Thursday, November 9, 2017

Xero and Intuit follow up

Xero recently published its half year report, so it is time to update our figures. The following table summarises the salient metrics:


2014
2015
2016
1H2017
Revenue
143m
207m
295m
187m
COGS
30%
24%
23%
20%
R & D
50%
48%
41%
49%
General
20%
15%
13%
11%
Marketing
75%
72%
56%
38%
Total
175%
159%
133%
118%


Once again, the figures are headed in the right direction. Although the company announced operating cash flow positive, adding in the impact of capitalised R & D still resulted in cash burn of $34m, leaving roughly $84m left in the bank, implying a steady runrate of just over 1 year. 

As a matter of comparison, let's look at Intuit's 2017 metrics:

Revenue USD$5.18 billion up 10% from 2016 (note: XRO growth is much higher)
COGS 15.6% of revenue
R & D 19% of revenue
General 10.7% of revenue
Marketing 27.4% of revenue
Total 72.7% of revenue (versus 74% for 2016)
Operating cashflow= $1.6 billion

The current market cap for XRO is roughly NZ$4.6 billion (a rise of nearly 45% since my last update). Still too rich for my taste. As a matter of comparison, Intuit's market cap is currently USD$39 billion.

Tuesday, November 7, 2017

Pip Watching

Imagine a hypothetical portfolio. This portfolio has a very healthy performance of 15% pa. The volatility/variance of this portfolio is roughly 10% per annum. Despite this, the probability distribution of price moves for any short time periods between one second to one day is just slightly better than 50-50. If an investor is assiduously following the price moves of this portfolio more than once per day, the statistical expectation is not much better than watching the outcome of a flipped coin.

Various studies have shown that the emotional impact of a loss is nearly 2.5 times the impact of a gain. Accordingly, the consequence of pip watching is net emotional deficit. And the absolute net impact gets bigger with increased frequency of pip watching, and also increased number of portfolio positions.

Bear in mind that 15% pa with 10% variance over a long period of time is a great performing portfolio. This means that a lesser performing portfolio will not be any better for the constant price checker. It may in fact be far worse. Further, there is also a feedback loop in place. The net emotional deficit may feed through into deteriorating performance, which will increase the emotional deficit, leading to a vicious cycle. At the same time, the random nature of punishment and rewards in pip-watching gives rise to addiction similar to the process in gambling. 

The physical consequences of chronic stress from pip watching include high blood pressure, diabetes, hormonal imbalances, possibly brain damage, eye problems and a whole other variety of ailments. An investor that keeps at this bad habit for long periods of time may actually be accumulating money at the expense of health. Wealth, happiness and well-being arise from a well-lived life, not just the bank balance at the end.

In other words, pip watching can severely affect your health, and also your wealth. 

Don't do it.

Stay healthy, enjoy and prosper,
Yours One Legged

Wednesday, October 18, 2017

Howard Mark's recent G & D interview quotes

I enjoy reading the Graham-Doddsville newsletter.


Some pertinent quotes, relating to the issue of indexing and quantitative/AI factor.


Howard Marks:

“If people take their money out of active management, then active managers would fire all their analysts, and then the market would not stay efficient. Then the necessary condition is satisfied for active to work. The point is, I don't think this move is permanent, I think it's rotational.”

“Because every dollar that goes into a truly passive fund is invested on autopilot, the fund must buy the stocks that satisfy its criteria, and that’s without regard to value. That suggests to me that prices can go farther in diverging from value before they get corrected. Think about what would happen if 95% of the money went into index ETFs or index funds. Who would be setting prices? There’s something called price discovery, and it’s done by thoughtful buyers and sellers. The price of a security in the marketplace is set by buyers and sellers coming together, and seeing if they can find a place to transact where the buyer thinks it has good upside, and the seller thinks it doesn’t. Who provides that function if all the buying are on autopilot? People put their money in index funds, with the presumption that they’re minimizing error, but how much of your money do you want to have managed in a fund where nobody’s thinking about the price of the stocks or the weightings within the portfolio? The thing about investing is that the efficient market hypothesis says that price equals value. Active management is about the assumption that price sometimes deviates from value, finding those deviations, and then taking advantage of them. It seems to me that the fewer the people who are looking at value, the higher the likelihood that price can diverge from value. But that’s just a hypothesis.”

