Value Investing 2.0 and 3.0

I consider myself a value investor, I have read several of the classic books on the topic and practiced it.

The original value investing, what Ben Graham practiced and thought, and what Warren Buffett started with I would now call Value Investing 1.0. Net-nets, low PB, low PE with nominal growth, and similar approaches worked then and can sometimes still work now. I think the risk currently is that the pace of change and ease of disrupting incumbents increased so much, that revenues and margins can decrease so quickly that such 'value' investment indeed becomes a value trap.
IBM, KHC (lately), retailers, etc. come to mind.
There will be of course good outcomes in that category, and I hope that BHC and VER will turn out to be like that in my portfolio.

Famously, Buffett thanks to Munger realized the value of quality/moat/growth and enhanced value investing to recognize these qualities. The prime example given by them is of course See's Candies.

The modern version of it are all the technology companies, which can grow revenues at a high rate with virtually no incremental capital required or when at worst R&D is the new Capex. Let's call it Value Investing 2.0.

Present-day FB and GOOG are ideal examples of that which I own. But many other companies fell into that bucket, with the increased importance of internet.


Lately I came across Whitney Tilson's interesting passage in his GOOG article:
Rather, it’s in part because the stock has always appeared expensive me, using the traditional valuation metrics with which I’m most comfortable • But there are other reasons, rooted more in emotion than logic: – As a contrarian and value investor, I don’t like owning what everyone else owns – I don’t like buying stocks that have already risen a lot (instead, I prefer to bottom-fish among the beaten-down stocks of out-of-favor companies, betting that they can turn things around) – I felt extreme regret for not having long ago purchased the stock of this incredible company – a classic case of the “I missed it” phenomenon

Buffett and Munger were asked, “…what have you learned about investing in technology companies?” Munger answered that their “worst mistake in the tech field” was not investing in Alphabet: • Well, we avoided the tech stocks, but as we felt we had no advantage there and other people did and I think that's a good idea not to play where the other people are better, but you know, if you ask me in retrospect, what was our worst mistake in the tech field, I think we were smart enough to figure out Google. Those ads worked so much better in the early days than anything else. So I would say that we failed you there and we weren't smart enough to do it and didn't do it. We do that all the time too.

On top of that, I listened to a great interview with Bill Nygren, which covered Netflix and how they would have only 14x PE in late 2017, should they increase price from $10 to $15. Another interesting angle on that is the approach to value users that Aswath Damodoran described here. In some way, this is of course what VCs always look for and try to value, at least during later funding rounds.

When done from a conservative perspective and based on proven track record and legitimate value that given service/product offers to customers with minimal marginal costs, I think this deserves a to be included in the 'value' world - as a distinct bucket, let's call it Value Investing 3.0. Post-IPO GOOG, FB and event recent NFLX per Bill's insight are I think prime examples of this.


This leaves my portfolio with one notable position which I did not bucket just yet - GM. That's because I believe it actually has pieces of each three. Let me explain:

1.0 - even though it's a cyclical stock, the current PE (adjusted for one-off charges) gives lots of safety and GM should break even at SAAR of 10-11M. With current SAAR in ~17M and average fleet age of over 11 years, I have a hard time imagining that we can reach 10M even in severe recession. The only reason it could happen is an ultra rapid adoption of self-driving across all types of vehicles...

2.0 - GM ain't internet business, but their capital allocation, discipline in building for the actual demand and keeping incentives at bay, as well as efficient capex and high ATPs make them a very strong player.

3.0 - I'm a big fan of self-driving and I think GM is best positioned to rapidly deploy in this space. Waymo is more advanced, but I think Cruise is catching up quickly and much better positioned to deploy quickly at scale than Waymo is. Integrating self-driving tech into an arms-length manufacturer's cars will be neither scalable nor cost effective. Investments from Vision Fund and Honda prove that this is a sound strategy.


AMZN is another outlier, which I actually think of as a combination of 2.0 and 3.0. While capital-intensive, the competitive moat of AMZN businesses is akin to Walmart decades ago - low-cost,  operator with huge scale that is almost impossible to fight with. But there is also a unique ability of Amazon/Bezos to expand into new areas and grab new markets. Such skill/ability is a truly unique thing.

Shorting

I just listened to Mark Spiegel vs. Whitney Tilson discussion over short selling and I'm intrigued by the fact that Whitney decided/was forced to cover after the short trade went against him.

If the 'buy low, sell high' is the (value) investing way to make money, it would be natural to 'sell high, buy low' to be the way to run a short selling operation. Unless investment thesis changes (which it didn't in this case), it seems foolish to realize loss instead of waiting or doubling down.

This implies that short positions should be small so they can be allowed to grow if the trade (initially) goes against short seller.


Another curious aspect is that clearly many short sellers (with allegedly value investing approach) increase they short positions as the stock goes down. For me this is an equivalent of momentum/technical investing - directly against the value approach. I acknowledge that it is somehow different, when a short thesis catalyst appears that drives price down, but if the stock bounces back (as Tesla did numerous times) one can end up with 'sell low, buy high' result.


I just reviewed my trading history with Tesla short:
- I initially shorted by long dated puts and they either expired worthless or a remaining few are 50% off mark-to-market
- the later approach, of scaling the straight short position as TSLA goes up and reducing the short as it goes down was much more successful (and done on a bigger scale)

I'm torn whether to go back to the first approach as everything seems to indicate that the end is near for TSLA. On one hand lots (pun intended) of unsold inventory, Oct 15th '2018 tax-credit guarantee' and now introduction of mid-range M3 indicate quickly drying demand.
As a side note - my suspicion is that mid-range RWD M3 is actually programmatically-limited long-range RWD M3, partially taken from those parking lots to generate cash even at poor or non-existent margins.

