In the mid-2000s, we began to observe a shift that could affect our investment theses across several of our holdings and create new opportunities on our investment watchlist. When we began our investment journey (all those years ago!), if someone wanted to purchase software, you went to Circuit City (really showing our age now!) and plunked down money for a box with several discs that we used to install the application on our computer. By the mid-2000s, a movement began in which software no longer resided on our computers but was hosted on a remote entity called “the cloud”. Goodbye discs. Goodbye to updates from additional discs. Goodbye to those afternoon runs to Circuit City. Instead, the applications became known as software-as-a-service (SaaS). This new model revolutionized software providers, from the largest, such as Microsoft and Adobe, to the most niche vendors. This move from software to SaaS underpinned many of our investments, ranging from Guidewire (GWRE) in P&E insurance to Veeva (VEEV) in life sciences informatics. 
 
We are now at the beginning of a new era in technology. In the past several years, the idea of SaaS has been gradually replaced by the recent rollout of fully functional artificial intelligence (AI) technology. Will it be as powerful as SaaS was? Who knows. Technologists and investors alike are harkening it to the creation of the Internet. That’s pretty powerful! 
 
What is artificial intelligence?
 
So, what exactly is artificial intelligence (AI)? We think NASA has done a great job of creating a working definition that is easy enough for us laymen to understand. 
 
“Artificial intelligence (AI) is a branch of computer science dedicated to creating systems capable of performing complex tasks that typically require human intelligence, such as reasoning, learning, problem-solving, perception, and decision-making. These systems, including machine learning and neural networks, analyze data to identify patterns, make predictions, and act autonomously.”[1]
 
They list the four major components of AI as:
 
Learning: AI systems, particularly through machine learning, improve their performance over time by analyzing data rather than relying solely on explicit programming.
 
Reasoning & Problem-Solving: AI can process information to make decisions, solve puzzles, or deduce conclusions.
 
Perception: Technologies enabling machines to interpret visual data (computer vision) or audio (speech recognition).
 
Autonomy: The ability to operate under varying circumstances without continuous human intervention. 
 
The use and scope of AI are nearly unlimited. It is expected that AI can replace millions of jobs and streamline business processes. Entire segments of the national economy can be improved and, in some cases, eliminated through full integration into our nation’s economic systems. Of course, one of the major issues in the stock market today is which industries will be most adversely affected by this adoption of AI. In terms of our portfolios, the greatest impact will be with our software/SaaS-based vendors such as Veeva (VEEV), Guidewire (GWRE), ServiceNow (NOW), Arista Networks (ANET), and F5 (FFIV). 
 
The threat and opportunity posed by artificial intelligence
 
AI poses a serious, transformative threat to traditional SaaS by shifting value from user interfaces to automated agents, which is forcing a move away from per-seat pricing. While AI will not "kill" SaaS, it threatens to commoditize basic software, disrupt business models, and reduce headcount-driven revenue. However, enterprise SaaS with deep data moats and workflows will likely adapt by integrating AI rather than being replaced. A great example of this is Veeva. The company is deeply embedded in nearly every mission-critical process in the pharmaceutical and biotechnology industry. Ranging from drug discovery and development to product sales and promotional support, Veeva is unlikely to be replaced by AI, but rather enhanced by its capabilities. 
 
The following are the key components of the AI threat.
 
The "SaaSpocalypse": We think the markets are overreacting to the potential impact of AI on the SaaS business model. Over the past several months, we have seen a bloodbath in software stocks – from some of the larger firms to privately held companies in private equity portfolios. This led to the “Saaspocalypse” you’ve been hearing about in the financial media. While we think AI could have an impact, we don’t expect wholesale destruction in the software industry. (See our previous description of Veeva.) 
 
Workflow Automation: We think this will be one of the greatest areas of impact. We could see AI “agentic” offerings automating everything from simple to relatively complex workflows. This could make companies that build human-facing user interfaces (UI) redundant. 
 
