What are you selling?

I have recently finished Seth Godin's latest book, The Icarus Deception (which is not good btw), and it has led me to conjure on the most basic business question: What are you selling? And I mean this in the most absolute, rock bottom sense of the question. No marketing. No advertising. What is it that you are selling?

For some reason, the question immediately led me to the thought of, "What is Starbucks selling"? How has Starbucks been on such an incredible tear opening thousands of stores a year? Starbucks sells the second most traded commodity in the world, coffee. And it's just that, a commodity. Anyone, anywhere in the world can obtain the exact same beans, roast them and brew them exactly the same as Starbucks and have the same quality of product. What is Starbucks selling?

It's truly an incredible thought. With most of the things or services you purchase in a day, your focus is on price, quality, experience etc. There are quantitative measures that you go through (even if they are subconscious) to come to a rational decision. But why do you wait in the drive thru at Starbucks to get a generic cup of hot water that you could get at any coffee shop in the country? Why do people flock to Starbucks?

Starbucks doesn't sell coffee. Coffee is just the medium through which Starbucks sells the brand. This is a very important point. No matter what line of business you are in, you're not just selling the product, you are selling the brand, you are selling yourself. Howard Shultz lives and dies by coffee. He is the most iconic, inspired coffee drinker of all time. He sold himself and in turn sold everyone on Starbucks.

For me, this is a major revelation. I am all but over the current business we are in. Mentally, I'm just checked out and ready to start anew. Everyone I've encountered has asked me, "Well what's next?". I've avoided all their questioning because I really haven't given it much thought. Certainly, there will be a "next" idea but I don't know what it is. Ultimately, it doesn't matter what it is. With this knowledge in hand, I could sell anything I am passionate about. The medium doesn't matter, it's the message that matters. And that is, "What you are selling". It's not a product or service, it's the message or feeling that that product conveys to the end user. Harness that feeling and you can sell anything.

Kill Facebook

Since my last post about Facebook on May 23, 2012, I have become an obsessive cynic. Today Facebook is trading at a PE of 1,903. Yes, 1,903. Facebook as a business is fundamentally flawed and it's valuation is even more flawed.

Facebook was founded in 2003 to connect people through the internet. I know, I was one of the original classes of college freshman who joined Facebook back in 2004. Facebook took an industry that was dominated by Myspace and became the purple cow. No longer was it hipsters and bands but it was just anyone looking to connect through the internet. Over the years, Facebook has grown to 1 billion users. Which brings me to my first point. There are only 2.5B active internet users in the world, at this point, Facebook can only grow another 250% assuming 100% market penetration. Trading at a PE like the above, should assume there is huge growth potential in the market - there isn't.

But the point of Facebook is no longer to connect people. The point is to advertise. Facebook trades at this crazy valuation because investors (and fools) believe that Facebook will change the way we communicate with customers. I say "we" because I am a small business owner who can speak from experience advertising on Facebook and not from "potential", which is Wall Streets perspective on how Facebook works. Facebook is great. It allows us to connect with our 12,000 fans through pictures and videos, allows us to communicate deals and specials and receive feedback all in the same place. A novel idea for sure. But how valuable can that really be? Advertisers spend about $500B worldwide annually. Currently, about 25% of that money is spent online. As the world races to, "get connected" surely that figure will increase. So let's say Facebook can possibly capture 50% of that market (if it will even be allowed by the FTC), that pegs us at $125B in revenue annually - currently more than AAPL.  These assumptions are at least what investors are hoping for.

Buy the Business, Not the Stock

Think more about Charlie's idea of buying a business rather than buying a stock. A reasonable valuation on a business can go to shit if the underlying business fails. Even if you find something with a huge margin of safety, the business can very easily collapse to competition or industry changes. It's a concept that you tend to think about for a second and say "yeah, that makes sense" but if you truly stop to dissect and invert the concept, more important than the price of any stock is the underlying value of the business you are buying. I know this sounds elementary but I just spent 5 minutes actually thinking about the statement and not just agreeing with it. 

To me, Facebook at any valuation is not as valuable in my portfolio as Wells Fargo at any price. Facebook is a 5 year old company in an industry that is subject to crazy breakthroughs and black swans. It's impossible to say where the internet will be in 5 years. I can much more confidently say that Wells Fargo will still have 10,000 branches and a trillion in AUM in 5 years. You say, "well what if you made this statement in 2006, you would have gotten whooped over the next 3 years". Which I did. But if you could have identified the worst offenders in the industry beforehand (Wachovia, Lehman, Bear) and bought WF through the downturn, your return would have trounced the market (WF up 300% off its 2009 low). And to that point, internet (tech) stocks have not faired so great over the last 5 years either. 

