Entrepreneurial Opportunity Cost

I am wondering out loud here: when people attempt to do some kind of modeling of the various opportunity costs of having government provide X, versus having “the market” provide X, do they factor in the opportunity cost of lost entrepreneurial progress inherent in bureaucratic provisioning?

For example, if someone was arguing that the government should control automobile production, is there any calculus attempted that examines the present value of foregone future improvements in automobile production and design that will inherently be included in bureaucratic provisioning?

A further example– the roads and highways we drive on, which have been provisioned by government for decades, haven’t changed all that much. But cars have made huge technological leaps in terms of how they’re designed and built. Cars have entrepreneurs behind them, roads and highways have bureaucrats behind them.

I’m not sure I am articulating my inquiry as coherently as I might like to but there it is nonetheless!

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Video – Rahul Saraogi On Value Investing In India

The Manual of Ideas presents Rahul Saraogi, managing director of Atyant Capital Advisors

Major take-aways from the interview:

  • Referring to Klarman, finding ideas and doing the analysis is a small part of investing; the two most critical factors to succes in any investment as a minority shareholder are corporate governance and capital allocation
  • Good corporate governance means a dominant shareholder who treats minority shareholders like an equal business partner: even aside from egregious fraud and legal violations, you can face situations where dominant shareholders use the company like a piggy bank or to promote personal agendas
  • Once you’ve cleared the corporate governance hurdle you must consider capital allocation: many times companies follow the same strategy that got them from 0 to a few hundred million in market cap, which will not work to get them to the next level; often by this time the dominant shareholder is sufficiently wealthy and loses interest in capital allocation to the detriment of minority shareholders
  • India’s investment universe:
    • Indian GDP close to $2T
    • Indian market cap $1.5-2T
    • 80-85% of India’s market cap is represented by the top 150 firms: mega-cap banks, steel producers, etc., that trade on ADRs and everyone knows of outside of India
    • Thousands of listed companies below this with market caps ranging from $2-3B to a couple million dollars
    • Rahul finds the next 1200-1300 companies below the top 150, with market caps ranging from $50M-$2B, to be the most interesting opportunity
  • Corporate governance is binary: either a company gets it, or it doesn’t
  • Case study: 1998, invested in a sugar manufacturer trading for $20M generating $20M in annual earnings with a 14% tax free dividend yield, virtually debt free, strong moats, dominant player in its field, grew from $20M to $900M market cap, the owners were very focused on growing capital, no grandiose desire to build empires, not trying to grow the top line at all costs or gain rankings, just allocating capital wisely
  • Every investor is looking for shortcuts and binary decisions, ie, “Should I invest in India or not invest in India?”; the reality is it’s a lot of work, it’s about turning over as many stones as you can– what Buffett has done well is finding people who can compound capital and then staying with them through market cycles
  • You can do what Buffett did in any market but you must dive into it, get your hands dirty, do the work it takes and then maintain the discipline to stick with what you’ve found
  • Home-market bias: most people are going to allocate most of their capital in their home-market, because by definition anything that is not familiar or proximate is considered risky; consequentially, “locals” will disproportionately benefit from economic and financial gains in their local markets
  • India can not and likely will not become a dominant allocation in a foreign investors portfolio; without devoting 100% of your time and energy to understanding that market, or having someone invest on your behalf who does, you will likely not understand the culture, motivation and habits of the people in that market
  • “It is imperative that in any market you go with people who understand it and are focused on it full time because investing is ultimately bottom-up”
  • Accounting, financial reporting and investor relations practices are modeled off the US and UK so they’re similar; however, many businesses are run by one or two entrepreneurs and they’re often too busy to be available to speak with outside investors, but persistence pays off when they realize you’re interested in learning about their business
  • Access to capital in Indian markets has improved, meaning it has become easier for Indian companies to scale
  • Why does India have high rates of capital compounding? India is a 5,000 year old civilization and has had borrowing, lending and private markets for capital that entire time meaning people are aware of capital compounding; that being said, India has companies and management that understand ROC, those that don’t, and those that are essentially professional Ponzi-schemes, issuing capital at every market peak and then trading for less than the issued capital at the trough because they’re constantly destroying wealth
  • Rahul sees the government as incapable of providing the public infrastructure needed by the growing economy; he sees the economy turning toward a “private-public partnership” model that is more private than public– enlightened fascism?
  • As companies rushed into this private-public space, a lot of conglomeration and corporate mission-creep occurred, resulting in systemically low ROC for companies in the infrastructure space as most as poorly run; failure of top-down investing thesis
  • “I’m looking for confirmation in facts, not in other investors’ opinions”
  • I can comment on whether valuations for individual companies make sense, but I can’t make a judgment on the value of a broad market index, I just don’t think that number means anything
  • Risk management: develop assumptions about the company’s business and then periodically analyze what the company is doing relative to original investment hypothesis; if your assumptions prove to be wrong or something changes drastically with the company, that is when you hit a “fundamental stop-loss” and corrective action needs to be taken immediately, even if the stock has done well and the price has risen