Pricing Models: Many SaaS models are billed per seat (i.e., per user). It is assumed that AI's ability to perform the work of several individual users will significantly impact revenue due to the loss of billable seats. This is what the industry calls “agentic work unit” pricing.
 
There are some more general risks that AI presents to the SaaS model. These include: 
 
Commoditization of Software: AI lowers the barrier to entry, enabling rapid, low-cost development of competing products, which pressures existing SaaS companies to differentiate.
 
In part 2 of this article, I will discuss how our portfolio holdings companies are addressing the encroaching risk of AI. We are comfortable that all of our holdings are either building out AI into their offerings or face little risk. 
 
As always, please let us know any questions or comments you have on this article. 
 
Disclosure: Nintai Investments currently owns shares in Veeva, Guidewire, ServiceNOW, and Arista Networks.  

[1] Executive Order 13960, “Promoting the Use of Trustworthy Artificial Intelligence in the Federal Government”,  
Section 238, National Defense Authorization Act of 2019

“We find whole communities suddenly fix their minds upon one object, and go mad in its pursuit.” - Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds 
 
As we’ve pointed out quite a few times (some say we are perseverating) over the past few years, we believe the markets are showing classic signs of a bubble. At the risk of continued underperformance, we have taken profits from many of our positions over the past twelve months. Many of you will see that we have reached double-digit cash positions. We have decided to break this article into two pieces. The first will be a brief explanation of what we think are the characteristics of today’s market bubble. An upcoming second article will discuss several key measurement tools we use to ascertain when/how the market data support our thesis. 
 
In 1929, at the height of the post-World War I economic boom in America, Joseph P. Kennedy Sr. was working as a stockbroker on Wall Street. As the story goes, Kennedy was heading back to his office when he decided to get a shoeshine. While polishing his shoes, the young worker shared some of his favorite stock picks. As he listened, Kennedy realized that when shoeshine boys give their patrons stock picks, it’s time to get out of the market. Kennedy exited his market positions and took short positions that bet on the market going down. Was the story true? While probably apocryphal, it certainly proved a point. Market bubbles and their associated tops generally have similar attributes. One of them is that even the most unwise of investors feel like geniuses as their portfolios keep increasing in value with each move. 
 
Having said that, it’s nearly impossible to call the exact moment when bubbles reach their apex. It can be one day, one month, or three years after you become convinced the markets are in one that the bubble finally pops. 
 
So how does one predict when a bubble might implode and take action to protect their portfolio? We think there are several attributes common to all bubbles. When markets begin to exhibit these simultaneously, we begin to reduce our positions and raise cash at Nintai. The major signs we look for are a.) valuations at sky-high levels, b.) a constant refrain of “it’s different this time”, c.) the bubble's theme becomes an inordinately large percentage of market share, and d.) companies beginning to spend like drunken sailors on the new-fangled toy. As we look out today, we believe the market exhibits all of these, and then some. 
  
We should be very clear: we have no idea when or how this bubble will collapse. But it will. Looking back at history, the devastation in the marketplace is usually broad and deep. In this instance, we aim to prevent the one thing that can devastate long-term returns: the permanent loss of capital in our investment partners’ portfolios. 
 
Valuations Have Reached Nosebleed Levels
Overall market valuation metrics, such as the cyclically adjusted price-to-earnings (CAPE) ratio, are at or near historical highs, indicating that investors have extremely high expectations for future growth. The Shiller PE ratio has reached levels comparable to those seen during the 1999-2000 Internet Bubble. In December 1999, the market’s CAPE ratio reached an all-time high of 44.2. In January 2026, the market reached a second-highest CAPE ratio ever of 40.6. The historical mean is roughly 17 - 18. We believe the levels we are seeing in today’s market are certainly indicative of a market bubble. 

