Author: Gísli Eyland

There are just too many interesting things going on

Financial Engineering…?

So, normally when people use the term financial engineering what they mean is that a company used leverage or some other type of financial instrument to optimize it’s capital efficiency.

I don’t really get why we use the term financial engineering to describe increased leverage. By definition, if you are overleveraged, you are at higher risk of blowing up.

You see, engineers are the group of people that make trains and cars and airplanes and what not. When an engineer engineers something that people use, say a bridge, they are inclined to overcompensate. Because they need it to be, you know, safe.

Back in the days of Andy Grove, Intel made sure to always have cash on its balance sheet that could cover 2.5 years of selling, general and administrative expenses. Now, that is what we should be calling financial engineering.

The Value of Luck

Few people are as good at framing ideas as Rory Sutherland. In a talk he gave at the SprintAd-dagen in March of 2019, Rory opened up with the following thoughts on the role of luck and experimentation under capitalism:

“You’ve got to leave enough money free and you got to enough eccentric things to give yourself the change to be lucky…

One of the reasons that a lot of people don’t like capitalism is that some of the people who do very well under capitalism are actually total idiots. They happen to stumble into a business at exactly the right industry at the right time. They got lucky.

And even spectacularly intelligent people, I think we can argue…I don’t think there is any argument that Gates and Jobs are hugely intelligent….they were both spectacularly lucky as well as being hugely intelligent…partly by accident of their birth.

If you notice, a lot of those people, Ellison, Gates, Jobs – the giants of the tech industry – were all born within about 18 months of each other. And there was a tiny moment where you had to be young to make it in tech. Five years earlier and they would have ended up working for IBM. Five years later and it would have been to late.

One of the important things about capitalism, interestingly, is that it is a mechanism for rewarding people simply for being lucky. And the strangest thing about that is that it is precisely that, that makes people so angry about capitalism.

But if you don’t have a mechanism that rewards luck, the majority of great discovery don’t get banked.

If you look at the history of science, there is probably as much you can attribute to lucky accidents… Penicillin, Viagra, for example…the two wonder drugs. Those were both a product of completely lucky accidents.

The discovery of vaccination was just one man that happened notice that milk maids didn’t get smallpox. It’s just those tiny things that can have huge effects and we need to leave enough space to actually be lucky.

And the very strength of capitalism is precisely that it rewards ideas that at first make no sense.“

Rory’s full talk at SprintAd-dagen

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Drowning in Data

If you agree with the proposition that more information leads to more efficiency in pricing in the markets, that should probably lead to the conclusion that markets have never been as efficient. We’ve simply never had this much data and data has never been as accessible as it is now.

Gone are the days when Warren Buffett could comb through Moody’s manuals to find net-nets. Now, data-rich stock screeners are readily available to anyone. On top of that, there are armies of hedge funds other quantitative investment shops out there, crunching data and trying to advantage of any arbitrage opportunity they can find.

A Valuable Lesson of VAR

Had you argued this to me about a year ago, I would have wholeheartedly agreed. Today I’m not so sure. And here’s the reason why.

You see, I’m a football fan (soccer) and recently they have implemented something called VAR into the game. VAR stands for Video Assistant Referee. It basically means that during a game there is now an additional assistant referee who reviews decisions made by the head referee with the use of video footage and analytical technology in real-time. He is then able to communicate with the head referee during the game.

The objective of the VAR implementation is to minimize human errors causing substantial influence on match results. Previously, the referee had to make split second decisions on incidents. Now he or she can utilize VAR, which means better data. The VAR can analyse incidents by replaying it from different vantage points and use graphics to determine rulings such as offside. Sounds great, doesn’t it.

The Interpretation of Data

The really interesting thing about VAR, is that after its implementation there is still a fair amount of dispute regarding key referee decisions. Even with the additional data provided by VAR, pundits are still arguing whether decisions on offsides, penalties and such where correct or not.

It seems that more accurate data by itself doesn’t necessary lead to better decision making. The data still needs to be interpreted. In that sense, it’s not just a question of decision being subject to human error or not. Sometimes, different people will perceive the same data differently. It is in some way a matter of opinion.

Financial Data and Insights

If we apply this to the investing world, it is safe to say the following:

If you would show two analysts the same financial and operational data two competing companies, it is entirely plausible that the conclusions that those two analysts might draw from the data would be diametrically opposed.

The interpretation of the data will be subject to frameworks the analysts used to draw insights out of the data. Insight, per definition, is the power or act of seeing into a situation. But insight, is in the analyst, not insight the data.

Generic vs Brandable Domains

I recently listened to a podcast on Domain Wire with SparkToro’s Rand Fiskhin (better known as the founder of the SEO analytics company MOZ). He also wrote the book Lost and Founder.

