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G’day guys, gals and galahs. #38. Big week discussing the value of DCF’s and building Social Capital. A quote from Hank Hill to start:
Bobby, some things are like a tire fire, trying to put it out only makes it worse. You just gotta grab a beer and let it burn.
Here’s the format of today’s email:
Part 1: Dodgy DCF's
Part 2: Social Capital
Part 3: Bonus Quirky Content - Something to Read, Watch, and Listen
Some housekeeping out the way, what is a DCF? A DCF is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future.
Ok so with that out the way, my takeaways on doing a DCF?
If you can’t do it in your head it doesn’t matter
Qualitative > Quantitative
Buffett and Munger have some pretty strong opinions:
Buffett: All investing is laying out cash now to get some more back in the future. The concept of "a bird in the hand" came from Aesop in about 600 BC. He knew a lot, but not that [he lived in] 600 BC. He couldn't know everything. The question is, how many birds are in the bush? What is the discount rate? How confident are you that you'll get [the bird]? Et cetera. That's what we do. If you need to use a computer or calculator to figure it out, you shouldn't [buy the investment]. Those types of [situations] fall into the "too-hard" bucket. It should be obvious. It should shout at you, without all the spreadsheets. We see something better.
Munger: Some of the worst business decisions I've seen came with detailed analysis. The higher math was false precision. They do that in business schools, because they've got to do something.
Buffett: The priesthood has to look like they know more than "a bird in the hand." You won't get tenure if you say "a bird in the hand? False precision is totally crazy. The markets saw it. - Source: @CharlieMunger00
Tom Tryforos: “Tom Tryforos, a fellow value investor, once told me that every company should be valued through the DCF method, but you should be able to do the calculation in your head. If you need to build a spreadsheet, then the investment is probably not compelling enough. He is right. It is better to be approximately right than precisely wrong.”
Paul Black: “Most people spend 95% of their time crunching numbers, running DCF models, which by the way has zero competitive advantage because you have thousands upon thousands of people doing the same work. Where we can get a massive competitive advantage is by doing the things that other people are not.” and “If you read Phil Fisher's Common Stocks & Uncommon Profits, of the 25 point checklist, 15 are qualitative, which is the reverse of what people do.”
Everything Is a DCF Model [Link]
Just read it. It’s peak Mauboussin.
DCF in spirit, not letter [Link]
DCF is self-delusion with decimal points.
and this is a great argument:
In spirit, I buy into DCF. More cash a business is likely to generate, more it’s worth. Lower the riskiness of that cash, more it’s worth. More conviction I can build around cash and risk, more it’s worth. Someone acquiring an entire business is likely to think on similar lines. So, the general idea of linking valuation to predictability, cash and risk is fine.
Problem arises in going from general to specific. There’s the practical problem of populating a model with unknowable parameters and fiddling with assumptions till it produces a convenient result.
Evidence-Based Individual Security Forecasting [Link]
The reasons the DCF fails are twofold. First, traditional DCF models assume we can accurately forecast revenue and earnings 3–5 years into the future. But studies have shown that growth is neither predictable nor persistent. Second, traditional DCF models assume that the capital asset pricing model can be used to assess the riskiness of an investment and set an appropriate discount rate. But the capital asset pricing model has been empirically invalidated.
Final thought on DCF’s
it would be hard to come up with a single definition that satisfied everyone. For the sake of simplicity, however, we can think of social capital as the links, shared values and understandings in society that enable individuals and groups to trust each other and so work together. - Source
Ahmed’s tweet thread is pure gold on the topic:
Social capital is a fancy term for something very simple, and that’s what you have to offer the people around you, and what they have to offer you. You can think of social capital as value, utility, or influence. You can think of it as opportunity, connection or community.
You can think of it as knowledge, expertise and insight. The words we use don’t matter as much as the underlying idea, which is this: Your network - your relationships - is built on, and grows from, what you have to offer to other people, and what they in turn offer you.
Take my podcast for example. I never really planned for this, but it’s been an unreal connector that I wouldn’t have had otherwise. I recently spoke to Jordan Schneider of ChinaTalk and I love his thoughts on starting a pod:
I was in grad school, and I didn’t like my assignments. And I was just reading on the side, and I figured, oh, maybe these authors would talk to me. And shockingly, they did. That was really awesome. Everyone should start a podcast.
Podcasts are hard don’t get me wrong. But I love it. I’m part of a group chat with former guests Aaron Pek and Michael Fritzell, and I feel silly saying how much joy and interest that brings me. That alone has made the podcast worth it.
the knowledge you get and the amount to which if you pick a topic and do… I’m like at 175 shows now. A ton of episodes about it, that kind of compounding knowledge that you just absorb by osmosis. Because every time I do a show with someone, and it’s their book, I read their whole book, because I don’t want to feel like a jerk.
And by reading someone’s book, and making a three-page outline of all the interesting quotes and things I want to say, you remember that in a way where half reading something, falling asleep at night, or for class when a test and the test ends, and you never think about it again, you don’t.
Social Capital in Silicon Valley [Link]
Social capital is readily available to anyone, if, and this is a huge if, you know how to ask for it the right way. The magic password is simply asking, using the right language and demonstrating that you’re socially clued in to what’s going on: “Can I be in the group? I’m like you, almost.”
Cold emailing is a superpower. I’m no expert, but it’s worked a fair bit for me with the podcast! And a couple ways to build social capital (albeit more specific to SV)
How else can you boost your social capital in Silicon Valley? Being a founder is obviously one way. Growth is also good at bestowing status - if you work at a fast-growing startup, even if it’s small or you’re not the founder, you’ll be in demand. Old fashioned charisma, being good at Twitter, or knowing good gossip obviously counts for something. You can also buy your way in by angel investing - so long as you do it the right way. Looking the part sure doesn’t hurt.
