Back to Basics

Back to Basics

When all else fails, investors can always go back to basics; own dividend-paying monopolies with powerful, lasting brands across multiple sectors. Save regularly, or better yet religiously, and also keep a healthy stash of seed capital in risk-free U.S. Treasury Bills earning that juicy ~5% interest.

This Bear Market will end as every other bear market ended, when, however is unknown. Some clues will be that the Federal Reserve stops hiking rates, inflation stabilizes or falls, and/or an increasing number of stocks begin to hit new 52-week highs.

The latter point is almost always a sign we have exited a Bear Market. So for those weary investors beaten to a pulp by bad economic policy and the Fed tightening the screws on you, hang in there. Continue to build positions and keep an eye out for the end of the bear. Until then, it is back to basics and avoid the Risk of Ruin.

 

Reverse Engineering

Reverse Engineering

Generally speaking, stock prices increase with increased earnings. When a company makes more money, in general, their shares are worth more because investors put value in growth and reward it by bidding up the share prices of companies that increase their earnings. Naturally, the opposite is also true. Granted, there are always exceptions to the rule, but for the most part earnings drive the market higher.

Along those lines, investors should be able to reverse engineer a portfolio based on their spend habits, or even consider the spend habits of a typical cohort. So for example, if you have a breakdown of your monthly expenses you can also typically trace that spending to broad sectors, and specially individual brands. This provided a good backdrop to the Chinatown adage of "follow the money."

A classic Maslow's hierarchy of needs also works well in this example. For the "average" American, the top three expenses on a recurring monthly basis are housing, medical, and food. Now for people who are NOT self-employed, that medical cost might not be too high because your employer is picking up the tab. Consider their cost in our example as yours.

So right from the start we can see from a percentage basis how much of our monthly income feeds the banks for mortgages or the landlord, the medical plan operator, and the food prodders. Depending on your situation, there most likely will be energy costs (fuel and/electric), clothing, entertainment, and many others. List them out and I suspect you'll start to see the brands behind the sectors popping up. Take note of the specific brands you utilize both as a function of your purchase, but also your time. You might only buy a smartphone once a every couple years, but you most likely are using it frequently. Same for a computer. TV. Internet.

All of these purchases and time uses trickle down to brand utilization. The brands with the most utilization should be ones you pay attention to from a portfolio perspective. You are probably not alone in your brand utility. And generally speaking, yet again, the fewer brands choices you have for a good or service or time usage the more of the total market that brand is capturing.

This reverse engineering exercise should reveal some very powerful, some would say monopolistic, brands in your life. Maybe you should consider owning them?

 

Branding Power

 Branding Power

There is no better adversary to inflation than a strong brand. Branding power allows a company, typically consumer-facing, to INCREASE their prices or "pass-along" underlying inflationary costs for their raw materials on to the end user. But this cost transfer is a little misleading. And something we as financial farmers should pay closer attention to.

Consider the lowly pound of coffee. Typically sourced from arabica beans in a mostly equatorial geography, a pound of coffee "arrives" here in the United States via a circuitous path from grower to harvester to roaster to grinder to your morning cup of Joe. Now the headline inflation number we might see for a pound of coffee might be 10% for example. Consumers just assume by constant media barrages that they will be paying headline rate increases. And they're right, kinda.

That 10% increase on a pound of coffee might translate to a whole price increase of $0.30 cents on the pound for a large, vertically integrated coffee company. That company can "cut" a pound of coffee into approximately 30 cups and sell each for a retail price of $5. But with "inflationary pressure" the NEW price is $5.50...a "10% increase." 

Quick math here reveals something quite different. That $0.30 increase at the wholesale level is a boon at the retail level, allowing the coffee retailer to rake in another $15 per pound. Assuming the brand is strong enough, and product good enough, an investment of $0.30 yields a an amazing 50X return for the retailer! 

We used coffee as an example, which is one of the most lucrative businesses in the world, but the same concept applies to nearly every other consumer-facing brand. Wholesale price increases "give permission" to the company to increase prices on the consumer. One could even argue that inflation to retail-facing companies is a flywheel which ignites further, compounded profits. Consumers are hard-pressed to find FALLING prices once an inflationary spiker recedes. Higher prices are sticky...and honey to the owners of these brands!

 

Betting on Human Behavior

 Betting on Human Behavior

My ears perk up whenever I see or hear about changes in human behavior because experience has taught me whenever human behavior changes, and that change is sustained, a lot of dollars are behind it. There are many ways to make money in this world, and one of my favorites is to bet on human behavior.

Almost always, changes in human behavior are subtle at first, then big and obvious. The German philosopher Arthur Schopenhauer described truth, an accurate corollary to human behavior, as passing through three stages: "All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident. To that end, I want to spot behavioral change early and act on it.

