The Unrepentant Recalcitrant

Lessons for an accidental entrepreneur

Archive for the tag “Business Strategy”

Economic Principles are Slaves to Psychology, not Math

Pity the poor entrepreneur who embarks on a path of business education!

Whether its by way of starting a company, studying for a MBA, or even a million other paths, business education holds some surprises for us unwashed (read: unsophisticated) masses.

Two whole fields exist to dazzle you! Microeconomics and Macroeconomics. Its all exceedingly complicated and not for the faint of brain, you are told.

Some of the smartest people I have met have been economists by profession. Very bright, very quantitative and eager to explain the world of money.
There is however a 800 pound gorilla in the room.

And that is, that economists are almost without exception unable to describe economic reality.

Under most real world conditions, their models don’t work and their math fails them.

Why?

Let an ignorant doctor tell you the one thing he understands better than anything else.

Mathematical formulas are inadequate as models of human behavior.

Economics is at its heart, human behavior applied to a special situation.

Math cannot help you brother.

Don’t tie yourself up in contortions trying to force that economic model to give you testable hypotheses!

Instead, just watch how we behave as social animals and you will get a much better sense of what is happening and what will happen in the future.

Want to master economics and the nature of markets?

Watch “Animal Planet” and throw away your models!

Go to the zoo and say hello to those 800 pound gorillas! You will learn more about how markets behave watching them, than you will watching CNBC.

Trust me, I’m a biologist.

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Principles of Value Investing

Toto, I have a feeling we’re not in Kansas anymore.

Yes boys and girls, put away your Excel spreadsheets and gather round the fire.

As Steve Jobs liked to say, “I’m going to tell you three things. No big deal. Just three things.”

That’s it folks.

Three Principles.

1. P/V
2. EVA
3. Rain Falls Down

( Bonus: They apply universally and are equally and importantly relevant to entrepreneurship as well.)

Before you swoon in admiration of my unparalleled genius, I want to be clear that these ideas and even the phraseology are not mine.

This is what I learned from my master, my Yoda. (Thanks Tom, for changing my life!)

Yes folks, this changed my life. If you pay attention, it might do it for you.

And then again for those of you too lazy to listen, it might not. YMMV.

 

Definitions first and details later. Ok?

 

1. P/V : Price/Value

The fundamental metric of all investing. The ratio of the price you pay for the value you get. This needs to be less than one at all costs and the lower it is, the larger your margin of safety (remember margin of safety?: https://unrepentantlyrecalcitrant.wordpress.com/2013/10/10/all-investing-is-value-investing-the-rest-is-speculation/).

All of Wall Street that makes money off of you, conflates price and value. It is the fundamental thesis of those that believe the markets are efficient.

(If you believe that, what in gods name are you doing on my blog? Go visit that fool Cramer on CNBC or something!)

Price is what you pay, value is what you get.

The lower the price and the higher the value, the better the deal.

Buffet talks about buying a dollar for fifty cents.

That’s a P/V of 0.5

Awesome.

I will discuss the estimation of value in some detail in a later post.

 
2. EVA : Economic Value Added

Also known as Abnormal Earnings ( Economists always think that profit is an abnormal situation!), EVA is defined as:

Return on Invested Capital – Cost of Capital = EVA

As an example, if your capital costs you 9% ( say a bank loan for your business) and you are able to generate 9.9% return ( savvy investing or your business profits), you have an EVA of 10%

Needless to say, it should be a positive number!

Before you laugh at that, I will in the future show you why most businesses (the majority) are not getting a positive number and as a result have a zero EVA (bad!) or even a negative EVA ( yes, they are destroying capital!).

If you are an aspiring entrepreneur, you must (MUST) have plans for a positive EVA! If not, don’t even bother. More on this later.

 
3. Rain Falls Down:

A little more fuzzy than the others, this statement underlines that certain things are an inevitability.

You must prepare for them and account for them in your estimation of value and decision to invest ( or grow your business).

Your resistance to rain clouds and gravity is useless. Rain will fall down.

 
Simple so far, no?

Remember, Value investing is simple but it’s not easy! Oh No!

I will take each of these points and expand on them in future posts.

I will review the only economic principle(s) that matter ( YES, most of economics is a massive waste of your time!)

The only thing I can’t help you with is mental toughness.

(You need to review Kipling’s poem again and internalize it!: https://unrepentantlyrecalcitrant.wordpress.com/2013/10/06/rudyard-kipling-was-a-value-investor/)

Oh, one last thing. You know that money you saved up to buy the latest Excel program?

Go get a great dinner instead.

You ain’t gonna need Excel anymore.

Arjuna and The Eye of the Sparrow: Without Focus, There is No Success

Arjuna and the Eye of the Sparrow (From boloji.com)

Arjuna and the Eye of the Sparrow (From boloji.com)

Another story from the Mahabharata.

