The first book I ever read on investing was a tome entitled “The Intelligent Investor” written by Professor Benjamin Graham. This treatise outlines Graham’s philosophy of “Value Investing“, of which Warren Buffett is the most well-known practitioner. As a young man I struggled a lot with understanding Graham’s idea of investing based on “intrinsic value“, because I couldn’t quite conceptualize what it was in my mind. Was it the value of retained earnings minus debt, the book value of the company, the projected earnings per share in perpetuity discounted by net present value? As I continued to feed my mind a steady diet of finance information, this did not alleviate the confusion, rather it compounded it. However, I still found immense value in Graham’s magnum opus. The one quote that has stuck with me for a long time since reading the book is:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
This is a valuable principle, because we often run into situations where what is popular is what is easy, makes us feel good in the moment and hurts us long term, while what is hard, makes us uncomfortable and brings us growth long-term is unpopular. This is illustrated by a conversation from the Andrew Ross Sorkin movie “Too Big Too Fail” in a conversation between Michele Davis (Cynthia Nixon), Neel Kashkari (Ayad Akhtar) and Hank Paulson (William Hurt)
Neel Kashkari: Poor bastard who bought his dream house? The teaser rate on his mortgage runs out, his payments go up, he defaults.
Henry Paulson: Mortgage-backed securities tank. AIG has to pay off the swaps. All of them. All over the world. At the same time.
Neel Kashkari: AIG can’t pay. AIG goes under. Every bank they insure books massive losses on the same day. And then they all go under. It all comes down.
Michele Davis: [horrified] The *whole* financial system? And what do I say when they ask me why it wasn’t regulated?
Henry Paulson: No one wanted to. We were making too much money.
In the short term, everyone was making too much money, and despite quite a few people being aware that it was going to become a major threat to the financial system, nobody wanted to be the canary in coalmine. They were faced with a choice, where they could side with the voting machine, face no negative consequences and in fact be positively rewarded, which was a much more palatable choice than to side with the weighing machine, face a lot of negative backlash from their colleagues, and potential lose millions. This is not uncommon, as whistle-blowers, “doomsayers”, and the messengers tend to be disliked because they ruin the mood.
A good analogy would be that a high school kid’s parents are out of town, and he decides to have a party. However, as the evening progresses, the party starts to get out of hand, people show up with kegs, before you know it the living room has turned into a mosh pit and people are playing ultimate frisbee with $200 china. If the kid decides to call the cops, or his parents, he is likely to be the person who faces negative consequences, despite the fact that he was not in the moral wrong.
On Virtue Signalling
I tend to prefer the Aristotelian description of virtue as a mean between two traits, for instance courage and foolhardiness. Meaning that a man should attempt to be both confident and humble, narcissistic grandiosity is no more a good trait than excessive meekness.
I’ve touched on virtue signalling in an earlier essay a while ago that I wrote on Social Justice Warriors, however, SJWs are merely the most extreme manifestations of a problem that has reached epidemic proportions in the western world, doing the easy thing to make the present comfortable for us, rather than doing what we know we must, despite it making us uncomfortable, this is true on an individual level, and on a societal level.
On an individual level, we can start with the “Man-Boy Crisis“, young men are increasingly dropping out of the labor force, of education, the marriage racket and in many other areas, this has been brought up time and time again, in descriptive terms. There have been a lot of suggestions for how to remedy the situation, from encouraging boys to get rid of their toxic masculinity, to telling them to man up and clean their rooms. I shared my understanding of Dr. Peterson’s simple advice, and it’s consequences, namely that if you start by making small, positive, incremental changes in areas which you control, this can often snowball into greater changes in other areas of your life.
The example I used in the recent Red Man Group podcast, was that if you start by cleaning your room, you feel better, and you may decide to learn how to cook a few simple meals. As you improve your diet, you get more energy because you are not eating crap anymore, so you may decide to take a walk and then one day while you’re out on your walk you see a gym, so you decide to start lifting weights. The small change of cleaning your room has lead to more positive changes.