My other short - SPY - was sold on avg. at ~290 and covered on avg. at ~286, with a very small position. Therefore it generated only a token profit, but still provided a reassurance during market swings and reduced anxiety created by using margin.
But during a more severe market decline this would hit me with even more rapidly increased long exposure than with just my basic approach of buying the dip and averaging down. And in exchange it is not likely to produce a meaningful profit. So for the time being I will forfeit this and focus on being long. TSLA is the only exception - the entertainment value alone is worth it.

End of quarter update and market valuation thoughts

There were not many changes lately in my portfolio, mostly more of the same:

• I've added to BHC (formerly VRX) and together with the ~15% gains it's now the biggest chunk of my portfolio
• I've added to GM (also via options) despite (or because :)) the significant price drop
• Added a lot of FB, as I appreciated the moat and the buying opportunity reemerged
• I've reduced BRK, mostly because of how much it appreciated
• Same for APPL, but on a smaller scale
• Added slightly to VER, especially after it plunged just a day before ex dividend day
• Reduced KHC and sold remaining WMT & GILD
• Established positions in Tencent and BYD (but sold already half of the latter to realize gains)
• Played TSLA on the way up and down as the "Fun with Musk" continues
• Similarly, bought and sold USDPLN on dips/ups, trying to be around zero PLN cash

I've just read the latest Howard Marks memo, where he reminds that with elevated valuations and lots of money chasing high returns it's time to be cautious. While I mostly agree and the excesses are surely out there, I also think that there are some unique opportunities that warrant being fully invested.

I can see first-hand from my work experience how powerful Google's and Facebook's traffic generation machines are and that virtually everybody else who wants to do business needs to pay them to generate sales since the commerce world constantly shifts to digital and digital means those two giants.

I'm therefore long FB as much as GOOG now, but also sold puts and bought calls that are 1-2 year out, as I think FB is very undervalued when taking into account their growth. I think they will grow more than management guided for, just because it's hard for them to say no to ad money and ad money has no alternative.

As an anecdote (and contradictory evidence), I'm in the process of setting up FB ads for an e-commerce store and FB locked me out twice already, asking to submit a foto. Probably they tightened their (blunt) security measures, but it is telling that I have little choice but come back to them, hoping they will get their act together. With any other vendor it would be a game over.

Amazon is still a wild card, but with Amazon Go potentially having huge growth potential (convenience stores can have high margins...) I'm debating investing even at today's prices. But I need to do the math first.


Elsewhere, I've sold roughly half of BYD during the rally, with no regrets for taking an easy profit quickly.

SEC's allegations for Musk are in my opinion the beginning of the end of TSLA. Even if they will print Q3 profit, I doubt they can print it in both Q3 & Q4. And in Q1, with smaller tax credit and competition arriving the demand will collapse. I doubt even gross-profitable $35k model 3 (which probably won't happen) would save them, given the SG&A, R&D and interest overhead. The demand for costly, small electric car is still not nearly high enough to support this overhead, let alone justify the absurd valuation. I keep my sell & buy orders $50 apart, hoping to gain from volatility and right now I expect to cover completely around $150. I see the intrinsic value of equity as close to $0 at this point, but I prefer some trading profits sooner to riding it all the way down, because a cash injection can easily prolong this by a year or two.

With some more options (sold puts and bought calls) I effectively tripled down on GM, which I think should see triple digit stock price in 2-3 years, given the great management, very low PE, buyback potential for adding shareholder value and GM Cruise potential. But it surely requires patience to see it fall into $33 from $44 where I bought majority of my position. Tariffs, etc. are of course short-term issues, but in the end what matters is their competitive position and I think they're very strong and capital efficient.

Fortunately, at the portfolio level I've compensated GM paper losses with other realized and not realized gains. Really looking forward for the earnings season, should be interesting.

Doubling down on GM and hedging the market

With the recent declines in GM stock price, I decided to double down, and extended my long position in calls a bit and also sold a bunch of puts with 35-40 strike prices and expirations between September and January'19. Because I intend to buy more of GM anyway should these price levels be hit at these days, I can as well collect some premium for this.

Because I bought non-trivial portion of my stock holdings on margin and I no longer anticipate significant incoming cash, I decided to hedge my market exposure to some extend by shorting SPY ETF. This is only covers a portion of my overexposure to the market, so this does not indicate that I'm less bullish than before about my stocks, but I see most of others in S&P 500 as likely fairly or overvalued, given the relatively high PE ratio (but without doing thorough analysis of all of them).

Another reason for this hedging is that right now my TSLA short position is only ~2/3 of what it was just after Elon's infamous tweet, as I covered at average price $320, for ~$50 per share gain for the stock I sold short around the tweet time. I always saw my TSLA short as a partial hedge against market going south, and given that I have less of that short now, I felt it's the right time to start hedging against SPY, as S&P 500 is (again) at all time highs. I do hope it will go higher so I can short more, and also reduce a bit the other long positions I have by taking profits.

My overall portfolio evolved a little bit between EO Q2 and now, with BHC (formerly VRX), GM, FB and GOOG being top positions and BRK a bit smaller then them. I also reduced VER a bit, held share count of APPL steady and halved KHC. ~1% of EPOL and ~3% TSLA short complete the portfolio, as I sold last pieces of GILD.

Occam's Razor

One can surely not say that Tesla story is not entertaining. Three days after infamous tweet, Musk nor Tesla still didn't provide any details and BOD actually seem to be distancing itself from Musk.

The simplest explanation, based on prior experience is simply that Elon wanted to hurt shorts and went too far. Maybe Tesla will issue 8k clarifying that funding is in the works today after hours? And then after few weeks will say that being public is the best for Tesla anyway because they care about retail investors.

I simply can't get long thesis and I doubt someone will put tens of billions on the table with Tesla financials and signs of weakening demand for M3. But everything is possible and if the deal goes through at 420 I will take my losses with dignity. But I have no doubt that shareholder lawsuits will live long after that and probably harm Tesla and their new owners anyway.

