Regarding… Vol 2 no 31 – Just sit there

Dear Fellow Investors and Friends,

Welcome to this week’s edition of my investment musings, where I try to make sense of the world around me and share stuff that I find interesting.

I do appreciate you taking the time to read this.

Today is Thursday, August 15th, the 228th day of the year. There are 138 days left until the end of the year.

Spring is slightly more than two weeks away, but we are still in the depths of a cold and wet winter here in Cape Town. Every May, as winter approaches, I anticipate what I imagine will be warm, cosy nights beside a fire. Every August, I wish the winter would go away and never come back.

On this day in 1969, the Woodstock music festival opened in Bethel, New York, on Max Yasgur’s Dairy Farm. It turned out to be one of the defining events of the 1960s – a cultural milestone for the Boomer generation.

An estimated 400,000 – 500,000 people showed up, by far the most people to ever attend such an event. One reason it became so famous was that it was so poorly organised – the attendance far exceeded anything the organisers expected.

Traffic jams, heat, rain, food shortages, and widespread drug usage all conspired to make it one of the most memorable events in pop history.

Here is an original news report of the event.

The amazing thing is that despite the circumstances, the crowd’s behaviour was reported as being quite peaceful. Of course, Boomers have always been more politely behaved than subsequent generations.

This brings me to the topic of this week’s letter: our behaviour as investors.

In Lessons Learnt, I referred to Carl Richards and his book The Behaviour Gap. In the book, he defined the “behaviour gap” as the difference between the investment return of an asset or portfolio and the return you earn as an investor.

Behaviour is an important determinant of the returns you will earn as an investor. So is luck.

Other, much less important ones are intellect, skill and aptitude.

Behaviour beats intelligence every time.

As with most things in life, there is a formula for this:

Lifetime Investment returns = (Behaviour to the power of luck) plus (Investment Skill/Time)

The thing you can control, modify and improve over time – your behaviour – is key. Luck, over which you have no control, amplifies the effect of your behaviour. Skill is additive; it has less impact on the outcome. Importantly, the longer the time period over which you apply good investment behaviour, the less important skill becomes.

My own behaviour has often led to sub-optimal investment outcomes. Many times. This has caused me to think long and hard about how to avoid my natural inclination to behave badly when investing. Especially considering how impeccable my behaviour in all other aspects of life has been.

These are some of the things I came up with that can be built into an investment process which can improve our behaviour:

Checklists – There is a reason highly skilled professionals like doctors and airline pilots use checklists. Human memory is limited, and attention spans can be interrupted, causing one to miss important steps in a process.

Guardrails – Implementing tight guardrails in one’s investment process removes the temptation to move outside your circle of competence. Let’s face it: when that bright, shiny new AI stock peeks its head above the parapet, we all want to buy it, despite not understanding the first thing about AI.

Forecasts –  Howard Marks said, “There simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality, and randomness. Politics and economics are two such fields, and investing is another. No one can predict reliably what the future holds in these fields, but many people overrate their ability and attempt to do so nevertheless. Eschewing certainty can keep you out of trouble. I strongly recommend doing so.” I have nothing to add here.

Emotions – Avoid situations where your emotions take over. The Limbic system processes our emotions and regulates behaviour during times of emotional stress. It’s a primitive system that basically reduces decisions to a simple fight-or-flight response. This is not a good response to potential investment opportunities. As Mauboussin said, “Think Twice”.

News – The main purpose of news is not to inform you but to sell more copies/clicks. It is literally aimed at evoking emotions. Rest assured, by not engaging with mainstream media, you won’t miss out on investment opportunities. When things get cheap, they stay cheap for a long time, and when they get expensive, they stay expensive for a long time. You will notice without having to endure the news.

Volatility – Sharp moves up or down in markets tend to make you think you are either stupider or smarter than you actually are. Very smart and very stupid people have one thing in common – they tend to do stupid things. I try not to watch the market all the time so that I won’t be influenced by short-term volatility, which conveys no valuable information.

Crowds – People in crowds behave very differently from individuals. From political rallies to sports games, from public riots to religious fervour, collective gatherings can incite strong emotions. As a result, decision-making is worse; there are fewer inhibitions and a loss of individuality. This can lead to a collective behaviour that is impulsive, irrational and unpredictable. As Pascal said, “The sole cause of man’s unhappiness is that he does not know how to stay quietly in his room.” it’s exactly in that quiet room that the best investment decisions are made.

