A prescription for a good company

Buffett’s letter to Sees…

I was walking down Queen St (still a disaster) earlier and looked at the state of luxury — Louis Vuitton had nary a person in-store (and frankly, the greeters at the door didn’t look inviting) but the store itself was impeccable — not a thing out of place. Louboutin, on the other hand, looks like some kind of discount store — perhaps somewhere selling Strandbags. Staff looked listless. Below is Buffett’s thoughts on retailing environments… it is, as Carrie Bradshaw would say, so key.

Four Rules from the immortal “Ace” Greenberg (the legendary chairman of Bear Sterns)

1.) People who talk too much seem to have bad luck.

2. People who do not return phone calls promptly do not seem to make the grade at a highly profitable firm.

3. People who object to end runs [an end run is going direct to top brass] will never make it in football, or with successful investment banking firms. Certain groups do need to observe a “chain of command” atmosphere, but highly motivated, intelligent people do not need this handcuff.

4. A firm that has enthusiastic receptionists and telephone operators starts off with a tremendous advantage over the dummies of the world. Keep in mind that the first impression people receive from Bear Stearns is with those associates.

NZ

NZD — The dollar is strong but why? Does anyone know? I don’t!

ATM — Disappointing outlook, less orders for Special Magical Milk.

MOVE — Special congratulations to Paul Millward, new CEO of MOVE logistics. Paul previously did an excellent job at 2 Cheap Cars (see, I’m not always negative). Paul inherits a business that has substantially underperformed the leader in the space (Mainfreight…be still my beating heart). Lots to do. I, a person with absolutely zero ability to drive a truck, suggest that the best place to start is by looking to Don and co. I also note that former chair Lorraine Witten was paid an extraordinary $140,000 (regular readers of this newsletter will note she is the current chair of Rakon — one wonders where she found all the time between RAK and so on). Purchased a small amount of MOVE for my PA as I think Paul is a good operator.

Speaking of RAK — ASM next week. I will be there. There are a lot of questions to be asked of the board. On the negative nonce side — i) why did the NBIO take so long, and why didn’t it proceed? Ii) why did the board spend so much of shareholder’s money on a failed NBIO? On the positive side, I hope to hear an explanation of the company’s recent AI and space chips — I think there is obvious value in that area and I doubt that RAK has left the minds of other, bigger companies… we undervalue our tech here in NZ … it ain’t over ‘til it’s over.

AUS

Uranium is still down in the ditches. Global demand hasn’t changed. Just sayin’…

Grape Glut — AFR reports on Wolf Blass and the decline of Australia’s “wine for all” industry (now, I know you are all drinking your Lafite as I write this, but don’t forget what a revolution Wolf Blass was back in the day…). Particularly thought this was relevant:

Chester Osborn, the winemaker and entrepreneur behind d’Arenberg in South Australia’s McLaren Vale, says some of the big corporate owners are machines that have become “soulless”, without a family figurehead with passion to drive sales.

“Wine is made by people, and if there’s no family behind it, no figurehead, it starts losing its identity,” Mr Osborn says.

World

Nintendo … continue to like this stock (IP + the arrival of the Switch 2, which my games industry analyst Dylan informs me Is Important).

A prescription for a good company… a talk I gave earlier this year

I gave a talk earlier this year to a group of investors and found my speech notes in the weekend. I thought I’d share it with you — they still feel relevant.

What’s the Rx for a good company? (April, 2024)

I was going to give you guys the usual presentation today, but after spending a couple of days talking with all of you I decided it would be better to go off script — I could tell you that what I look for is quality companies with a high return on invested capital, etc, but I thought it would be more interesting to talk about some elementary psychology and some lessons in “worldly wisdom” as per St Munger … that I have learnt over time, sometimes painfully slowly — I wanted to talk about the qualities a good business might have — a prescription for a good business, if you like 

The first is the power of reciprocity. We see this all the time. You are invited to someone’s house, so you bring them a bottle of wine or something to say thank you. We are coded as human beings to reciprocate — it goes back to the tribal practice of potlach, which is where the chiefs offer some grain or resource that is important to the tribe to the leader of the other tribe. It’s not just about impressing the other tribe. It’s about — ok, they did this for me, we owe something back to them.

Actually, if you go to a club in New York or Ibiza or some other degenerate city, you will see the same thing occur. There are always dudes spending a lot of money to spray around some champagne and have bottles delivered to them with sparklers and beautiful women and so on attached. They’re doing two things here, really: the first is they are saying I can afford to waste this precious resource and the second is I did this for you, what will you do for me?1 

We can’t underestimate that. I’m going to bring it back to a company and talk about LVMH. What is the first thing that they give you as a valued client? Some champagne, maybe a dinner invite, maybe an invite to an event. It’s reciprocity. I was at a wine tasting a while ago and there’s the implied thing — you tried all this fabulous wine, now you ought to buy a case — and you end up parting with more money than you first thought. Reciprocity is a very valuable feedback loop.

