Lyn Alden, whose work I greatly admire, has a fascinating piece out looking at the long term, with the encouraging title Most Investments are Actually Bad. Here I consider that thesis and show why it is not relevant to actual investing.
I've worked at tech startups since I was in college 22 years ago. Only Expedia was publicly traded and many of the startups have plateaued at some point. The winners in tech follow a power law distribution due to network effects and the ability to buy competitors (Google with DoubleClick, Facebook with Instagram, etc.) or adjoining businesses (Microsoft's many acquisitions.)
His conclusion is probably more accurate for startups, the vast majority of which provide no return for common shareholders since they either fail or the VC's get all proceeds as a result of their convertible preferred stock's liquidation preference.
In my free time I manage a website which imports 10-Q and 10-K financial data from the SEC and then compares that with stock prices: https://chartinsight.com
I default to price-to-sale comparisons because those work for the majority of stocks. It showed when Amazon, Google and Meta were undervalued at the end of 2022/start of 2023, and also showed the massive revaluation of Apple during 2020.
What I also notice is all of the companies that are delisted for one reason or another since I must reconcile them manually. Many are acquisitions but some are delistings of companies headed to zero. How he treats a company that is acquired would have a big impact on the outcome. I'm shocked he suggests investing dividends in T-bills but he's still getting paid as a professor so doesn't need dividends. One would think he would have a better appreciation for REITs given the WP Carey Business School there.
I looked at the Bessimbinder study years ago and I strongly suspected that there was some flaw in it. The conclusions simply did not seem to be compatible with real-world results of investors. I searched online for potential critiques of the study, but I don't remember ever finding one. It seems that you found some of the problems which no one else ever noticed, or at least ever commented on. Thanks so much for this article which appears to have solved a mystery for me that I've been wondering about for years!!
All "studies" and, especially, descriptions of studies, must be viewed skeptically. This study says that "gas stovetops are dangerous...they should be eliminated" Read the study - propane and NG grouped together but it is really propane that might be unhealthy and if there is a range hood there is no issue.
It's very easy to misrepresent study results to push a narrative. I am sure that sometimes the misrepresentation isn't even intentional but personal bias leads to the same result.
Yeah, I used to read a lot of climate change papers. Then I would read the IPCC report relying on thos papers. Then I would read the abreviated review of that report in the IPCC Summary for Policy Makers. Then I would read it again in the mainstream media. The last one and the first one were so divorced from each other that I had do double check that I had the references correct. Bias gets injected at every step and the end result is wildly off base.
My ex-wife was lead author for one IPCC chapter in one report and participate in quite a few of them. What a thankless task. All weekend every weekend for month after month. Relevant here was her description of the meetings where they would edit the summary for policy makers. There was a lawyer in the room from every one of the many countries involved. And they would wrangle over every clause in every sentence. No wonder all connection to the conclusions of the technical sections was lost by the end of that.
Richard Tol is the lead author for WGII (economic impacts) and he resigned in protest from the SPM. He had a rather lengthy explanation as to why on the web in several places, but they've all been deleted. He mentions watching in consternation as entirely inland countries crafted wording that would let them claim damages and compensation from sea level rise. There is a brief article on it in the following link which lays out some of the insanity, but his original letter was much more revealing.https://www.nationalreview.com/2014/04/ipcc-insider-rejects-global-warming-report-alec-torres/
I didn't read Bessimbinder but had a gut feel that it contained the type of gross error that Paul points out.
I have an even stronger gut feel that the "most investments are bad" theme was A) true and B) irrelevant.
I carry about 50 tickers at any given time. Of those, there are always 3 or 4 "longshots". The investment size is small. I've had a couple of monster winners (20X) and a long list of losers. I'm slightly ahead over all, but that's not the point. The point is that if you accumulate ALL the total losses I've had, since every time one goes bust I go looking for another one, the list of bad investments keeps on growing while the number of tickers I am managing remains at about 50. The longer I do this, the larger the number of bad investments in the list. At some point I expect that the total number of bad investments I have made will exceed the number of good ones.
So despite "most" of my investments being "bad", I've got a portfolio that has trounced the S&P. I just feel like the premise as stated doesn't take into account the reality of how people actually invest.
Hello Paul - One of the things that will be interesting is how aggressively triple net lease REITS increase rents at the end of lease terms going forward. Inflation was tame for a long period of recent history and the gap between FMV lease rates and the escalated lease rates at renewal wasn't likely great. Many of these REITS have a customer base that they rely on for new business. How good will they be at sitting across the table from them and demanding a rent increase of say 30%...or possibly even more (I'm likely understating this increase by a lot)? The value of these properties will have increased immensely and, in order to participate in the value-capture, these renewals are critical. This is easy to do Multifamily REITS. The renewals are only one year so there's no massive multi-year accumulation and the customer is a non-entity to the REIT. These long triple net leases are another story. Very few of the current triple net lease management teams have seen this kind of inflation in their careers and it'll be interesting to see how they handle it. I think about your comment about real life business operations vs academic study.....this could be one of those moments.