Tesla

Yesterday's news on taking Tesla private was unexpected, certainly by me, perhaps by everyone.
It's still very hard for me to tell if this could be real. I'm short Tesla for approx. ~5% of my portfolio worth, and for now, I cancelled all my buy orders above $300, as I assume this will not get through and stock will collapse soon afterwards. If this does go through, so be it, I'll accept the loss, but it would still be baffling who would invest such amounts in a losing company in very tough industry/industries. But stranger things happened, so this can't be ruled out. After all, Tencent invested in Tesla before, and I can imagine them or other Chinese player to be behind this (if this is real).

I'm quite happy with a long position of approx. 6% in BYD, much safer play on EV future in my opinion.

China

Everyone of course heard for last few decades that PRC is a big opportunity and than it was consistently validated by high GDP growth and other signs of fast development of the country.

At the same time there was/is a concern that PRC is not democratic and lacks western freedom.
I subscribed to the latter for a long time, assuming that no significant innovation can come from a society which lacks true democracy. Over the last few years I came to question this, partially because of Charlie Munger's appreciation to China progress, partially as I appreciated that different cultures might be, well, different. The latest trigger to rethink this came from Grzegorz Kołodko's book, 'Will China save the world?' It makes for a fairly balanced overview of current circumstances and path ahead China and the world.

I'm even more bullish on China after reading it and will try to spend some time on researching investment opportunities there.

What triggerred my somehow increased interest in China (and buying the book) was evalauating and finally buying into BYD. While I did not do enough research to fully understand company's situation and fundamentals to be fully comfortable, I think there are a few good reasons why it is a sound investment:

• It's clear that EVs are the future, especially in China, with pollution and government incentives
• Few (and certainly not Tesla) can match China in manufacturing prowess, with BYD being experienced player
• Based on some evidence (including Berkshire's early investment) BYD management seems to know what they are doing and have necessary integrity
• The runway and company's plans are ambitious, yet achievable
• Last but not least, the valuation seemed to get back to reality and be attractive again

I do not have enough confidence in my due dilligence for BYD to justify more than 1/5th of a single 'big five' position. Anyway, you have to start somewhere with China, and BYD seems quite reasonable place to start for me.

I intend to spend less time following stock news and do less 'incremental trading' from now on, to spend more time on a side project. Let's see how much I'll manage - investing is addictive.

Easy choices; Though choices

The second chance I wrote about lately (i.e. buying Facebook on the dip) was an easy choice. Facebook is an excellent business with amazing growth, long runway and wide moat. My favorite tech/business writer Ben Thompson just elaborated on that in his weekly article.

But with more money put into Facebook and recent drop of BHC, which triggered my buy orders that increased my BHC position by ~12% I extended myself a bit too much. I decide to reduce my BRK position by ~25%, given that the upside there is much more limited compared to BHC and I might be able to swing back into BRK after both earning releases. It is not something that I count on, but in terms of expected value, I see BHC as a more compelling proposition at these price, and below $22 I was inclined to increase size of it to be above Berkshire. This was a though call, but consistent with my value investing principles and contrary to Mr Market's price swings, as shown below:

Mr Market and second chances

Yesterday, after Facebook released their results, it seems like everybody thought this is the end of the world to have 42% revenue gain and somehow muted guidance.

But I felt like I was given second chance. I missed badly on recognizing Facebook a few years back, and after recognizing the mistake, I was not aggressive enough during the Cambridge Analytica storm. I only brought FB to ~10% of my portfolio, even though I estimated the intrinsic value to be twice of the market price.

My estimate is not change much based on latest results, so I welcomed the sell-off, backed up the truck and loaded to a full-position, with $171 average price now.

With that, I now have five core positions of roughly equal size: Baush Health (formerly Valeant), Berkshire, Facebook, General Motors and Alphabet. I like all of them and I'm considering getting rid of smaller, no-growth, holdings like Vereit, Walmart and Kraft Heinz to focus on these. 

End of Q2'18 update

In a regular end of quarter update, I tend to summarize my thinking on current/past holdings, so here they come:

• GM: I continue to see this as a great opportunity thanks to Cruise. It was somehow validated during the quarter by SoftBank investment, but I still feel it undervalues Cruise and the business opportunity in front of them. I did not immediately follow-through on my plans to buy much more stock options for GM. The stock went to $44+, but recently retreated, and I bought a bit by adding to my Jan'19 45 calls. I mostly ignore Trump-related volatility, as I assume the outcome will ultimately be quite reasonable or there will be ways to mitigate negative impact.
• BRK: I substantially increased the stake as the stock was relatively weak. Even if Q2 earnings are hit by unrealized investment lossess, the overall value proposition is still very sound and it will continue to be quite close to 120% of book value. I feel like the underlying value of major holdings (APPL, WFC, KHC) is attractive compared to their current prices, and couldn't be more happy than to hold them thorugh Berkshire, at the current prices.
• GOOG: I kept it relatively steady, trading a tiny bit on ups and downs, but still consider the price attractive. If Google continues to grow revenue & earnings at 20%+ pace for a few more years (which I expect) the current price will be deemed very reasonable.
• VRX: As Valeant continues its turnaround (and soon rebrands as BHC) I feel good about their prospect, even in the context of relatively pricey bond issues or delays in approval of key drug. Absent some storm the risk of bankruptcy is likely gone, especially with their move to more steady product categories.
• FB: Not much change here, holding to the original stake - not adding, reducing nor trading on ups/downs. I still think it's undervalued, but I'm hesitant to buy after the stock price recovered. I might consider buying calls or selling puts, but this requires more thought.
• VER: Not much to say here - even though there was some price recovery lately, I'm keeping it relatively steady to balance portfolio which grew elsewhere. The yield is still attractive and reduces mutual correlation of the overall portfolio.
• KHC: I tried to fish for the bottom in KHC and it seems like it mostly worked. I already took some profits and while not spectacular, it should prove to be an OK way to benefit from volatility. I do not see enough of return potential to hold it for a very long time and will be happy to take modest profits sooner than later. Should market further discount it, though, I'm OK to add back what I sold and then some, unless better opportunities arrive elsewhere.
• APPL: I traded it a bit on ups and downs, but overall increased the stake. The effects of compounding returns, stock buyback and tax changes is very solid, with limited downside. The service businesses and the wearables space provide for upside that is probably not yet discounted in the stock price.
• WMT: Beyond pure intrinsic value calculation of the current business, my assumption was that Walmart will be able to become more efficient in the ecommerce space by finally leveraging their existing assets and customers. It does not necessarily seem to be happening, and recent acquisitions (Flipkart by Walmart and innovative online pharmacy by Amazon) make me more and more doubtful in Walmart's future, especially that the current price is not low. I was able to reduce the stake by almost half at roughly my cost. I will be happy to dispose of the rest soon, and will probably not look back unless their actions show that they can continue to create new kinds of value for customers, in addition to what they undispudedly did already.
• EPOL: With weaker PLN and not much advancement in polish stock market I bought back a bit into the cheapest index fund I could find for Polish stocks. I treat this mostly as a way to hold some PLN, with market growth, not as source of alpha.
• PCG: I disposed all of it at very modest gain. I would have held it for longer, but the developments related to wildfires were worse then my (perhaps too optimistic) expectations and I felt that it's probably better to stick to other California company I know much better.
• GILD: Continues to be a marginal position, as the rate of business decline was worse then I anticipated it seems like the upside is quite limited.

