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

Just a Little Bit

Margins are very thin and not just with it being the Bezo's opportunity. In the 8 years from the start of 2017 to the end of 2024, the SPX compounded at 14.85% leading to 1 dollar becoming 3.03 dollars. The SPX is now down 13.54% after Liberation day and if you take away that performance from the previous 8 years, you will be left with 2.62 for a CAGR of 12.79% return. Nearly 2 percent of performance a year for 8 years wiped away. You still have to build that lead for the inevitable downswings at times. SPX had 5 days of >5% loss in 2008 and 2020. We have one this year, but Thursday was a 4.8%. All arbitrary, but inside the human minds, there are certain hurdles that mark milestones. Larry Fink claims in his annual letter that in a 30 year, the average pension outperforms a 401k by 0.5%. Compounded over 30 years, you will get returns of 17.45x instead of 19.99x assumming a 10% vs. 10.50% rate leading to 14.5% less in the retirement fund or 9 years of retirement. Charlie Munger always illustrated with 15% compounding for 30 years and paying 35% tax once or 15% each year and taxed 35% before investing again. It's the difference of 13.3% vs 9.75% return and over 30 years, what 3.5% does is a lot. Little things. On the Margin. A little late or a little slow.

Bounded Rationality

Sometimes it is better to just make a decision with just as much information as you have. From Bezo's 2016 shareholder letter:

Second, most decisions should probably be made with somewhere around 70% of the information you wish you had. If you wait for 90%, in most cases, you’re probably being slow. Plus, either way, you need to be good at quickly recognizing and correcting bad decisions. If you’re good at course correcting, being wrong may be less costly than you think, whereas being slow is going to be expensive for sure.

It is prudent to be patient, but a small starter position to learn more about a company is not the end of the world. Break problems down into managemable chunks and move fast and break things like Tech likes to live by.

Compounding and Consistency

It is amazing how much can be gained from preserverance and consistency as it compounds with time. Never unnecessarily interrupt compounding and just one step at a time and it will pile up.