So going back to LVMH — or for that matter Hermes. There are two factors at work. Reciprocity — here’s an event, here’s champagne, oh, you look fabulous with that handbag…

There’s also another concept I want to talk about at work. Mental buy-in. If you are buying a Birkin, the world’s most expensive handbag, or for that matter if you are buying a Ferrari or a Rolex — I know there are some Rolex lovers in the room — you are not offered what you want straight away. Would you like a Submariner? Ok, sure — here’s a datejust first. Would you like a Birkin? OK, madame, they’re not available at the moment but would you like to buy this scarf, some shoes, a robe, etc…

Of course — none of this is explicitly said. It’s a cultural understanding. We all know that’s how you get one of these objects that is deliberately scarce — there is the buy-in. In economics we call it sunk cost fallacy. It’s the I’ve already spent so much on this, I ought to finish it. Logically there is no rationale for this — why not just cut your losses? But what is occurring is buy in where people are actually giving their mindshare to something — once you have your first Rolex you are saying, OK, I am part of a club. Once you have your Hermes’ sandals, scarf, what have you, you are saying the same thing. 

By the way — the club is another powerful concept. There’s the joke about three Englishmen on an island: two of them will form a club and exclude the third. People, inevitably, want to belong to something — now maybe this is a crazy cult like Scientology or maybe it is a capitalist cult, like Rolex or Hermes or Ferrari, but it is a club.

An example of a typical member’s club…old men go here.

People get into a lot of trouble in pursuit of these things — sunk cost, wanting to be part of a club, reciprocity. Mohammad Al-Fayed had a lot of money but was obsessed with being English. He went as far as buying Harrods, that most English of institutions, and employing an ex-butler to the royal family. He had his son date Princess Diana — we know how that ended. The point is the poor man threw all this money at that most exclusive of clubs — the white pale English elite — and he was never the better off for it. These are remarkably destructive psychological impulses but people do them anyway, in spite of themselves. 

So, if I was picking a company I would look for aspects like this, because they appeal to humanity’s psychological impulse in such a way that makes it almost impossible to resist, even if it is to our detriment. Obviously there are high-end companies which fit into this model — the aforementioned Hermes’ and LVMH and so on. But also think of Costco or Amazon Prime — you pay for your membership, so they command some kind of “mindshare” — oh, I really should buy this on Amazon Prime because I have the membership. It’s amazing what that kind of mental “buy in” does to people — we find endless ways to justify purchases — sure, this coat was $1,000, but if I wear it twenty times it pays for itself. 

In other words, you want a company that has that kind of lollapolloza of qualities — reciprocity, mental buy-in and some kind of club. Do you know why sunk cost is so powerful, by the way? It’s because people are far more averse to losses than to gains — there are a number of studies which show this — with sunk-cost we are trying to regain lost ground. I know of a fellow who made a lot of money from a certain stock. He owns several Ferraris. He still does not own the Ferrari of his dreams. They won’t sell it to him. Point blank, they refuse. Now you might think a man like this would say OK, see you later, I’ve spent enough. But the opposite is true. He is lining up to spend more. The car salesmen must be having a field day.

The second thing one might look for is a company that isn’t first in the space. I’m going to go on a tangent for a more to explain why. In the 1800s there was first a railroad bubble and then a bicycle bubble at the tail end of the century — at one point there were hundreds of bicycle companies popping up within England alone. Then in the 20th century there was a whole lot — oil, radio, telecommunications, the internet…

All these bubbles had a fairly predictable trajectory — lots of people went broke, lots of companies went bust, but a remarkable thing happened in between.

What was it?

Well, you had railways stretching out from every which way and freight was revolutionised — suddenly you could get a shipment from the north of England to London fairly quickly and efficiently. I can’t stress how radical this was: you had the transition from pretty rudimentary roads to a bustling infrastructure fueled by steel and steam. 

In the process a lot of capital was expended and lost. I hate to tell you this, but it is a feature, not a bug. That capital had to be expended. It had to go somewhere! It didn’t stay in the pockets of investors, sorry to say, but it did provide an outlay of rail and track that fueled the modern world. On the whole for society it was a net benefit, in spite of it being a net negative for the financiers of many of the projects.

I’m drawing very unsubtle parallels to AI here — we are currently in a bubble where VC firms are throwing money at AI start ups like women throwing their panties and a Tom Jones concert, but the truth is that most of that money will be expended into fuelling this new infrastructure. This is fine. It’s what capitalism does at its finest — bubbles fuel growth. 

