Three Longs & Three Shorts

Published on: 14th April, 2019

This week’s reads focus on the lessons from basketball on investing, how Amazon workers could be listening to Alexa users’ conversations, lessons from the zip making industry, how single women are driving gentrification in cities, Buffet’s wide moat investing and Virgin Galactic’s customer service.

1. Long read: Two’s Are Now Underestimated – The Mikan Drill For Stocks
Author: Ryan
Source: Krueger & Catalano (https://kc-roi.com/blog/twos-are-now-underestimated-the-mikan-drill-for-stocks )

This is an interesting and rewarding long read from an investment advisory firm in Houston. The article uses the stats & the history of professional basketball in the US to draw analogies for stockmarket investing. The article appeals to us for the implications it has for our style of investing in well known, widely held and, dare we say it, boring long-term compounders which also pay a decent dividend. The authors explain that – in the American context – such stocks make you extremely wealthy in the long run. They also highlight that most American millionaires who hold such stocks live modest lives in unflashy homes with unflashy cars. [The flashier millionaires presumably give their money to hedge funds.]

The star of the article is “George Mikan was the very first superstar of the NBA. He was the key to the league even surviving before it could thrive. Making him one of the most underappreciated athletes of all-time. Maybe because he was not athletic at all. His go-to move can best explain how to shoot a high percentage in the Stock Market as well, always has, but it has become equally under-utilized.”

So what was the secret to George Mikan’s success? “George tweaked one of Meyer’s drills and developed his own simple routine. He took the ball directly under the basket and with one step learned how to lay it in with his right hand, jumping off his left foot. Catch it from the net with both hands. Then, one step to lay it in with the left hand, jumping off the right foot. Over and over, both the hands and feet learning the basic recipes for scoring anywhere close to the basket from any angle. George made three hundred of these 2-foot baskets per session. The Mikan Drill was born.”

Inspite of the simplicity and effectiveness of Mikan’s idea, very few players today use it. Why? “Go into any gym and you will see the exact opposite being practiced today, thanks to the analytics boom from the NBA. You will see high schoolers wide open, with the ball in their hands in front of the rim unguarded, exactly where the Mikan drill begins. Only now, he is instructed to lean around under the backboard and rifle a one-handed pass 23-feet to the corner so the shooter can take one step…into a 3-pointer instead…No longer were players looking for good open shots, or even their favorite shots, as the first century of basketball instincts had taught them. Now, they were pre-programmed for what the computers said were the most efficient shots. Kevin O’Connor wrote, “An LED board wraps around the Rockets locker room, above each player’s stall. But it doesn’t flash motivational quotes from Vince Lombardi or Jack Ramsay; it shows stats: offensive rating, defensive rating, effective field goal percentage, and quality-shot percentage. You get the feeling you’re in a mad scientist’s lab — a stat geek’s man cave, not a sweaty locker room for alpha males.”

The mad scientists wanted as many 3’s as possible now and the most precious element isolated in that lab is called the “short corner.” You see, in the far corner of the 3-point arc, by the baseline, it is exactly one foot closer to the rim. Untold billions of dollars began chasing that one foot when you add up all the contracts being given to 3-point specialists, staffs organizing offenses around them, and the technology departments being built from scratch to analyze this data….”
This obviously has striking parallel with quant investing in the stockmarket: “All that money and time and effort to find that one foot of difference sounds familiar in the Stock Market. It is no accident that some of the best quants on Wall Street are now leading sports franchises. Indexing with ETF’s have revolutionized their game as well. Unquestionably more efficient systems have taken over each sport.”

2. Long read: Thousands of Amazon Workers Listen to Alexa Users’ Conversations
Author: Matt Day, Giles Turner and Natalia Drozdiak
Source: Bloomberg (https://www.bloomberg.com/news/articles/2019-04-10/is-anyone-listening-to-you-on-alexa-a-global-team-reviews-audio)

Individuals’ right to privacy is one of the most intensely debated issues around the globe as technology has blurred the definition/meaning of privacy. Amazon’s Alexa has become very popular and has entered millions of homes across the world (78m smart speakers made Amazon, Google, etc were sold globally last year alone). Recent revelations that it is not just machines or software that are listening to your commands but “Amazon employs thousands of people around the world who listen to voice recordings captured in Echo owners’ homes and offices to help improve the Alexa digital assistant powering” will intensify the debate of right to privacy.
“….Tens of millions of people use smart speakers and their voice software to play games, find music or trawl for trivia. Millions more are reluctant to invite the devices and their powerful microphones into their homes out of concern that someone might be listening. Sometimes, someone is.

