Insanity of Investment - LNKD

While I am quick to bash Facebook, Groupon, and Tesla today I will take on another of their ridiculously priced brethren, LinkedIn. LinkedIn is currently trading at a P/E of 860. 860. This is not a case of, "oh, they had a bad quarter" or "once they monetize, the earnings growth will be astronomical". This is a case of pure irrational exuberance.

Since it's IPO in 2011 where it reached, on day one, near $130 (closed around $94 for fairness sake), LNKD has returned 46% (100%) to investors. This, in the midst of one of the greatest market turnarounds in history, the SP has returned 43%. So LNKD has about matched the market return in three years (depending on how precise your market timing is). Where is the growth? Who actually is making money?

Where is the money? The money all went to the founders, angels, VCs, and investment banks in the IPO. The instant burst of liquidity (to a barely profitable company) allowed all of them to cash out for massive multiples over what the actual business is worth. Today, none of the founding five members own a reportable stake. Why anyone pays ridiculous multiples for a business that doesn't make any money is beyond comprehension.

So who is left holding the bill? The current shareholders of course. Mostly through mutual funds, which may or may not be choosing to own the stock. Many surely own it as a reflection of their "strategy", which mimics some indexable formula (Growth Stocks, Mid-Cap, Technology etc.). In order for LNKD to return to a market matching valuation (~19xE), earnings would have to increase 45x over. Immediately. Not in 5 or 10 years or a DCF would need to be applied compounding the growth astronomically bigger. How can an established company with market penetration and a monetization strategy possibly increase sales by that factor?

The growth is already in the price. It was from day one when the founders took the company public. Sure, the stock has increased since then but the economics of the business can't possibly continue the madness. When will LNKD in revert back to the mean? I have no idea but a due date lingers for this rocket ship.

Letter to Eddie Lampert (SHLD)

Edward S. Lampert

CEO and Chairman

Sears Holding Co.

What is the plan?

We, as shareholders of SHLD, are closing in on a decade since the merger of Sears and K-Mart in 2005. Over the last decade, we have watched both Sears and Kmart continue to fall from market leading positions and lose ground to traditional and online retailers alike. So I ask the question, what is the plan?

Myself, like I’m sure many other shareholders, bought into SHLD because of a belief that you, very personally, would right this ship. It was very clear for any shareholder to see that there was value to be unlocked through real estate or the brands. That is why we joined the cause. We, as shareholders, believed that you would do what was in the shareholders’ best interest.  We had faith in you. We have faith in the entity that you and Bruce control a majority stake in. What do we have to show for it?

The business is in a state of chaos. I have a Kmart and Sears within 5 minutes of my house. I have never been to either of them (in 8 years). The most recent shareholder’s letter verges on insulting due to your lack of understanding of branding and consumer behavior. The failure to invest in capital expenditures for the brick and mortar stores has forced customers to the likes of Wal-Mart and Target. If your customers don’t want to go anywhere near your physical locations, why on earth would they shop with you online given the proliferation of superior online retailers? Certainly Kmart and Sears brick and mortar stores still have markets that are captive and verge on monopolistic and therefore are able to convert customers to Shop Your Way customers but this can’t possibly be the strategic plan for the whole company, can it?

You posted on your blog at the beginning of the year about transformative companies. For ten years, SHLD has been lost in the shuffle as all of its competitors transform around it. Building an integrated online and physical platform is not transformative; it’s the norm. If you want this company to be transformative, make it disruptive. Change. Do something.

Everyday the value of the real estate portfolio becomes less valuable. The proliferation of empty commercial real estate (mall real estate especially) in America signals the exact transformative change you outline in your letter. There are hundreds of stores not making money, why are we behind the curve in making a real transformation and closing all of them immediately?

Mr. Chairman and CEO, what is the plan? The last ten years have seen remarkable opportunity costs go down the drain. How do we add value to shareholders over the next ten?

Thank You,

Jason M. Nista

Configural Processing - How big is too big to understand?

How much information is too much to process? How big can an organization get before it would be impossible for a CEO to understand the intricacies and domino effects of each decision? My take is that it doesn't have to get that big. I define configural processing as the process of evaluating, weighing, and understanding interwoven effects of the parts of a whole. A complicated definition for sure so let's take a look at three examples that are relatable:

Example 1: Citigroup. Citigroup is the classic definition of too big to fail. Their business units that number in the hundreds are so interwoven in the global economic picture that unwinding them could prove fatal to the whole system. How could one person (CEO) or even a group of people (Board or Office of the CEO/Chair) possibly understand the relationship and intricacies of all of those units? If you are evaluating 100 units that compromise of a total of $1T in assets, how can you make an expert decision in all of them? It's impossible. Further, it would be impossible for a securities analyst to possibly try to value the company, the 10K isn't required to go into enough detail to intimately understand each unit. I proposed that Citi is a case of the parts being worth more than the whole - if it were broken up, each autonomous business would be better off. Case in point being the sub-prime crisis where some divisions were continuing to underwrite subprime mortgage while the trading desks couldn't unload them fast enough.

Example 2: Coca-Cola. On the exact flip side of the equation I propose KO. Produce, bottle, and distribute a proprietary liquid. Now this seems like a business that a human being could wrap their head around. Is it that simple? No. A CEO would still have to be experienced in bottling, distributing, exchange rates, branding etc. but all along one product line. Reading through a KO 10k, its written in real english, terms and values that an average human being and certainly an analyst can understand. Evaluating and making an investment decision with some degree of certainty, I propose is much easier with KO.

