Thread by @JerryCap

Re-reading Capital Returns: Investing Through the Capital Cycle

h/t Han Lue for the Hard Copy

"The Capital Cycle analysis/approach is used to understand how changes in the amount of capital employed within an industry are likely to impact future returns. How is the competitive position of a company affected by changes in the industries supply side?"

"Executive pay is frequently linked to a company's size. The incentives are skewed for managers to favor growth. There is evidence that managers with an ownership stake are more likely to *shrink* capital employed through buybacks."

"The best incentive system is insider ownership"

"Strong corporate cultures can persist long after the careers of those who put them in place. Frugal cultures may not sound attractive to employees, but when married to decentralized profit-sharing schemes they can work wonders" (i.e. $CSU $HEI).

"Investment Bankers and Brokers are paid to drive capital cycles, not to worry about the negative long-term consequences that capital expansion may have for clients."

Is this true?

"Capital Cycle analysis focuses on supply rather than demand. Supply prospects are far less uncertain than demand, and thus easier to forecast."

"A basic industry with few players, rational management, barriers to entry, lack of exit barriers and non-complex rules of engagement is the perfect setting for companies to engage in cooperative behavior."

Two purchase candidates

1) Businesses whose high returns are believed to be more sustainable than most expect (#NeverSell). The high ROIC "slow fade" thesis (top of pic)

2) Companies whose improvement potential is underestimated. The low ROIC to reasonable ROIC thesis (bottom)

Marathon suggests highly competent managers are often attracted by the challenging of turning around a troubled company (low to high ROIC candidate). I prefer to avoid these situations.

"When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, the reputation of the business remains intact." - Warren Buffett

I also believe that it's generally easier to forecast continued excellence which has inertia vs. the low to high ROIC thesis you must make a call on an inflection point (Takeaway long thesis at $80, $60, $40... $15).

Assuming continued excellence doesn't require timing but patience. Patience to wait for the valuation of a good business to come in (to buy shares) and then patience for the business to exceed those embedded expectations (to capture multiple expansion).

For the "low to reasonable ROIC" thesis, even if you get the ultimate thesis right, if you get the timing off the opportunity cost in a bull market can be massive.

The lollapollza.

A high ROIC company who has a very long fade rate but who is also priced like a low ROIC company (such as $GOOG $V $MA $SPGI $MCO post GFC). Today? $AMZN's eCom biz (high ROIC, priced like low ROIC, likely infinite fade period).

Investments that require timing of the capital cycle are areas where wisdom trumps compute/processing. These investments are better made by the grandpa's and grandma's of the investment industry whose heuristics have been fine tuned. Harder for the young (<50 yrs old) investor.

"The case for LT investing has centered around simple math (reduced frictional costs, tax, etc.) and fewer decisions (ideally leading to fewer mistakes). The real case, however comes from being able to ask more valuable questions and develop knowledge with a longer shelf life"

Appendix: China is Uninvestable (same shit happening since, well forever!)

"Beijing made life tougher for China Mobile and Petrochina within months after their capital raising"

"nearly every mainland China stock saw highest ROIC in the year before listing"

Appendix: The Moat for Analog Semiconductors

Lollapalooza*

You are so fucked when you make a ugly mistake in a big thread like this @elonmusk