Amazon.com Inc. employs thousands of people around the world to help improve the Alexa digital assistant powering its line of Echo speakers. The team listens to voice recordings captured in Echo owners’ homes and offices. The recordings are transcribed, annotated and then fed back into the software as part of an effort to eliminate gaps in Alexa’s understanding of human speech and help it better respond to commands. The Alexa voice review process, described by seven people who have worked on the program, highlights the often-overlooked human role in training software algorithms. In marketing materials Amazon says Alexa “lives in the cloud and is always getting smarter.” But like many software tools built to learn from experience, humans are doing some of the teaching….

…The team comprises a mix of contractors and full-time Amazon employees who work in outposts from Boston to Costa Rica, India and Romania, according to the people, who signed nondisclosure agreements barring them from speaking publicly about the program. They work nine hours a day, with each reviewer parsing as many as 1,000 audio clips per shift…

….Amazon says we have strict technical and operational safeguards, and have a zero tolerance policy for the abuse of our system and the process helps to improve the performance of the device…. Employees do not have direct access to information that can identify the person or account as part of this workflow.

…. Amazon, in its marketing and privacy policy materials, doesn’t explicitly say humans are listening to recordings of some conversations picked up by Alexa. “We use your requests to Alexa to train our speech recognition and natural language understanding systems,” the company says in a list of frequently asked questions. In Alexa’s privacy settings, Amazon gives users the option of disabling the use of their voice recordings for the development of new features. The company says people who opt out of that program might still have their recordings analyzed by hand over the regular course of the review process. A screenshot reviewed by Bloomberg shows that the recordings sent to the Alexa reviewers don’t provide a user’s full name and address but are associated with an account number, as well as the user’s first name and the device’s serial number……..“Whether that’s a privacy concern or not depends on how cautious Amazon and other companies are in what type of information they have manually annotated, and how they present that information to someone,” he added.

….A recent Amazon job posting, seeking a quality assurance manager for Alexa Data Services in Bucharest, describes the role humans play: “Every day she [Alexa] listens to thousands of people talking to her about different topics and different languages, and she needs our help to make sense of it all.” The want ad continues: “This is big data handling like you’ve never seen it. We’re creating, labeling, curating and analyzing vast quantities of speech on a daily basis.”

…..In homes around the world, Echo owners frequently speculate about who might be listening, according to two of the reviewers. “Do you work for the NSA?” they ask. “Alexa, is someone else listening to us?”

3.       Long read: The humble zipper has profound things to tell us about international trade
Author: Francois Leveque
Source: Quartz (https://qz.com/1578410/a-brief-history-of-the-humble-zipper-from-levis-to-ykk/)

Zip manufacturing is not the most often discussed industries in investor forums. Yet this article brings out some key insights about the implications of international trade on competitive intensity and more generally the competitive advantage and its implications on the consumers in the industry. We often think about pricing power as the manifestation of underlying moats or competitive advantage. And that pricing power is simply the ability to take price hikes with no commensurate impact on volumes or market share. However, the article shows that pricing power is perhaps more in relation to the firm’s ability to drive efficiencies superior to competition so that it obviates the need for any price increases which inturn puts pressure on competition. The zip industry’s experience shows that whilst opening up of global trade could drive competitive intensity, we could still end up with an oligopoly of sorts where one or two companies through sheer efficiencies could end up dominating up the industry. And despite such dominance, the consumer remains the biggest beneficiary of such efficiencies through lower prices. This is very akin to what we see in some of Marcellus’ Consistent Compounders Portfolio – where an Asian Paints or a Relaxo Footwear or Dr Lal’s Pathlabs have kept price increases fairly modest, driving their profitability through internal efficiencies (sourcing, workforce productivity, smart use of tech, etc) better than competition who in turn get suffocated by the lack of price increases.

