Podcast Summary
Understanding Inflation's Impact on Financial Assets: Unexpected inflation can lead to a significant decrease in the value of financial assets, making it crucial for investors to be aware of its potential consequences.
Learning from this episode of Invest Like the Best is the importance of understanding inflation and its impact on financial assets. Aswath Damodaran, a professor of finance at NYU Stern School of Business, emphasizes that inflation, particularly unexpected inflation, can significantly affect the value of financial assets. Expected inflation can be factored into financial assets, such as setting coupon rates for bonds to cover inflation. However, unexpected inflation can lead to a mad scramble to adjust prices and mark down the value of financial assets. It's crucial for investors to be aware of the potential for unexpected inflation and its consequences. Additionally, Damodaran highlights the value of learning from the experiences of investors in countries with high inflation, such as Turkey, to better understand the challenges and opportunities that come with inflationary periods.
Unexpected inflation in the 70s and 80s caused significant losses for stocks and bonds: Unexpected inflation can lead to major portfolio adjustments and potential losses for financial assets, particularly stocks and bonds
Unexpected inflation can be devastating for financial assets, particularly stocks. The speaker discussed how inflation in the 1970s and 1980s led to significant losses in various financial assets, including stocks and bonds. The unexpected nature of inflation during these decades caused investors to readjust their expectations and prices, leading to significant losses. The speaker also noted that there are relatively less damaged versus more damaged assets in a high inflationary environment. Companies can adjust to expected inflation, but unexpected inflation can cause significant issues, such as the need to change business models or pass on price increases to customers. The current market is facing uncertainty regarding inflation expectations, and it's essential for investors to carefully consider their portfolios and adjust accordingly. The historical precedent of the 1970s and 1980s highlights the importance of being prepared for unexpected inflation and the potential consequences for various financial assets.
Inflation's Impact on Companies: Delayed Projects and Pricing Power: High inflation can lead to delayed or abandoned projects, especially for infrastructure and capital-intensive industries. Companies need significant pricing power to adjust prices quickly, but most lack it due to competitive markets and regulatory frameworks. Discretionary goods and services are more vulnerable to inflation as consumers can delay purchases.
High and volatile inflation can be detrimental to companies, particularly those that need to make long-term investments. The uncertainty surrounding inflation can lead to delayed or abandoned projects, especially for infrastructure and capital-intensive industries. Companies require significant pricing power to adjust prices quickly in response to inflation, which is rare for most businesses due to competitive markets and regulatory frameworks. Additionally, goods and services that are discretionary or non-essential are more vulnerable to inflation as consumers can delay or defer purchases. The current economic climate, with a large portion of market cap coming from new and emerging industries, will test how inflation impacts discretionary spending. Overall, the ability to adapt to inflation and its volatility is crucial for companies to thrive.
The Consequences of Inflation: Inflation could widen income inequality, potentially lead to a recession, and disproportionately affect lower income populations. The Fed is taking action, but companies must adapt to the new economic reality to thrive.
The current inflation trend, if not addressed, could widen income inequality and potentially lead to a painful recession. The lower income population, who have less capacity to hedge against inflation, would be disproportionately affected. The Fed is now taking inflation seriously, but it may not have the political will to implement the necessary painful measures. Companies are responding by shifting business models towards subscription services and becoming more adaptable to changing economic conditions. The consequences of inflation, both economically and socially, could be significant and long-lasting. The 1980s recession serves as a reminder of the challenges and hardships that come with high inflation and a weak economy. Companies that can adapt quickly and effectively to this new economic reality will likely fare better than those that cannot.
