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.

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A Valuation Framework for Bitcoin

There is no new thing under the sun.

– The Bible

Disclosure first: This piece might be sacrilegious to many value investors. In Nov 2013 (yes, the last Bitcoin “bubble”), I put a small percent of my net worth then into Bitcoin. I have been holding and plan to hold them until it reaches my estimated value (showed below). Please do NOT see this piece as a defense to Bitcoin critics or as investment advices (In fact, I am always ready to change my view, however I just didn’t come across convincing counter-arguments. Or put it differently, I’ve been most of the critics’ place and held similar suspicion before but changed later). I see this piece as an alternative thinking framework to a potential significant invention in human history, and I welcome any sort of comments/feedbacks/critiques.

A few lemmas I want to establish before going further:

  1. The universe we live in consists of two and only two elements: energy and information. (mass, or material, could be unified to energy by Einstein’s famous equation: E = MC^2)
  2. Bitcoin’s value is binary (i.e. it should either 0 or something very large, there is no middle ground)
  3. If “intrinsic value” is defined as “present value of expected cash flow from a value producing asset”, Bitcoin (as well as all kinds of money) has NO intrinsic value.
  4. Global governments as a whole, is not as prudent and resposible as developed counties’.
  5. I have been wrong and could be wrong on Bitcoin

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YY – an Under-Followed Chinese TMT Play with Margin of Safety

YY is a Chinese video live streaming + social networking business with two main operational segments, YY Live (the general entertainment content streaming, a loose equivalent of Periscope) and Huya (Gaming content streaming, an equivalent of Twitch). Its share has risen 135% YTD and valuation moved from a dirt cheap 11 trailing P/E by 2016 to a less cheap trailing 16 P/E (still cheap compared to other Chinese Tech peers), so why I am still interested in this name?

In short, a debt-free cash-gushing main business poised to take more market share as the general entertainment streaming market start to mature and consolidate, plus a fast growing gaming/e-sports streaming platform close to turn profitable and filing IPO in a favorable secular tailwind should warrant a market average valuation.  In addition, I noticed both platforms achieved market leading positions without promotion and successfully fended off competitors who tried to copy their business model. Add to it, YY has a deep-thinking founder-CEO with some track records of continuous innovation in fast changing market environment. All in all, this is something I think should be priced at a premium to market. My neutral assumption based valuation shows there still could be 29% upside, and a conservative assumption based valuation shows 0% downside. (optimistic assumption indicates 90% upside, but I don’t have to count on it)

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Incentive System Evaluation – a Case Study of Coty

Coty is a new position last quarter. As mentioned in my Q3 letter, I think the “system” factor of Coty is very impressive. As an effort to document my own learning as well as knowledge sharing, I here formalize my notes. It’s not intended as a support for my judgement, rather I think it would be beneficial in general for anyone who involves in a principal-agent situation (e.g. board of directors, entrepreneurs, etc.) for designing or assessing incentive systems.

Investing community generally agree that a management with owner mindset is preferred. But how exactly could one evaluate “owner mindset”? One way is to talk to the management in person and make assessment qualitatively, however that’s not possible for all shareholders. CEOs typically are also very good at marketing themselves, which adds another layer of uncertainty. These are the reasons why some investors prefer founder CEOs, who are inherently owners.

Coty’s incentive system has following uncommon designs based on a heavy ownership philosophy.

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Book Notes – Big Money Thinks Small (by Joel Tillinghast)

Joel Tillinghast is a tenured Fidelity portfolio manager for its Low-Priced fund, however his name was known by few, including me, until recently. Tillinghast recently published his first book – Big Money Thinks Small last month, and was featured in a Barron’s interview in 08/12/2017 (Link here). When I first saw his interview, I found this manager interesting for his ability to consistently beat his benchmark, Russell 2000, for years with 100+ holdings. This diversified approach is very different than the “traditional” school of value investing, who advocates concentrated bets. Another impressive trait of Tillinghast’s fund is the extreme low turnover – only 9% a year. This means he on average holds each position for over 10 years!

For the sake of these special traits, I decide to pick up his book and try to see if there is anything I could learn from him.

BigMoneyThinksSmall

Overall, I think it is a valuable book, especially for someone had some investing experiences and is eager for historical investing case studies. Here are my key thoughts/lessons:

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Great Oriental Investors – Shoucheng Zhang, a Quantum Polymath (Award Winning Physicist and VC Investor at once)

As I mentioned in my first investor letter, my investing philosophy had deep roots in oriental philosophies. For this reason, I always find those investors who are able to master both eastern and western mental models extremely intriguing. On surface, lots of eastern mental models & philosophies resonate with well-known western principles already, but I also believe they have more unrecognized value to investing practices. I am planning to start a series to document all investors that fits this category, to document my lessons learned from them and to share with my readers their insights (many of which aren’t available in English media).

 

The first one is Shoucheng Zhang (Wikipedia Link). Zhang is an ingenious physicist, to say the least. He got admitted by one of the top universities in China purely by self-study after the Culture Revolution ended in 1978 when he was only 15, then went abroad and finished his PhD by 24. His best known finding is probably topological insulators, for which he was awarded a Dirac Medal in 2012. His work was estimated by Thompson Reuters to be able to win Nobel Prize in 2014 (Link). Zhang is also a tech VC investor. He is said to be one of the early investors of VMWare (as he’s a neighbor of the co-founder Mendel Rosenblum who is also a Stanford professor) and made hundred bagger on it. He officially started his profession investing career in 2013 by founding Danhua Capital (website link), an early/growth stage VC focusing on disruptive technologies.

 

Like Charlie Munger, Zhang also see Benjamin Franklin as an archetype. Zhang mentioned that he struggled at a young age on whether he should aspire to be a scientist or an entrepreneur, until he realized he really could be both after reading about Franklin, one of the greatest polymaths in history. Not surprisingly, he is also a fan of multi-disciplinary mental models. As a theoretical physicist, his application of quantum physics principles to investing (and life) is the most interesting insights among other thing. Additionally, contradicting to stereotype of physicists, he seems to have strong interests in Aesthetics.

 

Zhang’s key philosophy can be summarized by a quote he constantly mentioned in multiple interviews: “Complexity out of Simplicity” or “First Principle”. Before moving on, I think it would be beneficial to expand on the “First Principle” (Wikipedia link) as it initially appeared foreign to me. My understanding is that first principle is a thing/principle/notion which is in its most fundamental form and is self-evident without proof or deduction.  That is where you want to start your learning/thinking process.

 

Some of my favorite thoughts of Zhang (paraphrased) are below:

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All About Moats – Book Notes of Pat Dorsey’s Two Books

If you haven’t heard of Pat Dorsey, here is a quick intro for you: He started his career at Morningstar as a sell side analyst, moved up to the head of the reach team in a few year and stayed there for about a decade. After leaving Morningstar, he started his own firm Dorsey Asset Management in 2014. Although his track record as a fund manager is yet to be tested, I found his books very insightful, especially for firm’s economic moat/competitiveness study.

 

Dorsey is the author of below two books:

Image result for The Five Rules for Successful Stock InvestingImage result for The Little Book that Builds Wealth

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