Big tech likes to capture large data across multiple clouds to run predictive analytics. Visualizing data in this context is important because it allows companies to find sustaining trends. Although their resources are virtually limitless, big tech still depends upon someone, doing something, to change some human behavior. It may be just a nudge to an existing behavior, or it could be something truly disruptive, but the litmus test is spotting a trend based on evidence of human behavior change.

Trendspotting changes in human behavior early is valuable because changing human behavior at scale is capital intensive. People don't just line up to pay $5 for a cup of coffee; that behavior was nudged to where it is today. A lot of marketing, brand creation, construction, and products coupled with decades of advertising needed to occur to make that human behavior change happen. Many attempts at behavior modification fail. Hence, usually by the time a change in human behavior is noticeable, the seed has taken root and is growing. These are the seeds big tech is looking for and the ones investors should be cognizant of as well. Lao Tzu said it well, "To see things in the seed, that is genius."

Human behavior is often a leading indicator of where the profits will flow, especially if a company succeeds in turning a commodity into a brand. What do consumers ask for? Carmel-colored cola? Athletic sports shoes? Electric-powered cars? A video conference call? No. Consumers ask for the brands. Branding typically results from repeated nudges from marketing or praise from fellow consumers who have tried the brand. From there, if successful, human behavior grows tap roots and the brand becomes sustainable. Investors can reap significant gains in owning companies with high margin/high volume products and services typified by strong brands. There is, however, a sly danger to this success.

Danger arises when the human behavior changed becomes so successful that the brand reverts back to a commodity. Success breeds copycats. A niche without moats, such as superior technology or intense consumer loyalty, is usually exploited by competitors. Rarely have I seen a consumer ask for a branded gasoline or a branded wireless carrier for example, at some point a highly successful product or service reverts back to commodity status unless it innovates by changing human behavior and renewing the innovation cycle.

We're at that very crossroads today. With multiple crises engulfing our society, a whole new wave of companies are being formed as you read this blog and many will be coming to the market soon, if not hitting the tape already. Human ingenuity is a powerful force, the desire to survive is strong, and unleashing animal spirits creates opportunity. One change in human behavior that has caught my attention is in sports.

The reopening of sports leagues across the country has temporarily satiated the hunger for the proverbial "Bread & Circus" that runs deep in our collective psyche. Competitive physical human sports have been with us from the dawn of time. But along with the reopening of sports something else has occurred, or I should say reemerged, and it is a powerful, instinctive, human behavior.

The way many viewers increasingly enjoy sporting events now is directly tied to wagering on them, legally. Sports betting now has the umbrella support of the 2018 PASPA ruling, which changed everything. PASPA legalized sports betting at the federal level, and states like New Jersey jumped on the bandwagon early. Residents in these early-adopter states didn't waste time either; they've unleashed a proverbial tsunami of bets.

Sports betting has arisen as probably one of the most exciting new economic sectors in recent memory. The initial revenue numbers are staggering. Hungry for tax revenue, states are trying to pass legislation as fast as the quill can write. Twenty-two states and the District of Columbia have legalized sports wagering since the 2018 ruling.

As expected with a behavioral change at scale, there are all types of derivative jobs arising from this new (legal) sector. From payment processors to software developers to accountants, the potential spectrum of new jobs created is vast. New sectors typically have long runways and spawn secondary and often tertiary industries. All of this is a result of human behavior change. 

Prior to the PASPA ruling, sports betting was obviously still happening. But legal sports betting was primarily restricted to Nevada, and wagers had to be placed in person at a casino's respective sportsbook. Bettor's were issued a physical ticket. A confluence of events coupled with technology has radically changed the dynamics of betting in the pandemic stricken post-PASPA world; now every living room is a potential sportsbook. 

A Tale of Two Markets

A Tale of Two Markets

It was the best of times, it was the worst of times...the NASDAQ's heavy tech components roared to new 52-week highs on almost a daily basis, while iconic global consumer brands struggled to keep their heads above water. What happened?

I have noticed a massive decoupling in the stock market over the past 5 years, and over the past year in particular. Typically defensive consumer staple stocks have gotten hammered...and we're talking Bear Market territory for many of the largest brands in the world (a Correction is a 10% selloff from a stock's high, while a Bear Market is defined as a 20% or more fall.)

How could this happen when rates are still at historic lows, unemployment is low, the global population continues to grow, and the economy is booming? Not so fast. The economy IS booming, BUT in CERTAIN sectors. Consumer staples (think toothpaste, diapers, soap, hot dogs, macaroni & cheese, bleach, tissues, paper towels, etc.) have for decades relied upon BRANDING to charge a massive premium over a similar generically produced product. Who ever orders just a "cola" from a restaurant? Or asks for carbonated water and sugar? No one. Consumers have been steered towards brands since birth. An interesting thing is happening though, and it seems to be accelerating.