Figure 1: Historical CAPE Ratio: 1870 - Present, Source: https://www.multpl.com/shiller-pe

No, really….it’s different this time.
During bubbles, investors are often confronted with questions about their willingness to pay what seem like incredibly high prices for what they’re investing in. The almost invariable response is the assertion that “this time is different.”[1] In recent years, as prices and valuations have slowly risen to nosebleed levels, we have begun to hear this phrase used all too often to explain such conditions. Here are some recent examples:
 
“It’s Different This Time”: Debt
One of the things cited as the major difference between the last technology or real estate bubbles is that AI generates lots of revenue, unlike the 1999-2000 Internet hype. That may be true, but it also matters a great deal about the underlying costs of generating this revenue. For many years, large tech could fund initiatives with strong free cash flows and cash on the balance sheet. No more. In 2025 alone, large tech issued over $121B in debt. In the first three months of 2026, an additional $42B was raised. In Oracle's (ORCL) case, the company has gone from $37B in cash/short-term instruments on the balance sheet in 2020 to less than $10B in 2025. Conversely, total debt has gone from $71B in 2020 to $123B in 2025. The company expects to raise an additional $20-$40B for AI investments over the next five years. Meta's AI spending frenzy has taken the company from a net cash position of nearly $30 billion in 2023 to minus $7 billion today. Some relatively large assumptions are being built into the ability to service such debt. 
 
“It’s Different This Time”: Investors are wiser
We like to think that after the technology bubble of 1999 - 2000 and the real estate/credit crisis of 2007 - 2009, it would be painfully evident to most investors that remarkable returns, inflated valuations, and accounting shenanigans are too good to be true. Unfortunately, this simply isn’t the case. Two instances in particular show that investors never lose their desire to make big profits quickly. Both were fanned by rates close to zero percent, leaving savers with little choice but to seek investment gains in the bond market. 
 
In 2020 and 2021, Wall Street saw an explosion in Special Purpose Acquisition Companies (SPACs). SPACs offered a faster, less regulated path for private companies (especially in tech, EV, and space) to go public than traditional IPOs. SPACs would raise billions of dollars as “blank check” companies, then use these funds to acquire a private company and merge it into their publicly traded SPAC. Over 600 SPAC-based acquisitions received billions of dollars in less than two years. Inevitably, the market collapsed for several reasons. First, SPAC owners made their profit on the acquisition, not on the acquired company’s performance. Second, the explosion in SPACs created a race to acquire with a relatively small pool of quality companies. With both factors at work, most SPACs began to fail within months, as their acquired companies simply weren’t good investments. As usual, Wall Street movers and shakers made their profits, while individual SPAC investors were left holding the bag. 
 
After the SPAC model imploded, they were quickly replaced by the MEMO stock craze. 
A meme stock is one whose company’s financials and business fundamentals appear very weak, yet whose stock price suddenly surges, driven by social media hype (such as Reddit communities or subreddits) and massive retail buying. Frequently, these stocks are heavily shorted by Wall Street players, including private equity firms. This model was a way to profit from short squeezes against these players. It should be noted that this model has nothing to do with investment models utilizing valuation metrics or business fundamentals. This is wholly market gambling, with little interest on investing for the long term. Originating in 2021 with GameStop, the phenomenon has shown resilience, with resurgences occurring as recently as 2024 and 2025. In its later stages, the MEMO stocks began to create their own groupings, such as the “DORK” stocks - "DNUT (Krispy Kreme), OPEN (Opendoor Technologies), RKLB (Rocket Lab), and KSS (Kohl's).
 
It’s Different This Time: Profits
One factor that led to the bursting of the Internet bubble in 1999 was the proliferation of companies that went public with no reasonable way to generate profits, short-term or long-term. We are beginning to see the first ripples of concern as the AI model is questioned about how companies expect to generate a profit. In Q4 2025, Harvard Business Review published a report[2] that questioned this very issue.
 