Companies with flexible business models and cost structures better positioned against inflation: Flexible business models, low debt, and less discretionary offerings in tech sector make companies less vulnerable to inflation risks
In today's economic climate, companies with flexible business models, such as subscription and platform businesses, and cost structures that can be tied to inflation, are better positioned against inflation compared to traditional consumer product companies. These companies, often found in the technology sector, have less discretionary offerings, flexible investments, and low debt, making them less vulnerable to inflation risks. Additionally, return on invested capital (ROIC) is a useful metric, but it should not be the sole focus of an investment strategy. ROIC is designed for mature or declining companies, and young, growth-oriented firms may have meaningless or even negative ROIC. It's essential to consider ROIC as part of a broader set of metrics and to be aware of the potential pitfalls and biases that come with an investment strategy based solely on ROIC. Furthermore, the importance of effective capital allocation by management, including CEOs and CFOs, cannot be overstated. Their ability to allocate capital wisely and adapt to changing market conditions plays a crucial role in a company's long-term success.
Investors discuss importance of product innovation, growth, and diversification: Invest in companies with innovative products and potential for growth. Diversify portfolio across asset classes, company types, and geographies for risk management.
A focus on capital structure and debt management in a company's strategy can be a sign that its best days are behind it. This conversation between investors highlights the importance of product innovation and growth in young companies, while mature companies may prioritize cost savings and capital allocation. The investor emphasizes the need for diversification in a portfolio, spreading bets across asset classes, types of companies, and geographies. Real assets, such as traditional real estate, can serve as a hedge against inflation, but the securitization of real estate has made it behave more like stocks and bonds. Gold, as a collectible and store of value, can be a consideration for investors in times of market confusion or inflation, but it's not a guaranteed long-term investment. Overall, the conversation underscores the importance of a well-diversified portfolio and the need to adapt to changing market conditions.
Amazon's story of building it and customers coming: Understanding a company's story and consistency is vital for investors. Amazon's persistence with Amazon Prime despite losses shows the power of a strong narrative.
Stories play a crucial role in driving the value of a company, as illustrated by Amazon's evolution from an online book retailer to a disruption machine. When Amazon first started, its story was about building it and the customers would come. They stuck with this story, even when Amazon Prime was a money loser for seven years. Today, Amazon Prime has built a loyal army of customers, making it a powerful tool for disrupting businesses. For investors, understanding the story behind a company and the consistency with which it is acted upon is essential. Even number crunchers should consider the narrative of a company, as Warren Buffett emphasizes the importance of understanding the business, management, and story behind the numbers. When evaluating a new company, listen to their stories and consider the total addressable market they present as a key component of their narrative.
Caution against overhyped market valuations: Invest wisely by focusing on own analysis and story of a company, rather than relying on external estimates or hype. Consider price and quality before investing, and beware of unsustainable growth models.
Investors should be cautious of overhyped market valuations and focus on their own analysis and story of a company instead of relying solely on external estimates or stories. The speaker shares his experience of valuing companies based on his own story and being wrong at times but staying true to his approach. He also warns against companies like Netflix that have unsustainable growth models and emphasizes the importance of considering the price and quality of a company before investing. The use of visual metaphors like the hamster wheel and Thanos adds to the understanding of the concepts. Ultimately, the key takeaway is to approach investing with a critical and thoughtful perspective, rather than being swayed by market hype or delusions of grandeur.
Tech Giants' Core Businesses Still Drive Most of Their Revenues: Google, Facebook, and Apple generate majority of their revenues from search ads, user data, and iPhones respectively, leaving them vulnerable to potential declines or failures.
Despite the diversification efforts of tech giants like Google, Facebook, and Apple, a significant portion of their revenues still comes from their core businesses: search advertising for Google, user data for Facebook, and the iPhone for Apple. The speaker argues that these companies have been successful in monetizing our usage of their free products or services, often at the expense of our privacy. Google's dominance in online advertising is unrivaled, with over 93% of its revenues derived from it. Facebook, despite widespread criticism and user dissatisfaction, continues to generate significant revenue through its business model built on user data. Apple, once a computer company, has become an iPhone company, with the iPhone generating the majority of its revenues. These companies' reliance on a single product or service leaves them vulnerable to potential failures or declines, which could have significant consequences for their financial performance.
Shifting Competitive Edge in Investing: To succeed in investing today, go beyond basics, understand companies deeply, consider risk, diversify, focus on consistency, and follow the Hippocratic Oath.