Example 3: Berkshire Hathaway. The king of kings for all things investing. Not only do Charlie and Warren only invest in businesses they understand such as KO (the author has no comment on WFC common), they leave the management in place of the companies they acquire fully. They expect each business to operate with autonomy, holding each accountable for their performance, not allowing businesses to become intertwined or share resources. They've created possibly the greatest business in the world by acquiring Example 2 type businesses and not allowing management to destroy themselves by getting too large.

So what can be taken away from this analysis? Its naive to assume with any degree of certainty that you can place a reasonable value on a business as complex as an investment bank. I suspect that many analysts that cover such companies as C (whose earnings forecasts are perpetually wrong anyhow) have so many variables to consider that they can't possibly make a reasonable prediction aside from looking at previous results and guessing macro climates. Even if they are correct, are the theorems that made them correct proven out or is it by chance? Stick to your circle of competence. Be humble on what you understand. Ignore popular opinion.

Book Review: Where are the Customer's Yachts?

It's been quite a while since I've been moved by a book like I was by this one. I was unable to fall asleep last night because the thoughts were so vibrant and alive in my brain. For a book published 74 years ago, much of the wisdom is very consistent to this day and I will exact quote the important points:

"God forbid! ho home and relax. Like most other Wall Streeters, bankers suffer from the inability to do nothing. Your average Wall Streeter, faced with nothing profitable to do, does nothing for only a brief time. Then, suddenly and hysterically, he does something which turns out to be extremely unprofitable. He is not a lazy man."

"As the man said after he had had the subject of relativity explained to him in a few unsuccinct phrases: 'And from this Mr. Einstein makes a living?'"

"When there is a stock-market boom, and everyone is scrambling for common stocks, take all your common stocks and sell them. Take the proceeds and buy conservative bonds. No doubt the stocks you sold will go higher. Pay no attention to this - just wait for the depression which will come sooner or later. When this depression - or panic - becomes a national catastrophe, sell out the bonds and buy back the stock. No doubt the stocks will go still lower. Again pay no attention. Wait for the next boom. Continue to repeat this operation as long as you live, and you'll have the pleasure of dying rich."

Three of the most profound insights to investing summarized very neatly and succinctly. Stop overthinking.

Reading Too Much Syndrome

Could it be possible? Is it even conceivable? Is it heretical? Is it possible that there could be a point when a person has learned too much information? This is a theory that has begun to cross my mind over the last 3 months. As I have reviewed previous blog posts, revisited Evernote bookmarks and reorganized my book collection I have come to an enlightening conclusion: I forget a lot.

I consider myself a pretty voracious reader. Certainly I go in cycles. I will go a month or two where I get a few hot books and it propels me to read more and more and I might finish 5-10 books in a matter of a few weeks. At some point, I usually cool off and go a couple weeks where nothing really piques my interest. But overall, after reviewing my book collection (app. 150 books), I'd say I've done quite a bit of reading since I reached the age of enlightenment (personally, 20). But what have I gained? Surely, a lot. I consider myself well read, well versed, and generally well rounded. I'm a good Jeopardy player, a respected businessman, and when I put effort into it, "quite an interesting conversationalist"(it certainly doesn't come naturally).

But have I gone too far? Well, possibly. While its quite conceivable to reason that subconsciously, all of the information that I have attained has made me the self-conceived "well rounded" person. It is also quite conceivable that I have dumbed down the most important lessons with mediocre lessons. Over the last few weeks, I've come to the realization on three separate occasions that I was teaching myself something for a second time. I quite literally had forgotten the information. Call it old age, call it ignorance, call it ADD but I had absolutely forgotten that I had previously learned something (and important things at that)!

Furthermore, the last couple of days I've had time to reflect on what I am most passionate about and what I want to do after this chapter of my life is complete. I've found myself reinvigorated with the equities market. The first thing I noticed was the noise. Predictions high, predictions low, massive volumes...blah, blah, blah. I found myself deeply annoyed. So I went back to my most trusted advisor, Charlie Munger. Charlie coined a term a number of years ago, "sit on your ass investing", that he applies to his investment strategy. A "sit on your ass investing" strategy is quite literally not a strategy, he just sits on his ass until good opportunities present themselves to be a strategy.

Now let me relate that strategy to reading. We are taught, and it is generally a sound principle, that the more we read, the more we will know. Well, yes in theory, but that fails to take into account that the more you learn, the more you could possibly forget. Back to "the noise" that comes from "Squawk Box" everyday (it's amazing that people actually listen to a show with that name). They fill the air with nonsense. They put thoughts in investors minds that clog reasonable thinking, causing them to make actions against sound market principles. Is that what my reading is doing? Do I read and read and read, clogging my head with "new" mediocre ideas and cloud-out the best, time-tested commandments that I should be living by?

For me, it's back to the basics. Across many different disciplines there is some acknowledgement that humans are only capable of focusing on a small number of thoughts, goals, or processes at one time. Charlie has four, clearly defined investment filters (Do we understand the business?, Does the business have a durable competitive advantage?, Does it have good management?, Is there a margin of safety?). Rather than clouding my head with more and more ideas, I need to go back and master the most basic of ideas and spend more time sitting on my ass.

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.