“…Take a sample of five items in your clothes closet and examine the tabs on any zippers. Odds are that at least one is marked with the letters YKK. It was made by a Japanese firm, currently the world’s top zipper manufacturer, with $10 billion in annual revenue and a 40% global market share—pretty impressive.

In the 1960s the incumbent zipper manufacturer, Talon, enjoyed a comfortably dominant position in its home market. Its name featured on seven out of ten tabs. But a decade later it had lost half its market share and these days it barely rates just a few percentage points. This was a classic case of a monopoly coming unstuck after resting too long on its laurels. It didn’t do enough to improve productivity, so its prices were too high; it failed to innovate, consequently neglecting new applications such as handbags, luggage or outdoor gear; averse to risk, it exported little, despite the fact that textile manufacturing was fast relocating.

Soon after the Japanese firm was incorporated, it started building its own machines to achieve faster, higher-quality production. It also went abroad, soon setting up subsidiaries in Malaysia, Thailand, and Costa Rica. It first appeared in the US market in 1960, marketing zippers that were cheaper than Talon’s and comparable, if not better. YKK’s first US production unit followed 12 years later. In a humiliating blow to Talon, the pressure suits worn by the first two astronauts to walk on the moon were fitted with YKK zippers. It was as if James Bond’s zipper-unzipping magnetic watch in Live and Let Die hadn’t been invented by the gadget-master Q, but by the R&D division at YKK.

For our champion zipper manufacturer, one of these assets was its machine-tool know-how. Unlike its competitors, the Japanese firm based its expansion on developing its own materials and equipment. From the outset it designed its own tools and fed them proprietary materials. It only purchased plastic pellets and a mixture of alloys of its own invention.

Under equivalent competitive conditions this will benefit the consumer because the price will be lower. Which is indeed the case in Melitz’s model. The same competitive regime prevails regardless of how open international trade may be. At equilibrium all the firms cover their average unit cost and none of them behave strategically. The firms go on operating as separate entities, as in a situation of perfect competition.

Yet international trade generally encourages the emergence and consolidation of powerful firms with substantial market share, or in other words oligopolies which coalesce and gather strength. So it changes the intensity and competition regime.”

4.      Short read: How single women are driving gentrification in Hong Kong and elsewhere
Author: Igor Vojnovic & Minting Ye
Source: The Conversation (https://theconversation.com/how-single-women-are-driving-gentrification-in-hong-kong-and-elsewhere-99970)

All of us live with the knowledge the living in HK or London or even Bandra is an expensive affair. Many of us have elaborate financial theories for why this is so. This article comes up with a novel explanation for why living in the big financial & tech capitals of the major economies is becoming prohibitively expensive – it is all happening due to single women.

“We study urban development and its social, physical and environmental impacts. We recently examined two decades of cultural transitions in Hong Kong with a focus on how the changing status of women and attitudes toward marriage have altered the real estate market. What we found is that single women in Hong Kong have played a surprising and little-studied role in gentrification. Women have been marrying later in life around the world for many years…Throughout the second half of the 20th century, East and Southeast Asia, in particular, witnessed a growing number of single men and women. From 1950 to 1990, the number of young single women across Asia – China excluded – increased almost fourfold, from 22 million to 82 million…This trend has produced a ripple effect throughout the economy, including the property market and local redevelopment, as the increased number of single women – who are also attaining higher-paid jobs – boosts demand for housing.”
So how big is this effect? The authors have done some useful number crunching. “We analyzed standardized census data from 1986 to 2006 across all of Hong Kong, with a focus on exploring the impact of women on neighborhoods that were gentrifying. The analysis, which took four years to complete, identified about 34 percent of Hong Kong as experiencing gentrification…A telltale sign of gentrification is the shift from rentals to owner-occupied housing. The share of units with owners living in them in these areas climbed from 45.5 percent in 1986 to 64.2 percent two decades later.

During the same time period, the number of people employed in traditional, working-class sectors like manufacturing more than halved, from 177,917 in 1986 to 73,870 in 2006. At the same time, the number of residents employed in finance, insurance, real estate and business services tripled, from 49,276 in 1986 to 150,237 in 2006…Single women increased by 53.2 percent over the two decades, compared with a rise of just 15.2 percent among single men…As a result, the share of households led by single women, whether never-married or divorced, jumped to 47.1 percent in 2006 from just 25.8 percent two decades earlier.”