There’s been a push to have investors focus only on gross revenue, assuming that many of the costs that go into generating net revenue will go away over time. This seems an awful lot like the move to using EBITA as the valuation criterion or the old days of not expensing stock options. As Warren Buffett stated: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?" Or as Charlie Munger so niftily stated, “EBITDA is bullshit earnings.” 
 
Clearly, we haven’t figured out how AI will be profitable. In 2024, OpenAI lost $5B, and Anthropic lost $5.3B. In 2025, OpenAI was expected to lose roughly $8B, and in 2026, roughly $14B. Anthropic, after initially estimating a $3B loss in 2025, saw the actual number come in at $5.2B. Last year, OpenAI committed to $1.4T (yes, that’s trillion) in capital spending on data centers and related infrastructure before reaching profitability. 
 
To become profitable, OpenAI will need to generate roughly $200B in revenue (15x current revenue in 2025) by 2030. Sam Altman, CEO of OpenAI, stated that investors are overexcited and "someone is going to lose a phenomenal amount of money." Not what one wants to hear as an AI investor.  
 
“It’s Different This Time”: AI Lifts All Boats 
In their recent post, “Valuing AI: Extreme Bubble, New Golden Era, or Both?”, 
Jeremy Grantham and Edward Chancellor discussed how AI has become the central focus for market capitalization growth. They write:
 
“The United States, whose companies are at the center of the AI boom, now makes up more than 70% of the MSCI World index. J. P. Morgan estimated last September that 44% of S&P 500 capitalization—over a quarter of total world market capitalization—was accounted for by just 30 AI-linked names. In January 2000, 7 of the top 10 companies by market cap came from the technology, media, and telecoms (TMT) sectors. At the time of writing, the eight largest companies in the world were Nvidia, Apple, Google, Microsoft, Amazon, Meta, Broadcom, and TSMC. Of those eight, Apple is the only one 
that is not a highly active participant in or apparent beneficiary of the AI race (although doubtless there will be synergies between AI and Apple's products). Saudi Aramco, the producer of 10% of all the world's oil, is down in ninth place.”
 
It is easy to see why the Magnificent Seven (or is it Ten now?) has generated most of the equity gains over the past few years. This is where almost all the profit growth across the S&P 500 has come from. This is evident in the chart below. The M7 has delivered consistent earnings growth of more than 20% annually since 2023. Profit growth from the S&P 493 has been much lower, averaging 3% over the same period.

Conclusions
 
The past five years have been extraordinarily difficult for those who haven’t invested in AI/Magnificent 7/Meme stocks. At Nintai, we’re among those who missed out on this cycle. Not investing in any of these stocks has crushed our returns relative to the S&P 500. That said, we aren’t disappointed with the business returns of our portfolio holdings. On average, our companies increased free cash flow by 11.9% annually over the past 5 years. Our average return on invested capital is 31.6%. While our investment returns have been difficult, our underlying businesses are doing just fine. When will things turn around from an investment perspective? We have no idea, but the case we’ve laid out in this (far too) brief article gives us some comfort that we will avoid the inevitable return to the mean. We didn’t boast when we outperformed in the first four years of our investment management services, and we aren’t going to cry in our cups about missing out on bubble-like returns. We will continue to do what we know best – find outstanding businesses with great capital allocators at the helm and let long-term compounding do its work. Until then, we thank our investment partners for their patience and trust in our investment process. 
 
Disclosures: None

[1] We, of course, would be remiss not to thank Sir John Templeton for his classic rejoinder, “The four most dangerous words in investing are ‘it’s different this time.’”

[2] “AI Companies Don’t Have a Profitable Business Model. Does That Matter?”, Danielle Kost, Harvard Business Review, November 12, 2025

This will be our last article reposted while the Nintai team is on vacation. We hope everyone had a wonderful holidays and we wish you all a safe, happy, and healthy New Year. 