You can listen to the Domain Wire podcast episode here. Below are interesting transcripted bits from the interview.

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A Brief History of Domain Names

Asked about the history of domain names and on the importance of domain names, Fishkin said the following:

“In the early years of SEO and Google, and of search engines being the primary way of how we find everything, there was a good 10-15 year period, at least, where keywords (the words and phrases that people search for and how Google makes associations between those words), using those keywords in domain names could actually have a really positive beneficial impact.

These were sort of the gold mine days of these semi-ridiculous domain names. You want to rank for “best auto dealer Seattle”? Well, you should register best-auto-dealer-seattle.com.

And that ended somewhere between seven or eight years ago. It started getting much less powerful. And about three or four years ago it really dropped again. And today, it is very minimally beneficial. And I would actually argue that you lose out, even just in terms of just SEO.

You really lose out when you compare the value of a domain name like that, compared to something that I would call Consumer Brandable. A domain name and a business name associated with that domain name that people can say, speak, hear, remember, build an association with.

Keyword rich domain names are just not those.”

Is there still value in the one word exact match domain words (like clothing.com)?

Fishkin: “I personally wouldn’t do it. I would be much more inclined today to say… Look, there are people today who would invest in clothing.com. They think it has value. They think they could build a brand around it.

I would absolutely say that a short, pronounceable word that has no meaning but could be a memorable brand, is far better. So I would take Zappos over Shoes.com any day.”

What about actual words that are not the actual keyword that you are targeting?

Fishkin: “It’s plausible, but I think it is actually really challenging. I’ve seen a lot of challenges around this re-branding of a name that means something else. I don’t know if you remember, but Jonathan Sposato here in Seattle where I live, he was the founder of picnik.com. They struggled for years.

Picnik was a photo editing, storage and manipulation website. Sort of in the early days of Instagram and those kind of things. Picnik was a big player. They were bought by Google and probably integrated into Google Photos eventually.

The struggles over the years to get that domain name to mean the right thing to the right people. And to get over the cognitive dissonance between the slightly misspelled version of the word with the K at the end.

Lemonade (the insurance company) is I think a little bit more like Amazon where it can be brandable. It is definitely doable. I personally would not choose it, because I would not want to deal with the baggage and challenge of association. But I think a decent brand builder could use it.

The bank in Portland, Simple. They have been moderately successful I would say, building up a brand around it. It helps that the word is a adjective rather than a noun.

For you to rank you need to outrank the other meanings of the word

Fishkin: “Right. You have to get some serious traction and then outrank a lot of other things. There is almost certainly going to be other brands that also use the term simple. The same thing is true with Lemonade, right? You’ve got to outrank a Beyonce album?! Oh, man.

For that reason alone, I wouldn’t take Lemonade.com. Especially because there would be the natural and perhaps very reasonable accusation that you were trying to [piggyback of the album]. Especially so close to that albums release.

If it were talking 10 or 15 years on, its a different story. If you want to registered Thriller.com today, I don’t think anybody is going to complain that you are stepping on Michael Jackson’s toes. But if you registered Lemonade.com today, I could see a lot of Behive fans being…

The value of anchor text and exact match domain names?

Question: What about the value though, if I do have that exact match domain name – lets say I was selling shoes on Shoes.com – the anchor text that people would use to link to the website is shoes.com. Do you think that still has some value?

Fishkin: “Some, but it is declining every year. And it is much much smaller than it used to be. The really interesting thing today is that Google has got this system that has structure whereby the algorithm builds entity association with keywords and phrases.

I registered SparkToro.com and over the last couple of years, Google has come to associate SparkToro.com with audience intelligence and market research. all the things that the company does. So, the words and phrases that whatever press and reporters cover us with. And every journalist mentions.

I’m on you podcast and you are going to say something about that Rand Fishkin is the founder of SparkToro an audience intelligence software platform. I hope you are going to say that. In the text on theweb page that this podcast lives on.

From that, and hundred of thousands of others, Google is going to build up this entity to keyword association database. They know how to associate, whatever it is, Barack Obama with 46th President. They know to associate Harrison Ford with Indiana Jones. They to associate Andrew Altman with Domain Name Wire Podcast.

From that entity association build-up comes much of the value. In fact, sometimes even greater value then what you saw ten to fifteen years ago with anchor text and exact match keywords. And using shoes.com to link to shoes.com, which told Google that shoes.com was all about shoes and gave them a rankings boost.

It’s not to say that this is completely gone. There is still a fragment of that value left. It is just that you can achieve a lot of the same algorithmic input and value from essentially the entity graph then the anchor text.”