Notes – The Philosophy Of The Stoics, From The Meditations Of Marcus Aurelius

These quotes are derived from The Meditations of Roman emperor Marcus Aurelius.

From the Meditations:

  1. Begin the morning by saying to yourself, I shall meet with the busybody, the ungrateful, arrogant, deceitful, envious, unsocial. All of these things happen to them by reason of their ignorance of what is good and evil.
  2. Since it is possible you may depart from life this very minute, regulate every act and thought accordingly.
  3. A man then must stand erect, not be kept erect by others.
  4. It is in your power whenever you choose to retire into yourself. For there is no retreat which is quieter or freer from trouble than a man’s own soul.
  5. Take away your opinion, and then there is taken away the complaint, “I have been harmed.” Take away the complaint, “I have been harmed,” and the harm is taken away.
  6. How much trouble he avoids who does not look to see what his neighbor says or does or thinks, but only to what he does himself, that it may be just and pure.
  7. Look not round at the depraved morals of others, but run straight along the line without deviating from it.
  8. On every occasion a man should ask himself, Is this one of the unnecessary things? Now a man should take away not only unnecessary acts, but also unnecessary thoughts so that superfluous acts will not follow after.
  9. Time is like a river made up of the events that happen, and a violent stream; for as soon as a thing has been seen, it is carried away, and another thing comes in its place, and this will be carried away, too.
  10. Be like the promontory against which the waves continually break; but it stands firm and tames the fury of the water around it.
  11. “I am unhappy, because this has happened to me.” Not so: say, “I am happy, though this has happened to me, because I continue free from pain, neither crushed by the present nor fearing the future.”
  12. Remember, too, on every occasion that leads you to vexation to apply this principle: not that this is a misfortune, but to bear it nobly is good fortune.
  13. In the morning, when you rise unwillingly, let this thought be present: I am rising to the work of a human being.
  14. Do not be disgusted, dissatisfied or discouraged if you do not succeed in doing everything according to right principles; but when you have failed, return again, and be content if the greater part of what you do is consistent with man’s nature, and love this to which you return.
  15. Where a man can live, there also he can live well.
  16. Nothing happens to any man that he is not formed by nature to bear.
  17. Are you angry with him whose armpits stink? Are you angry with him whose mouth smells foul? What good will this anger do you? He has such a mouth, he has such armpits: it is necessary that such an emanation must come from such things.
  18. Consider if you have hitherto behaved to all in such a way that this way be said of you: Never has he wronged a man in deed or word.
  19. The best way of avenging yourself is not to become like the wrongdoer.
  20. If it is difficult to accomplish something by yourself, do not think that it is impossible for man: but if anything is possible for man and conformable to his nature, think that this can be attained by you, too.
  21. Let us overlook many things in those who are like antagonists in the gymnasium. For it is in our power, as I said, to get out of the way and to have no suspicion or hatred.
  22. When you wish to delight yourself, think of the virtues of those who live with you; for instance, the activity of one, the modesty of another, the liberality of a third, and some other good quality of a fourth.
  23. It is in our power to have no opinion about a thing and not to be disturbed in our soul; for things themselves have no natural power to form our judgments.
  24. Do not let the future disturb you, for you will arrive there, if you arrive, with the same reason you now apply to the present.
  25. Whatever any one does or says, I must be good, just as if the emerald (or the gold or the purple) were always saying, “Whatever any one does or says, I must be emerald and keep my color.”
  26. Is any man afraid of change? What can take place without change?
  27. In a little while you will have forgotten everything; in a little while everything will have forgotten you.
  28. When a man has done you wrong, immediately consider what opinion about good or evil he has. For when you have seen this, you will pity him, and will neither wonder nor be angry.
  29. Look within. Within is the fountain of good, and it will ever bubble up, if you will ever dig.
  30. The art of life is more like the wrestler’s art than the dancer’s, in respect of this, that it should stand ready and firm to meet onsets that are sudden and unexpected.
  31. It is a ridiculous thing for a man not to fly from his own badness, which is indeed possible, but to fly from other men’s badness, which is impossible.
  32. Receive wealth or prosperity without arrogance; and be ready to let it go.
  33. No longer talk at all about the kind of man that a good man ought to be, but be such.
  34. Practice that also wherein you have no expectation of success. For even the left hand, which is ineffectual for all other things for want of practice, holds the bridle more vigorously than the right hand; for it has been practiced in this.
  35. How ridiculous and what a stranger he is who is surprised at anything that happens in life.
  36. If it is not right, do not do it: if it is not true, do not say it. For let your impulse be in your own power.
  37. Consider that everything is opinion and opinion is in your power. Take away then, when you choose, your opinion, and like a mariner who has rounded the headland, you will find calm, everything stable, and a waveless bay.
  38. Cast away opinion and you are saved. Who then hinders you from casting it away?
  39. How small a part of the boundless and unfathomable time is assigned to every man! On what a small clod of the whole earth you creep! Consider nothing to be great except to act as your nature leads you.