“None of this stuff is easy. The greatest quote in my book is from Charlie Munger, who said, “None of this is meant to be easy, and anybody who thinks it’s easy is stupid.” All this stuff is really complex. It’s easy to talk about, but it’s hard to implement. How do you tell the ones who are good but unlucky, from the ones that are bad? It’s not easy. It takes judgment. That’s why I believe that this whole thing can never be completely computerized, because I think exceptional investment success requires judgment, and I don’t know if AI can be taught to make those judgments.”

Dear readers, any thoughts?

Yours One-Legged

Thursday, September 14, 2017

Book Review: Big Money Thinks Small

Big Money Thinks Small: Biases, Blind Spots, and Smarter Investing (Columbia Business School Publishing) by [Tillinghast, Joel]

https://www.amazon.com/Big-Money-Thinks-Small-Publishing-ebook/dp/B0743JNFBZ/ref=tmm_kin_swatch_0?_encoding=UTF8&qid=&sr=

An interesting read. In terms of concepts and philosophies, the reader will not find anything new that was not encountered before if one has been constantly reading up on the topic of investment.

The author ties together concepts of value investing augmented with experiences and practical applications of financial history and behavioural psychology. The main takeaway for me is his account of the travails of Dendreon and the dangers of investing in a "story." To summarise, Dendreon was a biotech which developed a treatment for cancer. The main bull story for Dendreon was that once FDA approval is obtained, earnings will rocket to the sky. The ending was that Dendreon did actually obtain FDA approval, and its share price went up tenfold, however sales were disappointing and the company eventually declared bankruptcy!

There are several stocks on the ASX in which investors are clearly enamoured with the "story", the most vivid example being Mesoblast.

The author also addressed the issues inherent in indexing, factor investing and macro investing.

The only gripe I have with the book is that it could be better organised. The way it was written looks more like a stream of thought cobbled together hastily without any overarching framework.

A reminder that there is a library of my reading here.

Enjoy and prosper
Yours One-Legged

Thursday, July 13, 2017

Book Review: Priceless



https://www.amazon.com/Priceless-Myth-Fair-Value-Advantage/dp/0809078813


This is a very entertaining and easy read. Not much prior background knowledge required, but you will gain a lot more insights if you do.

Specifically relevant to investing, you will gain an insight as to why price trends occur in all markets, how and why market bubbles form, and how/why this has and will repeat themselves.

The reversal preference experiments show clearly why many investors (including myself) hang on to losses and cut their winners too early.

The anchoring and adjustment experiments will be known to many of us. However, I think many will miss the essential lesson- being that anchoring and adjustment is an artifact of guessing. With investing, there will always be a degree of guessing, so the challenge is to be able to deal with effects of anchoring and adjustment.

Enjoy and Prosper
Yours One-Legged



Tuesday, May 16, 2017

Musings on Passive Investing via Index Funds

The Basic Proposition

As per Buffett and Munger, Indexing makes sense if you do not know what you are doing. In aggregate, active managers cannot achieve a result better than the index. In fact, given the extreme skewness of the stockmarket, it is virtually guaranteed that over a long period of time, a majority of active managers will never do better than the index, especially after deduction of significant fees. Given that all long term records of stockmarkets show an upward trend, it makes sense to be invested in the whole market rather than betting on its discrete elements, especially if the attendant costs/fees involved are much lower.

The Problems

The first problem with indexing is that the market is self-correcting, and too much of a good thing becomes a crowded trade. Indexing becomes a problem when too much money is chasing after it. If this happens, prices are no longer tethered to values, and you will have a situation where asset prices rise purely because they are rising and vice versa. This means that asset prices no longer reflect actual business performance, which is unsustainable. Conceptually, index funds are intended to passively track the index. However, if too much funds are involved, the fund inflows by themselves will have a significant effect on the index levels. Index funds will no longer be passively tracking the index, rather, they would be a major factor affecting the index.