Bravado and Investing
 
In World War II at the Battle of Samar, a task force of small US escort carriers and destroyers suddenly found itself facing an enormous Japanese fleet including the world’s largest battleship the Yamato. Completely outgunned, and without enough speed to outrun the enemy, it looked like the Task Force was guaranteed to be completely destroyed. As shots from Yamato’s huge 18 inch guns started to straddle one the carriers, an Ensign said with false élan, “Don’t worry boys, we’re sucking ‘em into range. We got ‘em right where we want ‘em now[1]”.
 
Sometimes successful value investing takes a certain form of bravado like our aforementioned naval ensign. But this type of enthusiasm can easily cross the line from supreme confidence to delusional thinking. Successful investors see that line quite clearly. Many unsuccessful investors cannot distinguish between the two. 
 
How does one make a clear distinction between the two? How many of us have let our preconceived notions – or worse our emotional need – drive our investment decisions? It happens to all of us. I remember in my younger days estimating growth of X% for a company I admired. Later that afternoon I met with my partner to review my findings. His one comment was that my growth projections were double the historical rates of the corporation’s past 33 years. When eyed with a reptile-like steely gaze, my assumptions resembled Samuel Johnson’s definition of a second marriage - “a triumph of hope over experience”. Adam Smith pointed out that sometimes you provide information in a way to support your thesis (“The company growth will provide dramatic value over time”) or as a means to blame your holding for poor results (“It’s not my fault management blew the new product launch”).[2]. What is most frightening in this case was that I either simply didn’t recognize a potentially bad investment or I had fooled myself into thinking it was a great company with high growth rates. Neither of these would likely lead to a successful investment strategy.
 
My mistake is quite common in the investing world and is known as optimism bias. Investors project estimates that will fit with their investment thesis and have a tendency to disregard information contrary to their investment outlook. This type of thinking can lead to devastating results. Many individuals (and professional money managers) simply could not accept the fact that in 1999-2000 technology spending growth had to drop dramatically. Even more importantly, many were simply unable to question analysts’ estimates that were later proven wildly inaccurate - and in some cases – grossly unethical. 
 
As usual Michael Mauboussin captured the problem in a clear and concise manner. He states that insider optimism is susceptible to “anecdotal evidence and fallacious perceptions.” In this case, insider doesn’t refer to a company insider, but rather to an individual who looks inwardly for confirmation. He goes on to say that outside thinking “asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems and, if so, what happened. The outside view is an unnatural way to think, precisely because it forces people to set aside all the cherished information they have gathered.”[3]
 
The Children of Lake Wobegone
 
A 2006 study by Dresdner Kleinwort Wasserstein Macro Research[4] makes a compelling case that investment managers are not immune to optimism bias. In a survey of 700 US and foreign-based investment managers, individuals were asked whether they thought they were above average at their job.

Roughly 75% of respondents felt they were above average, 24% felt they were average, and less 1% felt they were below average. Anybody with a high-school level knowledge of statistics knows these results cannot possibly be accurate. Nearly 25% of the individuals most likely suffer from optimism bias (and an inflated ego). 
 
So what can we take away from this? The main point is professional money managers – with years of hard performance data – have convinced themselves they are mostly above average in the skill sets. Second, optimism bias can lead you far astray from the cold hard facts. Yes, you might have a genuine affinity for making successful decisions, but only if the data support you in your claim. Last, an optimism bias can lead to rejection of information (or lack of information per Smith’s theory) essential to making wise decisions. 
 
Conclusions
 
The line between reasoned optimism and optimism bias can be mighty thin sometimes. The ability to make that distinction by applying outside thinking and data means you have a leg up on most other investors. Don’t get me wrong. There’s nothing inherently bad about having a cheery disposition, but an investment manager utilizing such an outlook can cost his/her investors dearly. Like our sailors at Samar, sometimes a certain amount of bravado is required. Just not in investment management. 
 
I look forward to your thoughts and comments. 