Crude Economic Analysis: Government Student Aid Edition

This is a funny headline from the WSJ.com:

College Tuition Hikes Slow, but Aid Falls
The rate of tuition increases at colleges has slowed for the second year in a row, but government aid has fallen, continuing a cycle of rising costs and debt for students.

There seems to be a correlation in the data here. As government aid lessens, rate of tuition increase lessens.

But it would be crude to jump from here to the conclusion that there is a necessary causation in the data. Right?

“But” implies there is no causation and that the status of aid availability is a separate problem.

“And” or “As” would imply causation. Interesting how the WSJ editors chose their words on this one.

This Just Blew My Mind: The Moneyball Secret & Warren Buffett

I read Michael Lewis’s Moneyball a few months ago after having seen the film. I would’ve preferred to do it in the other order (if I had ended up seeing the film at all) but I hadn’t gotten to the book yet on my reading list and an opportunity to see the movie presented itself that I decided not to turn down.

As I understood the story, the basic premise was the principles of Grahamite value investing in baseball– buy cheap things rather quality things and wait for reversion to the mean to kick in. These cheap things may not be worth much, but you can buy them at such a discount it doesn’t matter as they’d have to be truly worthless for you to have made a mistake in the aggregate.

Specifically, Billy Bean, the GM of the Oakland Athletics at the time, was recruiting players with no star power and no salary-negotiation power that could fill his roster with an above-average on base percentage. In contrast, all the big teams with the big budgets were buying the massive stars who were known for their RBIs and home run percentages. Billy Bean’s motto was “don’t make mistakes”, like a value investor who looks for a margin of safety. The other big teams with their massive budgets were operating with the motto “Aim for the stands, hit it out of the park”, like the huge mutual funds with their marketing machines and their reliance on investor expectations to add super fuel to the market.

That’s the story I thought I read, anyway, and it made a lot of sense. Inspiring stuff for a little value investor guy like me.

Today, I sat in a marketing presentation from a vendor who used Moneyball as a metaphor and he threw an image up on the projector during his slide show of the Oakland A’s stadium. It is a shared stadium meaning it is not dedicated to the A’s but also serves as the Oakland Raiders football team home field. As a result, the baseball diamond has a lot of extra foul zone on the first and home base lines, which you might be able to see if you get real close to your monitor and squint.

 

I had never seen the A’s stadium before. I had no idea it had extra large foul zones. I didn’t realize that in a 160-odd game series the As would play around half, or nearly 80 games, at a stadium that had extra large foul zones.