The oft-cited force of "tech disruption" has uniquely impacted classic brands in a singular way; consumers can now price shop globally and have orders filled at signifiant discounts to traditional full retail prices. Rather than laser-focusing on innovation, distribution, and consumer satisfaction what I've seen are major brands saddling up with lean manufacturing to such an extent that employees have to justify ordering pens or toilet paper. This is a race to the bottom.

The flip side of the coin are the tech innovators who leverage their massive economies of scale and state-of-the-art logistics to provide an unrivaled consumer experience. Many of them are pure software companies, some are not, but the result seems to be the same: extremely satisfied customers who have developed TRUST in the brand. So much trust, that these tech innovators can repeatedly launch offshoots of their core brands into a captive consumer market that actually embraces the new product or service. And many of these products or services directly compete with established legacy brands.

The game plan needs to change for legacy brands to thrive; the old vertical mindset of acquiring lowest cost raw commodities, manufacturing with razor thin margins, spending billions on marketing, and capturing the global consumer from birth is giving way mightily to logistical systems offering consumers ease...and better prices.

Mergers & Acquisitions

     Today's proposed merger of KraftHeinz (a product itself of the recent mega-merger of Kraft and Heinz) with Unilever begs the question of truly how many companies really control most of the consumer brands we use? Shockingly few is the answer, and looking like even fewer in the future as jobs and workers are replaced with autonomous factories, warehouses, and shipping. The drive in recent deals has been to laser focus on logistics, remove any friction to seamless inventory control, and vertically integrate operations.

     After squeezing every nickel out of manufacturing efficiencies, the next logical step is to squeeze the workers out of their jobs. This has been the hallmark the M&A world for decades, and has become an art form amongst some of the biggest private equity firms. Much of the cost savings of vertically and horizontally integration comes from reducing headcount, traditionally the most expensive cost in a manufacturing operation.

As the above graphic illustrates, only about a dozen global conglomerates control nearly every major food & beverage brand in the world; the economies of scale in terms of their ability to manufacture, market, and distribute are undoubtedly the purest definition of a monopoly. The big winners are the direct owners, the losers are phased out workers and ultimately consumers that become price-takers.

The Power of Branding

The diagram above created by Convergence Alimentaire provides a powerful mental image of many of the brands we enjoy on a daily basis, and in particular, how very few companies actually control vast branding power.

As financial farmers, powerful branding is important to us because it leads to cash flow. Cash flow in turn leads to compounding (seed growth in our vernacular), which is the entire purpose of planting your own diversified financial farm.

There are several companies above that own multiple billion dollar brands, brands that if spun off on their own would be world-class enterprises. The success of these conglomerates, however, is greatly enhanced by their ability to vertically integrate various product lines under a single umbrella. Theoretically, cost savings can be harnessed in advertising dollars, marketing, technology, manufacturing, distribution, and most importantly personnel. 

There are many advantages to owning quality brands, the individual who plans to Invest Like A Farmer should consider establishing the core of his or her financial farm with multiple high-quality brand-centric companies. Several advantages include significant barriers to entry, established shelf positions, mental identity from the consumer, and proven track records to name a few. What this typically translates into is revenue, and more importantly, profit for the financial farmer.

Brands successfully marketed and sold lead to strong cash flows, increasing dividends for shareholders over time and considerable market share. These are all good results that any prudent farmer would love to plant and harvest.

Three Cheers for Boring Investors!

As reported in the Wall Street Journal this morning, boring investors did well in 2013. Apparently, this is such big news that it was actually ABOVE the fold on the front page. Of course frequent readers of this blog have known this approach since day one. The extent that this strategy worked in 2013, however, was truly impressive. After literally several decades of pain, those who decided to Invest Like A Farmer notched a spectacular win this year. For a quick recap of the rule set T. H. RAPKO & COMPANY, LLC implements, see below:

Rapko's Rules

1. Boring is undervalued. Look for companies with established brands. If they are exclusive, finite, hard-to-get, vital, addictive, and/or monopolistic, so much the better.

2. I prefer companies that pay me to own them. Specifically, I want to buy companies that pay quarterly dividends that have historically risen over time.

3. Of the four possible outcomes; high margin, high volume is best.

4. A steadily moving higher and higher left to right stock chart is a good thing; the inverse it not.

5. Inevitably, and by definition, more time is spent holding a losing position than is necessary. Cut your losses.

This rule set has served the financial farmer very, very well in 2013 and based on the economic climate going into 2014 it should prove equally fruitful. What's really so surprising is that this is of any great news at all. Warren Buffet has preached this sermon for over 60 years and NEARLY every successful long-term investor follows a similar rule set in some form or another. There are notable exceptions, but for some reason they always seem to end up in jail. 