The competitive edge in investing has significantly shifted over the decades. In the past, access to information and computing power gave professionals a significant advantage over individual investors. However, with the advent of technology, this edge has largely disappeared. Today, anyone can access vast amounts of financial data and run complex valuation models with just a few clicks. The challenge for investors now is to find a niche or a unique approach that sets them apart from the competition. Merely running screens and following a value investing strategy is not enough. Instead, investors need to go beyond the basics and develop a deep understanding of the companies they invest in. They must also consider risk and create a well-diversified portfolio. The focus should be on consistency rather than seeking high alphas at any cost. Moreover, the Hippocratic Oath of doing no harm should be the guiding principle for anyone managing other people's money. In essence, the key to successful investing today is to go beyond the basics and adopt a holistic approach that considers all aspects of investing, including risk, diversification, and a deep understanding of the underlying businesses.
Learning from Successes and Failures: Successful investing involves studying various investors, recognizing the role of luck, and staying open to feedback to maintain perspective.
Successful investing involves learning from both good and bad experiences, recognizing the role of luck, and maintaining perspective. The speaker emphasized the importance of studying various investors, including those who have made mistakes, as there is value in understanding their approaches and identifying what worked and what didn't. However, it's crucial to remember that markets are influenced by both skill and luck, and attributing success or failure solely to one factor is misleading. The speaker also acknowledged common pitfalls in investing, such as letting recent history drive forecasts and falling in love with a particular story, and emphasized the importance of staying open to feedback and being willing to admit when you're wrong. Ultimately, successful investing requires a balanced perspective, an understanding of macro trends, and a willingness to learn from various sources, including unexpected places like Uber drivers.
Shifting business landscape and investment strategies: Understand momentum's impact, distinguish investing from trading, and adapt strategies to the evolving business world
The business landscape and investment strategies have significantly evolved in the 21st century compared to the 20th century. Traditional assumptions, such as perpetuity in valuation, may not apply to today's companies, especially technology firms, which can rise and decline rapidly. Momentum, as a trading strategy, has become a powerful force in markets, often surpassing the significance of fundamentals like earnings and growth in the short term. While some investors may focus on momentum, it's crucial to understand the difference between investing and trading and employ appropriate strategies accordingly. Traders thrive on momentum but can be wiped out by it, while investors assess a company's value and buy at a discount to that value, hoping for the price to adjust over time. It's essential to recognize the shift in the business world and adapt our investment strategies accordingly.
Mean reversion strategy may not be effective in the 21st century: Understanding inflation and real growth is crucial for determining interest rates and discount rates, as they're related.
Mean reversion, a strategy that worked well in the 200th century for investors by buying good companies and ignoring macro variables, may not be effective in the 21st century due to structural breaks in the economy. Mean reversion can be a deadly force when there's a significant shift in the economy, and investors may not revert to the mean they anticipated. It's crucial for investors to consider whether they believe the economy they're investing in will continue to be mean reverting before relying on this strategy. Discount rates and interest rates are related, with interest rates ultimately being a component of discount rates. Interest rates are not set by the Fed but are driven by expected inflation and real growth. Therefore, understanding inflation and real growth is essential for determining interest rates and discount rates. If inflation rises, for example, long-term bond rates will also increase to reflect that. It's essential to recognize these relationships and consider them when making investment decisions.
Historically low interest rates leading to increased investment in risky assets: As interest rates rise, equity risk premiums increase, potentially impacting cash-burning young companies negatively. Stay informed and adjust strategies accordingly.
The current economic environment, characterized by historically low interest rates and discount rates, has spoiled investors and companies, leading to an unprecedented period of investment in risky assets like early-stage equities. However, this dynamic is changing as interest rates rise, causing a significant increase in equity risk premiums and a potential drawdown of risk capital. This shift could negatively impact young companies, particularly those that are cash-burning and dependent on continuous capital access to survive. It's essential for investors and entrepreneurs to be aware of this trend and adjust their strategies accordingly. The equity risk premium, which reflects our collective fears and hopes, is a dynamic number that changes based on economic conditions and geopolitical events. As we collectively become more terrified of the economic future, the equity risk premium goes up, making it more challenging for risky assets to perform well. It's crucial to stay informed about these shifts and adapt to the changing economic landscape.
