcf + .75*20 (.75 growth and 20 is the valuation of the growth) 15% for a total of 20%. Eventually the growth will be exhausted and its fcf yield will have to equal all the return as nothing can grow infinitely. The bond rate is a good rate to discount a company's fcf yield to. Until I actually used numbers to fill in the quote that I knew, I did not understand ROIC is not just a proxy for a durable competitive advantage, but can provide details about the future if its retained earnings can be deployed at the ROIC rate. It is easy to hunt for fcf yield, but combining it with ROIC will be measurably more powerful. I am starting to look at the distributors in the "real asset" space in FERG(plumbing/HVAC), MAS(plubmbing/paint), amd POOL(pool supplies). Their ROIC seem to be good even if their fcf are in the low single digits. I am not sure MAS can deploy their capital in the future as much as FERG or POOL even if its higher fcf yield makes it attractive. UNH might be getting interesting as healthcare is robust and a space that is not going away. NVO always stares at a patent cliff, but its ROIC is high as well. Again, ROIC might not be important though because if there is nowhere to deploy retained earnings, then the future dictates that only fcf matters as ROIC would be a measure of past employed capital.

Habits

"The chains of habit are too light to be felt until they are too heavy to be broken."

"We are what we repeatedly do. Excellence, then, is not an act, but a habit."

Buffett was able to compound his habits to generate 19.9% over 60 years at the helm of BRK for 5,502,284% vs. 39,054% under SPX. $1 would have returned 55,022 with Buffett vs $390 for SPX the last 60 years. The SPX return was 10.46% a year. It's so important to build the foundation/habits to insure a house will stand stable for many years. I am currently reading another book about Amazon in addition to the 3 I have read the last few years and have it ingrained in me that Jeff wanted to start with reading because it could develop the "habit" with the consumer. It's now the goliath that is a force like Berkshire has been. Maybe more so as it's the times with data, scale, and technology applied. The three books over the last three years are: The Everything Store by Brad Stone Working Backwards by Colin Bryar and Bill Carr Bezonomics by Brian Dumaine Currently, I am reading "The Everything War" by Dana Mattioli and have Amazon Unbound by Brad Stone on my list.

I Hate Bonds

Warren once said that bonds that were once "priced as risk-free return were now return-free risks." Yes, he might have changed his mind with the recent increase in yields to combat inflation by the Fed, but that statement has always poignant in my mind. I have always abhored bonds as "safe." I try not to be risk-averse or risk-loving, but risk-neutral. I think one day when I need to transtion to have some stability to anchor the portfolio, it will not be in bonds. It will be in stalwarts, but the downfall of UNH and PEP leads me to ask are they just like the bonds in the past. Risk is not knowing what you are doing. Maybe there will be a stalwart, but every portion of the portfolio should be a well-priced risk.

Scaled Economics Shared

Just finished a Greenwald piece on local strategy in HBR and he details how the two best advantages a business can have are customer captivity and scaled economics shared. Another way of saying it would be scaled economics shared. A bit nicer way to put the network effect/switching cost with scale. Strategy is how to respond to competition and what separates one from its competition with barriers to entry. I prefer to think of it as choices of what not to do as a way of inverting. https://archive.is/53ru5#selection-1585.577-1585.970