My point being: things people can not avoid using no matter what - banks, grocery stores, cars, fuel, coke, gum on the whole, should provide you with better businesses in the long run than things that can change - retail, internet, technology. I think they need to be bought at a reasonable price and if you can get them at a great price all the better but why should I clutter my portfolio with stocks that I hope will go up when I can load it with institutions that people must have no matter how living evolves over my lifetime? If I can load my portfolio with banks, X, FM, and KO their price may fluctuate but their underlying business is solid steel. And if they screw if up at some point (new coke, housing downturn, banking collapse, cars sucking), that should be an opportunity to pick up a great underlying business at a discount. 

This macbook air is absolutely amazing. Was I using it 5 years ago? No? Will I be using an apple product 5 years from now? Maybe. PNC is PNC. I was using them 5 years ago, I am using them today, and I will probably be using them 5 years from now. 

I noted on this in my previous post but I think in searching for a greater truth, most people have overlooked the message that Charlie and Warren are really trying to send. Quit over thinking investing. Models aren't needed. Calculus isn't needed. Beta isn't needed. Buy good companies at good prices and just go do something else. Its a tenant of Warren's to buy a company and not look at it for ten years. I think this should be a commandment. Revisit the company and industry once a year to make sure nothing material has changed. If not, ignore the stock price and carry on. Tdameritrade is the death of the value investor. Being able to check how much money one is making every 5 seconds allows emotion to enter an otherwise rational business decision. 

Having said, I am going to do something I never do and that is recommend to myself to review XLF in the future. The US banks are still coming off demolition in terms of earnings. They got nailed in the financial downturn. But the value of their AUM, brands, and earnings power in the future is remarkable. The whole XLF is trading less than book value. On the whole, owning American banks for the long run seems like a no-brainer to me. 

Poor Charlie's Almanack

Being only 250 pages into the book, it would be premature to call Poor Charlie's Almanack the best book I have ever read. But it is definitely up there. There will be many points to discuss but the one that is stuck with me right now is Warren's idea of "20 investments for a lifetime"

If you are only given the opportunity to invest 20 times over your whole life, you will make those investments very very wisely. This is generally counter to the way money is managed in the rest of the world. I would say the average person goes through 20 investments a year. Over a 30 year period thats 600 investments. How important then is each investment?

Charlie continually stresses how vital Berkshire's top ten investments were to the overall success of the business. For example, they bought a significant stake in the Washington Post in 1973. Their investment has returned 50 fold since. When you see a great opportunity, you need to have the liquidity and chutzpah to make it happen.

Another of Charlie's (and also Warren's tenants from past readings) tenants is a lazy approach to investing. Lazy is not the proper term. Patient is a more proper term. The most prevalent example of this is Charlie and Warren's rule to go home at 5pm while all other manager's work through the night. What could they (I) possibly be doing? Charlie and Warren are so comfortable in being patient waiting for one or two investments a year that they don't have to worry about a new investment every day. There is no rush to act. Which is also why Charlie and Warren are not in new york. They don't give a shit about what's happening on wall street. They don't want Goldman to call them to talk volume. They want to be renaissance men who can apply their omniscient knowledge to investments.

Berkshire Hathaway Annual Meeting 2012

What a day. This year, Mike, Pete and I decided that the stars have aligned and it was time for us to make the journey to Omaha to see The Oracle.

I arrived in Kansas City on Wednesday night where Pete picked me up from the airport and we drove toward Lincoln, NE. We ended up sleeping in Pete’s truck at a rest stop on the side of the highway. We picked Mike up Thursday morning in Lincoln and headed for Omaha. Thursday and Friday were relaxing days where we were able to catch up and just hang. 


Friday night I got my first taste of “Networking with Mike Morton”. We went to the YellowBRKers meeting for a cocktail hour. In retrospect, it was the best opportunity to network and get to meet people. We met some interesting people despite my absolute disdain for “networking”. We went to Borsheim’s for the shareholders cocktail hour. It was a complete zoo and we left immediately. It’s unfortunate that Berkshire has had to split thus allowing any clown to become a shareholder. We went to Gorat’s for dinner where we had a nice meal and met some good folks.

