Equity Mates
Posts
📈 Compounding Optimism | Thought Starters

📈 Compounding Optimism | Thought Starters

A collection of our favourite articles from the past week

Equity Mates
July 23, 2023

Today’s email is sponsored by Fidelity

Compounding Optimism by Morgan Housel

Morgan Housel is one of our favourite finance writers here at Equity Mates. When he publishes, it is generally worth your time. In this article he make the case that it is not just financial returns that compound, but progress compounds in similar ways.

The question is: Did George Wheelwright know that he would influence Edwin Land, who would then influence Steve Jobs, who would then design a phone that 2.5 billion people would use?

Did Michael Faraday, who died in 1867, know that his ideas would directly influence the light bulb, which effectively led to the creation of everything from the modern power grid to nightlife?

Did Ben Graham know that his 1950s finance class would lead to 45,000 trekking to Omaha every year to hear his student speak?

Of course not. It’s so hard to know what an idea, or an invention, or a philosophy, will influence, and what a person who’s influenced by it will go on to create.

Ideas and inventions compound over generations. Incremental change may unlock something completely unexpected and lead to the next big breakthrough. And for Housel, that is a reason to be optimistic.

He believes that so much pessimism is driven by the individualism that dominates our thinking today.

If you view progress as being driven by the genius of individuals, of course it’s hard to imagine a future where things are dramatically better, because no individual is orders of magnitudes smarter than average.

But the beauty of technological innovation and social progress is that it hasn’t been driven by individuals in isolation. Much like incremental returns over a lifetime can create incredible wealth, incremental progress over generations creates incredible change. That, for Morgan Housel, is a reason for optimism.

A Closer Look at Berkshire Hathaway's Bet on "Old" Energy

Over the past few years, Warren Buffett and Berkshire Hathaway have been doubling down on their energy investments. A lot of this has been through the shale oil producer, Occidental Petroleum, of which Berkshire owns almost 25%.

For years, Warren Buffett’s right-hand man Charlie Munger has argued that concerns about climate change are overblown. So we shouldn’t be too surprised that they are doubling-down on oil and gas investments. (Importantly, Munger doesn’t disagree with the science of carbon dioxide trapped in the atmosphere warming the planet. He just doesn’t believe the consequences will be as bad as predicted).

This article takes a look at Berkshire’s recent action in the energy space. In particular, it looks back on what Warren and Charlie have said about Occidental and about their other big oil investment, Chevron.

Whatever you think about oil and gas, the fact of the matter is that 60% of the world’s energy still comes from oil, gas and coal. And even after we (if we) transition away from these fossil fuels for energy, the world will still rely on oil as the basis for a number of chemicals and for products like plastic. Similarly, natural gas will still be an important component in fertiliser. And green steel and green cement remain at the research stage, meaning that even if coal-fired power plants are phased out tomorrow, we will still rely on coal for some time to come. All of that is to say that the world is just at the very start of its decarbonisation journey. And in the meantime, Warren Buffett and Charlie Munger plan to make money while the world still relies on oil.

Let the Kids Get Weird: The Adult Problem With Children’s Books

In case you’ve missed it, it feels like every celebrity has a kids book. Seriously: from Australian celebrities like Zoe Foster Blake, Andy Lee, and Ed Kavalee to political figures like Barrack Obama and Meghan, Duchess of Sussex. From athletes like LeBron James and Serena Williams to singers like Lil Nas X and Madonna. If you’ve got a profile, chances are there’s a publisher that wants you to write a kids book.

This article made us think more about the business of children’s books than we ever have before. Because when you stop and think about them, they are a strange product. They are a product made for kids but pitched at parents (and aunts, uncles, grandparents et. al. looking for gifts).

That is why celebrities dominate the children’s book charts despite these children never hearing of them (and having no ability to remember even if they had). And, as this article unpacks, many children’s books have a “nostalgic or abstract point of view that I’m not convinced children share”.

Even when the book industry faces tough times, it seems like children’s books will be a bedrock for publishers. Parents will go to great lengths to do everything they can to set their child up for success - reading early and often is one of those things. And the books that are chosen often have a performative element to them. So the publishing industry will keep marketing to the parents - with celebrities they like, values they want to instil or nostalgia they hang on to - rather than to the kids.

Q2 2023 Right Tail Capital Investor Letter

As we move on from the second quarter of 2023, we are starting to see investor letters released from funds around the world. Over the next few weeks in Thought Starters, we’ll be featuring a few of our favourite. But we had to start with this one, not least because we get a mention.

“I also recorded a podcast with friends from Australia.”

The letter is from Jeremy Kokemor of Right Tail Capital, and you can listen to our podcast interview here (Apple / Spotify). In this quarter’s email Jeremy writes about the importance of patience as investors and then turns his attention to one company in his portfolio: NVR Corp.

NVR Corp is one of America’s largest homebuilders, and Jeremy believes it is under appreciated by the investment community. While most homebuilders will buy land, build houses and then sell it, NVR operates differently. They try to avoid buying the land and by doing so, earn a much higher return on any profits they reinvest into the business. This model also allows NVR to be the low cost producer in most markets.

Whether or not you’re interested in the US homebuilder market, we thought this was a good case study on an under-appreciated form of disruption: business model disruption. There’s been plenty written on technological disruption but just as powerful can be business-model disruption, where companies build a sustainable competitive advantage by changing how they operate. A classic historical example is Coca-Cola outsourcing bottling operating to third-parties and earning higher returns on invested capital as a result. Jeremy see NVR Corp’s different operating model as a potential source of long-term competitive advantage for the company.