“Faced with the choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy on the proof.“ – John Kenneth Galbraith
We continue to experience a K-shaped recovery. Many of us (and most likely those reading this post) live in a way that limits insight to the challenges that many still face. A narrow segment of the population is flush with cash having had limited spending outlets over the past year. As vaccine roll out becomes more widespread and faster, mask mandates begin to be lifted. Consequently, local economies open and an accelerated return to normalcy takes place filled with individuals eager to repeat the “Roaring 20s.” Conversely, another segment of the population is having an entirely different experience that isn’t part of the “roaring re-opening” narrative.
The Biden Administration’s $1.9T stimulus Bill is a continuous liquidity push. One of the questions to ask is ”if the economy is doing so well, why is there a need for $1.9T in stimulus?“
Beneath the surface, there is a struggle:
- Job losses
- As of January 2021, there were 10 million people still unemployed with 40% of those having been out of work over six months. Individuals who are unemployed for long periods typically experience lower reemployment wages.
- Household leverage
- Continuous child care struggles
- Soaring healthcare costs
- Soaring housing costs
There are also businesses experiencing the lower side of the “K” recovery. Business travel is essential to the U.S. economy, and the U.S. lost $245B in business travel in 2020. With Zoom replacing travel for commoditized transactions, it will take years to return to prior levels. Even post Covid, retailers are struggling with 1 in every 11 stores expected to close within the next 5 years.
The “K” is becoming more pronounced as the Covid economy is affecting everyone differently. Even if all the above concerns only marginally impact, a post-pandemic boom would create significantly elevated consumer spending in the summer. Economists believe that such an immediate spike could trigger inflation and higher interest rates if production of goods can’t keep with the demand. This would effectively push GDP back towards a lower growth trajectory.
Back on the upper branch of the K-recovery, investors sitting on their saved cash are looking for attractive returns amid limited investment options. As a result, investors are moving up the risk curve. Money from fixed income is moving to equities. Equity money is moving to Private Equity. And now, investors are eyeing cryptocurrencies and NFTs. The moderately valued options have become overvalued, and the overvalued options have become bubbles! The FOMO malady is affecting many investors.
But what if this time it really IS different?
This backdrop significantly impacts how we allocate portfolios and select investments. In markets like this, discipline is crucial but challenging. Investors are being rewarded for lack of discipline. Dismissing fundamentals and chasing momentum epitomizes lack of discipline. From our perspective, the margin of safety for the entire market has been compressed and so we have to be even more stringent in our stock selection. We have become more selective in managing the short book, even if it means deviating our net long exposure to adjust to the current environment. On the long side of the portfolio, we are focusing even more on a company’s ability to generate cash flows and how those cash flows are valued. Near term cash flows are much more valuable than cash flows in the mercurial future.
This opinion deviates from many who see nothing but clear skies ahead. However, as an investor, if you are unwilling to hold an opinion that differs from the crowd, then it is correspondingly impossible to have an outcome that stands out from the crowd if your opinion proves prescient. In essence, during this period, we are trying to avoid the “institutional imperative”. This concept is credited to Warren Buffett from his 1989 letter to shareholders. The term refers to the pressure, and tendency, of executives to “mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”
We vigilantly avoid this behavior. In practice, this means being truly long -term focused and staying disciplined in the face of irrationality, while allowing for bold movement when it is prudent. It means investing idiosyncratically using a process and methodologies we know will generate long-term performance and not forcing ourselves to fit neatly into preconceived style boxes.
“It is impossible to produce superior performance unless you do something different.”
– John Templeton
This tendency to follow the institutional imperative is prevalent and rampant in most areas of business. The behavior we were scolded for as children (“Don’t worry about what other kids are doing!”) persists well into adulthood and is omnipresent in the corporate world.
At Richie Capital Group, we seek to invest in companies with management who may be cognizant of institutional imperative, but ignore these pressures. The best managers are able to think independently and use rationality and logic to maximize profits for the company and increase shareholder value. Additional traits we seek in a manager include:
- Long-term focused
- Candid – being honest about the business environment and learning from mistakes
- Astute capital allocators – practical, opportunistic and flexible
- And to borrow from Thorndike’s book “The Outsiders” – an unusual combination of conservatism and boldness
We believe that Leland Strange, CEO of Intelligent Systems (INS), fits this description perfectly. Leland has led INT and its predecessors since the late 1980s. Since 2015, the company has been squarely focused on software solutions for the Fintech market. You would never know it, but the understated Leland is beyond financially secure from his early business ventures. He continues to lead INS because he enjoys the work they are doing, and he is focused on his long-term vision of INS becoming the dominant player in payment processing software. Leland considers himself to be working purely for the benefit of shareholders. His rationality is reflected in his early decision not to hire a sales and marketing team. INS consistently has more customers than they can handle and, because they weren’t carrying a bloated operation during the pandemic, no layoffs were required. Instead, Leland was able to act boldly by stepping in when a major European customer (Wirecard) collapsed. He acquired portions of the business and its people which will aid INS in expanding their presence internationally. You can find our analysis and investment thesis for Intelligent Systems here. We think you will agree with our assessment.