Going into 2014 individuals who wish to Invest Like A Farmer should laser focus on either buying or developing quality brands that have both scale and utility. America still has one of the best climates, quality of soil, and promising batch of seeds to plant for your own financial farm. Embrace calculated risk and plow ahead.

Here's a toast to very happy and profitable 2013 and may many more years of the same follow. Cheers!

Create A Brand

T. H. RAPKO & COMPANY, LLC Logo ™

I'm often asked by readers of this blog the best (and fastest!) way to make money. I usually respond with the same answer; you can either buy brands or create them, but making money in either situation takes time and patience. Fast money is nice, but it also has consequences; repeatability is called into question, greater risk, and higher taxes on short-term gains are all concerns. Many young investors don't have adequate seed capital to purchase meaningful quantities of shares to help launch their financial farms early in their careers and find themselves in a quandary. How best to pursue creating wealth without seed capital? It is truly difficult to see a global stock rally and not participate in it, but fear not loyal blog readers, all is NOT lost!

One of the most important lessons is that to profit from growth, you need to be in the game in one form or another. That means securing some type of equity position, which generally leads to two choices for someone who wants to Invest Like A Farmer; purchase positions in real estate, bonds, or (preferably) equities OR go about creating your own brand. Many successful financial farmers do both.

What is a brand? It is the (ideally) trademarked name and/or logo of a product or service (or both) which immediately calls to mind what that product or service is when the brand is mentioned (termed a metonymy.)

Why is a brand important? A brand selectively targets a consumer for its product or service, and generally speaking, a branded product is typically sold at a greater premium than a generic product or service which in all actuality maybe nearly identical to the branded product. The successfully branded product, however, has established a greater perceived utility than a generic product and consequently charges a higher price for the good or service. The better the brand, the greater the implied prestige and usually the higher the margin, profits, and market share. Couple this with mass appeal and you may have a winner on your hands.

Assets come in a variety of forms; from physical assets like farmland, gold, and oil to legal assets including shares of stock, debt instruments such as bonds, and intellectual property including trademarks, copyrights, and brands themselves. The prudent financial farmer is always looking to cultivate quality assets on his or her financial farm; if buying a brand isn't feasible, consider creating one.

A Bet on Population Growth

If there has been a "sure" bet, it has been the bet that the worldwide population will increase; indeed, since the middle of the 14th century there has been continuous growth in global population. The United Nations estimates that by 2050 we will have between 8.3 and 11.9 billion people on Earth, from 7.1 billion today.

What does this mean for the individual that wants to Invest Like A Farmer? It is pretty clear to me that following some semblance of "Rapko's Rule's" (see below) should pay off handsomely assuming the financial farmer doesn't interrupt the compounding cycle and also has a reasonable (think several decades) of investable time on his or her hands.

Rapko's Rules

1.  Boring is undervalued. Look for companies with established brands. If they are exclusive, finite, hard-to-get, vital, addictive, and/or monopolistic, so much the better.

2.  I prefer companies that pay me to own them. Specifically, I want to buy companies that pay quarterly dividends that have historically risen over time.

3.  Of the four possible outcomes; high margin, high volume is best.

4.  A steadily moving higher and higher left to right stock chart is a good thing; the inverse is not.

5.  Inevitably, and by definition, more time is spent holding a losing position than is necessary. Cut your losses.

In summary, I look for boring, dividend paying companies that have a high margin, high volume business with steadily increasing left to right stock charts. I'm not afraid to cut my losses early.

Now, what do the Rapko's Rules have to do with making a bet on population growth? Everything!

The dynamics of population growth are very interesting because across humanity many of us want the same things; a sense of purpose, good health, longevity of our family, communication, pleasurable pursuits, and the ability to make a positive impact on the world are just a few. Having traveled a fair amount, I can see many, many similarities across the globe. HOW these goals are accomplished, however, varies greatly. Many developing countries have completely skipped the desktop, laptop, and advanced directly to mobile phones for their communication and internet access. The same can be said of medical care, where a drug delivery solution which may have taken hundreds of millions of dollars to develop by some of the most brilliant minds on Earth, can be administered globally with ease.

With a high degree of certainty, it can be surmised that the global population will continue to grow. Will there be drastic breakthroughs? Absolutely. But from the viewpoint of a financial farmer, there are many seeds that can be planted which focus on branding, utility, and scale that should perform very well without necessarily having to take a significant risk in terms of the disruptive technology. Will a disruptive technology create many billionaires and millionaires? Absolutely, but so will focusing on branding, utility, and scale that an ever-increasing population demands.