ESG: A Feel-Good Scam?: The ESG trend, driven by establishment endorsement and potential financial gains, lacks consensus and foundation, and may not significantly impact fossil fuel use or address root causes of environmental and social issues.
The ESG (Environmental, Social, and Governance) trend, which has gained significant traction in recent years, is being driven by various factors including the establishment's endorsement and the potential for financial gains. However, the speaker raises concerns about the lack of consensus and foundation for ESG, the questionable quality of research, and the potential for greenwashing rather than actual change. The speaker argues that the focus on publicly traded companies in the US and Europe may not have a significant impact on the overall use and development of fossil fuels. Instead, private equity groups and less scrupulous actors may be the ones benefiting from the divestment. Ultimately, the speaker sees ESG as a feel-good scam that is making some people wealthy without addressing the root causes of environmental and social issues.
ESG Investing: Subjective and Manipulable: ESG scores are not objective measures, define your own standards, and look for companies that adapt and offer unique value propositions during disruption.
The Environmental, Social, and Governance (ESG) investing landscape is complex and subjective, with concerns over transparency, gaming of the system, and political influences. The speaker argues that ESG scores are not objective measures, but rather a result of a checkbox system that can be manipulated by companies. They also point out that what one person considers "good" may differ greatly from another's definition. The speaker encourages investors to define their own standards and not rely solely on ESG scores. They also discuss the concept of disruption, using Tesla and Costco as examples. Tesla, an industry disruptor, has faced challenges from established automakers, while Costco has managed to thrive despite the rise of e-commerce. The speaker suggests that companies that survive disruption do so by adapting and offering unique value propositions to their customers.
Offering unique experiences to differentiate from e-commerce giants: Costco's subscription model, bulk shopping, and in-store experiences set it apart from Amazon. Alibaba's online retail presence catered to China's cultural preferences. Adapt and innovate to stay competitive in a disrupted marketplace, considering potential impact on cash flows, growth, and margins.
Successful businesses, especially in the retail industry, need to differentiate themselves from e-commerce giants like Amazon by offering unique experiences that cannot be replicated online. Costco, for instance, has managed to do this through its subscription model, bulk shopping, and in-store experiences like tasting stations. Alibaba, on the other hand, succeeded in China by creating an online retail presence that catered to the cultural preferences of its customers. When valuing a company that faces disruption risk, it's essential to consider the potential impact on cash flows, growth, and margins, and adjust valuations accordingly. For instance, when valuing Aramco, it's crucial to consider not just the company's oil reserves but also the geopolitical risks associated with the region where it operates. In essence, businesses must adapt and innovate to stay competitive in an increasingly disrupted marketplace.
Valuing companies with a subjective approach and adaptability in leadership: Successful leadership and investment strategies require uncertainty and adaptability. Value companies with strong teams and adaptable leaders, avoid those overly reliant on a single personality, and trust in free expression while acknowledging challenges of maintaining a completely free social media platform.
Uncertainty and adaptability are key factors in successful leadership and investment strategies. The speaker discussed the importance of valuing companies with a subjective approach, considering potential changes in leadership or market conditions. He emphasized the need for adaptable leaders who trust their teams and build companies that can outlast them. He also warned against investing in companies overly reliant on a single leader or personality. Regarding Elon Musk and Twitter, the speaker believed Musk's primary motivation was a belief in free expression, but acknowledged the challenges of maintaining a completely free social media platform. Lastly, the speaker expressed disagreement with the notion that more disclosure leads to better investment decisions, arguing that excessive disclosure can be misleading and detract from the important information investors need.
The Overabundance of Disclosures: Confessions or Commitments?: Regulatory pressures and activism have led to excessive disclosures, potentially diluting their value. A more thoughtful and targeted approach is needed to ensure crucial information is not overlooked or ignored.