More about Domains and Brandable Names

Value vs Growth

If you follow the financial media and the media coverage around stock markets on topic that repeatedly pops up is the Value vs Growth debate. Apparently, Value has underperformed Growth for many years now and some have even gone so far as to declare Value Investing dead.

Why Value Investing is indeed Dead

I also think that Value Investing is dead, but not for same reasons that the pundits do. The general conception of the value is dead logic is that:

  1. The market is much more efficient now and the competition within value investors is fiercest. This drives away any pricing opportunities sooner that it used to be.
  2. The internet and globalization has created an environment with more extreme scaling effects and power laws. This results in winner-takes-it-all situations where one or two players dominate the market and take in all the profits.

The conventional value invest retort is that value is relative to price. That is, that a good company is not a good investment at any price. Value investors also tend to believe that the move into passive investing has favored companies that are considered growth companies at the cost of companies that would be considered value stocks.

What is the opposite of Growth Investing?

My logic for declaring Value Investing dead, is that Value Investing never existed in the first place. Value Investing and Growth Investing are both fundamental investing methodologies. Both strategies are looking at fundamental factors (revenues, earnings, cash flows) and estimating the current value from those factors.

But is value the opposite of growth? If Growth Investing is about discovering and investing in companies that are growing fast and that this growth underestimated in the current value of the stock. You could say that growth investors are of the opinion that the market over-discounts the value of future profitability of high quality growth companies.

The opposite of Growth Investing would be to discovering and investing in companies that are deteriorating but that this deterioration is overestimated in the current value of the stock (and/or higher up in the capital structure). The opposite of Growth Investing, in my humble opinion, is Distressed Investing.

Distressed investing is Value Investing. But Growth Investing is also Value Investing, because all Value Investing is just Fundamental Investing.

How did Grayscale grow its AUM so fast?

When I write this, Grayscale Investments has about $9.8 billion in Assets under Management. This undoubtedly makes Grayscale one of the fasted growing asset management companies in history.

Established in 2013 by Digital Currency Group, Grayscale operates trusts that allow investors to invest in various cryptocurrencies. Trusts are open-end, which means that the number of units will change as investors move in or out of the funds.

The units in the Grayscale Bitcoin Trust (GBTC) and the Grayscale Etherium Trust (ETHE) are that are quoted on the OTCQX market. Both trade at a significant premium to the net asset value (NAV) per share. That in itself is intriguing, since Grayscale charges a 2% management fee on assets.

Why does the Grayscale Bitcoin Trust exist?

The Grayscale Bitcoin Trust is passive, as opposed to being an active fund. The investment policy is simply to hold Bitcoin. Passive funds are usually set up to track and index or some other benchmark. So you might ask yourself what is the point of setting having a fund that only holds one asset?

Why would somebody buy this as opposed to buying the underlying asset directly? How come that investors are willing to buy Grayscale Bitcoin Trust units at a premium to Bitcoin per unit and pay Grayscale a 2% annual fee, instead of just buying Bitcoin directly?

The answer is two-fold:

  1. Most institutional investors are simply not allowed to invest directly into Bitcoin. They have a strict mandate on what they are able to invest in. So, they can’t, even if they want to, get exposure to Bitcoin unless it is through a security, such as a trust unit. Eventually, we can expect the Grayscale Bitcoin Trust to convert into an ETF and the management fee to go down.
  2. Most investors into the Grayscale trust are not buying investing through the open market. They participate in something called an Offered Product. Accredited investors participate in the Offered Product and receive an allocation that values the trust units they receive on a NAV-basis, or Bitcoin per share. By participating in the Offered Product, they are also bound to selling restrictions and subject to significant limitations on resale and transferability.

More on Cryptocurrencies

The Value of Making Up Brand Names

In a recent episode of the Invest Like the Best podcast, Patrick O’Shaughnessy asked Rich Barton about his thoughts about coming up with brand names. His reply is a great guide on the value of brand names. 

Here is the gist of what Rich Barton said (this is paraphrased as I didn’t have much time to transcribe, but you can find the section on minute 56 in the podcast):

Rich Barton: “I love to make up words for companies. I love to make up brand names. It’s just a classic example of thinking long-term versus short-term. 

If you are thinking short-term, you think of the easiest most recognizable words. Put a dot com after it and that’s the name of your company. Blood.com. I don’t want to insult anybody by giving you the name of a real company. But a lot of companies have done that. And that’s great. The SEO is really great in the short term. Everybody knows what you do. It’s easy. 

What’s harder is to make up a word. But if you can do it and fill that empty vessel of a word with meaning and emotion, then long-term you will have invented something that actually enters the language.  And it is yours. It’s much better in the long-term. 

