Sunday Finds + 3 Thoughts From Last Week
Portillo's, Playway, Power Hour #5
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. How far can a stock fall? (spoiler: as far as investors want)
Many investors (myself included) bought stocks in 2020 or 2021 that are down 50% or more right now. Experiencing these drawdowns is never fun. They are psychologically painful and make you question your original thesis for buying shares. It also makes you constantly think about this important question:
How much farther will [X Stock] fall?
While a lot of people in the financial media and Twitter may sound confident when trying to answer this question, they have no clue. Zero. Unless you know exactly what the next buyer of a stock is willing to pay on any given day (you don’t), it is impossible to predict with a high degree of certainty where a share price will be three months from now. Or six. Or a year.
A stock will fall or rise as far as investors collectively want it to. The floor is $0.00 a share, and the ceiling is infinity. Realistically, if you hold a quality business with minimal risk of going bankrupt, you won’t lose 100% of the money you put in. But the market can be fickle sometimes. During the 70’s and the two periods after the 20th century World Wars, the U.S. stock market’s average P/E was below 10. I’m sure some riskier stocks in unloved industries were trading at P/E’s closer to 5. Today, the S&P 500’s average P/E is 21.
All this is to say that I don’t think you should try to figure out how far a stock will fall, given that it is an unanswerable question. If you bought something at a discount to how much cash it will generate over the next 10 - 20 years, it doesn’t matter what the share price does in the interim. In fact, if you have a company with a strong capital allocator at the helm (something really important to us), then you should embrace big drawdowns in the stock, as it gives them the opportunity to repurchase shares at dirt-cheap levels, increasing the future cash flow per share you will earn as a remaining shareholder.
I remember in the Snowball the author talking about Buffett scooping up stocks trading at a P/E of less than 1. If it happened before, don’t think it is impossible for it to happen again.
2. How do you know what you don’t know?
This is a scary question to ask because it reveals the uncertainty in almost all investments, but it is vital to focus on because it can help you better understand what risks you are taking when putting your money to work. I think most people are afraid to embrace this uncertainty, or at least unwilling to try and figure it out.
Understanding what you don’t know is extremely difficult, way harder than understanding what you know. It is also something you permanently try to get better at. But I think I’ve developed two “tests” that constantly help me evaluate whether I am aware of what I don’t know (or in other words, the uncertainties with a business).
The first test is reading the risk factors (at least the important non boiler-plate ones) in a 10-K and immediately understanding all the puts and takes that could negatively affect a company’s financials. Another way to frame the risk factors section is a company telling you ways the business/shareholders could get screwed, but they just don’t know when or if it will ever come to pass, and at what magnitude it will harm operations. The simplest example of this is oil prices for energy companies. You do not know what the price of oil will be in the future. When making an investment in an energy company, it is vital to understand that you don’t know this.
The second test is reading a relevant news item on a company and easily understanding what you know will happen because of it along with understanding what you don’t know will happen but could. This is in the same vein as scenario planning, a task that seems easy but I find to be incredibly hard sometimes when doing an analysis on a potential investment.
You’ll never get to a point where you understand 100% of what you don’t know. That’s just not how things work in a complex adaptive system. But if you put in the work, inch by inch, to try and make progress in knowing what you don’t know, I think your portfolio will benefit from it.
3. Should we be expecting a Bull Whip effect?
A lot of charts are getting thrown around about inflation peaking. I have no idea whether this is true, but if we look to history, I think there is a good chance we get some bad bull whip effects across the supply chain:
The bullwhip effect (also known as the Forrester effect) is defined as the demand distortion that travels upstream in the supply chain from the retailer through to the wholesaler and manufacturer due to the variance of orders which may be larger than that of sales.
This happened post-WWI when manufacturing demand fell off a cliff, and has happened in pockets in numerous industries across the last 100+ years. With the supply chains so mangled and seemingly every company worried about getting inventory stable right now, demand distortion is a real possibility.
Another way to describe the bullwhip effect is a cycle of inflationary pressures followed by deflationary pressures followed by more inflationary pressures. Given how different the world is from just a few decades ago, I don’t know how much these effects would hurt the economy. But I can’t imagine it would be good to have all this chaos.
Hopefully, if these effects occur, they get dampened out rather quickly.
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
In Praise of Memorization - Pearl Leff
But as I've gotten older I've started to understand that memorization is important, much more than we give it credit for. Knowledge is at our fingertips and we can look anything up, but it's knowing what knowledge is available and how to integrate it into our existing knowledge base that's important.
Efficiency is highly overrated; Goofing off is highly underrated. Regularly scheduled sabbaths, sabbaticals, vacations, breaks, aimless walks and time off are essential for top performance of any kind. The best work ethic requires a good rest ethic.
Overtreatment in American health care is a problem - Matt Yglesias
America’s lack of price controls means that companies have a strong incentive to deliver new treatments here first. And the fat margins they can achieve in the U.S. market clearly drive more investment in treatments than in a more typical system. Reformers often say we could compensate with other pro-innovation policy ideas, and I totally buy that — we could. But if we just cut out the money, there really would be less innovation.
1 Good Listen
Biologist and genetics expert Dr. David Sinclair is out to prove he can live past 100 years old, and he thinks you can too. On this episode Sinclair goes in-depth on the process of aging and the techniques you can incorporate into your life that help you live a longer, healthier life, including optimizing your diet, the benefits of exercise, the role of a positive attitude, the importance of sleep, the three supplements he takes every day, why it’s never too late to slow the process of aging, and so much more.
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