Today my story is even older than the story of Abhimanyu (https://unrepentantlyrecalcitrant.wordpress.com/2013/10/02/the-story-of-abhimanyu-why-you-must-have-an-exit-strategy/).

It’s a story from the childhood of Arjuna, Abhimanyu’s father.

Arjuna, a warrior prince, and his brothers and cousins are being trained in archery and warcraft by the great teacher Drona.

Drona assembles the young princes together, places a wooden sparrow on the branch of a tree and asks the princes to aim for the eye of the bird.

He asks one of the princes to come forward, draw his bow and then asks, “Tell me what you see?”

The prince responds, “I see the bird, the branches and the tree.”

“What else do you see?” asks the venerable teacher. “Tell me everything you see”.

“I see the sky, the clouds, the sun..Oh Drona” responds the prince.

Drona then asks the next prince in line the same question.

“What do you see?”

“I see the bird, the tree, the sun and the skies..Oh Drona.”

One by one the princes are asked the same question and they describe everything they see.

Then its Arjuna’s turn.

“What do you see boy?” asks Drona.

“Blackness, my teacher. I see blackness”.

“What else do you see?”

“Nothing but blackness, my teacher. That is all I can see.”

Drona presses Arjuna. “What is this blackness Arjuna?”

“It is the blackness in the center of the eye of the sparrow, my lord. I can see nothing else.”

“Shoot” says Drona. “You will be a Master Archer someday.”

And he was. The best archer in the world. A warrior without equal.

Look for this in your lives my dear readers.

Look for the blackness in the eye of the sparrow.

See nothing else, do nothing else, dream nothing else.

Perfect this and you will be perfect at what you do.

A Master without peer.

All Investing is value investing. The rest is speculation

Value Investing. Growth Investing. Momentum Investing. Trading. Real Estate. Precious Metals. Shorting.

A million different ways to lose your money (We should include failed startups to this now shouldn’t we? Heh Heh).

I am going to review some of the lessons I have learned about investing over several future posts but lets spend some time clarifying what we are talking about. Being exact is helpful in a situation where we are surrounded with many different voices in chaotic confusion.

An asset is something that puts money in your pocket either today or in the future. Today it might be cash in your pocket, and in the future it may be the result of an investment, a gamble or a speculation.

Value Investing (or Investing) is the act of acquiring an asset for less than what its worth. Once the asset reaches the point where it is valued at what it is worth (or more), we have made a profit. Agreed?

Speculation is the act of (well speculation, I guess!) an informed (yes, informed…maybe incorrect but informed) betting on the movement in the price of an asset or a presumed asset. If the speculation is correct, a profit is made, and if not, a loss is suffered.

Gambling is the act of largely (not uniquely, no) uninformed speculation that most often results in losses for the gambler and winnings for the counter-party. The counter-party may be a speculator or an investor.

Now lets be theoretical for just a second and invoke math (or maths, if you are British). The only guarantee of profit in the above scenarios comes from buying an asset for less than its worth, i.e. value investing. Its more complicated than that but lets start with the numbers.

When you speculate, you position a bet to take into account certain unperceived or less perceived visions of a future wherein the asset you purchase will sell for more than you paid for it, regardless of whether it is worth what you paid or what the next person pays you for it (Greater fool theory).

That last bit is important. Its important because it underlies the idea of “margin of safety”. The concept of margin of safety says that you have purchased an asset for so much less than it is worth, that even in the likelihood that the greater fool theory did not apply, you would either minimize your losses or make a profit when the asset is fully valued.

A value investor lives or dies by his margin of safety.

A speculator is less concerned by it.

A gambler does not even know it exists.

Every situation where you buy an asset for less than its worth is therefore an example of value investing (stocks in 2009, real estate in 2010, Europe for the longest time etc).

Every time you don’t do that but you believe something good will happen to you, (i.e. currency trading, buying and selling gold, real estate in 2007, European debt over the past few years etc), you are speculating. There is nothing wrong with it, but its good to know what you are doing very clearly isn’t it?

The difference then between these two methods of generating wealth is therefore predicated on whether there is a difference between the price of an asset and its intrinsic value. That in turn is predicated on the estimation of value, the most important item in our arsenal.

Let me be very clear on this so there is no doubt where I stand. If you are unable to ascertain the value of an asset, you are a speculator and if you don’t even know that there may be an intrinsic value that you are missing, you are a gambler and one that will lose to the house every single time.

Every single time.

You have no business investing/speculating/gambling if you are unable to ascertain value.

Am I clear?

Would you perform surgery on yourself without going to medical school?

Exactly. (sigh..I can see the gamblers in the audience going..Hmm.. Why not give it a try?)

If you insist on doing this without the fundamental knowledge of valuation, I have some news for you. You have a name on Wall Street.

Sucker. Muppet (if the counter party is Goldman Sachs).

