Financial/Investing Content - Julianek's Essays

I’ve been thinking lately if organizing your knowledge somewhere outside your brain really helps.
The notes that I’ve taken have been rarely reviewed and I know that I can access again most of the material I’ve consumed. Any good resource or study about this topic?

As I posted in an other thread, “Money Stuff” is a cool finance newsletter.

For example, I found the following part about the CS - Archegos Incident very interesting:

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I just published an essay describing my framework about how I think about equity investment returns, and in particular how to find a margin of safety in growing companie (especially in those times where earnings multiples are quite high). You can find my article here:

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A new essay is available!

This time it will be about the Efficient Market Hypothesis. In particular, I discuss:

  • When the EMH does hold and when it does not
  • What are the drivers of market efficiency and when can they break down
  • Why Low-Cost Indexing is still the best strategy for most people (even when the EMH does not hold)
  • What active investors can do to improve their odds.

Your feedback is welcome!

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Thank you for sharing, I haven’t seen your blog before. Interesting.

I just have one question, feel free to redirect me if it was answered already. When you write about quality, you always talk about individual stocks. How is it in your opinion with indexed investment in quality, like MSCI quality? Does it make sense at all? Or should it always be individual stocks with dividends reinvested, and then it goes to the ground or to the moon?

I addressed it on this thread :slight_smile:

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Another idea: Inflation hedging.

How exactly is it that some assets have or do not have a built-in hedging against inflation? While some are clear, some are less clear. Maybe if the topic interests you, you might want to write something about it?

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You’re lucky because I have thought a bit about the topic (and also because it seems to be a question everybody in my acquaintances ask me about - sign of the times? :slight_smile: )

Even if my answer won’t be as detailed as a potential essay, here are some elements:

You can start by asking what will defiinitely be hurt by inflation:

  • Bonds won’t fare well. In most cases, they entitles the bond owner to fixed, contractual cash flows. With inflation, the value of these cash flows will decrease significantly.
  • For the same reason, bond proxies (i.e, stocks of mature businesses with very little growth, whose dividends are functionally equivalent to a perpetual bond’s coupons) won’t fare well either.
  • I don’t have any opinion regarding commodities. For instance, at the begining of the year everybody thought that lumber prices would go through the roof, but prices have crashed since. Hard to say.

I often hear people saying that stocks will do well because they will be able to pass their costs to their customers. It’s a bit more nuanced than this and I see two determining factors:

  • does the business have a competitive advantage?
  • Is the business capital intensive?

Competitive advantage:

If the business does not have any competitive advantage, its products/services are as good as those of any competitors in customers’ eyes, and the unique differentiating criterion is price (we call these businesses “commodity businesses”). Think airlines, oil stations, shipping,…
If you have a commodity business, it is unlikely you will be able to raise your prices enough to cover inflation, because you are at the mercy of your competition. If you have one competitor who is more efficient than you are (i.e his costs are lower than yours), then he doesn’t need to raise prices as much as you do, and he will steal your market share.

Capital intensity

The second important determining factor is how capital intensive your business is. How much hard, tangible assets do you need to run your business? For instance, utilities (water and power plants), manufacturing, car industries, etc need a lot of factories, machinery and inventories to run their business.

To maintain their level of profitability, these companies need to replace over time those factories/machinery/inventories. The problem is of course that with inflation, the price of those assets is a lot higher: all of your profits are spent into replacing your assets. Although in the short term your financial statements will show an accounting profit, capital expenditures will be so high that you will feel like running on a treadmill, not going anywhere. If all profits are reinvested into new assets that do not generate more profits, the value of the business will be seriously impaired.

So asset light businesses with a competitive advantage should do well (or, at least, much better than other businesses) during inflation. The good news is that they also do well when there is no inflation, but if you have read my other articles, you already know that :smiley: .

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Thanks for your precious insights.

What would be your thoughts about a broad, worldwide diversified basket of stocks vs inflation? Since different businesses make their profits in different countries and probably not all are affected by inflation in the same manner at the same time, would that allow it to hold its real value better (in the same way as holding a broad basket of currencies would, except with growth expectations baked in) or are the markets too interconnected nowadays for it to work that way?

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Having read @Julianek 's previous comments, I believe what he is getting at is quality investing.

There does not seem to be one aligned definition of quality but if I look at Fundsmith’s interpretation, they focus on businesses with a “deep moat” (competitive advantage) which means pricing power, and high Return on Capital Employed which filters out capital intensive businesses

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Well if you want to specifically hedge against inflation, I don’t think that a Noah’s ark approach (“take two of each kind”) will work too well. Your basket will be made of two kind of businesses:

  • those who won’t be affected by inflation (which will fare as well as usual)
  • those who will be affected by inflation (which will do worse than usual)

I am not aware of any kind of business that would be improved by inflation. So that means that depending on the composition of your basket - how many businesses are impacted by inflation - your basket will fare from a little worse to a lot worse.

But again, this is only from a perspective where your main goal is specifically to protect yourself against inflation.

To be more precise, I was thinking about a subset of the quality universe.

When you look at return on invested capital, you can decompose it in the following way:
Return On Invested Capital = ROIC = Earnings/Invested Capital = (Earnings/Revenue) * (Revenue/Invested Capital).

The (Earnings/Revenue) ratio is called net margin, and the (Revenue/Invested Capital) ratio is called capital turnover.
So ROIC = Net margin * Capital Turnover. (this is known as the Dupont analysis decomposition).

Businesses with a big competitive advantage and thus a high sustainable return on capital can achieve this high return in two ways:

  • A high capital turnover and low margins (a good example would be Costco, with net margins of around 2%. By the way, here is a fantastic and very pedagogic analysis of Costco).
  • A low capital turnover, but very high margin (ex: luxury brands like Hermes or LVMH, Software companies)

And of course you can find other cases between both extremes. The point is that businesses with a high capital turnover will by definition turn over their capital a lot - in the case of Costco for instance, they renew their inventory twelve times per quarter. Although i like Costco’s business model, i am not sure it would work as well with higher inflation. But when I think about it, this business model was created in the 1970’s by Sol Price with its Price Club, and it worked even if inflation was double digits at the time.

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