Disclosures have become akin to confessions, with companies focusing more on confessing past sins rather than committing to future changes. This overabundance of disclosures, driven by various regulatory bodies and activists, risks diluting the value and importance of crucial information. As a result, we may end up with extensive disclosures that are overlooked or ignored. The speaker emphasizes the need for a more thoughtful and targeted approach to disclosures, rather than a one-size-fits-all solution. Additionally, the speaker reflects on the importance of kindness and the transformative impact it can have on individuals, using his personal experience of immigrating to the US as an example.
Empowering Critical Thinking through Effective Teaching and Innovative Tools: Effective teaching goes beyond showing ways, empowers critical thinking. Google searches can hinder it. Innovative tools like Catalyst offer a 'window on process' and free time for higher-level analysis, enhancing critical thinking skills.
Effective teaching goes beyond just showing people how to do things; it's about helping them develop their own way of thinking. According to the speaker, the overreliance on Google searches for answers can hinder critical thinking skills. Instead, teachers should provide a "window on process" to let students see their reasoning, allowing them to learn from it and build their own ways of thinking. Complex models, like those used in investment banking, can provide false comfort with their intricacy, but they can also obscure the essential details. The speaker was amazed by Catalyst's ability to create detailed and sophisticated models in a simple, one-tab format. This innovation freed up time previously spent on manual model building, enabling the speaker to focus on higher-level analysis. In essence, effective teaching and innovative tools can empower individuals to think critically and efficiently, ultimately leading to better decision-making and problem-solving abilities.
Canalyst's Financial Modeling Tool Transforms Financial Analysis: Canalyst's automated financial modeling tool streamlines workflows, reduces errors, and fosters collaboration among financial analysts, revolutionizing the financial analysis process.
Canalyst's automated financial modeling tool is revolutionizing the way financial analysts work by providing a single source of truth with no errors, reducing friction, and allowing for quick and easy collaboration among team members. The speaker shared his personal experience of discovering Canalyst through a podcast ad and how its use spread virally among his team. He highlighted the historical challenges of model ownership and maintenance in finance, and how Canalyst eliminates these issues. The speaker also compared his use of Canalyst in his hedge fund days to his current role at LK Advisors, noting that the global coverage universe requires different approaches but that Canalyst's quality scorecard feature has been particularly valuable for cross-comparing companies. Overall, Canalyst's tool is transforming the financial analysis process by streamlining workflows, reducing errors, and fostering collaboration.
European investment firm streamlines model updating with Canalyst's extensive coverage and quick response: Canalyst's extensive coverage, quick response, and intuitive interface help a European investment firm efficiently evaluate over 250 KPIs for companies, reducing the time and resources required for model updating.
Canalyst's extensive coverage of global companies and quick response to user requests have significantly streamlined the model updating process for this European investment firm. With over 250 KPIs and a scorecard system, the firm can evaluate companies efficiently, a process that would have taken years without Canalyst. The expanding universe of companies and close collaboration with the product team have made Canalyst an indispensable tool. However, the firm still sees potential for automation, such as a buy-side consensus feature or a more user-friendly platform for larger-scale scoring mechanisms. Despite the benefits of outsourcing model updating, the firm values the human touch and understanding of the business that comes with following companies closely. Canalyst's intuitive interface and customizable templates enhance the process of making sense of the business and complement the firm's proprietary processes.
Understanding complex systems through modeling: Modeling helps make sense of complex data and trends, revealing opportunities for growth in various fields, including finance.
The importance of modeling in understanding complex systems and making informed decisions. Giuseppe's extensive experience in this area has given him valuable insights into the power of modeling, particularly in the context of financial markets. By breaking down complex data and trends, models help us make sense of the world around us and identify opportunities for growth. If you're interested in learning more about modeling and its applications, be sure to check out Colossus.com. Our podcast episodes, complete with transcripts and show notes, provide in-depth explorations of various topics related to modeling and data analysis. Additionally, by signing up for our newsletter, Colossus Weekly, you'll receive a weekly digest of the most important ideas, quotes, and resources from each episode, as well as the best content we find on the internet each week. So, whether you're a seasoned professional or just starting out, Colossus has something for you.