However, I’m less convinced that making such changes for yourself, and perhaps your sphere of influence such as your family, circle of friends or colleagues, will drive the major epidemic back. This is for the simple reason that it contradicts my observations of human behavior. As a species, we have an immense capacity to share knowledge and information through language, we are also capable of observing other people get positive or negative feedback from reality based on their actions or behaviors. Yet, we appear to have to face crucibles of our own in order to gain the drive to put the information and knowledge into practice. As long as the the expected discomfort of doing something is less than the discomfort of doing nothing, we remain inert. Furthermore, human beings have a preference for things that are easy, instant gratification and takes little effort.
Thus, on a social level, while a society is composed of individuals, the general trend of the zergling rush, is difficult to defend against, or slow-down without large, external calamities acting as crucibles.
In general terms, society is ambi-directional, not purely bottom-up or top-down. Building an army of individual men who are all men who have fixed themselves as a bottom-up groundswell matters little if the general top-down trend is stronger. In business terms, it doesn’t matter if one of your business units is making bank if all the others are losing more than it makes, sooner or later the risk of relying on one business unit to fund the whole will manifest itself. A company can outperform it’s industry, and an industry can out-perform the economy as a whole during a bust, but a company can also underperform it’s industry and an industry the economy, during the boom.
Virtue signalling can simply be defined as the broadcasting of one’s own status as a proponent or defender of what a group, groups or individuals, hold as characteristics, traits or behavior of value, in order to increase ones status within the group(s), or secure entry to the group(s). In essence it is an attempt to derive status or value through professing ones allegiance to a group or a set of values that one does not necessarily demonstrate, or have any intent to demonstrate. This is not a negative thing in and of itself, as social signalling is common in most animals, however false social signalling is a threat because it disrupts normal signals.
If you can gain the same status, admiration and dopamine rush from posting that you are going to quit smoking on Facebook, then you keep smoking. Then you gain the value of something something, but it doesn’t cost you anything. This is the same as being a communist when you’re broke, of course you are, because you have everything to gain and nothing to lose. However, the person who has worked hard to amass a war-chest of assets, is most likely not a communist because he has everything to lose and nothing to gain.
There has to be actual value behind the appearance of value, because a masquerade always has an ending.
Summary and Conclusion
In retrospect, my error when reading Graham was that I added complexity to a book that is actually quite simple in both its style and principles. What Graham means by intrinsic value is pretty much the answer to the following three questions:
- Does the company earn money for its shareholders?
- Are the earnings reliable?
- Are the earnings sustainable?
This has in part been my issue with quite a few prominent companies, they do not earn money for their shareholders, they have unreliable earnings and their earnings are not really sustainable. You can realize a lot of money trading in such companies, the same way you could if you traded CDOs back in the early 2000s, but you are playing a game of economic chairs with the financial system hanging in the balance.
As I’ve stated in prior episodes of the Red Man Group, one of my major issues with the way “Game” was sold back in the early 2000s, was that it was utterly focused on appearing as if you were a man of value, rather than building you into a man of value.
This is no different than how certain companies may have never earned money, do not have a strategy for monetization or have a strategy for monetization that is not sustainable, yet they have similar market capitalizations as companies that have earned money for their shareholders for over a century, have paid reliable dividends just about every year, and produce something boring that everyone has to have.
The weighing machine is a long term metric, and while a company can exist for a long time without making money, with unreliable earnings and running an unsustainable business model, they cannot live forever. The market can stay irrational longer than you can stay solvent, but the market cannot stay irrational forever.
For the individual person who just had their portfolio hit with a margin call, this is little comfort, in fact it’s probably little comfort if they are proven to be right even a few days after the margin call. However, from a slightly bigger picture perspective, companies that do not and will never realize a return for their shareholders, and for whom what little earnings they do have, are erratic and earned through unsustainable means represent an inefficient allocation of capital, and thus resources.
These companies, just like the early PUA are in many cases the orchestrators of Ponzie schemes, set up to last long enough for them to convince the target, get the papers signed, get the money transferred and get the hell out of dodge. This is why a large part of “The Game” deals with what happens when the man behind the ponzie scheme gets drunk on the game, and attempts to milk the target when he should get out of dodge.
At first glance the prospectus looked great, the IPO papers were signed by a reputable bank, the financials all checked out, and the presentations were fantastic. However, when investigated, the prospectus was plagiarized, the IPO papers fake, the financials imaginary and the fancy corporate offices non-existent.
Sooner or later, reality breaks through the illusion.