Warren Buffet says and I paraphrase “Every game has a sucker. If you don’t know who that sucker is, its you. Sucker”

I know the wider world thinks buying and selling stocks and “playing” the market is easy. Dead Wrong.

The market makes its money off of you.

Ok, lets summarize what I said so far.

The least risk (or most sure way) to generate positive returns is by investing and specifically by buying an asset for less than it is worth.

Speculation done well is an art that is beautiful to behold. Some of the richest people in the world are successful speculators. However, its extraordinarily difficult to do and to do it consistently over time is a rare feat. When you see the best at their game, its sometimes difficult to tell whether they speculated or whether they are very savvy value investors.

Most speculators are lousy and should be reclassified as gamblers.

Its more risky and much more stressful.

I don’t need to say anymore about gambling, do I?

Whats next?

In future posts I will discuss the concepts of valuation, its pitfalls and what you must learn in order to perform a reasonably good valuation.

We will then go over the principles of value investing (There are only three principles, my wide eyed acolytes, so don’t worry!!).

Among these posts in the future, I will discuss why these principles can and should be generalized to entrepreneurship and perhaps even to the Right Thinking principles I have been discussing so far.

Flood me with your comments, but please only positive ones.

I have a fragile ego.

If You are not out in front of the Herd, the View never changes

You will spend your life looking at someone’s ass.

And thats ok, if you are content. Who am I to judge?

I speak for all of us that want to strive for something that does not yet exist in our lives.

This is not just about entrepreneurship. No sir.

All the difference made in this world bar none has been made at the margins of the common, the accepted and the ‘norm”.

You will never make a dent, and never shake things up if you follow the herd.

To use a scientific turn of phrase, you need to embrace a paradigm shift.

A paradigm in science (or elsewhere for that matter) is a framework to think about things.

(See below for a reference to Thomas Kuhn’s famous book on paradigms)

Each paradigm is a temple of sorts for those who wrap themselves in its teachings.

If everybody (or more correctly the majority) believes something to be true, two things necessarily follow:

One: There is little to be discovered within its folds..it has been exploited and understood.

Two: The territory outside the paradigm has not been well explored and is ripe for new, innovative, ground shaking ideas and development. Also, the competition here is slim compared to the paradigm where the sweaty masses are spending their time.

Every body knew the sun revolved around the Earth until they didn’t. People lost their lives trying to change that paradigm.

Everybody knew that man could not fly until that paradigm shifted.

Ok, but you and I are not the Wright Brothers! (at least not I!).

If you are an entrepreneur, everybody knows your idea is crazy. Of course! If they did not, the competition to get your idea to market would destroy your chances!

If you are a value investor, everybody knows your stock picks are all wrong. Heck everybody knows value investing doesn’t even work “anymore”!! (Ha!, now thats a paradigm for you to bust). This is a good thing…trust me. Your stock picks are safe. It will be like taking candy from a baby.

(Note to the moms out there..I am not advocating stealing from infants).

Ok, maybe not that easy. But you get my drift.

A Nobel prize winning scientist I had the good fortune to speak with briefly once told me “When they think you are crazy and shun you, you should know you are on to something.”

This guy discovered/described a new form of life and almost lost his career and reputation doing it.

The takeaway for those of us that are far away from winning Nobel Prizes is really about conviction in your thought process.

It matters a hoot what others think. Listen to them, dissect their arguments but for heavens sake learn to think for yourself. It will serve you well over a lifetime.

And when everyone (sic) thinks a certain way, there is likely money to be made by taking a bet against them.

The House does not always win.

 

 

Bibliography:

Kuhn TS. “The Structure of Scientific Revolutions” 1962. University of Chicago Press. ISBN 9780226458113

Rudyard Kipling was a Value Investor

Those of you reading my blog for the last several columns have figured out by now that I believe that the traits and character required for an entrepreneur are very similar to those a good value investor should have.

I am going to add to that.

As you think deeply about the kinds of behavior, instincts and thought process that result in success in these areas, you will no doubt find that many of those ideas are transferable to life itself. This is something I have termed “Right Thinking” in prior posts (not my term, but one I think is appropriate).

Understanding this and applying this thinking to your project(s), you may find you are “doing better” in other parts of your life. (Oh the horror! I have become my mother!)

Think of this as a welcome side effect (As a doctor, I think in these terms…what can I tell ya!)

By no means am I a fan of Rudyard Kipling (I can tell you where he should stick his “White Man’s Burden”!).

But credit where credit is due. I believe his poem IF, reproduced below is a graphic and exact description of what you need to succeed as an investor, as an entrepreneur and at life.

I will discuss aspects of what he says in this column over time, but I am unable to summarize the whole as elegantly as he has done.

You can do much worse than read it carefully, ponder and apply to your situation! Rinse and repeat!

