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Sport is vicious, what with the zero-sum outcomes of winners and losers. World Cup group play tames that a bit by giving a point for a draw and the hope of moving on. But the bitterness of that last minute goal – the beautiful arcing ball from the world’s best player, placed perfectly on the forehead of his teammate for the equalizer – threatens to linger. We were so close to the sure thing…to making it out of the group of death into the round of 16! Now the US Men’s National Team must face the juggernaut Deutscheland and rely (perhaps) on fate to see us through.

I confess to waking up last night, replaying the long pass in my head, agonizing over the “what-if” scenarios. What if we didn’t dawdle with that final substitution? Maybe the keeper of the clock would have added one minute less of stoppage time. That would have been enough to keep the ball from Ronaldo and his final assist. What if, what if, what if. My wife did the same, the what-if curse being worse for her as each soccer match transports Kate back to her own college-playing days. Now imagine what those players are thinking.

Were I in that locker room after the end-of-game jersey-swaps and given the chance to address the players, I would say job well done. Now let it go. Don’t let the what-ifs into your minds. You can control process, but the outcome is the domain of the fates. You had a good strategy. You were conditioned well and played hard. You left nothing on the field. You were prepared, and the process was right. More often than not that will be enough to see you through, a good process will create victory. But sometimes you can do everything right, and bad luck rears its ugly head. That’s what happened last night in the final minute of stoppage time.

Here’s a matrix from the 2001 book, Winning Decisions, meant for business but maybe better suited for sports. The US men were prepared. That high level of preparation gives them the best chance of landing in the top right square, “deserved success.” But sometimes unlucky failure strikes despite your process. You end up in the bottom-right quadrant.  All you can do is shrug it off and move on.

Preparedness Luck matrix B Shadow

The real test comes next. Is this team resilient enough to bounce back from being so close to a sure thing? Can they trust their coach, each other, and the process to bring it one more time against Germany? Can they use this matrix with its oversimplified logic to rid their minds of the what-if curse and focus on preparing for the next match?

I believe…

I believe that…

I believe that we will win.

I’m re-reading Nassim Taleb’s Fooled By Randomness. There are a handful of books I think worth revisiting every year or two to see how your refined understanding of the world – those things you’ve learned since reading it the last time – influence how you interpret it. It can become a measure of how you’ve matured in your learning quest. Taleb’s book(s) belongs in that rarefied air.

I’m not sure what it means about my own intelligence or reading comprehension level, but it just seems fresh with each new pass. Like I’m reading it for the first time though this is my third time flipping through its well-worn pages.

This will not be a book report. I wanted to highlight a quote that appears before the first chapter and relate it back to a previous post here.

Solon’s Warning

Taleb retells an apocryphal story from ancient Greece in which King Croesus (the richest man) is making a futile attempt to get Solon (the wisest man) to agree that the former’s wealth and success mean he must be the happiest.

Solon responded:

The observation of the numerous misfortunes that attend all conditions forbids us to grow insolent upon our present enjoyments, or to admire a man’s happiness that may yet, in the course of time, suffer change. For the uncertain future has yet to come, with all variety of future; and him only to whom the divinity has [guaranteed] continued happiness until the end we may call happy.

These are the thoughts it inspires (mostly self-plagiarized from a previous post):

Thoughts on Success and Failure

What is success? Is it really an outcome? Too often we think of it as a destination as if it were a platform we land on and upon which we reside forever more. I think we would find that most people we consider successful don’t think of it as such a static thing. It’s very dynamic. And it’s not accurate to use the term in such a general way. I would argue it’s just not a precise use of the term.

Perhaps you accomplished a specific thing successfully. You employed strong thinking in an investment decision process that produced an outcome with high returns. That was an example of being successful, but does it define you as a “success.” Or say you produced a string of these good outcomes with high returns. Again, those are multiple instances of success, but are you now a “success?”

You can have a thousand such “successes” followed by a single “failure.” How are you then labeled? Or you have a thousand failures followed by a single success.

Such labels are meaningless. I’m reminded of Malcolm Gladwell’s New Yorker profile of Nassim Taleb  [ah, this is why these thoughts reconnect for me a few months later…neural synapses, funny things] several years ago. (Click here to read Blowing Up: How Nassim Taleb Turned the Inevitability of Disaster Into an Investment Strategy.) Taleb revered Victor Niederhoffer as one of the world’s best traders and a brilliant thinker. Niederhoffer had a respected fund with investors desperate to include their capital in his investments. He had more wealth than most people could hope for.

Niederhoffer had it all. Until he didn’t. He “blew up”, as traders put it, when the strategy he had used with such success for a decade suddenly didn’t work. He lost everything. One day he was a “success” and the next he was a “failure.” Well, that would be the description if you chose to think of it in such “destination” terms.

It all brings to mind the story of the Taoist farmer. I had a vague recollection of the tale, and googling it produced this version (from this source):

This farmer had only one horse, and one day the horse ran away. The neighbors came to condole over his terrible loss. The farmer said, “What makes you think it is so terrible?”

