Investor Letter – 2017 4Q

Below is general commentary section excerpt from my investor letter for 17Q4

Download pdf: TaoValue_2017_Q4_final

General and Market Commentary

If anything is to be remembered for the financial markets in 2017, the lack of volatility will be on the list. S&P 500 index, for an example, finished positive for all 12 months, unseen for majority of the investors living today. The unprecedented financial market quietness was also accompanied by the mania in cryptocurrency as all major cryptocoins pocketed astronomical returns for 2017. It is not hard to identify bubbles everywhere under traditional definition, but I find it is meaningful to think through a level deeper. Below is my attempt to find some common lessons by doing quick studies of “bubbles” in three distinct markets. As always, I like to think about the most controversial ones, as they are the most “information-rich”. I hope they are interesting read for you as well.

Tesla (Public Market)

2017 is not Tesla’s best year, as it underdelivered the dream they sold before about Model 3 by large margin. However, Tesla bears are bewildered by the lack of reaction of Mr. Market to negative developments. One possible reason to this phenomenon is the bulls’ almost religious belief in Tesla. That means the time for Tesla short to work out is not the “change of the fact”, but rather “change of collective perception towards the changed fact”.

To see whether this positive collective perception is justified, I think of the Tao (i.e. the societal value it creates and the corresponding return it takes) of Tesla. An alternative way to see it is that Tesla may be Elon Musk’s clean energy social campaign disguised as a corporation. If you in 2003 were given a mission to push the global auto industry to a more innovative and socially responsible (e.g. cleaner energy) direction, what would be your estimate of the time line and budget? Tesla single-handedly took about a decade and 0.08% of the societal value created in 2017 (Tesla EV/Projected 2017 Gross World Production). Not a bad score for a social campaign.

However, whether the incremental societal value would be entirely accrued to Tesla in forms of shareholder value is uncertain. This is why I wish Tesla could have remained private, thus funded by more loss-tolerant classes’ wealth. I also wouldn’t short it, because there is still possibility some incremental value could accrue to Tesla through M&A.

Juicero (Private Market)

Made famous by a mockery Bloomberg article in April 2017, Juicero found itself in an awkward position where people start to realize its $600 “high tech” juice machine just does things what human hands can easily do – Squeezing. Five months later, it decided to shut the company down. It can be interpreted simply as a sign of overheated VC industry, I see a level deeper. I think the reason why VC (including Google Venture) seriously considered Juicero is that they agreed with the potential of altering collective perception of how human consume fruit & vegetable, in a not too dissimilar way from Keurig does to coffee. In essence, both Keurig and Juicero try to cultivate a neater hardware-dependent habit of consuming staples, and to monetize on the distribution such staples. Although there are other defects (including lack of fresh food logistic system, pricing of the hardware, etc.) contribute Juicero’s demise, the failure of “habit cultivating” is a major one in my opinion. This case also shows how easily and quickly collective perception can be altered in a centralized informational world nowadays. I think this new way of how society is organized has huge implication to the definition of a “brand” moat.

Bitcoin/Cryptocurrency (Emerging Asset Class Market)

Thinking through how to value such an asset like Bitcoin led to the essence of “money”, which I deduced it to one word – trust (another way of saying positive collective perception). Interested investors could read my blog post: [link] for further details. This thought process also revealed that all assets in modern history are quoted in an arbitrary and unstable unit – fiat money.

It should be noted that thinking about it (even still holding it since 2013) doesn’t mean I endorse investing in it at current price. On the contrary, as history tells us, the first wave of mass adopters (after the hobbyists and researchers) of financial innovations usually is dominated by bad exploiters. I believe we are flipping to this page with activities like dubious ICO, shady intermediaries, pump-and-dump, scalping, cornering and fraud, all of which can be found in playbook of the last big financial innovation – stock market, from the past century.

In essence, Bitcoin, as the first application of decentralizationism, represents a new ideology of how society should be organized. History is not unfamiliar with new ideology gained massive traction in short period of time and went obsolete before long – Communism is one recent example. The right way to invest in cryptocurrency space to me is to 1) study it so you fully understand and believe in such ideology; 2) size it (in % of your net worth) as if a “donation” to that ideology; and 3) buy it only at the point of maximum pessimism against that ideology.

It is obvious to see one important factor popping up in all three cases affect both price formation and value estimation – collective perception (belief, habit & ideology being its different forms). Using Shelby Davis’ famous return decomposition, I add one component and elaborate my new thoughts on each applicable component.

Stock Return = Liquidity Expansion/Contraction + Profitability Growth + Multiple Expansion + Capital Allocation Return

  • Component 1 – One should be aware of liquidity cycle as all assets are quoted in and distorted by fiat money. “bubble” caused by it is essentially purchasing power erosion, and is almost impossible to avoid.
  • Component 2 – One should value profitability in a more universal unit. e.g. economic & societal value, rather than value in fiat term. Amazon was a good historical example, and Netflix may be the next good example on this point.
  • Component 2 – One should update understanding of brand moat. The legacy type of brand is much more susceptible to erosion in current centralized information age. An evolved enduring brand should have characteristics like “habit forming”, “culture building” or “collective perception altering”.
  • Component 3 – One should understand perception’s elasticity to information and think through why certain counter-intuitive phenomenon persist. “bubble” caused by this component is madness, and can be avoided with discipline.

In summary, I believe what an intelligent investor of new age should do is to understand the evolution of collective perception and invest in opportunities that are attractive after adjusting perceptional distortions.

 

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