But really it’s about the basics: knowing the words for things; having some situational awareness about what people in tech have opinions about this week. Knowing what the pattens are, and how you fit. It sounds basic but it’s an essential part of signalling: I’d like to join the group, and I have something to offer.
Something to read: How To Write With Style by Kurt Vonnegut [Link]
Selfishly, an article for me to provide the best experience for you.
Find a subject you care about
"Find a subject you care about and which you in your heart feel others should care about. It is this genuine caring, and not your games with language, which will be the most compelling and seductive element in your style."
Do not ramble though
Keep it simple
"Remember that two great masters of language, William Shakespeare and James Joyce, wrote sentences which were almost childlike when their subjects were most profound. ‘To be or not to be?’ asks Shakespeare’s Hamlet."
Have the guts to cut
"If a sentence, no matter how excellent, does not illuminate your subject in some new and useful way, scratch it out."
Sound like yourself
"I myself find that I trust my perfectly enchanting own writing most, and others seem to trust it most too, when I sound most like a person from Indianapolis, which is what I am. What alternatives do I have?"
Say what you mean to say
"If I broke all the rules of punctuation, had words mean whatever I wanted them to mean, and strung them together higgledly-piggledy, I would simply not be understood. So you, too, had better avoid Picasso-style or jazz-style writing if you have something worth saying and wish to be understood.
Readers want our pages to look very much like pages they have seen before. Why? This is because they themselves have a tough job to do, and they need all the help they can get from us.”
Pity the readers
"Our audience requires us to be sympathetic and patient teachers, ever willing to simplify and clarify - whereas we would rather soar high above the crowd, singing like nightingales."
Something to watch: How Tony Leung Acts With His Eyes [15 mins]
Watched Tony Leung in Shang Chi and he is just incredible.
"Even to today, I'm still like this. I see myself [on screen] and get bothered by all the places I can improve"
Tony Leung's career is brilliant because he constantly surpasses what he had done before. To him success should not be a one and done thing. It should be a continuous process of self-improvement. And that process, now lasted 40 years. It led to Shang-Chi introducing him to a massive mainstream audience.
Something to listen to: Tooze and Klein on Chinese Growth Miracles, Hyperinflation, and Napoleonic Authoritarians [Transcript] [Apple Link]
Required listening to understand the growth of China’s economy in the 20th century and some of the problems they faced along the way. I loved this episode.
I think that despite the stereotypes that people have about authoritarian regimes having a long time horizon, I'm sure there’s also reason to be skeptical of how that plays out in practice.
In the Chinese case, the growth model that was so successful in the past forty years created a set of entrenched political and economic interests that benefit from the emphasis on investment in physical capital rather than human capital.
Those people then become an impediment to the transition that everyone—including the top leadership of the CCP—says they want to do. This was not a controversial point when Michael Pettis and I wrote it: it’s in the 2013 plenum that there should be more focus on raising living standards, improving healthcare quality, and things of that nature.
Yet it doesn't happen, which I think is a very interesting and revealing fact about how the actual political economy works, even if we don't necessarily see all the mechanisms that make it work, as you can in a place like the United States where it's more transparent. Clearly you look at the end results and that tells you something really important.
Something to listen to (from me): Daniel Tabbush on Compounding Curiosity [Transcript] [Apple Link]
This pod was sooooo bloody fun. Gotta admit my poor little brain was going flat stick to keep up with Daniel, but so rewarding! And if listener feedback is anything to go by, this has been pretty valuable for them too.
I think banks are the ultimate leverage to where we are now, to economies, to reflation. We’ve got incredibly low rates, so there’s a push and a pull on credit. There’s pent up demand for investment, there’s pent up consumer demand for certain kinds of consumer loans. Imagine all the spending that hasn’t occurred on travel that people still want to have come through.
Like I said before, all of this has driven loan to deposit ratios down, capital ratios way too high. We know that there was restrictions on dividends in pretty much every country, let’s just say, that’s just been lifted by the MAS and has with other countries. You have that coming through, which will help. But it’s an incredible environment, positive environment for banks.
Bonus links that don’t fit anywhere else:
The Great Cancellation [Link]
"It’s been hard to describe what’s been happening in China…but there’s been a palpable shift. Some of China’s most glamorous celebrities and feted tech billionaires have found themselves on the outs."
US-China Commercial Relations with James McGregor [Spotify] [Apple]
"The Golden era of the expats in China is now over. When they needed you they built villas and golf courses for you. Now, you're less than special."
Ever Grande [Link]
Timely. “When I shut down my Bloomberg and exited the Mayfair office of my hedge fund for the final time a few years ago, one of the last prices I saw flickering on my screen was the bond price of a Chinese real estate developer called Evergrande. The price was part of my ‘canary’ screen. Evergrande is the biggest player in the biggest industry sector in one of the biggest economies in the world. It is also very highly leveraged. So when its bond price falls, it’s useful to take note.”
Joe Ferrari: The high-rolling life of Thailand's controversial ex-police chief [Link]
This story is wild. “Confiscated cars are auctioned, and until recently the police and officials were paid "finders fees" of around half the value, netting well-connected officers millions of dollars. Thai customs officials say Mr Thitisant confiscated 368 such cars since 2011, which could potentially have earned him around 400 million baht.”
Until you’re lucky enough for me to grace your inbox again, have a good one!
- Kalamari 🦑
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