Agree completely, Bill. A lot of triple net renewals in recent years have involved a decrease in rent, with the cost of retanenting a big enough threat that the win-win deal was a lower forward rent. With recent and likely inflation that will have to change.
As to the size, over say 20 years a 3% per year increase is a doubling. And anyway a doubling of prices over the next 20 years may be an underestimate. Will be interesting to see how the various managements handle these changes indeed. Probably will imply exiting some of them and entering others.
Great piece, Paul. Lyn's work is often a little too esoteric for me. She's a smart cookie but doesn't always teach to the dumbest kid in class-me, probably. Tech investing has been transformational since the 90's-with some sidesteps periodically with a few companies delivering outsize returns-but probably growing proportionally to the extent they were changing the landscape of the economy, and the rest of the market largely treading water, or delivering T-bill caliber growth. I agree with you reinvesting dividends is crucial to out performing other financial instruments. My own sub-sector-upstream oil and gas, has short periods of outperformance, followed by long periods of underperformance. Traditionally, If you catch a wave higher in commodities in your energy equity investing, you do well. If not capital erosion awaits until the next upcycle. What's different now about energy investing is oil companies no longer mindlessly chase growth at any cost. The new paradigm of prioritizing capital returns is just getting its legs under it and it remains to be seen what sort of longevity it can endure. If it is a true paradigm shift then energy may be in for a long period of outperformance. Thanks again for a great read this AM. Cheers
I agree completely, Doc. Cautiously hopeful here that there is a new paradigm in energy. But you can never count on that absolutely, can you? There may be a next time to exit for awhile, especially from upstream.
Could be...but. There's a paradigm shift coming in upstream energy. Demand for gas in AI centers has not been factored into anyone's forecast. It is the reason-in addition to new demand 2-BCF/D from Freeport LNG in spite of storage bursting the seams, that NG has rallied the past couple of months. Let's watch what happens with injection vs production to see if this is sustainable. If it is... there is a new day dawning for gas producers. Cheers
Thank you for the through analysis of his study.
I've worked at tech startups since I was in college 22 years ago. Only Expedia was publicly traded and many of the startups have plateaued at some point. The winners in tech follow a power law distribution due to network effects and the ability to buy competitors (Google with DoubleClick, Facebook with Instagram, etc.) or adjoining businesses (Microsoft's many acquisitions.)
His conclusion is probably more accurate for startups, the vast majority of which provide no return for common shareholders since they either fail or the VC's get all proceeds as a result of their convertible preferred stock's liquidation preference.
In my free time I manage a website which imports 10-Q and 10-K financial data from the SEC and then compares that with stock prices: https://chartinsight.com
I default to price-to-sale comparisons because those work for the majority of stocks. It showed when Amazon, Google and Meta were undervalued at the end of 2022/start of 2023, and also showed the massive revaluation of Apple during 2020.
What I also notice is all of the companies that are delisted for one reason or another since I must reconcile them manually. Many are acquisitions but some are delistings of companies headed to zero. How he treats a company that is acquired would have a big impact on the outcome. I'm shocked he suggests investing dividends in T-bills but he's still getting paid as a professor so doesn't need dividends. One would think he would have a better appreciation for REITs given the WP Carey Business School there.
Thanks for all that color.
I looked at the Bessimbinder study years ago and I strongly suspected that there was some flaw in it. The conclusions simply did not seem to be compatible with real-world results of investors. I searched online for potential critiques of the study, but I don't remember ever finding one. It seems that you found some of the problems which no one else ever noticed, or at least ever commented on. Thanks so much for this article which appears to have solved a mystery for me that I've been wondering about for years!!
All "studies" and, especially, descriptions of studies, must be viewed skeptically. This study says that "gas stovetops are dangerous...they should be eliminated" Read the study - propane and NG grouped together but it is really propane that might be unhealthy and if there is a range hood there is no issue.
It's very easy to misrepresent study results to push a narrative. I am sure that sometimes the misrepresentation isn't even intentional but personal bias leads to the same result.
Yeah, I used to read a lot of climate change papers. Then I would read the IPCC report relying on thos papers. Then I would read the abreviated review of that report in the IPCC Summary for Policy Makers. Then I would read it again in the mainstream media. The last one and the first one were so divorced from each other that I had do double check that I had the references correct. Bias gets injected at every step and the end result is wildly off base.
