I hope you all had a great Halloween weekend, and hopefully enjoyed my last posts (they are here in case you missed them)! I have received some constructive feedback , and a few encouragements… keep them coming, I am eager to improve! I had some feedback that this stuff is too heavy, which I appreciate and beg you pardon, I will try to include some lighter content in the emails but… this is the stuff that gets me interested, and I will hold no grudge if you skip the emails… I understand that!
The inspiration for today’s post was actually not a tweet but a sentence I heard in an episode of a cool podcast I listen to regularly:
“If the last 10 years was about beta, the next 10 years is about Alpha. Not all companies are going to do well, not all companies are going to bounce back.”
In this context he refers to Beta as innovation and growth: in the past 10 years most of the winners in the market were companies that created new products, drove topline growth, disrupted markets (e.g. Rivian, Peloton, Shopify, Robinhood, etc). On the contrary by Alpha he means going back to the basics of corporate management, focusing on unit economics, bottom-line, cash flow, long term sustainability etc.
This sentence was part of a segment of the podcast where the hosts were talking about business environment dynamics, especially in the Big Tech industry, and more importantly what we should expect for the recent future. While most of the discussion below is going to be focused on Tech companies, the repricing of assets has interested many classes, from NFTs (remember those?) to BTC to… Rolex prices apparently (not that I noticed I must admit):
In that discussion another point that hit for me was that the recent market correction (S&P500 is -22% YTD, and the FAANG stocks have all materially repriced) is driven by markets pricing-in two factors: Earnings compression and risk of fat tails.
Starting from the second part I think there’s a lot of truth to that, we can all appreciate how business results especially for large caps in the coming months do not only depend on controllable inputs but also on the impact that low probability yet very impactful events would have (I hope I did not butcher too much the definition of “fat tail”, Mr Taleb please forgive me). Some key things that come to mind are the risk of war in Russia, the chip war in China, the consequences of the CCP meeting in China and the potential implications of a war in Taiwan, etc.
These large scale geopolitical events, combined with the impact of high inflation and a recession, definitely have a non negligible impact on the trend of stock markets. I will not go deeper here because I do not think I have anything interesting to say, these are very complicated and nuanced issues that I have no business discussing. I spend a lot of time reading and going deeper on these topics, but I do not think I have any smart thing to say on this specific moment.
The second factor, the compression of earnings resulting from this economic environment (i.e. increased cost of supply chain, inflation, contraction of consumer demand, etc) is instead something that I spent quite some time thinking about.
One starting point is that zero interest rate has surely driven some poor investment decisions, as the Brad Gerstner puts it “I actually think free capital was a weapon of economic destruction. Free capital hurt good companies from being great companies. They hired too many people, their margins were too low”. The future success of companies is going to be driven by the ability to build great products and drive great business models that allows them to compete and continue to invest at high rates in the next wave of innovation (e.g. AI, next gen green tech, etc).
The tendency in the last quarters, both in public but also in private markets (based on what we read on the news) is to have a very strong focus on improving earnings. The authors have a very interesting perspective that the winners in the medium run will be companies that can show ability to scale and do that with a balanced earnings profile.
“The only irony there, is that that comes as a surprise. God forbid we should actually expect companies to prove unit economics and and to make profits.” It’s very hard to remember this when you’re in the middle of a market wave, but we have been for a long time in very long bull run where to be frank unit economics were often disregarded and profit looked at like some kind of self-punishment.
While the discussion is glooming and at points depressing, there’s actually a very material silver lining at the end. The authors, and I concur, conclude this discussion by agreeing that leaving aside the impact of the fat tails (it is very hard to say what are the precise probabilities of a nuclear war, and what impact it would have on the stock market) most of the repricing is already behind us: “Last year we were all sitting here and said asymmetry to the downside, multiples at all time high, interest rates at all time low… we saw that starting to roll over, we saw smart people like Elon start to sell into it. As as I sit here today, yes we're going to have harder times ahead economically but it feels to me like a lot of it is priced in. I do not think we have a huge asymmetry in the downside. It does not look like the time to call the big short, but rather a time to be neutral to positive”.
A final point on this topic is more around the management skills and the culture that we have built in this bull run and whether those will help us face the headwinds of this new phase we’re in. Still quoting the podcast: “It's like we've gone through an entire decade of under training an entire generation of people in Silicon Valley. You know we have under under trained and under mentored the product managers, the engineers, the senior executive management, the CEOs. Many of these people unfortunately don't have the skill set to execute at a high level at any point in the cycle except when rates were zero. For many business models now that rates are not at zero, these people are turning out to be extremely underdeveloped and unable to run these businesses”. I often joked with my friends who lived the 2008 M&A s-boom that at some point having lived through a recession would have been a good point in our CV.
This goes back to the Alpha vs Beta discussion above, it’s not a matter of being better/worse but it does take a very different skillset to drive a beta company (i.e. innovating, launching new products, challenging the status quo, etc) and alpha company. There’s a lot of good books and knowledge about “Alpha company skills” (e.g. SV-classic Zero to One) and “Beta company skills” (my favorite, another SV-classic The Hard Thing about Hard Things)… I have read some but do you have any good advice that comes to mind? I would love to hear those!
Have a great weekend, and I hope you find something interesting in the links below!
Ciao!
THINGS I LIKED THIS WEEK:
First of all big shout-out to a beta feature that the Musixmatch team put out, that focuses on podcast and has the great advantage vs other podcast players to show the transcript of the show. I love it! As always Musixmatch is killing it, big Italian pride!
Very cool AppleTV series on the story of Wework (Wecrushed). To be honest I enjoyed more the book (Billion Dollar Loser), that I read a few months ago, than the series. But Anne Hathaway is a great actress and the story is a really fascinating one… kind of the sublimation of “Beta years madness”!
Being a long weekend I actually got to read more than usual and I stumbled upon two short but very nice books that put me in a very good mood. I learnt from an avid reader friend to always have 2 books in parallel on the Kindle, and I always do that with a fiction and a non fiction:
Fiction - A Man Called Ove (in Italian the title is cooler: L’uomo che metteva a posto il mondo). A really sweet story staged in the nordics, that reminded me a lot about Clint Eastwood’s character in Gran Torino (old grumpy man with a good heart) .
Non fiction - The Go Giver, this is a short business book put in form of a story. The reason why I liked it is that usually business books are about the rhetoric of “go-getters”, “hustler” and aggressive goal-oriented attitude. On the contrary this book is about the power of being nice, giving with no expectation of a return, and caring for others. And how that ends up being a good thing also for business, besides karma!
Liked it a lot. Also reminded me of this quote by Kurt Vonnegut: “Another flaw in the human character is that everybody wants to build and nobody wants to do maintenance”.