The second problem with indexing is the wide sweeping assumption that everything tends to average. An often used marketing angle of index funds is that a majority of fund managers cannot beat the market.  This is true, but it fails to address the main issue of how to select a fund manager who is capable of beating the market. A system with average values will often have wide non-random variability between its system participants. There are persistent winners, and there are persistent losers. Try to remember the kid that always comes first in class over your entire experience of primary and secondary school. And don’t forget the one that comes consistently last. We ask ourselves why? In every field of endeavour, there is a pecking order which is inviolate, and the top and bottom can often be identified very early in advance. Proponents of indexing sweep this away under the carpet.

The third problem with indexing lies with its basic proposition that equity markets inevitably rise over time, ostensibly at a steady rate of 7% per annum. This is true over a truly long time span, say 60-100 years. The reality is that market returns in discrete periods fluctuates greatly. The following are US Equity returns during the Post-War period:
1946-2012 6.4%
1946-1965 10%
1966-1981 -0.4%
1982-1999 13.6%
2000-2012 -0.1%

An investor invested in index funds in the year 2000 would have had made a loss over the next 12 years. The critical message- unless your investment horizon is truly long term over at least 50 years, there is no guarantee that index funds will do well.

The Consequence

Human behaviour and the power of incentives will ensure that so long as investors want salt, they will be sold salt. It is not in the best interest of promoters and managers to sell a single index fund where investors are encouraged to stay invested indefinitely with no churn. If there is no activity and no churn, how are they going to earn their bread? Marketers know the basic behavioural problems of average investors and they will act accordingly, leading to a proliferation of different ETFs.

Investors want choices because each of them believes they are above average investors able to make superior choices than the average punter- hence a proliferation of ETFs will be created to satisfy this demand. If enough people want an ethical ETF which promotes social notions such as gender equality or white supremacy, then the market will surely create this ETF to satisfy demands. Given that the average investor is also unable to sit still and clamor action, there will be plenty of different ETFs to satisfy the need for action.

Investors are also greedy, so leveraged ETFs are created to turbo-charge returns. After all, over the long term, the sharemarket only ever rises.  Investors are also envious creatures. They will not be happy with a steady 7% per annum with a vanilla index fund when their neighbours are raking in 15% from the latest triple leveraged ETFs. Leveraged ETFs will then be in hot demand. 

As investors race up the risk curves, the market will continue to create products to satisfy this demand. Pretty soon, derivatives of ETFs will be created, and then further derivatives. They will all be marketed with great endorsement and validation- virtually assured returns with very little risks involved- whilst the promoters rake in fees and bonuses.

Does this sound familiar to you?  How would all these end?

The Solution?

In the tradition of Fermat, I am nearly finished with my suggested solution, but [insert suitable excuse].


Stay tuned. 

Yours One-Legged

Wednesday, May 10, 2017

Xero Follow-Up

Xero published its full year report today, so it is time to update our figures. The following table summarises the salient metrics:


2014
2015
2016
2017F
Revenue
143m
207m
295m
410m
COGS
30%
24%
23%

R & D
50%
48%
41%

General
20%
15%
13%

Marketing
75%
72%
56%

Total
175%
159%
133%



Once again, the figures are headed in the right direction. Cash burn is still $71m, with $114m left in the bank, implying a steady runrate of 1.5 years. 

As a matter of comparison, let's look at Intuit's 2016 metrics:

Revenue USD$4.7billion up 12% from 2015 (note: XRO growth is 44%)
COGS 16% of revenue
R & D 19% of revenue
General 11% of revenue
Marketing 28% of revenue
Total 74% of revenue

The current market cap for XRO is roughly NZ$3.2 billion. Still too rich for my taste. As a matter of comparison, Intuit's market cap is currently USD$33 billion, trading on a historical PE of 33.