The best investors are not omniscient polymaths. Rather, the best investors have a systematic investment process, apply it patiently and don’t let the tug of news flow, volatile markets or the action of others influence their behaviour.

Just leave your portfolio alone and let it compound. Don’t do something, just sit there.

I wrote about UMG in May of this year when its share price finally rose to above its listing price. You can read what I said about it in “Sanctions Don’t Work”.

More recently, the share price of UMG took a hit to levels once more below the price at which it listed in 2021:

That’s almost three years of not going anywhere, despite having Taylor Swift on their books. This once more goes to show that when a stock comes to the market via an IPO, it’s not because the owners are being nice to the new shareholders.

Be that as it may…

Like Netflix, UMG is a content business, which is generally a good place to be. UMG’s strength is that their content is timeless, as we tend to listen to the same 80’s music over and over. In contrast, Netflix must produce new content every year. We just don’t rewatch the same movies over and over. That is if you ignore “Pretty Woman”, which my wife Amanda might or might not have watched more than 50 times.

The type of content UMG owns – an extensive portfolio of record labels and publishing entities – gives it tremendous power. But in business, the best distributor almost always wins. In the music business, the distributors are Spotify, Apple Music, etc.

My take: The recent 25% decline in UMG’s share price was caused by a slowdown in streaming and subscription sales due to the distributors – Apple Music, Spotify, and Amazon – increasing their prices. These distributors make up around 75% of UMG’s revenues. This highlights UMG’s vulnerability to the pricing decisions of its concentrated client base. Priced at 25x earnings, UMG is still too rich for me. It’s a great business, but at this price, possibly not a great investment.

We love music but need food. You would think food producers would be more expensive than music producers. But it’s hard to make good music and easy to make more chicken.

So, the chicken business has ended up being a cyclical commoditised business, where scale can help you survive but seldom thrive. The king of the chicken business in South Africa is Astral Foods. It is a well-managed, scaled business. It produced 200 million(!) broilers (the term for a chicken bred for meat production) annually.

Despite its advantages, Astral’s share price is only a bit higher than it was 10 years ago.

Enter its main competitor, Rainbow Chickens, into the market after being unbundled from its parent, RCL Foods.

Rainbow slaughters 197 million birds annually, so it’s similar in size to Astral. It has similar revenues and is similarly loss-making at present.

Its problem is debt. RCL unbundled it with more than its fair share of debt, which for a commodity business can be a death knell. Since its listing in June, Rainbow has gone south:

My take: When it comes to chicken businesses, I’m a chicken. And when it comes to indebted chicken businesses, I’m even more chicken. Also, only 20% of the business was floated on the market. Remgro owns the other 80%. They are no doubt also looking for an exit, so there is a substantial overhang.

The Glencore share price has not suffered as much as most other commodity companies:

I guess its ownership of strongly cash-generating businesses that provide a dividend yield of over 7% helps!

One of those businesses is its coal mining business. Glencore has been flip-flopping around its ownership of coal assets for quite a while now. First, it said a “responsible steward” of coal assets would run them down in line with the “energy transition” – referring to themselves, of course.

Then, it bought more coal assets from Canadian group Teck Resources while simultaneously offering the green energy lobby the olive branch of a spin-off of the whole “dirty” bundle.

Finally, eight months later, it put the question to a shareholder vote. Thankfully, shareholders voted for Glencore to keep its coal assets. Glencore’s coal assets generate tremendous amounts of cash, and the prospect of fat dividends swayed the vote – as it should.

CEO Gary Nagle also said that Glencore “preserves the option” to consider a spin-off of its coal assets in the future. Of course.

My take: Glencore did the rational thing by keeping its coal business and not depriving shareholders of cashflows like Anglo American did when it spun off Thungela. The MWI Value Fund owns Glencore; it doesn’t own Anglo-American.

This brings us to Glencore’s little fourth cousin, twice removed – Merafe. Merafe’s revenue and operating income are primarily generated from the Glencore-Merafe Chrome Venture (“Venture”), which is one of the global market leaders in ferrochrome production. Glencore has operational control and control over capex. Merafe earns a 20,5% share of the EBITDA generated by the business.

This is not an insubstantial amount, albeit cyclical. Over time, the share price has reflected this strong earnings power:

Being cyclical, a sensible way to look at those earnings is to take a 5- or 10-year average number. Based on 10-year average earnings of 29cps and a current share price of R1,45, Merafe is being priced on a 5x P/E. During this time, earnings per share have been as high as 70cps and as low as -3,4cps. The latest six-month number is 28,2cps.

