Dear Fellow Investors and Friends,
Welcome to another edition of my newsletter, where I share my efforts to understand markets and the world around me.
I do appreciate you taking the time to read this. Feedback is welcome; it’s great to start conversations.
Today is Thursday, May 29th, the 149th day of the year. There are 216 days until the end of the year. Today, 14 years ago, thousands started protesting in Greece against austerity measures imposed as a condition for international bailouts during the Eurozone debt crisis. Being part of the European Monetary Union, Greece had given up the ability to print money and, in so doing, earn seigniorage with which to pay down its debt. It was forced into unpopular austerity.
The best business model in the world is not accessible to investors. This business model is called seigniorage, which is the difference between the face value of money and the cost of producing and distributing it. Profitability varies depending on the amount and type of materials used in the money (metal alloys for coins, paper/plastic for notes) and its denomination. For instance, a Canadian $20 bill costs around $1,40 to produce and distribute. Thus, the profit margin on this example of seignorage is around 93%. Few business models are this profitable.
Today, with most money being created electronically, the seigniorage margin is 100%.
Seigniorage is an investor’s holy grail, but how the world is set up today only allows governments to profit from seignorage.
However, it could be helpful to look for business models that approach the profitability of seignorage. Business models with high margins are nirvana for investors. They promise robust earnings with a buffer against cyclicality or interruptions and the ability to choose how to deploy the generous income to increase earnings power even further.
It’s no wonder that businesses with high operating margins enjoy high ratings. If the business is scalable, even better.
In the table below, I have identified some major industry groupings and selected a company as a “poster child” for its industry. These companies share one thing in common – they are strong businesses, with operating margins ranging from high to very high. However, their P/E’s – the rating the market assigns to their earnings – differ significantly. The market values of the different businesses also vary greatly.
Some quite interesting patterns emerge.
But first, eyeball the table for yourself:
BHP is a miner and earns a healthy operating margin on its output, generating over 40 pence for every pound of sales, most years. However, the massive capital cost of extracting, maintaining, and growing its reserve base of mining materials does not appear in the income statement. Furthermore, BHP has no pricing power whatsoever, so even though it earns a healthy margin in a normal year, it often achieves a negligible return or even incurs losses when commodity prices decline sharply. Through the cycle, shareholders are frequently at a disadvantage. Consequently, the market places a low rating on its earnings stream. The business is scalable, but only with sufficient capital investment. As a result, the market value remains relatively small, and the company is not well represented in many indices, despite being one of the largest miners in the world.
Johnson & Johnson is a pharmaceutical and medical technology business. Many of its products enjoy patents lasting up to 20 years. This affords them strong pricing power, resulting in operating margins above 20%. The reason it isn’t higher is that they must spend heavily to build out a distribution network. But the margin is stable – almost year in and year out, they earn over 20 cents for every dollar worth of sales. Despite this, their P/E ratio is relatively low because they, much like the resource companies, must invest heavily in R&D to develop the patented drug pipeline. They also struggle to scale significantly, as their products come off patent regularly, resulting in a drop in pricing power. Replacing these with new drugs is fraught with regulatory difficulty and significant competition from peers. Finally, if their products are found to be defective, they face significant legal risk. As a result, their market value is on the low end of the scale.
LVMH is the representative from the luxury goods sector. It sits slightly higher up on the scale than the previous two businesses. It has margins similar to those of pharma businesses but a significantly higher P/E. This is because it has a lower capex requirement and more pricing power. But it does have to spend quite a bit on marketing, which puts a ceiling on the margin. Also, scarcity is one of the pillars on which the luxury goods business model is built, which limits its scalability. As a result, even the biggest luxury goods business in the world – LVMH – has a market cap on the smaller side in our table.
Philip Morris International is our chosen representative from the tobacco industry. It has been selling the same product for almost 100 years now. The tobacco industry is characterised by low distribution costs, no marketing costs (by law) and little competition due to extensive consolidation. This combination results in an operating margin comparable to mining companies, despite having almost no capital or R&D outlays. They get to keep nearly 40 cents of every dollar of goods they sell! The one flaw in the business model is that they tend to kill their customers, eventually resulting in declining volumes. It’s very hard to scale off a declining customer base, explaining the low market value of the business.
Next week I’ll discuss the other 6 companies, and try to come to some sensible conclusions.
Markets
1. Bitcoin
This week, Bitcoin hit a new all-time high. The bull market in “electronic gold” is in full swing, just like the market in real gold:
I wrote about Bitcoin here, here, and here in an attempt to understand it. At the time, Bitcoin was priced at around $ 60,000. Today it is at $ 110,000. In the piece “Crypto is a Scam”, which I wrote on 1 August 2024, my conclusion was: “For quite a while, I have been buying a little bit of a range of different cryptocurrencies monthly. For the price of one good meal every month, I get a ringside seat to watch something develop into something special. Or not, as the case may be.”
