Sunday Finds + 3 Thoughts From Last Week

Sprout Social + Adyen

May 29, 2022

Welcome to Chit Chat Money’s Sunday Finds + 3 Thoughts From Last Week. In this newsletter you will find three topics I thought about last week, links to shows we’ve recently released, and links to some interesting articles, podcasts, and tweets. Check out the archive here.

1. Is there a right way to do executive compensation?

On the Power Hour this week, we had a nice discussion on executive compensation and how to evaluate it as an investor. This is a topic that comes up a lot in investing circles. Do CEOs deserve big stock bonuses? Should they be paid in cash only? What is the right amount of base salary vs. potential bonus, and at what hurdle rate?

To me, it feels like every company is unique, and the executive compensation needs to be evaluated from first principles. For example, you might expect a 15-year-old company with a founder at the helm who has a 20% ownership stake to be paid differently compared to a turnaround story that just hired a whole new executive team. The founder would (hopefully) take a minimal salary given how much of their wealth is tied to the stock price, while the newly formed executive team will likely need higher compensation and/or stock grants to stick around.

I’m looking for two things with executive compensation:

Not taking an unreasonable amount of compensation home as a % of gross profit each year.
An incentive structure that is not egregiously misaligned with shareholders.

From a higher level, I have a feeling we all pay too much attention to how much and in what form executives are paid. If your thesis rests on whether a CEO is paid on adjusted EBITDA or free cash flow, is that really a company you want to own for the long-term? I doubt it.

2. Vitamin-D enhanced Crispr tomatoes.

Hopefully, these will be in supermarkets around the world soon:

Scientists have found a way to edit the genetic makeup of tomatoes to become a robust source of vitamin D.
A research team at the John Innes Centre in Norwich, UK, have been working on the newly designed tomatoes to help people receive appropriate amounts of the vital vitamin.
Vitamin D regulates nutrients like calcium that are imperative to keeping bones, teeth and muscles healthy.

The tomatoes were designed using Crispr technology, which tweaks the fruit’s genome so it accumulates an abundance of the vitamin. Many people shun genetically modified foods (GMOs), which have gotten a bad reputation among environmental and health-focused groups. In fact, groups hate the idea of messing with food genes so much that they’ve stopped Vitamin A-enhanced Golden Rice from being sold in poor countries, lettings millions of children die and go blind in the process. Similar to nuclear energy, I have no idea why the world isn’t heavily embracing GMO foods, as it could help us generate a step-change benefit in human health.

Anyway, the talk of Crispr reminds me of the difference between technological progress and an investable industry. Vitamin-D enhanced tomatoes can save and enhance the lives of a meaningful amount of people around the world, and if this can be applied to many foods/vitamins, has the chance to make humans substantially more happy and healthy. This would provide an enormous amount of value to society.

But putting an investor hat on, I would worry about how much shareholder value breakthroughs like this would generate. Five years ago, there were tons of investors hyping up Crispr stocks because of how revolutionary the technology was. The tech is clearly next-level, but that has no bearing on whether you should own the stock. In fact, if a technology is so obvious that even a non-scientist like me can see it, there’s a good chance the sector could turn into a bubble, something we all want to avoid.

3. Snap and perceived correlations.

There seemed to be two lines of code in a lot of people’s heads the past few weeks:

Big retailers (Target, Wal-Mart) just gave weak guidance. Sell every retail stock we have.
Snap just guided down on its Q1 results. The digital advertising industry is screwed.

We’re in a bear market now (psychologically and emotionally speaking) and it seems like people are just looking for the flimsiest reasons to get bearish on a sector. For example, the Target and Wal-Mart reports shot down Ulta Beauty stock by 10%, even though Target said people were still spending money on beauty items (this makes sense, with more and more people going to in-person things again). Then, this week Ulta Beauty reported a fine quarterly result, sending shares up by more than 20%. I’m not saying everyone should have known this would happen (I didn’t have money betting either way), but it is fascinating to see the perceived correlations going on right now.

Snap and its guide down is another example. The company is pausing new hires and said revenue growth would be below its prior guidance. Since it operates in the digital advertising market, everyone perceived there was a correlation between Snap and other players like Facebook, Google, Roku, and the Trade Desk. All these stocks were down 5%+ on the news. But then, the Trade Desk filed an 8-K saying it was still on track with its quarterly guidance, indicating it had not seen a deterioration in spending among advertisers. Turns out not all businesses in digital ads are on the same trajectory, with some (the Trade Desk) being more well run than others (Snap). I could be oversimplifying things, but has anyone considered that Snap just might not be that great of a business? I don’t know.

Who knows for sure though, and maybe by the end of this year, we’ll all be saying the slowdown in digital ads and non-COVID bumped retail spending was inevitable.

See you next week,

Brett

***Our fund, Arch Capital, may own securities discussed in this newsletter. Check our holdings page and read our full disclosure to learn more.***

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Catch up on Our Shows From Last Week

3 Good Reads

Global Value Investing (2006) - Tom Russo

It soon became obvious that the spirits industry in the U.S. was consolidating mightily, and that the people who were in the spirits business wanted to concentrate their brands by sole distributors in any given market. What had previously been scattered affiliations throughout many distributors were now allowed to concentrate with one distributor.

Bull Market Rhymes - Howard Marks

Raging bull markets are examples of mass hysteria. At the extreme, thinking and thus behavior become unmoored from reality. In order for this to occur, however, there has to be some factor that activates investors’ imagination and discourages prudence. Thus, special attention should be paid to an element that almost always characterizes bull markets: a new development, invention or justification for the rising stock prices.

Tim Sweeney Interview - Financial Times

Epic Games plans for the Unreal Engine to be a massive revenue driver for our customers and not so much for us. We aim to give everybody the 3D real-time content creation tools they need to bring content to the metaverse and our aim is . . . to offer a premier destination for them to bring their content to. So our business isn’t about extracting money from creators as much as helping them find opportunities — and profiting alongside them from the opportunities as they emerge.

1 Good Listen

Edward Thorp: A Man For All Markets - The Time Ferriss Show

Edward O. Thorp is the author of the bestseller Beat the Dealer, which transformed the game of blackjack. His subsequent book, Beat the Market, coauthored with Sheen T. Kassouf, influenced securities markets around the globe. He is also the author of A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market.
Edward was one of the world’s best blackjack players and investors, and his hedge funds were profitable every year for 29 years. He lives in Newport Beach, California.