[1] The story of the Battle of Saran and the fight of Taffy 3 is an extraordinary story. You can read more about the battle in the book “Last Stand of the Tin Can Sailors”, by James D. Hornfischer.

[2] For a wonderful and modern look at Adam Smith’s theories you should read “How Adam Smith Can Change Your Life”, Russ Roberts, 2014

[3] Think Twice: Harnessing the Power of Counterintuition, Michael J. Mauboussin,  Harvard Business School Press, 2009

[4] “Behaving Badly”, Dresdner Kleinwort Wasserstein, February 2, 2006 

“It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." 
 
                                                                                                   -     George Soros 
​
We’ve always valued the wisdom of George Soros and have a copy of the quote seen at the beginning of this article displayed in our office. But over the past five years, we’ve begun to quibble with this quote. We think there is a third option: how much money you make when markets are making even more. Over the past five years, Nintai Investments has generated solid returns for our investors. In fact, we have outperformed our proxies—the Russell Mid-Cap Growth Index and the Russell 2000. That said, we have significantly underperformed the S&P 500 over the past 1, 3, 5, and 10 years. 
 
Monolithic Power Systems: Good, But Not Good Enough
 
We have owned Monolithic Power Systems (MPWR) since 2021 in most of our portfolios. During that time, the company has been performing exceptionally well. As shown below, growth and profitability have been impressive over one-year, five-year, and ten-year periods. 

On October 30th, the company reported its third-quarter results. Third-quarter revenue came in above guidance, rising 19% year over year to $737 million. Fourth-quarter guidance was positive, implying 19% year-over-year revenue growth to a midpoint of $740 million. Here was Morningstar’s take on the quarter and the company’s 2026 outlook.
 
“MPS' strong momentum is continuing, with widely diversified growth across its served markets. We like MPWR’s' ability to win new customers, move up the value chain in key markets, and take market share. Artificial intelligence and automotive growth continue to be bright spots.

• AI revenue was a headwind in the first half of the year, with lumpy order patterns and MPS ceding some of its dominant share. We like that this business is back to growth and anticipate further expansion with the firm qualifying into custom AI accelerators at new customers like Google.
• MPS' march up the value chain in automotive is impressive. The firm won another advanced driver-assistance system design in the quarter. We expect ADAS strength to continue and for MPS to layer in battery management and electric vehicle drivetrain solutions longer-term.
• We expect another year of 20% sales growth in 2026 and see double-digit growth enduring into the long term. We expect data center revenue to grow most rapidly but expect the firm's attractive end-market diversity to prove durable behind widely strong growth across its markets.

The bottom line: We've raised our fair value estimate for wide-moat MPS to $920 per share from $840. We like the company's diverse growth opportunity and continue to see the highest growth in data centers and autos.”
 
From this review, you would consider the company’s quarterly report and 2026 outlook exemplary. Indeed, few companies in today’s market have achieved such levels of profitability, growth, and capital allocation. 
 
For all of this, the day after announcing earnings, the stock dropped by 12% by midday. What in the world would cause the markets to slash the stock price by double digits after such a report? 
 
Two words: artificial intelligence (AI). Market participants didn’t see enough discussion (and market growth) related to AI. Management reported that, in Morningstar’s words, “AI revenue was a headwind in the first half of the year, with lumpy order patterns and MPS ceding some of its dominant share.” We’ve now reached a stage in a market, driven by AI, where a company with double-digit growth foreseeable through 2035 and free cash flow estimated to grow by 18-20% over the same period sees a double-digit price decline because AI revenue was “lumpy.”
 
