Unqualified Opinions 4/10/23 - 4/14/23
By Tim Hanson
When You Should Know Everything (4/10/23)
This recent piece (“Ignorance Really is Bliss When It Comes to Investing”) in The Wall Street Journal is mostly spot on. Its conclusion? That knowing more doesn’t help you make better investing decisions.
Back when I ran a team of public equity analysts, we had a rule that no financial model could run longer than 20 rows in Excel. The reason? Limiting your inputs forced you to boil down your thesis to the metrics that really mattered.
But there’s nuance here in that ignoring the fine print is really only something you should do when you have asymmetric upside i.e., your potential gains are uncapped but your losses stop at zero. Because if you have losses that could generate additional liability, then you should absolutely read the fine print. The reason is that if you don’t dig into everything you could inadvertently wander into uncapped pain.
Here’s a real life example. We were recently looking at a company where the core business looked strong. But we discovered in the course of asking a lot of questions that its warehouse abutted a property that was a contamination site. Moreover, they’d never had a phase 1 let alone a phase 2 environmental assessment done on the property yet the lease held the tenant liable for remediating any issues caused by said tenant. So if we took on that lease without knowing what was already in the ground on that property we could end up on the hook for a multiyear multimillion-dollar clean-up.
Was any of this germane to the core investment thesis? Of course not. But could it turn a promising potential investment into a massive loss. Of course it could.
This is among the reasons we have Taylor (our CLO) on staff and why his diligence request spreadsheets run way longer than 20 rows.
See, when you’re in charge of upside, you need to focus on what matters. But if you’re accountable for the downside, you need to know everything. So who carries the day? We should all always be in charge of and accountable for everything but still, we come from where we come from and so that’s always the subject for debate.
How the Muppets Ended Up Singing Nirvana
(4/11/23)
At the risk of dating myself, “Smells Like Teen Spirit" is one of the great songs ever. If I owned the rights to it, I’d consider it closer to the irreplaceable end of the asset spectrum and not cheapen it by letting anyone else use it for anything other than rocking out.
And yet here on the internet are the The Muppets doing a pretty horrendous barbershop quartet version of it…
And here’s another (not as bad but not as good as the original) version at the opening of Disney + Marvel’s Black Widow film…
What happened was that Nirvana frontman Kurt Cobain’s estate sold some of its voting rights in matters like these for a tidy sum of money to an entity that’s more than happy to license rights for cash flow and the other original members of Nirvana voted along with that because they had diminished economic rights anyway (don’t fact check me, I read it on the internet). But at the end of the day, the asset was commercialized in a way that impaired the underlying value of the asset…maybe…
Irish playwright Samuel Beckett (he of Waiting for Godot fame) catches flack in some quarters for being notoriously strict from beyond the grave in his demands for how his plays are produced:
But I’m good with it even while acknowledging that other interpretations might also be valuable:
And yet ownership matters:
If you own something of incredible, irreplaceable value, commercializing it to be marginalized in a Muppets movie (and I love the Muppets) seems shortsighted. So, too, however, does thinking that your way will always be the right way and that something you created can never be improved upon.
There’s a world where “Smells Like Teen Spirit” should have never been sold to be sung by The Muppets. But there’s another where a new take on Waiting for Godot is a global blockbuster that enhances the value of the original.
There’s a Small Chicken Shortage
(4/12/23)
I did not expect to open The Wall Street Journal the other day and see the headline “KFC, Other Chains Hunt for Elusive 4-Pound Chicken,” but there it was. Apparently due to the skyrocketing popularity of spicy chicken sandwiches (and they are delicious; shoutout Hattie B’s) small-breast meat is in high demand while chicken farmers prefer to produce larger, meatier, more profitable birds.
The market should correct for some of this but among smaller businesses there’s a concern that “in a few years the large fast-food chicken chains will hog the tight supply.” And it’s a valid concern. In fact, one of the biggest risks for any small business is that a larger, better resourced competitor changes the rules of the game because any changes will have a disproportionate impact on the small business.
A good summary of this reality comes from a 1981 Harvard Business Review article that I discovered back before I took a job at Permanent Equity when I was reading around trying to get a lay of the small business landscape. “A Small Business Is Not a Little Big Business” makes the compelling case (and I’ve found it to be largely true) that small businesses, through no fault of their own, suffer from resource poverty and therefore “external forces tend to have more impact on small businesses than on large businesses” The authors warn further that “small businesses can seldom survive mistakes or misjudgments” (also true), which is why when you meet small business owners liquidity, and not ROI, is paramount.