 
If

If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or, being lied about, don’t deal in lies,
Or, being hated, don’t give way to hating,
And yet don’t look too good, nor talk too wise;

If you can dream – and not make dreams your master;
If you can think – and not make thoughts your aim;
If you can meet with triumph and disaster
And treat those two imposters just the same;
If you can bear to hear the truth you’ve spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to broken,
And stoop and build ’em up with wornout tools;

If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: “Hold on”;

If you can talk with crowds and keep your virtue,
Or walk with kings – nor lose the common touch;
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds’ worth of distance run –
Yours is the Earth and everything that’s in it,
And – which is more – you’ll be a Man my son!

 
Now tell me thats not the most amazing advice you ever got!

Dear Dumb VC — What I Learned Building… — Medium

Andy Dunn, the author of the post I have linked below, is the founder of Bonobos. He writes endearingly scathing posts about his experience as a founder looking for capital.

Dear Dumb VC (Venture Capitalist)  has created waves all over the venture community and has been hotly debated from both the sides of the investor, and the bruised and battered entrepreneur.

It’s a love letter (NOT!) from a successful entrepreneur to his erstwhile VC. There are lessons here for all of us that start companies or projects and weigh capital raise options.

It’s a departure from the rubbish they teach you in business school (Yes even in the best schools, they teach you rubbish about the real world!)

Let’s be clear on a couple of points first.

I dont’t believe VC’s are unintelligent per se.

They are more often than not highly educated and very well spoken.

I also don’t believe that all VC’s don’t understand business.

We should draw the distinction between VC’s who have built or worked in business before (Operating VC’s) and those that have not (Financial VC’s).

But most VC’s I have met have not been been operating VC’s. So called Financial VC’s, most certainly are less experienced about actual business concerns and in many cases are only looking to turn a quick profit regardless of the overall outcome for the business.

All VC’s prefer the moniker “Operating VC”. Of course they do. Wouldn’t you?

However, having worked in business development role  in another persons company or having a career exclusively in consulting is NOT operating experience. Sister Please!

Flipping a business in a year or two is also not an “operating experience”. I don’t care what you say about it…I believe it takes time to build operating experience in a business. You may be successful as an entrepreneur if you sold your business quickly, but you don’t know operating from a hole in the ground.

A true Operating VC is worth her weight in Gold. If they are real OVC’s, you really shouldn’t care whether they want to invest in your company. Put them on your board, befriend them, do whatever it takes, but don’t ever let them go. They could be the difference between success and failure and more importantly knowledge and ignorance.

Enough of my opinion. Read and decide for yourself. It’s a very well written piece!

 

Dear Dumb VC — What I Learned Building… — Medium.

The Story of Abhimanyu: Why You Must Have an Exit Strategy

Let me tell you the story of Abhimanyu.

Long long ago in a kingdom far far away, an epic battle was fought.

The battle and its larger story were immortalized in an epic Sanskrit poem called “The Mahabharata”.

The war was between two families of cousins battling for control of their kingdom.

Abhimanyu, a warrior prince learnt the strategies of war while in his mothers womb. His overheard his father Arjuna telling his mother Subhadra how to enter, exit and destroy various battle formations.

The most complex of these  battle formations was the “Chakravyuh”, a formation resembling a rotating spiral that moved forward and expanded at the same time.

Here is where the story gets interesting (and relevant, so pay attention!).

Subhadra, listening to her husband teach, fell asleep before he finished. Abhimanyu, learnt the method of entry into the Chakravyuh, the way to fight once inside, but did not hear how he should exit.

Fast forward to the battle, many years later. The bad guys (sic) are winning. Things look grim. The Chakravyuh is advancing on Abhimnayu and his forces. It seems unstoppable.

Abhimanyu, hero that he is, rushes forward and uses his knowledge to penetrate the spiral. He breaks his way in and fights the enemy from the inside.

Alas, he does not know how to get out of the spiral, once he is in. He lacks an exit strategy.

He is surrounded and killed by the enemy forces, and dies a bloody death on the battlefield.

 

I think I’ve made my point to all of you here (and It isn’t that you shouldn’t fall asleep in class!).

Whatever you do, entrepreneurship or investing or anything else with meaning to you, consider your exit strategy.

Not an exit strategy, not even a couple. You should be devising a decision tree of exits based on your view of multiple different outcomes for your task.

While your life may not depend on it as it did for our hero, you should behave as if it does.

Your outcome(s) will thank you.

 

As a coda for readers interested in the Mahabharata, it is the longest Indian poem (the title means Great Indian Story), is available in English translation and is one of the most gripping tales ever told. The Bhagavad Gita, a discourse by Lord Krishna is a story within this story and probably better known. In the Gita, Krishna speaks to Arjuna (Abhimanyu’s father) and explains right living and the concept of “Karma”. Try it. You will love it.

 

 

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