I had no idea that a lot of players who had high on-base percentages got there because they hit balls that would normally end up in the stands at most other stadiums, but at the A’s home field it’d end up in the extra large foul zone. I had no idea that this meant those kinds of players would be extra valuable only on the Oakland A’s baseball team. I didn’t realize, as the demonstrator told us, Billy Bean was building a “pitching team”, not just a cheap on-base team (whatever that means).

This blew my mind. Maybe I just missed this in the book, and the movie. I am not a sports fan so maybe Lewis mentioned it and it wasn’t a detail that stuck out to me (which is actually another important lesson from all of this, but I digress…). Or maybe he didn’t. Maybe Lewis, the consummate story-teller, focused on the point he wanted to make from the story even though the reality, while related, was really determined by something else– the extra large foul zone at the Oakland A’s home stadium.

It reminded me of one of those situations with Warren Buffett. The first time you read Buffett’s biography and learn about his investments, you get the hokey “Just buy good businesses at fair prices!” schtick and you think, “Hey, that sounds simple, makes sense, that’s all there is to it!” Then you learn a few years later that what he was ACTUALLY doing was gaming the tax system, or creating synthetic leverage for himself, or whatever. You find the REAL angle, and it’s a bit more sophisticated and a bit harder for the average Joe to replicate by following the “invert, always invert” mantra of Charlie Munger.

What I took away from this is that people tell the stories they want to tell and you should never, ever take something at face value that involves a story of a person becoming wildly successful, wealthy, etc., just by figuring out some seemingly obvious, simple trick like buying cheap baseball stats.

There’s always an angle, like, he was buying cheap baseball stats that worked especially well in his home stadium.

That’s still genius, no doubt, but there’s less there that anyone operating outside that specific context can learn from it.

 

More Banking Confusion: Liquidity Versus Solvency

Here is a choice quote from the recent EconTalk podcast with Anat Admati of Stanford University:

Well, they have fancy ways to talk about banks, and we try to unpack those. They talk about maturity transformation, liquidity transformation. What that means is really that the depositor, the people who lend to the banks, often time want their money quickly, especially demand deposits. But when they invest it, they kind of invest it longer term and in less liquid things. So there is a sort of imbalance between the money that they use to fund and their investment in the sense of the length of time until something has to happen and also the speed with which they have to pay versus get paid. And so that mismatch creates fragility by itself, which also means for example if all of us run to the bank at the same time then the bank may not be able to cover all of that. Even if it technically would be solvent, it has everything, that’s kind of an inefficient run that you could have, in principle. So basically the banks tend to run a little bit more than other people into liquidity problems. You could say that, just, I have the money but I didn’t go to the ATM kind of thing–I can pay you back but we’re going to have to find a liquidity solution, sort of a rolling back my debt. Their funding is kind of fragile almost by definition because of the way it comes and the way people can come back for their money on short notice or any time they want. So that’s part of the funding. And the investments are not as liquid or longer term than that. (emphasis added)

This is an utter confusion. This is not a “liquidity problem”, it’s a solvency problem.

Money-in-an-ATM is not the same economic good as money-in-my-hand. That is, money-five-minutes-from-now is not the same as money-right-now.

They are separate economic goods due to the time value of money. What Admati has done is create an arbitrary distinction between a future money good and a present money good, by projecting her preference/judgment onto an exchange involving two other parties of which she is not one.

If party A demanding “liquidity” from the bank B truly saw no difference between money-right-now and money-a-few-days-from-now, for example, then a bank run would never happen and these items would trade at the same price, which they do not.

This is a fundamental error of economic reasoning. I expect a professor of finance and economics to understand something like this and as a result I find myself disappointed to see that she does not.

Economists and politicians only let banks get away with this. If anyone else were to be so arbitrary and haughty toward contracts they’d be thrown in prison, but for banks insolvency never comes so long as you can contort logic to the point that you convince yourself that all that’s missing is a bit of liquidity.

This is more free lunch thinking.

Four Views On Gold And Gold Miners

1.) Atyant Capital, “What is gold saying?”:

Gold stocks lead gold and gold leads currencies and currency moves correlate with stocks and bonds. Gold stocks have been declining for two or so years now. This is in part due to unavailability of capital and credit for gold mining projects, but in our assessment, not the whole story. We believe gold stocks are also correctly forecasting lower gold prices.