Tesla progress in ramping up Model 3 was better than I anticipated, but nevertheless I consider it very overvalued. I shorted a bit more as it rallied and already (by August 3rd when I'm finishing writing this) I bought back a portion after stock price tanked. The short thesis is well alive, but I'm less confident in timing now.

I just reread Adam Smith's "The Money Game" and was again impressed by it. I'm revisiting in my mind two important questions - the use of margin and potentially managing other people's money. This requires much more thinking, though, and certainly warrants a separate post.

GM's cost and boldness advantage

I've just done some reading (some 1/2 year old - pretty ancient) on Autonomous Vehicles and it prompted me to reaffirm a few points, I already thought are true, but perhaps have not stated clearly here yet.

Integration

Waymo had and maybe still has a lead in software, but this is far from enough to succeed. My favorite GM lacks some of Waymo's advantages (Google Maps, both for data and for demand generation), but compensates for this and then some by being fully integrated.

This post from GM Cruise CEO explains clearly why being able to retrofit hundreds of cars with self driving capability is so much different than building millions of cars on a proper assembly line. The former is nice, but only with the latter one can build a sustainable business.

What it also shows and I did not appreciate enough earlier, is that GM will have a huge cost advantage in building AVs compared to virtually everybody else. Waymo's deal with Chrysler for 62k cars surely will require similar assembly-plant integration, but fear of IP ownership and haggling on R&D and Capex costs will surely slow them down and make for an inferior process.

I think alleged Larry Page's decision to not front costs for Ford to do deep integration will be one of the biggest lost opportunities out there. I admire him in general, but being slow in bringing Waymo to market will probably make a difference between winning and loosing this huge market. Hell, Google should have bought Ford, GM or even Magna Steyr to enable rapid commercialization.

I don't believe working with auto OEMs at arm's length (Android model) will work for what's ultimately a complex integration between: base auto, self-driving hardware and self-driving software.

Development and deployment choice

Furthermore, by launching first in Arizona, Waymo seems to optimize for safety, rather than for business scale. Another post from Kyle Vogt shows GM's advantage in pace of learning, and it's hard for me to imagine that Cruise will not catch or overtake Waymo in software capability soon, or it hasn't already.

Waymo being first to launch will be a pyrrhic victory, as it will just pave the way for more scaled competition, probably GM. They will join Tesla and Uber in being 'first' (in having 'autopilot' and by having their self driving car causing first death - respectively). But it will not ultimately matter.

GM stock, catalysts and option pricing

It's another story when the market will catch-up with the opportunity and what will be the catalyst of realizing GM's value. I can see a few potential moments for that, with varying degree of uncertainty:
1) Waymo launching commercial service this year
2) Alphabet reporting a jump in 'Other' revenues in some quarter, attributable to Waymo
3) GM launching a beta test with the public, or another major partnership or actual vehicle production number.
4) GM launching actual service to the public sometime in 2019

Based on that, I'm inclined to buy a substantial amount of far out-of-the-money options for GM. The relative weakness and low volatility of the stock makes for a great risk-reward ratio, and while I do have some OOM options already, the time is ripe to buy much more to get leverage with little downside. I want to get the timing right, though, as time decay is simply costly, and GM has fallen after their AV announcement late last year, and can easily fall between latest SoftBank announcement and the time they actually deploy the fleet. This would provide an even better entry point.

I believe that while widely accepted, the Black-Scholes option pricing model can really fall down when dealing with real world, and Warren Buffett noted in his 2008 letter.
In this case, I think judging range of potential future prices of GM stock based purely on it's past volatility and not taking into account optionality (sic!) provided by Cruise is just wrong. It will allow me to profit at the cost of option sellers relying blindly on the model.
Of course one will argue that this optionality is already priced into GM stock. But a rational value analysis disproves that notion - GM is dirt cheap, even if it had no Cruise.

By the way - there's another interesting angle to GM - according to this site, it will likely surpass 200k US deliveries of plug-in vehicles later this year. This kicks-off a phase out period (which might be removed). In a few quarters of the phase out, GM could potentially deliver to Cruise tens or hundreds of thousands of vehicle, while still ripping off (partial) tax credit for them.

62'000, but when?