We arrived at the CenturyLink Center at 4:45am Saturday morning. We were nowhere near the front of the line. Mike was able to meet Mohnish Pabrai standing in line, which was awesome for him. It was a dead sprint once the doors opened to our seats in section 125.

What a day it was. Over the last 7 years, I have learned a lot from the teachings of Warren and Charlie. Saturday was just confirmation that I am on the right track. Listening to them speak, I found that their values are exactly the same as mine. Most importantly, we don’t act like Wall Street. I don’t have a Wharton MBA. I don’t network with other fund managers. I love being negative on an idea before being positive. The day reinspired me to be a fund manager.

We went to Whitney Tilson’s after party, which turned out to be a scam. He was there but so were 100 leaches that fall into the “networking” people mentioned above. Pete and I, tired of having the same conversation over and over, made a B-Line for the door. Going downstairs, we crossed paths with Ajit and got a picture that I can’t wait to hang on my wall.

Overall, it was one of the most inspiring days of my life. I am so glad I spent the money to go see Warren and Charlie before there is no more Warren and Charlie. I plan to send a letter to Charlie, in hopes of becoming his protégé. I will be able to tell constituents and descendants alike about the day I spent with Warren and Charlie.

For a better penned entry, see Pete McBride at:

http://harveysrun.com/2012/05/07/the-woodstock-of-capitalism/ 

Passive Active Investing

I have been developing an idea for a couple of weeks. The idea centers around the concept that no company lasts forever. For every GE, there are at least 1,000,000 companies that don't make it. My all-encompassing hypothesis of "why?" is that companies fail to change. Whether it is in technology, hamburgers, or pencils we are constantly moving forward. If you can not see the future, how can you position your company to do well in the future?

Well there is one way. It goes counter to Buffett's Chicago Rivet and Machine or Coca-Cola.* If you invest in companies that aren't afraid to try new things, they might have a change to position themselves to do well into the future. By creating an atmosphere of constant change, whereby the company and employees of the company are encouraged to try new things and fail, a company might better position itself against a bureaucratic market leader. The first company that comes to mind is Apple. They went from personal computers to mp3 players. It is quite a leap to think of IBM or Dell coming out with a successful mp3 player. But Apple did it, and did it right. Steve Jobs was a change kind of guy, always envisioning a new product no matter how absurd it may seem.

Would it be possible to identify companies that foster change? Could you invest in companies based solely on their corporate culture? It seems like these days every company had a cool corporate culture with mod work spaces and open areas but could you go deeper to see how companies envision changing the future? Citigroup is definitely not going to change the future. Rawporter might.

On another note. I predicted very early on that I thought Facebook would far surpass Myspace. I won't say at this point that Facebook is doomed but I worry they are heading in the wrong direction. Sometimes change can be a bad thing (see: Netflix). Facebook is making it's systems so complicated now that the casual user can't log on and figure it out. Twitter has resisted all the changes and might be better for it. Linkedin is purpose driven - assembling business contacts. I think there is a market for a new social network that goes back to the basics. Google+ appears to have missed the mark because it too is too complicated. Either Facebook comes out with Facebook Lyte or someone is going to come after them.

*Side note - possibly identifying industries or products that will never change and coming up with a list of those companies and just waiting for their pricing to become attractive could also create a new style of investing.

Book Review: The Spirit to Serve

-MANAGING BY WALKING AROUND

-Figure out how to do something right, then write it down

-By nailing the basics into place, systems allow employees to provide more customized customer service

-Take care of your employees and they will take care of your customers

-Listen to the family problems of your associates

-One, most people will do anything to avoid being the bearer of bad news, and two, thank goodness there are a hardy few who won't

-To say the right thing at the right time, keep still most of the time.

-"What do you think?"

-No grunt work=no growth. No growth=no future.

-Change is to business what oxygen is to life - vital.

-Companies that don't risk anything will inevitably find themselves falling behind those that do. You can lead change or it can lead you.

-No tree grows to the sky

-There's a price to be paid for thinking too well of yourself

-Competitors are often your best motivators and, consequently, a key factor in your success

-Part of what gets us out of bed in the morning is the search for new ways to keep customers happy, earn their loyalty, and win more customers.

-The success of our service innovations grows out of two of our most fundamental corporate values: attention to detail and good listening skills.

-The first and most important rule is: Be willing to make a decision.