Sunday Finds + 3 Thoughts From Last Week
Coinbase and Camplify Holdings
3 Thoughts From Last Week:
Resisting artificial constraints. I tweeted this out earlier this week: Are you flexible enough to own stocks with a P/E below 10 alongside one with a P/E above 40? People replied “yes” pretty distinctly to the question, but when looking at a lot of portfolios out there (whether professional funds or individual) the answer is clearly no. It is confounding to me why people (and maybe it is just inadvertent) put this artificial constraint on themselves. I would even go as much as to say that there is no benefit, only potential harm, that can come from looking at a P/E ratio for a stock. Like I mentioned in last week’s newsletter, there are three things that matter for forward returns, and none of them involve looking at a P/E ratio and immediately discarding a company because it is too high or too low.
Prediction on podcast advertising. Making a prediction is always dangerous, so don’t hold my feet to the fire here. I did a Twitter poll this week and got some surprising results. 62% of respondents said they would stop listening to a podcast if it had four 30 second advertisements on an hour-long show. This would equate to two minutes of every listening hour being sacrificed for advertising time, or a 3.33% ad load (two divided by 60). My prediction is that respondents who chose this result are lying to themselves. Here’s some evidence for why I believe this. One, on other advertising-supported entertainment mediums, customers have shown a willingness to endure a 10% - 20% ad load (TV, linear radio, etc.). For internet/digitally-enabled advertising marketplaces (YouTube is a good example here), ad loads are probably closer to 5% - 10% given the ubiquity of content and higher CPMs. Podcasting should fall under this category as advertising goes dynamic over the next decade. Two, there is already evidence that podcast listeners are fine with an ad load above 3.33%. Shows I listen to that routinely top the charts in their categories (The Investors Podcast, Bill Simmons, and Pardon My Take) likely already have ad loads over 3.33%. Clearly, since they are at the top of the charts, the shows haven’t lost 62% of their listener base because they run ads for four minutes of every hour instead of two. There’s no reason to think that all other shows (on average) would have the same fate, and that podcasting ad loads will steadily march towards 5% over the next decade.
When is free cash flow actually free cash flow? There was a good Twitter thread put out this week (linked below) highlighting how one-time or unsustainable changes in working capital can allow a company to inflate its free cash flow, especially when it is growing quickly. The account uses Tesla as an example, but this can apply to any business with major working capital needs. Read the thread if you want to understand the concept, as I’m not going to explain it fully here. But it did make me think of one question: What is the difference between a sustainable and unsustainable working capital advantage? Each company is a unique situation, but I think there are some rules of thumb we can work with. I believe a sustainable working capital advantage is one that springs from the business model itself, while an unsustainable one just stems from business growth. For example, Amazon (time mismatch in paying suppliers vs. when it collects cash from customers on its marketplace), Spotify (royalty payouts coming well after collection of subscription revenue), and Airbnb (collecting bookings upfront and paying out to hosts later) all have distinct characteristics to their business models that give them a sustainable working capital advantage. This is why I think their operating cash flow and free cash flow numbers can be taken at face value, even if some investors throw them out because a lot of it comes from working capital dynamics (Airbnb’s has been lumpier recently but I think will smooth out over time as the COVID gyrations abide). On the other hand, it is harder to have confidence in Tesla’s stated free cash flow because it seems like it is just from squeezing suppliers and paying for last year’s materials this year, which are on a smaller unit base than the revenue the company collected this year from customers. If/when Tesla’s car business stops growing, we will see if its free cash flow was legit, or just an accounting gimmick.
See you next week,
Brett
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