So, my rules of making up words – and I don’t think that every company should do it, but most I think) – but when I’m thinking about consumer brands, which is kind of my space. 

I have a few rules. 

  1. The first one is High-Point Scrabble Letters. For the Scrabble players out there […] you know that the highest point Scrabble letters are z and q. Those are 10. Why is z worth 10? Z is worth ten because Z is the least used letter in English. Which means that when you see it on a page, it stands out and is memorable.  
  2. Two syllables is good. I think fewer syllables is better. I think the sweet spot is two. Expedia was too long. It had the X which was great. It kind of invoked speed and expedition. But it was four syllables and was just too long. 
  3. Does it make a good dog name? That is rule number three. 
  4. Something interesting about the letters. Palindromes are really interesting. Double letters are interesting. Zoom is a really terrific one. They actually repurposed an existing word and then refilled it with a new definition. Zillow filled all of these goals so maybe I’m doing a kind retrofit. 

When people call me and ask me about making up words, then this is the checklist I go through.

Are you looking for a brand name? Make sure you have the .com domain ending. Check out available .com domains for memorable and readable names at Dragon Value.

Value and Growth are Joined at the Hip

Most people think Warren Buffett is a value investor but if you want to go into the particulars, one could argue that he is primarily a fundamental investor. Buffett famously said that growth and value are joined at the hip. Both are areas of fundamental analysis.

One could also argue that many business owners would not easily understand the question if you would ask if they focus more on growth or value in their capital allocations. Business owners simply allocate capital to the projects with the highest expected IRR, irrespective of any category you might want to fit it into. 

Personally, I really like the framework put forth by the late Marty Whitman. In his opinion, there are are 5 main areas of fundamental finance: 

  1. Value Investing (limited to minority positions in public co’s) 
  2. Distress Investing
  3. Control Investing
  4. Credit Analysis
  5. First and Second Stage Venture Capital Investments

Warren Buffett, as an example, has been active in all of those categories, either directly or indirectly. Henry Singleton, as well, is someone you could not classify as a value investor specifically. He just went where he thought the highest IRR was at any given time.

Why is Chuck Royce such a Good Investor?

The title of this post is a question posed by Tobias Carlisle to his guest Micheal Green of the Logica Fund, on his The Acquirers Podcast. Micheal’s answer to this question was pretty interesting, to say the least, and beautifully formulates the investment framework of Chuck Royce and the Royce Funds.

Michael Green: “First of all, Chuck has just an incredible mind and an incredible awareness of the embedded optionality in securities. And so, his philosophy as it relates to securities selection at Royce [Funds] was that he focused on small cap stocks, but he required that they have very low levels of leverage. And the reason why he did that…I think he intuitively knew this but I don’t think certainly he was explicitly modelling it in the same way I would be forced to do.

When he recognized this, that they had option-like characteristics, right, owning a portfolio that has small cap names in it is the greatest potential to exhibit that lottery-like winner capability. And he was very agnostic between value and growth from that standpoint. Always looking for that option-like characteristic. But his simple rule was that the company couldn’t have enough leverage that would lead to aggregation or a shortening of that option duration.

So he was effectively trying to pick infinitely lived option-like assets. And he just did it extraordinary well. I mean, he had seen so many management teams and he had seen so much. I met him in 2003 for the first time and he had been running Penn Mutual Fund which was the core of the Royce universe. Which he acquired for $1 in 1974. People forget how bad things got.

There is maybe a little bit of this feeling in the active manager community today. But he was able to buy Penn Mutual Fund for $1 dollar. Because the owner, it had assets, and it had a bit of a track record. But the owner was incapable of paying directors salaries, registration fees etc. So he bought it for a dollar and then it proceeded to lose money for some time as he paid directors and others. But it turned into this extraordinary vehicle on the back of his talent. 

Tobias Carlisle: My interpretation of the Royce firm is that they seem to have a holding in every single stock I ever look at. A tiny holding. 

Michael Green: So, I think that’s true. I think that is again a reflection of Chuck’s philosophy that each of his securities represents this option like characteristics. A typical portfolio of Royce would have somewhere in the neighborhood of 160 to 300 stocks. There would be multiple portfolios.

Portfolios would typically be launched in a new fund when we thought it was a peak of a market. Which sounds counter-intuitive. Until you realize that what this actually means is that you have launched a vehicle that has an excess of cash in an environment of high valuations. And so as the markets sell off, that cash creates actually an out-performance characteristic.

So when the next cycle emerges, not only did you have cash to deploy at more attractive valuations, but you benefited from the cash component. And I mean, that type of insight. And again, I highly doubt that Chuck modeled it, but he just knew it intuitively. And that’s part of what I referred to with my respect to Chuck. I think he is probably the single finest investor I have encountered.