I stand by that view.
Like any other cryptocurrency, Bitcoin is simply a reward for applying computing power to validate information – i.e. solving a cypher – on a blockchain. Its value is determined by the amount of computing power in the system at any time, the amount of crypto offered as a reward for solving the cypher, and the cost of the actual computing power (“mining rigs”).
So, far from consisting of electronic hot air, it does have an underlying intrinsic value.
Because some cryptocurrencies, like Bitcoin, are programmed to have a finite amount in circulation, their value will increase over time to the extent their underlying blockchains attract increasing amounts of activity.
My take: As time passes, increasing amounts of information are moving on to blockchains. However, the real explosion in activity will happen once information on the blockchain starts disintermediating established financial intermediaries. This is not a matter of if but when. The MWI Worldwide Flexible fund (aka the cockroach) owns a company slowly and responsibly transforming into a bitcoin miner, with the ultimate aim of earning seigniorage from this new type of currency.
I’ll leave this quote with you:
“Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.”
– John Kenneth Galbraith
2. Japan
The Japanese market also hit a new high this week:
There is no doubt this is a bull market! And, like the best bull markets, it’s going up with very few passengers. Japan is only 5,6% of the MSCI World Index, down from 44%(!) in 1989. Everyone owns US assets, which make up 71%(!) of that index. When was the last time you heard someone pitch a stock idea outside the USA, let alone one from Asia?
One of the factors driving it is increased money printing, as evidenced by the growth in their money supply:
As a percentage of market capitalisation, Japanese corporations’ cash holdings have consistently been much higher than those in other G7 countries, often exceeding 40%. With long-dated interest rates having increased from 0% to almost 3% over the past couple of years, these companies will show strong earnings growth just from interest earnings.
Despite a declining population, the Japanese have rediscovered their love of spending money. This chart is from Richemont’s recent earnings report:
Japan is cooking! It’s becoming clearer by the day that Japan has reached escape velocity from the deflationary environment it has been mired in for over thirty years.
My take: Japanese stocks are cheap, under-owned, and sit on a lot of cash with very little debt. What’s not to like?
3. Lewis vs. Tencent
One stock has done extremely well over the past few years, and no one owns it. The other stock is Tencent Holdings.
This week, I was reminded by someone on X called David Brent that, on 18 May 2022, I posted this:
What was the outcome?
Since then, Lewis has risen from a price of R36 per share to its current price of R81. Additionally, it has paid cumulative dividends of R13 per share. This yields an annualised return of approximately 38%. Over that period, the rand has depreciated against the US dollar by 4,3% per annum. Therefore, Lewis has delivered an impressive return of over 33% per annum in US dollar terms.
Tencent hasn’t done badly, going from $42 per share to its current price of $64. It has also paid $7,20 in dividends, which equates to an annual return of 19% p.a.
My take: a cheap, unpopular goodie is a better fighter than an expensive, popular goodie.
4. Nuclear power is making a comeback
NuScale Power Corporation provides small modular reactor technology solutions. It listed a few years ago via a SPAC merger, and has done well:
The primary catalyst for the most recent increase in the share price was President Donald Trump’s signing of executive orders aimed at accelerating the approval process for new nuclear reactors and strengthening nuclear fuel supply chains.
But nuclear energy is a global story. China recently approved 10 new reactors, and already has 30 under construction, representing nearly half of all nuclear projects worldwide.
This means that 60 projects are underway worldwide, and the buildout is set to accelerate. There are currently 440 operational nuclear reactors, so the growth rate is over 15%. Finally, it seems as if the world is moving to clean energy.
At the same time, miners of nuclear feedstock, uranium oxide, are mothballing capacity.
My take: Uranium could represent a significant chokepoint in the growth of nuclear energy. It represents a small input cost in the overall system, so the price could be subject to massive (upside) volatility if the current demand/supply dynamics continue. In its “hard asset” allocation, the cockroach owns shares in Yellowcake PLC, an investment holding company whose only asset is uranium oxide concentrate (U3O8).
5. Goldrush Holdings
Goldrush Holdings is an investment company listed on the JSE that RECM manages. It unbundled its Mauritian investment holding company, Astoria, to its shareholders a few years ago, leaving it with its only significant asset: a 60% shareholding in Goldrush, an alternative gaming company.
Yesterday, we heard that a consortium with Goldrush as a significant shareholder was awarded the license to operate the National Lottery.