Merafe, due in no small part to Glencore’s judicious capital allocation policies, refrains from investing in new projects – that destroyer of every mining investor’s hopes and dreams. It can, therefore, pay a regular, substantial dividend. The latest interim dividend is 20 cents.

Today, Merafe is on a dividend yield of 29%.

My take: I call Merafe the little stock that could. It has been a great investment for the MWI Value fund under the able guidance of its CEO, Ms. Zanele Matlala, who also happens to be on the board of the RECM Foundation and Goldrush Holdings. Both entities have benefitted tremendously from her guidance.

Two things stand out: The South African Rand is cheap, as are the Taiwanese and Japanese currencies.

My take: I’ve said it before. Japan is one of the most special places on earth to visit. Go as soon as you can. It won’t stay this cheap forever. And for my foreign readers – South Africa isn’t half bad, either!

Here is a chart showing how the GDP of different Southern American countries have grown over time:

One can draw a few conclusions:

• Venezuela used to be twice as wealthy as Chile.
• Then Chile followed Milton Friedman‘s ideas while Venezuela was ruled by socialists.
• Venezuela is now half as wealthy as Chile despite its ample oil reserves.
• Argentina has done surprisingly well despite its policies.
• But this might have to do with a latitude bias in wealth which seems to hold at a global, continental, and country level. The further from the equator, the richer. Proper scientific studies on this simple observation would be interesting.
• Maybe that’s why everyone in South Africa is moving to Cape Town.

My take: You can be a socialist at home, and most of us are. But when it comes to allocating resources in a large, complex system, like a national economy, socialism fails miserably. The market does a much better job – not perfect, but much, much better.

I didn’t watch much of the Olympics after that opening ceremony, but I did manage to watch some of that most athletic of sports, breakdancing. Especially the Australian entry, who goes by the name of Raygun. Yes, I know…

In any case, here she is, showing off her Olympian athleticism:

It’s hard to believe, but the judges gave her a score of 0 in one of her so-called “battles”.

My take: I just heard the bad news that this sport event has been removed from the next Olympics. It was the one thing at the Olympics I couldn’t tear my eyes away from.

I watched this series on Netflix last week while travelling to and from Mauritius. It follows the season of five wide receivers in the NFL (American Football). Wide receivers are the guys who catch passes thrown by the quarterback. Receivers are fast and have good hands, almost like wings or fullbacks in rugby union.

The football used in the NFL is smaller and harder than a rugby ball. As a result, it’s really hard to catch, especially with a bunch of defenders trying to stop you from catching it.

These guys make it look easy.

The NFL also does not have laws protecting the ball carrier from dangerous tackles. At least none that I could make out. The receivers are targets for a demolition derby, which is what tackling in that league mostly resembles.

That they can still walk after the season is a miracle.

Anyway, this series showcases the amazing lives of these players, on and off the field—the ups and downs, the highs and the lows, warts and all.

My take: Even if you don’t know the first thing about American Football, if you love sport then this is a riveting series. It also proves – yet again – that everything the Americans do is bigger, brasher and better than what the rest of us even think about getting up to. Make up your own mind on whether that is a good or a bad thing.

This week, I built a playlist of my 10 best cover songs. I think Steve Jobs said that the more constraints you impose on a project, the better the outcome. At least, I think he said so.

So, the constraints I imposed on this playlist were the following:

• It had to be by an artist whose body of work I really liked.
• The original had to have been by an artist whose body of work I really liked.
• The original song itself had to be a goody.
• The interpretation by the cover artist had to be an interesting take on the original.

So, here’s what I came up with on Spotify.

You will notice there are 11 songs on the playlist. 10 was one constraint too far!

See how many of the original songs and artists you can identify (remember, this is a safe, AI-free zone).

Hopefully, there are some songs here that you really like, too!

One more observation – women are better than men at many, many things. From my limited sample, cover songs are one of them. But not so much breakdancing.

Also, this week, my stepson Zac celebrated his 24th birthday in London. His mother is very sad, as this is the first time she has not been with her son on his birthday. All you mothers out there will feel her pain – and her joy that she has raised such a wonderful young man.

I just wish he would work harder so I can retire sooner. The pounds are not coming in fast enough.

That’s all for this week!

And remember, always and at all times, be super careful out there.

Piet Viljoen