5. Short Read: Replicating Buffet’s Wide Moat Investing Method
Author: Justin J. Carbonneau
Source: Validea (http://blog.validea.com/replicating-buffett-wide-moat-investing-method/ )

At Marcellus, we like the idea of using a mixture of quantitative and qualitative methods for identifying firms with big moats. The author, an American fund manager, seems to be doing something similar in the US.

Whilst we use YOY revenue growth and ROCE as our filters, he uses: A decade of earnings predictability: Our Buffett model looks at 10 years worth of earnings and rewards firms that have increasing earnings over that time period. Using 10 years should give a snapshot of corporate performance over various parts of the business cycle. Growing earnings in and of itself isn’t completely a sign of a competitive advantage, but a decade of growing earnings can give an investor confidence in future earnings of the company.
A decade of above average return on equity and return on total capital: It’s not enough for a company to just have consistent earnings, but the real determination of whether a moat exists comes in looking at 10 years of return on equity (ROE) and 10 years of return on capital (ROTC). ROE measures the profits a company is able to generate on its equity, or net assets, since equity equals assets minus liabilities. Since leverage can be used to magnify earnings, ROTC takes both equity and debt, or total capital, into consideration.”

Then even more interesting part of this paper is data from a book by the legendary Roger Ibbotson on whether these firms with wide moats outperform. “Research from the new book: Popularity: A Bridge between Classical and Behavioral Finance by Roger Ibbotson and three Morningstar investment researchers, Thomas Idzorek, CFA, Paul Kaplan, CFA, and James Xiong, CFA, counters the belief that wide moats equal superior stock returns. What these researchers found was that characteristics like a strong brand name, a defined competitive advantage, a wide moat, or a good reputation made stocks more popular, and therefore more expensive. For wide moat firms specifically, the authors measured the performance of those companies with the highest Morningstar Economic Moat ratings and compared the performance to firms with narrow moats or no moats. The data shows “wide moat” firms actually underperformed narrow moat or no moat firms from a raw performance perspective, but did generate superior risk-adjusted performance.”

The article gives a table from Ibbotson’s book that the Sharpe Ratio for firms with “wide moats” (quantitatively measured) is 0.82 whereas the Share Ratio for firms with “no moats” 0.73.

6. Short read: The Great Space Wait – How Virgin Galactic kept ticket holders’ interest and money
Author: Elizabeth Culliford
Source: Reuters (https://graphics.reuters.com/SPACE-EXPLORATION-VIRGINGALACTIC/010091EW222/index.html)

A beautiful piece on customer service, especially the role of customer communication when it comes to handling adversity and sustaining trust that underpins the relationship with the customer. Virgin Galactic’s multiple delays in its long anticipated retail space travel can be quite frustrating for customers who have signed up a long time ago, some as long as 15yrs. This article is about how Virgin has retained the interests and enthusiasm of its customers not just in the face of these delays but also adverse events such as that of a fatal crash of test flight.

“….While waiting for their trip, some since 2004, Virgin ticket holders have been busied with treats on earth: from a custom-created solar eclipse festival in Idaho and test-flight viewings in California’s Mojave Desert to spaceship-shaped cufflinks at Christmas and group excursions to Branson’s private island in the Caribbean, where they can play tennis with the famous entrepreneur and swap design ideas for the spaceflight around a campfire.

“It’s more than just a trip to space, it’s a huge, ongoing event,” said Icelandic ticket holder Gislason, who has a Virgin Galactic logo tattooed on his arm and bought his ticket to space in 2010. “I’ve already got what I paid for, so I’m just in for a bonus,” he added.

The biggest test of this carefully built customer community came in 2014, when a test flight crash killed the co-pilot and seriously injured the pilot.

“I remember very well waking up very early on Saturday morning after the Friday accident and wondering what would happen to this customer base,” Attenborough said.

The company reached out to customers by email on the day of the crash, both before and after the co-pilot’s death was known. There was a blog post from Branson on that day, and later, a video message. A subsequent email from the astronaut relations team said that they planned to call every customer individually.

In the end, Attenborough said only a “handful” of customers asked for refunds.”

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