This is where higher prices for small chickens, or a lack of supply, could be devastating for the not Chick-fil-As of the world. That’s because direct costs, such as chicken prices, are likely to be a greater percentage of total expenses for a small business than a large one. Moreover, a higher percentage of operating expenses at a small business are likely to be fixed or difficult to cut because they have fewer employees, smaller marketing budgets, etc. Finally, if a small business has to do something like borrow to buy its raw materials, rising input costs and rising interest rates can combine to wipe out any remaining profits pretty fast and there is likely less ballast on the balance sheet to sustain them.
Or as HBR put it, the short-term variances during the year at a big business are relatively small compared to the overall result so their financial statements describe a system in approximate equilibrium. Small businesses, on the other hand, are “seldom in equilibrium, or even near it.”
When you don’t have a steady state, any adversity can be major adversity if you’re not prepared for it with a lot of room for error.
Pistachios, Six Flags, and Assumptions
(4/13/23)
My daughter and I were getting set to make the 90 minute drive home from St. Louis after one of her soccer games when we decided to stop at a convenience store to get a road snack. She picked out chips and I, trying to be slightly healthier, grabbed pistachios. We got back in the car and on the road and it was then that I noticed my mistake: the pistachios weren’t shelled. Since there’s no way to shell pistachios and drive (responsibly) on the interstate simultaneously, my road snack was worthless.
“I was wondering how you thought you were going to do that,” she smiled.
Thankfully she shelled my pistachios for me after she finished her chips, so all was not lost.
Now this is admittedly smaller stakes stuff (though never underestimate h-anger), but it’s illustrative of the fact that game-changing mistakes can be made when you take small things for granted (leaving aside what me assuming all pistachios are shelled says about my own moral degradation).
Here’s a related example…
Mark (our COO) told me about a time when he was a kid and visited Six Flags with his family. When they arrived, the computers were down, so the park couldn’t accept credit cards. Thankfully, Mark’s dad Paul is old school and carries cash. He was able to pay for everyone’s tickets out of pocket even as those trying to pay with plastic were out of luck, so the family got to enjoy the park crowd-free for a few hours until the computers came back online.
That’s not an example of how taking something for granted led to a mistake, but rather of how not taking something for granted can create a massive advantage if everyone else takes it for granted. No one except Mark’s dad Paul thought they might need cash at Six Flags and 99.9% of the time you don’t. But the 0.1% of the time you do, well, that’s World’s Best Dad stuff.
So a very interesting question to ask is “What do I take for granted and what might it look like if I didn’t?”
Back when I worked in public equities I took it for granted that given the liquidity of public markets, I would always be able to buy and sell investments. Now that I don’t, my behavior as an investor is different, particularly when it comes to underwriting risk and spending time on relationship building and origination. This is not to say that Current Me would have done Past Me’s job better, but rather that Past Me might have benefited from thinking a little bit more like Current Me on this topic.
Businesses can take things for granted as well, such as employees staying healthy, customers abiding by payment terms, and so on. Yet the real world inevitably intervenes. Now, in order to be efficient it’s not necessarily to always be examining all of your underlying assumptions, but it is worthwhile to list them from time to time and ask what you might do differently if you didn’t take them for granted.
Read Your Own Emails
(4/14/23)
We were in a meeting the other day when I said something colossally stupid. The table called me on it, and I agreed.
What I’d proposed was an idea that would net a small gain for one of our portfolio companies at the risk of exposing our entire portfolio to loss. While it might have worked, that’s not ring-fencing, it’s inviting contagion. “It’s like I don’t even read my own emails,” I muttered later to myself.
And yet…
There’s a reason why “Do as I say, not as I do” is an aphorism. It’s often much easier to say something than actually do it. One example in sports is the football coach who punts when the entire team and the television commentators and all of the fans in the stadium know they should go for it.
There are a lot of cognitive biases at work for why this can be the case, particularly in stressful situations. To combat them it’s important to have objective procedures in place such as checklists or manuals or reference guides to know when you are deviating from the standard you set when weren’t stressed. But even more important, particularly if you’re in a position in leadership, is to make sure you empower everyone around you to call this out when it happens.
After all, one of the most important things someone can do for you is tell you you’re wrong and be right.
Have a great weekend.
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