Conclusions
 
We are in a market that challenges many of the values we've upheld for the past few decades. We've always focused on companies that generate high returns on capital, strong free cash flow margins, little or no debt, and trustworthy management. We have always preferred to let the company and its management handle the heavy lifting over time. Eventually, the returns will follow. Over the past five years, we've seen two market segments—artificial intelligence and cryptocurrencies—drive most of the market’s outperformance. Don’t get me wrong—our portfolios have performed well, delivering roughly 10% returns over the past decade. However, these returns have simply not kept pace with assets that either lack obvious value (crypto) or haven't produced significant free cash flow yet (AI). Ultimately, we are unlikely to invest in either market category. We believe companies like Monolithic Power Systems are excellent organizations that will yield strong long-term returns. AI and crypto? We’re not so sure. But one thing we are confident about is that we will not risk our investors’ hard-earned dollars on such hollow ventures. 
 
As always, we look forward to your thoughts and comments.
 
DISCLOSURE: We hold Monolithic Power Systems in our current investment partners’ and personal portfolios. 
 

To Our Readers:

We will be on vacation from July 27th through August 10th. We are posting an article from the archives in replacement of any new writing. 

“I used to be Snow White, but I drifted.”
                                                                                 -    Mae West
One of the more interesting stories in aviation history is the example of the Gimli Glider. The incident took place in 1983 with the new Boeing 767. Halfway through the flight, the plane ran completely out of fuel and was forced to glide to a former Canadian airbase and make an emergency landing. The mistake was made by a series of human errors and the simple fact that fuel calculations were made in metric (liters) versus imperial (gallons). Having loaded less than 50% of the fuel necessary for the planned flight, the crew found itself flying a glider over Manitoba rather than a jet airliner.
The Gimli Glider story has quite a few similarities to value investing. In the final analysis, a simple mistake can turn an event, a company, anything really, into something quite different than your expectation. The journey getting from point A to point B can become quite different than first envisioned. If a company’s strategy begins to wobble in year two, it’s likely you will be investing in a very different company in year five and something not even remotely the same in 20 years.
The Gimli flight crew thought they were flying the most modern jet airliner in the world. In a matter of moments, they were flying the largest and heaviest glider over flown. Sometimes a value investor thinks they are buying a jet but get a glider. Avoiding these unexpected conversions is one of the top ways to be a successful long-term investor.
In my time at Nintai Partners, I averaged an 8.7-year holding time for each portfolio member. Each year, we would evaluate our investment case of each holding with a particular focus on what we called the “drift factor.” This evaluated how different the company was from a strategic, operational and management sense year over year. Over time, we found that those holdings with the largest “drift” factor were almost always our largest losers. We also found the quicker (or larger) the drift, the worse the loss. Essentially, we were buying a jet that drifted into a glider (no pun intended).
Andrew Carnegie once said the way to become rich is to put all your eggs in one basket and then watch that basket. As a focused investor (from both number of holdings and number of industries), my job as an investment advisor is to allocate capital in companies that minimize drift over the long term. With such focus, the smallest amount of such drift can cause dramatic changes in the quality of the portfolio in a very short time.
That’s why it’s vital to be a very different critical thinker if you want to be a long-term investor. The idea of sitting by a lake reading Barron’s as your companies compound cash is somewhat correct but mostly wrong. Watching that basket all the time is like flying that jet – it takes considerable work.
To me the importance is to track the drift within the context that your holding period will be a decade or more. It’s a difficult path to follow. Here are the important criteria I use to assist in meeting these goals.
Confidence of same industry business in 10 to 20 years
It’s very difficult to invest in a company that you are confident will be doing the same thing in a decade or two. It’s a challenging exercise, but I think can be done with some (the operative word) accuracy. Research in five areas in particular can give an investor a reasonable shot at the potential for drift.