Yes, Steven Koonin makes this point very well in his book, "Unsettled."
My ex-wife was lead author for one IPCC chapter in one report and participate in quite a few of them. What a thankless task. All weekend every weekend for month after month. Relevant here was her description of the meetings where they would edit the summary for policy makers. There was a lawyer in the room from every one of the many countries involved. And they would wrangle over every clause in every sentence. No wonder all connection to the conclusions of the technical sections was lost by the end of that.
Richard Tol is the lead author for WGII (economic impacts) and he resigned in protest from the SPM. He had a rather lengthy explanation as to why on the web in several places, but they've all been deleted. He mentions watching in consternation as entirely inland countries crafted wording that would let them claim damages and compensation from sea level rise. There is a brief article on it in the following link which lays out some of the insanity, but his original letter was much more revealing.https://www.nationalreview.com/2014/04/ipcc-insider-rejects-global-warming-report-alec-torres/
I didn't read Bessimbinder but had a gut feel that it contained the type of gross error that Paul points out.
I have an even stronger gut feel that the "most investments are bad" theme was A) true and B) irrelevant.
I carry about 50 tickers at any given time. Of those, there are always 3 or 4 "longshots". The investment size is small. I've had a couple of monster winners (20X) and a long list of losers. I'm slightly ahead over all, but that's not the point. The point is that if you accumulate ALL the total losses I've had, since every time one goes bust I go looking for another one, the list of bad investments keeps on growing while the number of tickers I am managing remains at about 50. The longer I do this, the larger the number of bad investments in the list. At some point I expect that the total number of bad investments I have made will exceed the number of good ones.
So despite "most" of my investments being "bad", I've got a portfolio that has trounced the S&P. I just feel like the premise as stated doesn't take into account the reality of how people actually invest.
Hello Paul - One of the things that will be interesting is how aggressively triple net lease REITS increase rents at the end of lease terms going forward. Inflation was tame for a long period of recent history and the gap between FMV lease rates and the escalated lease rates at renewal wasn't likely great. Many of these REITS have a customer base that they rely on for new business. How good will they be at sitting across the table from them and demanding a rent increase of say 30%...or possibly even more (I'm likely understating this increase by a lot)? The value of these properties will have increased immensely and, in order to participate in the value-capture, these renewals are critical. This is easy to do Multifamily REITS. The renewals are only one year so there's no massive multi-year accumulation and the customer is a non-entity to the REIT. These long triple net leases are another story. Very few of the current triple net lease management teams have seen this kind of inflation in their careers and it'll be interesting to see how they handle it. I think about your comment about real life business operations vs academic study.....this could be one of those moments.
Agree completely, Bill. A lot of triple net renewals in recent years have involved a decrease in rent, with the cost of retanenting a big enough threat that the win-win deal was a lower forward rent. With recent and likely inflation that will have to change.
As to the size, over say 20 years a 3% per year increase is a doubling. And anyway a doubling of prices over the next 20 years may be an underestimate. Will be interesting to see how the various managements handle these changes indeed. Probably will imply exiting some of them and entering others.
Great piece, Paul. Lyn's work is often a little too esoteric for me. She's a smart cookie but doesn't always teach to the dumbest kid in class-me, probably. Tech investing has been transformational since the 90's-with some sidesteps periodically with a few companies delivering outsize returns-but probably growing proportionally to the extent they were changing the landscape of the economy, and the rest of the market largely treading water, or delivering T-bill caliber growth. I agree with you reinvesting dividends is crucial to out performing other financial instruments. My own sub-sector-upstream oil and gas, has short periods of outperformance, followed by long periods of underperformance. Traditionally, If you catch a wave higher in commodities in your energy equity investing, you do well. If not capital erosion awaits until the next upcycle. What's different now about energy investing is oil companies no longer mindlessly chase growth at any cost. The new paradigm of prioritizing capital returns is just getting its legs under it and it remains to be seen what sort of longevity it can endure. If it is a true paradigm shift then energy may be in for a long period of outperformance. Thanks again for a great read this AM. Cheers
I agree completely, Doc. Cautiously hopeful here that there is a new paradigm in energy. But you can never count on that absolutely, can you? There may be a next time to exit for awhile, especially from upstream.
Could be...but. There's a paradigm shift coming in upstream energy. Demand for gas in AI centers has not been factored into anyone's forecast. It is the reason-in addition to new demand 2-BCF/D from Freeport LNG in spite of storage bursting the seams, that NG has rallied the past couple of months. Let's watch what happens with injection vs production to see if this is sustainable. If it is... there is a new day dawning for gas producers. Cheers