A month later, the horse came home–this time bringing with her two beautiful wild horses. The neighbors became excited at the farmer’s good fortune. Such lovely strong horses! The farmer said, “What makes you think this is good fortune?”

The farmer’s son was thrown from one of the wild horses and broke his leg. All the neighbors were very distressed. Such bad luck! The farmer said, “What makes you think it is bad?”

A war came, and every able-bodied man was conscripted and sent into battle. Only the farmer’s son, because he had a broken leg, remained. The neighbors congratulated the farmer. “What makes you think this is good?” said the farmer.

Luck is fleeting. It is a point-in-time result. What we perceive as luck today, we may view as the root of great misfortune tomorrow. The same reasons we might have used to consider a person lucky today we might use to pity him tomorrow.

So goes success, and so the path is circuitous and the arrow points forever further.

Henry Blodget

I’m hesitant to admit such a fascination with him, but after several posts quoting or featuring him, I must now confess a bit of an obsession with Henry Blodget. To refresh on his story, you may turn to Wikipedia here.

It helps to know the back story to understand the context of why he posted this image on his business news aggregator Business Insider back in April:

 

The grit required to stage a comeback (it’s in process) after being laid so low is a much better story – a Greek tragedy reversed – than a straight line success story.

Here’s a thought in the early stages of baking in my mind…

In his 2009 book, The Big Switch, Nicholas Carr describes a experiment in which researchers brought together one group of politically liberal-minded folks and an off-setting group of conservatives. They surveyed each participant beforehand to understand his pre-existing views on topics such as same-sex marriage, affirmative action, and global warming. This was the baseline. Then they put the liberals together in one room and the conservatives in another and basically said talk amongst yourselves.

When discussion time expired, the researchers surveyed the individuals again, asking the same questions as before. How did the discussion with like-minded participants influence the initial views as expressed in the baseline questionnaires?

In short, people’s views became more extreme and more entrenched on all three issues. The liberals came out more liberal, and the conservatives came out more conservative.

Deliberation thus increased extremism…every group showed increased consensus, and decreased diverstiy, in the attitudes of its members.

The researchers came to call the effect ideological amplification. It’s one of those funny wiring glitches of the human brain, and its effects go far beyond matters of politics.

Throughout the weekend I found myself thinking about this tendency and its potential to create trouble. If you’re in a profession that requires complex and nuanced logical thought – think scientific discovery, philosophical truth-seeking, medical diagnosing, investing – it’s imperative that you find ways to root out the bias that inevitably creeps into your process of thinking. You must design thinking mechanisms for identifying them and then formulate the discipline to root them out.

Yet this is hard to do. Very, very hard. It’s so difficult to challenge your own ideas. Our natural tendency is to find ways to support what we’re thinking, not to disconfirm it. And this becomes more true the more we develop the idea, especially if we begin promoting it to the world.

And since we’re social creatures, too, we often take our ideas to the world in search of support. It’s a rare person that takes his ideas to groups of people that are likely to shoot them down. More often we take our ideas to Confirmation Marketplaces…supporting family members and like-minded colleagues. Or industry conferences, email listservs and online forums whose tendencies we already recognize to be aligned with the bent of our existing thoughts.

What happens here, and I don’t think we sufficiently account for this in our thinking process, is ideological amplification. These groups and forums become places for us to feel better about what we’re thinking. To confirm our existing thoughts – and often to promote them – rather than challenge them.

Such confirmation is probably fine if you’re idea is already well-threshed out and true. But more often than not, the ideas require a healthy dose of intellectual pummeling to verify and/or deny the reasoning behind them. Disconfirming challenges to off-set our natural confirmation biases. If we seek out the echo chamber of confirmation marketplaces, we’re not likely to get that.

The Fanatic, as profiled in this previous post, is a construct to apply to all investing opportunities. Two vantage points to consider:

Vantage Point One – Is the business you’re evaluating run by a fanatic?

This presents its own set of opportunities and challenges that I won’t go into here. Suffice it to say, investing with fanatics requires that you possess a deep conviction in the upside of the opportunity for market growth, the fanatic’s ability to win that growth, and his ability to win it in a way that provides suitable returns on capital over the long-term.

As the profile suggests, fanatics will not show many traits of shareholder friendliness while engaged in the thrall of winning market share from the competition.

Vantage Point Two– Can the business you’re evaluating survive attacks by the fanatic?

This the more common construct you’ll use in evaluating investment opportunities. It forces you to understand the deepest competitive advantage of any business by forcing your thinking process outside the simplistic world of rationally-motivated agents.

A rational agent competitor will work through MBA uber-logic in determining whether and how to compete with your business.

Ponder this…

Continue Reading…

Becton Dickinson (BDX)

February 10, 2012 — Leave a comment

A hat tip to Matt Mandel of the Mandel Capital Blog for sharing his thoughts on Becton, Dickinson & Co. (BDX). It’s an excellent piece of high-level analysis steeped in a fundamental premise with which I could hardly agree more: when you find good companies priced fairly by the market, buy them!