And just a few minutes after posting about GM, I'm reading that Waymo stroke a deal with FCA to buy 62'000 for the self-driving service.

As Alphabet is my second largest holding, I'm happy to see them move forward, but I worry this might be too little too late if the 62k number will only be deployed over a few years.
The encouraging part is naming San Francisco Bay Area as the next place they'll deploy their fleet.

I think the economics are going to be much better there then in Phoenix.

It's just great to invest in two reasonably priced businesses, which such big optionality for free.

Bittersweet news from GM

The big news for today (as I'm writing this from Newark airport, still on May 31st) is the Softbank investment in GM Cruise.

Given that GM was my largest holding, I'm naturally happy to see it go up, as I did not plan to buy more of it in the near future (at current price).

But I think the implied valuation of $8.2B now and $15.5B at the point of commercialization is well below the true value of Cruise at this point. I estimated that segment to be worth ~$200B as of today, by discounting future cashflows.
It is true that it's still early stage and there are still non-trivial risks (we have discount rate for that), but the chances of any other firm catching on with Cruise are narrow and chances of Waymo getting to scale fast enough are slim.
We're talking about multi-trillion market with relatively high profit margin, first-mover advantages and big network effects and valuing a clear leader to capture it at only $15.5B.

I completely understand why SoftBank did this and would do it on their side any minute.
GM was very shareholder oriented all the time and I think it continues to be. I see two potential motivations on GM side:
1) Frustration on permanently depressed valuation and lack of patience to wait until it catches with intrinsic value (which I'm estimating at close to $200, vs. today's ~$40).
2) Being "blackmailed" into this deal by SoftBank. Maybe they effectively threatened that they will buy other AV startups and subsidize the human-operated ride sharing competitors of GM's future network in the markets GM will deploy. That way, GM wouldn't be able to reach scale on the demand side, until SoftBank-funded AV technologies catch up and become good-enough for commercial deployment through existing ride-sharing networks. Few companies have capability to outspend SoftBank and GM's shareholders might not have a stomach for that. Alphabet of course has the resources, but I doubt they will be able to deploy at the same pace that GM will.


But it's good that GM keeps the option of having their own network open, per Seeking Alpha transcript:

John Murphy

But Dan the concern I guess is like what we’ve seen in the past with other fleet sales and obviously is a very different thing than what we’ve seen in the past with these. But there is some concern that you would be supplying vehicles to a fleet and then be diminished in value in value capture. So I mean is there way that even if you partner with somebody else and selling to a fleet or partnering with a fleet that you can really protect yourself in economics. Do you think even that has been in the past in the value chain?

Dan Ammann

We see this in a very different way. We think the -- bringing this technology to scale with the right level of safety and really operationalizing and then commercializing and it’s been an extraordinarily unique challenge, and we don’t see a number of people being successful with that in the near term. It’s also important as we talked about before to understand that the rate of improvement and rate of iteration that we’ve been talking about, that continues just as much the day after commercial deployment as it does between now and then. This is a product and a service that will continue to improve rapidly over time. That’s why we think rate of development is so important. That’s we think first mover advantage is so important. And so we think this is a completely different dynamic versus some of the other business models that you alluded to.

It is true that selling AV fleets will not be the same as selling dumb car fleets, but I doubt there is much value to be captured beyond the value of the TaaS service itself. This means, that as soon as a few players can deploy cars at scale, a race towards basic economics is almost inevitable and will put a tough ceiling on profits of even the most efficient and successful company.


There's also an interesting theory in the comment:
What I gather from this transcript is:
1. Most Analysts are still crueless.
2. No spin-off is planned.
3, GM will be valued as Sum-of-Parts: OEM and Taas.
4. Masayoshi Son is a great partner for global TaaS market.
5. There’re two segments of TaaS:
1). Moving people.
2). moving goods.
6. On moving goods, GM’partners are:
1). US-Amazon
2). China-Alibaba.
7. On Moving people, GM partners are:
1). US-Uber.
2). China- ?

I agree with first 3 points. I also think that GM will likely partner with others on retail part of 'moving goods' segment. For "Uber Rush" equivalent, I can see them potentially going alone too.

For moving people, which I expect to be the core of TaaS business, I think anything except Cruise deploying their own network would be a mistake.
Given that economics of AV win hands down with human-operated ones, especially in mature markets, I think it won't be hard for GM to quickly take over customers from Uber and Lyft. The very high Customer Lifetime Value of ride-sharing users, can easily justify Customer Acquisition Cost even into the thousands and the product is going to be very sticky.

To sum up, I see this as a validation of my thesis, that reduces risk of my GM stake, but also reduces the potential reward, as I just 'lost' 20% of it to SoftBank in exchange for them being presumably less aggressive in this space and some pocket change.

Autonomous cars, Waymo & GM

I just watched a great video about self-driving cars where Cruise gets a bit more technical about autonomous cars than in other videos I saw before (which were created for broader consumption). Even though it's not the latest status update, I think it shows a solid overview of the domain, even if it's perhaps common knowledge for people in the industry.

It's really a super interesting race and I am more and more convinced that Cruise/GM will be a leader in deploying autonomous taxis at scale, thanks to tight partnership between apparently great software team and experienced and disciplined automaker.
I'm placing my investing bets accordingly and thinking of having even more outsized position in GM given the attractive price. I also have sizable position in out of money calls for GM, which are not captured on the breakdown below.

The beauty is that even if GM does not succeed in autonomous cars, it's still cheap and relatively safe investment, despite all the caveats of being in cyclical industry, peak auto, etc.

I'm quite content that I have added to my FB and AAPL positions in the recent decline, but I'm decreasing slightly the AAPL stake. It's a great investment with outstanding capital allocation, but IMHO close to be fully priced. The biggest opportunity they have is IMHO in wearables/AR, but whether they'll be able to capture it remains to be seen.