So, the question is how would you avoid that? We are investors. I return to the Jacobi solution — Jacboni the mathematician — invert, always invert2.

The opposite approach would be to wait for the bubble to play out and pick the most likely candidates. Most people do not like this. They don’t like it because they are afraid of missing out on the train — this is another psychological bias, by the way — FOMO. 

So, I’m not going to talk about the railways, because frankly I was not alive then and everyone who was is dead now. I’m going to ask you to cast your mind back to the 90s, where there was a lot of internet companies around — do you remember Yahoo, AOL, askjeeves, pets dot com…? 

Now, most of those companies are no longer with us. The leader in search at one point, Yahoo, now exists as a kind of specter, but the dominant player in search is Google. Google was only founded in 1998. It wasn’t the first mover in the space. In fact, in my prescription for a good company, I’d say that you almost don’t want a first mover because history is against those companies — xerox invented the first mouse, blackberry once dominated the phone market, MySpace was once the dominant search engine…very rarely is the first mover rewarded handsomely. Frankly, I don’t care if a company says we did that first.

You know, Kodak actually created one of the first digital cameras. But they were too worried about canabalizing the film business, so they shelved it. The top brass looked around and said — ‘we make so much money in film, and the margins are so good. Why the hell would we want this digital shit?”

So, I would like to disimbue you of the notion that first mover advantage is anything special, or that you will be missing out on “the next big thing”. Bubbles inherently mean competition, which means that there is all kind of disavtanages when it comes to pricing. Look at airlines — nobody is making money in that business because there’s so many of them all flying the same places. So, let’s invert that and look for a business which has little competition. 

In sum, the best business to own might be one which functions sui generis in the space of which it occupies. I have already spoken about several: Hermes, LVMH, Ferrari, etc. These all benefit from that lollapollza effect of multiple pyscholical biases going in its favour. How do they differentiate? A Ferrari is not just a car – it’s a Ferrari. A Birkin is not just a bag — it’s a Birkin.

What is a Ferrari or a Birkin, though? Or a Rolex, to that matter?

They are concepts. They are ideas. They are dreams.

So — the biggest part of this prescription might be to find a company which sells a concept with a product that happens to be attached.

This is really key. I want to hone in on watches because they are a fantastic example of an object that has been surpassed by technology many times over. When the Japanese came out with quartz mechanisms it triggered a whole event — the quartz crisis — Swiss watchmakers came under attack and faced very real existential threat

What was the solution?

Actually, it was a two pronged solution. The first part was to put the watches on the wrists of famous people, because people associate fame with special qualities. The second was to push the watch as an object of prestige. It is especially effective with men because male jewellery is fairly restrained in this day and age: there’s very little competiton for decoration. It’s all watches.

But the truth is Rolex, or Patek, or Cartier or whoever are not selling a watch. They are selling a brand vision. A dream. When you buy one of those watches, in spite of your iPhone being perfectly fine, you are buying into that dream.

If you can look at investments and discard them if they don’t match any of the above criteria, you are probably avoiding a lot of dreck. I think the best skill is saying no to things. 

I want to finish by telling you about my worst investment, which I made as a young analyst when I was working for a fund, and the MD would always say “you’re not in a candy store, Eden! You can’t pick everything!”

The investment was Doc Martens. I had noticed how many people wear the shoes, they were about to IPO, and it ticked a lot of the boxes I look for … a very loyal fanbase, a heritage product, good margins…

Well — it went terribly. Every day I would look at the sheet of our positions and see it down a few percent, then ten percent, and so on

I couldn’t work it off out. Where was I going wrong?

Well, the first think about is what happens when a company makes something too well! Old Doc Martens were very well made…there was no need for a replacement pair. This is a great problem for the consumer and a terrible one for the manufacturer. 

Then the company went the other way, and made the product far worse … they moved manufacturing to China and suddenly their very loyal user base got pretty mad, and stopped buying them. Then docs had an inventory issue…they had made too many of the things and had to move them. They couldn’t 

Finally, I had made the cardinal mistake of investing nearby IPO. This was incredibly stupid. Private equity investors were looking to get out. No matter how right you are about a company it doesn’t matter if half the owners are rats looking for the exit. 

So my final prescription for finding a good company is this … if you make a stupid mistake, be sure it was stupid, and cut it, because all that money that was spent on Doc Martens stock could have been spent on Hermes or LVMH or something well run…if you can do all the above then perhaps one can find a good company, and more importantly, live a good life where you are not worrying about some second rate shoe company. It’s important to live a good life, if you can.

Last word… Buffett on comp (see: NZX Directors and ors…)

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