The Goldrush Holdings share price has reacted positively to the news:
The gaming industry depends on gamers’ willingness to spend their marginal rands. Over the past few years, consumers have had very few marginal rands to spare, so it’s been tough out there.
My take: It isn’t easy to quantify the impact of this award on Goldrush’s profitability, but it is moving things in the right direction. Importantly, it also affirms the Goldrush executive team’s capability. We are proud to be associated with Mergan Naidoo and his team.
In The Media
1. When bad people make good art
A few years ago, an artwork I owned caused some controversy. It was a photograph by Zwelethu Mthethwa and was included in a show at the Iziko National Gallery called “Women’s Work”. Mthethwa, at the time, was accused of murdering a prostitute and was subsequently found guilty.
I thought the work could stand independently of its creator. But many people thought differently, and the show was effectively “cancelled” by the art world. There were protests outside the gallery, and artists whose works were in the show forced the curator to remove their works. The curator also came under humiliating public attack.
It was an unpleasant period in my life, with so many people in the art world – people that I otherwise respected – acting with overt hostility towards me.
So, when I came across this article by Ted Gioia – “When bad people make good art” it resonated with me. Gioia’s main conclusions were:
- Accept the fact that many smart, creative people are flawed human beings;
- We need to offer second chances and forgiveness more often;
- Consumers should make prudent decisions, drawing on their core values, about the books, music, movies, etc., they consume – but individuals, not mobs, should make these decisions; and
- Nobody gets a free pass due to artistic talent.
As Gioia says, there are no easy answers here. But mob justice is not one of them.
My take: I agree with Gioia here. Being cancelled by a mob destroyed my love for the art world, and I stopped supporting it. I’m pretty sure it doesn’t miss my small contribution, but still.
2. Advice from Peter Attia
Peter Attia is my favourite health expert. If you haven’t read his book Outlive, get it now. This week, I want to highlight two interviews involving him.
The first is with Bill Perkins, one of the world’s most successful hedge fund managers and entrepreneurs, and the author of the bestseller, Die With Zero. In this episode, Bill unpacks the Die With Zero philosophy, which challenges conventional thinking about balancing health, wealth, and time – the three crucial variables for fulfilment. Bill makes the case that we should strive for maximum net fulfilment rather than net worth (or even health).
You can watch the interview here.
The second is a podcast on Attia’s channel, The Drive. In this special episode of The Drive, Attia joins a unique conversation inspired by his daughter’s volunteer experience at a senior care center, where she formed meaningful relationships with residents curious about healthspan, lifespan, and strategies for living well as they age. It’s only 43 minutes, but it could be the most important 43 minutes of your life. Listen to it here.
3. Book Review – Plato, The Republic
Plato, along with Socrates and Aristotle, was a foundational figure in shaping the intellectual tradition of the West. I read this book as part of my journey through the humanities, guided by Ted Gioia of The Honest Broker. He offers a 12-month immersive course in the humanities. It will undoubtedly take me much longer, but I’m all in.
Book no. 2 in the course was “The Republic”.
The highlights for me were the famous Allegory of the Cave, and Plato’s concept of the “Philosopher King”.
This allegory describes a group of people who have been imprisoned in a dark cave since childhood, chained so they can only look at the wall in front of them. Behind them is a fire. Between the fire and the prisoners, people walk along a raised walkway carrying various objects. These people and objects cast shadows on the wall, which is what the prisoners see and hear. This is the full extent of their reality.
One prisoner is eventually freed and escapes to the outside world. Initially, he is disoriented, but gradually, he sees the real world for what it is. He realises that the shadows in the cave were distortions of reality. When he returns to the cave to liberate the others, they resist and reject his claims, favouring the familiarity of their limited reality.
The allegory illustrates Plato’s view that most people live in ignorance, unaware of actual reality. It also highlights the challenges faced by those who want to remove the “veil of ignorance”.
Plato was disillusioned with Athenian politics and sought a remedy in philosophy. He was convinced that Athens would never be an appealing place to live until philosophers assumed the role of rulers. He introduced his concept of the “Philosopher King” – a wise ruler who loves truth and possesses knowledge of the ultimate reality.
Although Plato wrote the book, the entire work is presented as a Socratic dialogue, with Socrates acting as the main speaker and philosophical guide throughout the text.
I expected reading the book to be a slog, but the translation by Desmond Lee was quite enjoyable.
That’s book number 7 for the year done and dusted! It’s a real joy to read more.
Finally, I know Johann Rupert says he sleeps with his door open, but the rest of us need to be more careful out there.
Piet Viljoen
RECM