My own analysis has BDX trading around 14.5x its previous year owner earnings and that it has compounded those earnings at an annual rate of 14.1 percent since 2004. It did this while maintaining a healthy balance sheet (i.e., debt it can easily manage based on its cash flows) and returns on equity hovering around 20 percent. Not bad at all.

We can make conservative estimates of its future by cutting that earnings growth rate in half (seven percent), projecting an earning multiple on par with the general market (15x), dividends growing slightly below its historical rate, and using excess cash to buy back shares on the market to the tune of 24 million over the next five years. These assumptions would give us a business worth about $142 per share in 2016. That’s about 13 percent compounded growth. Again, not too bad.

The financial analysis looks pretty good. Add to that some basic facts about BDX’s products: they tend to be non-discretionary purchases primarily from hospitals, with some elements of the razor-and-blades revenue model,  changing suppliers seems to be hard to do, and the price points of various needles and syringes (the primary business) don’t make it worth the headache of customers trying out new vendors anyway.  The thesis seems to be getting stronger by the moment.

Alas, the paranoia kicks in. Two things bother me. 1. Healthcare payers are under duress, and they are a major force behind buying decisions in the service of healthcare…something upon which BDX is highly dependent; and 2. What does something like the BD Insyte Autoguard with Blood Control do? I have no idea.

On the first point about healthcare payers, my thinking goes something like this…while I understand the demographic drivers of healthcare consumption – that human population growth is inexorable, that aging populations have a nearly insatiable need for health services, and that developing countries are a growing source of demand for western-style healthcare – I have no idea how people (or THE SYSTEM) will pay for it. I help old ladies across the street not because I’m a good Boy Scout, but because as an informed contributor to the Medicare and Social Security tax base. In other words, I know what ceramic hip replacement surgery costs if she falls down!

The point is this: healthcare demand is not driven by typical models of supply and demand. There is a powerful X-factor in the form of government and other payers. These payers are under stress. (Indeed, it’s not too difficult to argue that the government sources of payment in the U.S. and Europe are effectively insolvent already based on future obligations versus any reasonable assumption of having that funding available without bankrupting taxpayers.) When the payers become more strict with their approval of procedures and diagnostic services, it has a direct affect on the manufacturers of the products that are used in surgery or blood tests or whatever else.

It certainly puts Stryker at risk of selling fewer ceramic hip replacements when the aged population has to jump through more hoops to get approved for a $15,000 procedure. There are fewer of these surgeries. BDX faces a similar risk, albeit less pronounced. Fewer surgeries mean less demand for their catheters and needle systems and all of those other items they sell.

Non-discretionary products becomes a misnomer when the service that requires their use becomes discretionary.

All that being said, no matter how gloomy we might be about the future of healthcare reimbursement, there is no question that will continue to be tremendous demand for needles, diagnostic cell testing, and the like. The question is more about how much demand there will be and what impact that might have on BDX earnings growth.

So here’s my paranoia on point one…with the uncertainty surrounding payment methods for healthcare services, can we be very certain BDX (and its peers, for that matter) aren’t priced at a peak of market demand for their products? Part of my checklist for any investment is to ask whether the business itself is showing peak earnings for one reason or another. If so, you try to normalize those earnings to get a more realistic expectation for the future. And you certainly don’t want to pay a high multiple on top of peak earnings! Well, apply the similar logic to the question of whether the healthcare market has shown peak demand for its services based on physicians ordering excessive cover-their-rear diagnostic testing (fear the tort) and surgeons being eager to cut with the knife because they know they’ll get paid (a lot!).

What if we’ve peaked there? Despite the demographic trends suggesting increased demand for more healthcare in the future, the challenge of the payers makes me highly uncertain about how it plays out. I don’t like that level of uncertainty when investing.

Second, despite having some background in the healthcare supply chain, I have no idea what the vast majority of BDX products actually do – like the titillating BD Insyte Autoguard with Blood Control mentioned above. Nor can I make a reasonable estimate of what the market for these products might be. Moreover, if I assume I have the brain wattage to learn enough about it at all, adding it to my circle of competence would easily take months or years buried in a deep research dive.

All that being said, the company could very well go on to compound its earnings in the coming years as the issues I cite become moot. In which case, I have the regret of omission. It would not be the first, and it won’t be the last.

To sum it up, BDX has many hallmarks of a great company and a respectable investment opportunity…BUT…the flux surrounding the payment models for the industry makes me anxious about its ability to achieve even an historically conservative rate of earnings growth (seven percent versus 14 percent)…AND I tend to need to understand the products or services of the businesses I invest in (at least at a minimal threshold anyway)…AND I’m living proof that altruism (e.g., helping old ladies cross the street) is bound-up in self-interest. Call me homo economicus.

How does a business compete against a true fanatic?

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A fanatic with a winning model?

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A fanatic with access to resources?

 

The fanatic is, by definition, either oblivious to criticism – so convinced his path is correct – or he is constitutionally impervious to its effects.

He is NOT a rational player who sticks to conventional rules or employs conventional tactics. He has a higher threshold for pain, does not keep banker’s hours, and revels in keeping foes off balance.

The fanatic chooses a path, making appropriate corrections as he proceeds, and sticks to it with stubborn resolve.