Long term readers know my gold pricing model puts fair value at $1100 per ounce (Alpha Magazine Aug 24, 2011). So at $1700-$1800, gold was about 60% overvalued, floating on a sea of credit. Gold declining now tells me the sea of credit is receding here and now. This should translate to a higher US Dollar and pressure on asset prices globally.

2.) Value Restoration Project, “Gold miners – Back in the Abyss – An Update“:

Gold mining stocks remain cheap by almost any objective measure.

One way to look at mining stocks is to compare them to the price of gold itself.

Comparing miners to the price of gold itself, show miners are cheaper today than they have been in decades.

[…]

Today, gold appears undervalued relative to the growth in the monetary base that has occurred up to now, and in light of the monetary expansion the Fed and other central banks are currently undertaking, gold appears more undervalued. The Fed’s current quantitative easing program probably won’t be curtailed until households stop deleveraging and the government can handle the rising interest expense on its expanding debt.

Yet, in the face of all this, many gold mining stocks are now selling at valuations that suggest the market has priced in a decline in the price of gold back to 2007 levels, before the Fed began expanding its balance sheet during the financial crisis. Many gold mining stocks are now selling near or below their book value, which is the market’s way of saying that these businesses won’t be able to add shareholder value in the coming years by mining gold and silver. If the price of gold were to decline below $700 or so, it would certainly be the case that most mining companies wouldn’t be able to profitably sell gold. Yet such a decline in gold is the main implied assumption being priced in by the market today, and this has sent valuations of gold mining stocks to their lowest levels since the current bull market began.

3.) Robert Blumen, “What is the key for the price formation of gold?“:

The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets. As individuals filter these events through their own thoughts they form their preferences. But that’s not something that’s measurable.

I suspect that the reason for the emphasis on quantities is that they that can be measured. Measurement is the basis of all science. And if we want our analysis to be rigorous and objective, so the thinking goes, we had better start with numbers and do a very fine job at measuring those numbers accurately. If you are an analyst you have to write a report for your clients, after all they have paid for it, so they have to come up with things that can be measured and the quantity is the only thing that can be measured so they write about quantities.

And in the end this is the problem for gold price analysts, you’re talking about a market in which it’s difficult to really quantify what’s going on. I think that looking at some broad statistical relationships over a period of history, like gold price to money supply, to debt, things like that, might give some idea about where the price is going. Or maybe not, maybe you run into the problem I mentioned about synchronous correlations that are not predictive.

Part of the problem is that statistics work better the more data you have. But we really don’t have a lot of data about how the gold price behaves in relation to other things. The unbacked global floating exchange rate system has never been tried before our time. How many complete bull and bear cycles has the gold/fiat market gone through? My guess is that when we look back we will see that we are now still within the first cycle. Our sample size is one.

[…]

I do think we will have a bubble in gold, although it may take the form of a collapse of the monetary and a return to some form of gold as money in which case, the bubble will not end, it would simply transition over to the new system in which gold would go from being a non-money asset to money.

I have been following this market since the late 90s. I remember reading that gold was in a bubble at every price above 320 dollars. I very much like the writings of William Fleckenstein, an American investment writer. He has pointed out how often you read in the financial media that gold is already in a bubble, a point he quite rightly disputes. Fleckenstein has pointed out that the people who say this did not identify the equity bubble, did not believe that we had a housing bubble, nor have they identified the current genuine bubble, which in the bond market. But now these same people are so good at spotting bubbles that they can tell you that gold is in one.

Most of them did not identify gold as something which was worth buying at the bottom, have never owned a single ounce of gold, have missed the entire move up over the last dozen years, and now that they’re completely out of the market, they smugly tell us for our own good that gold is in a bubble and we should sell.

So, I don’t know that we need to listen to those people and take them very seriously.

4.) Me:

I don’t know what the intrinsic value of gold is. I don’t think gold mines are good businesses (on the whole) because they combine rapidly depleting assets with high capital intensitivity and they are constantly acquiring other businesses (mines) sold by liars and dreamers and schemers. And I don’t think this will end well, whatever the case may be. So, I am happy to own a little gold and wait and see what happens.

I wonder what the short interest is on gold miners?