KHC and VER do not have great growth prospects, but I treat them as bond-equivalents that will stabilize portfolio. Of course this plan did not go very well for VER for now, but with business being steady, it's hard to see much more room for decline of their price.

Finally, I'm content about the VRX progress and they probably chose a good moment to change company name to embrace the Bausch part of their business. I still see a lot of value beyond current share price, so I'm mostly holding my shares in it, with only very light profit-taking.

Loss aversion and revaluing a stock

I do not follow GILD so much anymore as some remaining of it now make only 0.5% of my portfolio, but latest results seem to be worse than I have modeled and it seems like a potential example of 'sell at a loss after intrinsic value fell' example.

I'll try to run the numbers when I have a moment, but overall it looks like a good learning opportunity that will probably make me more humble in my projections/valuations.

FANG and Aswath

I'm a big fan of Aswath Damodoran who teaches practical valuation (and corporate finance). I have went through online materials for both courses and it has been time well spend.

Having said that, I do not always agree with his assumptions. I oftentimes come up with valuations much further from the current stock price than his. For example I am much more optimistic on Valeant than his most recent valuation (my $97.5 vs. his $12.68).

This time I want to briefly discuss his latest FANG valuations.
Before I dive in, I'll admit that a lot of insights into these business that drive my thinking about them are coming from the Ben Thompson's excellent stratechery.com.

Starting with Facebook, I don't agree with his margin assumptions (going down from 57.7% to 42%). If anything, I would expect that them to go up, as fixed costs spread over rapidly growing revenues. Facebook benefits from being THE destinations and does not to have to pay anyone for traffic as Google does. The growth story is also IMHO far from over and instead of 20% for 5 years, I would expect very gradual tapering off from 40% in year 1 to 15% in year 10.

I admit that these numbers are not substantiated by deep market research, but from the observation that many potential improvements in their monetization systems and operations are likely still possible, overall time spent on FB's apps will continue to increase and ability to monetize users in developing countries will increase rapidly.

I (finally) did a valuation of FB, and with my assumptions (25% growth for 5 years and 15% for another 5 years), my valuation is at $331, twice the current price. While I did add substantially to my FB position after the recent drop, it's still only 7% of my portfolio - I should have probably been more aggressive during the dip.


I did not spend enough time to value Netflix myself (I wish I did). While valuation seems nose-bleeding, It seems like it's strongly positioned to rule the video/entertainment segment for the years to come.


As for Alphabet/Google, I did spend a lot of time working there and thinking about it.
Here, again, I'm much more optimistic than Professor Damodoran. First of all, his estimates revenue growth coming down from 15% a year to 12% a year for the next five years. My number for last 5 years is 19%, and I expect it to continue like that for next five years, as the growth rate was actually accelerating lately. Core advertising is probably still doing well and the new drivers (YouTube, Cloud, Hardware) do not show a sign of slowing down and the other bets such as Waymo will start to contribute, instead of being a drag. While some of these businesses will have lower margins, higher capex or both, I think that with Ruth doing her magic (or actually just common sense discipline, actually) on the cost side, the operating margin will stay around where it is today.

Overall my latest valuation pegged Google at $1600 vs. his $968 and I invest accordingly, with Google comprising quarter of my portfolio.

End of quarter update

Q1 2018 has seen a return of volatility, which I very much cherish.
I've had a chance to buy into or increase position in a few names I observed, but that were priced too high for my taste earlier.

Below is the usual breakdown:

I've increased meaningfully my GM position thanks to the decline in stock price. I'm as bullish as ever on GM, given that it runs disciplined, profitable operations and provide great upside potential with their autonomous driving program.

Google has for a short time sold for below $1000 and I used it to slightly increase my stake. I don't see an end to the revenue growth and they are increasingly disciplined too. I think they are executing well strategically, with investments in cloud, hardware, other bets and last but not least, evolving the ad products.

Valeant stock price declined, with little changes in underlying fundamentals. I think their 2018 guidance was low-ball and they set themselves for an easy 'beat' of expectations. Increasing interest rates will make their debt more costly over time, but their first maturities are two years out and the cash flow will enable them to pay down a good chunk of it ahead of time. There's a good chance they'll return to revenue growth and there's less and less effect of loss of exclusivity on older products. I can see them improving balance sheet and stabilising business going forward, but perhaps it will take a bit longer than I originally expected, given reduced cash flow.

Berkshire is a stock I most likely won't sell completely no matter how high it goes, but I trade around my core position when it goes up or down. I've tried to draw position size (red) vs. stock price (blue) below:

Note: the horizontal scale is not linear, but only reflects transaction dates.
The initial buildup of the position comes mostly from transferring from other brokers to Interactive Brokers, so it's somehow artificial.
Overall, I'm happy with my strategy of buying as price declines and selling as it raises. I've much larger positions today in other stocks beyond Berkshire.

Vereit has declined significantly, to the point of exceeding 8% of yield. The company is as solid as ever and dividend is safe, so I'm happy with increasing the position a bit as it declines, but I don't want to build a huge position there, as the upside is limited (compared to GM/GOOG/VRX) and it's not a compounding machine like BRK.

I've used the recent 'Facebook scandal' to add to my position, essentially tripling the size over the last month or so. This too shall pass is my approach, and I don't see the fact that others misused FB data to affect its business model. I don't think people have high expectations of privacy of the data they share with FB to begin with, so their behavior shouldn't change.

I've bought into Kraft Heinz again after the shares dropped into a somehow attractive territory. It's not a bargain bin yet, but the downside is also limited. Just going forward with the business should make it grow thanks to debt repayment, while potential future accretive acquisition provides some potential upside.

Apple is as great an investment as ever, and I keep thinking if I shouldn't have more in it. In the recent volatility period, I mostly traded in and out to shave off a few dollars of market's chaotic moves, but I'll keep thinking of increasing the position size. The downside is very limited and when they update on capital allocation plan in late April, it can be a strong catalyst.

Last three positions are PCG, WMT and GILD (which was unchanged).
I've reduced PCG position by more than 50% at a small profit. This was mostly to free up funds for other bargains (primarily GM and FB) as my thinking of the company did not change much.

I don't consider WMT cheap, but have added quite a bit in last market correction, I still see it as a primary contender for Amazon in 'physical world'.

Last but not least, I've reduced my short in Tesla by ~1/3 and locked ~20% profit for them in the latest decline. It seems like the short story is unfolding quickly now and bankruptcy/reorganization this year is not out of question. Beyond straight short position, I have only a few $50 and $100 puts for Jan'19, which would pay nicely in case of bankruptcy, but they're very small relative to the whole portfolio. Should the stock price rebound meaningfully in the future, I'm very much prepared to double down on either straight short (if available for borrowing - are not in IB now...), buying out of money puts or selling deep in the money calls.
On the business side, I don't care much about Model 3 ramp, as it doesn't change the profitability and valuation question.

Self-driving

The latest AutoPilot problems are something I think was inevitable as Tesla pushes to prove it's 'lead' in autonomy, even though they're deep behind. Both this and Uber's last accident emphasize why:
1) requiring constant driver's attention is a dead end in autonomy (some pun intended :/)
2) LIDAR is a must given current state of camera's usable dynamic range in driving condition vs. human eye and level of awareness it can algorithmically deduct from visual signals in real time.

So I'm very bullish on autonomy, but right now it requires LIDAR, explicit programming of driving rules and extensive testing/tuning. This means GM/Waymo, but not Tesla.

I'm really curious how Level 3 autonomy will work out - Audi A8 is the first incarnation and it sounds like it could work in a well-defined conditions, with reasonable handover protocol to human driver. 

Position sizing, new approach

I've recently tested quantopian.com platform for easy backtesting. I essentially plugged in the valuations I posted previously. Using quantopian forced me to come up with an algorithmic approach to sizing positions.
I ended up using a simple and natural approach. For each security I have a target price. Therefore I can calculate a percentage upside as (target_price - current_price) / current_price. Then I summarize all upsides into a total_upside and allocate to each security upside / total_upside percent of funds. This keeps me 100% in the market as long as any security has any upside (they usually did, but it varied greatly from single-digit percent to 4x).

I think this approach strikes a good balance between maximizing my upside, while keeping some diversification (if my valuations are correct, of course). Strictly speaking to maximize upside I should  put 100% in the stock that has the highest upside at given point in time, but that will result in no diversification and no room for valuation error.

The full results are here. I would not pay too much attention to numbers, as the stated goal of mine (maximize returns) and risk metric (permanent capital loss due to misunderstanding of the underlying business) is quite different from what alpha/beta or volatility measure. I also used a very simple approach, with only 3-6 securities in the portfolio, annual updates to intrinsic values, etc. Having Google (which performed very well) in the portfolio skews dataset in two ways - it's of course a plus, but early on as Google price increases, the allocation decreases significantly and a good chunk of the gains is 'missed' that way.

The biggest benefit for me from this exercise is the new approach to portfolio sizing. I don't plan to use quantopian, but I will look into using Interactive Brokers API to automatically place my orders according to my intrinsic valuations and in line with portfolio sizing.

Capital light vs. capital intensive and what is the right price

I have been following Amazon as a business and to a lesser extent as a stock, but I have refrained from investing in it. The price seemed so high all the time that I did not even try to value it. Even if I would come up with a scenario in which the current price is low, I would likely see many reasons why it's 'too optimistic' and refrain from investing anyway. Of course I missed out a lot of gains and I might be missing more of them in the future. But it's just not in my DNA.

In lieu of Amazon, I'm thinking of other entities that could be significant in online retail. In the US market, it's hard for me to think of someone else than Walmart. They certainly know how to run lean operations and be the low-cost competitor. They are not as savvy in online world as Amazon, but I do not see a fundamental reason why they couldn't crack this.

My only issue is valuation - while Walmart is certainly far from Amazon's expensiveness, it's not exactly cheap either. My only solution for this for now is to buy a small piece (~1% of portfolio) and start tracking the company much more closely. Hopefully it can get cheaper or I can become more convinced that they'll not only defend but even increase their market share going forward.

Rebalancing and some thoughts on the companies I own

At the end of January I left Google - it has been a great ten years, but I'm much more focused on looking forward than looking backwards. I'm joining Spring - an ecommerce company that aims to change the way we shop. It's going to be interesting for sure.

I've already transferred most of my Google stock out of company brokerage account to my private one. I've also performed some of the rebalancing driven by my last valuation exercise.

I kept Google, Valeant, Gilead and Facebook at similar levels. I used the market selloff to increase my positions in General Motors, Vereit, Apple, Berkshire and Pacific Gas & Electric.

Short motivation for each change, in a decreasing order of current position size:

• Google (25%) continues to grow top and especially bottom line at astonishing pace and the impact on earnings from Tax reform and EU fine is temporary. But I already have an outsized position in Google and do not grow it by much, unless it becomes much better bargain or the fundamentals change.
• General Motors (20%) is valued as a cyclical car manufacturer, but they are relatively resistant to potential drop in car sales, allocate capital prudently and have gigantic optionality in TaaS. The downside is limited, while the upside is huge. I added quite a lot lately.
• Valeant (15%) continues to be the turnaround of a decade, with outsized potential for gains to equity holders thanks to the leverage they use. But the leverage is coming down quickly and the company is executing well. I expect positive earnings release, perhaps with another jump in share price after it. Even if not, I'm confident that by the time next piece of debt is due (2020) they will be in much better financial position and perhaps this will be recognized by the market. If not, I believe current management will prudently allocate capital, including buybacks.
• Berkshire (13%) is still an admirable company. I gradually sold off a bit of my holdings during the recent rise to ~$215, and was happy to gradualy buy these shares back (and then some) when it dove into ~$190 territory. I still only have ~70% of the numbers of shares that I have had when it was trading for $144 just before US elections. By now Buffett's buyback threshold is already north of $150 per B share, and I'd happily add much more if it approaches these levels.
• Vereit (10%) sold off heavily and I've been buying. The dividend yield touched 8%, and it makes it a bargain, given that the dividend is well covered. I expect positive earning release and might lighten up my holdings if market recognises that via higher share price. Still, Vereit is the company where I'm most heavily in the red right now (not counting dividends).
• Apple (7%) is a great company and the two regrets I have is not buying more when it was ~$90 (it was still by 3rd biggest holding then after Google & Berkshire). The other regret is selling off too early, starting gradually around $120. The management's plan to have zero net cash provides great upside through accelerated buybacks, and I now have even more shares than I had when it was at ~$90. It's not such a bargain anymore, but I have more capital to allocate now, and Apple looks very attractive when it approaches $150, when they have ~$53 cash per share ($33 net of debt).
• Pacific Gas & Energy (5%) I wanted to establish a larger position in PCG and my wishes came true - it dropped together with the broader market and I was able to establish a decent position. It's unlikely that California will punish PCG so much for wild fires, as it is such a vital part of its infrastructure. I also think it will reestablish dividends once the liabilities become more clear. The earnings call confirmed my expectations.
• Facebook (4%) I expect Facebook to continue to grow rapidly for a few more years, as it scales its Sales efforts and monetizes userbase. Therefore I find the valuation reasonable, and would add much more if it goes lower. The intraday low of $167 from Friday is actually already very attractive - I just didn't have my typical gradual buy orders placed for FB.
• Gilead (1%) I bought Gilead as a value play and it performed OK, but not spectacularly well. I'm mostly out of this position, but I'm keeping a small chunk in order to keep watching it. The revenue decline continues rather strongly, perhaps more than I originally anticipated. Given that I have a few other value plays in my portfolio now, I will probably not be adding much, unless the price or fundamentals change materially.

• Tesla (-5%) - the quarterly report surprised me by a large cash position, but it all came from balance sheet tricks, not an improvement of the actual business. The business seems to still be structurally unprofitable. Even if it starts generating profits, there is no way it would justify a price close to the current one. I'm managing the short position as it goes up (or down), by selling more (or buying back shares). It's hard to predict when this will go towards zero, it might be this year, might be another few years. Once TaaS reaches high tens of thousands of cars deployed in US, it will inevitably have an impact on new car sales. I expect target market of Tesla Model 3/Y buyers (big city residents) to be most prone to forfeit buying new car and instead use TaaS. GM's most profitable markets (suburban SUV and rural Truck buyers) should be the last ones to resign from personal car ownership. I do not expect fully autonomous Tesla to be ready before 2020 - and by then the company may well be after bankruptcy already.

Valuation

Even though I think of myself as value investor, I am not a valuation purist. Specifically:

• I do not use CAPM, as I do not think beta derived from price action has much meaning
• I use flat 10% discount rate, and strive to be conservative in estimating cashflows
• I try to read through and understand details of financial statements, but usually I do not model each variable separately, but use aggregate data
• I strive to limit myself to companies with very good business models and able and honest management
• I follow developments in each company I'm invested in and try to understand if there are any changes that permanently affect the business
• I choose growth rates based on history and my understanding of the business, even if superficially they look wrong (e.g. for a few years I was estimating GOOG EPS growth in 14-18% range for the next 10 years - bold, but if anything, I actually underestimated it)

I also do not update my models very often - usually once a year, unless I think that the value has changed materially.

I just revisited the valuations I did 1.5 to 1 year back, and they are often quite close to current price. I do not attach too much meaning to this short term check, especially in the context of raging bull market. Anyhow, here it is:

Company	previous price	previous valuation	2018-02-02 price	2018 valuation
AAPL	103	168	160	183
BRK.B	144	222	209	223
GM	31	44	41	188*
GOOG	773	1064	1111	1607
WFC	48	60.5	64	-
VER	11.06	11.38	7.09	10.63
KHC	81	62	77	-
VRX	-	-	18	97.5*

With '-' I marked stocks that I did not value this year.
* - yes, I'm estimating GM & VRX to be few-baggers within a few years. These valuations are of course very sensitive to the assumptions I made and on top of that VRX has a substantial risk due to high debt that I do not explicitly discount for. GM's valuation comes mostly from my projections of Transportations as a Service earnings, while VRX comes mostly from repayment of debt thanks to robust cash flows.

Based on this latest iteration, I will be rebalancing my portfolio soon. Stay tuned.

REITs and Utilities

My adventure with REITs started just after (former) ARCP reported accounting irregularities and their price plunged from $12 to $8. It offered attractive yield and reasonable AFFO (Adjusted Funds From Operations). The dividend (as could be expected) was suspended, but the AFFO was largely intact and the business has been stabilized by the new leadership.

The share price fluctuated a bit, reaching >$10 for some time, but recently declined with raising interest rates, reaching $7.26. I do not see things negatively here, so I substantially added to my position on the way down, with VER now being my 4th biggest stock, comprising ~10% of my holdings.

I'm treating REITs as a 'stabilizing' part of my portfolio - not something that will rise a lot, but also without significant downside. The returns are fairly predictable and above the cash/bond alternatives.

When I learned about the recent general drop in Utilities' prices I researched this topic a bit and decided to focus on Pacific Gas & Electric. The market discounted it not only on interest rate raise, but also on California wildfires. The dividend suspension also did not help. I think the first two problems are overblown and I don't mind for the dividend at all. The valuation seems attractive enough to provide decent expected return over time. As of today, only the first of my limit orders triggered, getting PCG to become ~1% of my portfolio. Hopefully it goes down further to trigger my other buy orders so I can build a decent stake.