M&A: Has the company had a history of M&A? Are acquisitions largely accretive or small snap-on purchases to enhance current offerings? Do they enhance the company’s moat, making it harder for competitors to catch up? Conversely, has management done a deal that clearly destroys shareholder value?
Regulatory: Does the company have an advantage supported by government regulations? For instance, biopharmaceuticals will have a regulatory moat for branded products that can last a decade or longer. Conversely, is there a risk that regulations may restrict the company’s strategy or operations?
Technology innovation: In 1978, the head of Encyclopedia Britannica was famously quoted to the effect that encyclopedias were the safest product line to bet on in the future. I’m not sure what happened to that executive, but I hope he didn’t bet his future retirement based on his market predictions.
Business process innovation: The phrase “to build a better mouse trap” has been around as long as there has been ... well ... mousetraps. And yet for all the amount of times you’ve heard that phrase, a mousetrap is still a mousetrap, and the model designed in 1934 still has 90% of market share. The catch (no pun intended) is that the price has dropped roughly 90% since its introduction. Almost all of the cost squeezed (OK, that might have been intended) has been in better business processes (cheaper raw materials, cheaper labor, design tweaks, and so forth). 
Competitive moat: Competition can lead your investment company quickly astray. When you think of companies with wide moats from small (WD-40) to jumbo-sized (Coke or Pepsi), you can imagine them selling the exact same product 15 to 20 years from now. Investing in a product with a deep moat managed by great capital allocators is the value investor's dream.
Length of time of the investor’s ownership
As I mentioned earlier, my experience has been that the drift factor can be exponential when it comes to owning a stock for 15 to 20 years. In the doldrums in the history of Coca-Cola (KO, Financial) in the 1980s and early '90s the company actually owned a shrimp farm and Columbia Pictures. How it got from carbonated beverages to raising future cocktail hors d'oeuvres and shooting films is a story in itself, but not the kind of story you want to hear as an investor.
Fortunately, the board and Bob Goizueta recognized the drift factor when they saw it. From 1981 until his premature death, Goizueta increased the stock price by 65 times. If you had held the stock during the '60s and '70s, you might have missed the slow drift away from Coke’s core competency. But for those who held on for the entire tenure of Goizueta, the lack of drift and return to laser-like focus on its core business made many peoples’ fortunes (just ask Warren Buffett (Trades, Portfolio)).
Conclusions
Over the course of my investing career. I’ve had quite a few holdings that fell prey to the drift factor. Several have been due to the deadly urge to acquire while being pushed by consultants’ assurances of “synergies.” Others have been simply that management and the boards didn’t keep their eye on the ball and saw competition fly by. In the case of Coke, they were saved by the fact that their CEO figured out less was more.
Which brings us back to the Gimli Glider. Passengers that day learned that gifted leaders and intense focus (with a little luck) can turn a rather dramatic drift problem into a positive solution. Quick reaction, identification of the problem and a practiced checklist can help an investor too. It can make all the difference between a safe smooth flight or a short and bumpy ride.
As always, I look forward to your thoughts and comments.

“Patience in Market, is worth Pounds in a year.”
 
                                                                   -     Benjamin Franklin, ‘Poor Richard’s Almanack’ 

Over the last four years, we have observed a clear split in the returns of Nintai portfolio holdings. Eight of our holdings (40%) have experienced losses greater than 30%. Conversely, four have returns exceeding 100%, and five more have returns over 50%. The stocks with the biggest losses have hampered the portfolio’s performance during this period. Interestingly, these same companies fueled our strong outperformance in the first four years. Frustrating times, indeed. 
 
This quarter, we decided to review the worst-performing positions and see if any raise concerns about our business case. One of our main worries is the permanent loss of our investment partners’ capital. This can occur for various reasons. The company may have lost its competitive advantages (or moat), the business model could be outdated, or management might have proven to be poor at allocating capital. The question we seek to answer is whether Mr. Franklin’s thoughts apply here - will patience be worth pounds in a year (or more)? There are currently eight stocks that have losses greater than 30% since our initial investment. 
 
Some Initial Thoughts
 
As we examine each of these companies, we try to assess underperformance in various areas. Some of our holdings have more influence over these than others. These include:
 
Regulatory Status: Because a high percentage of our holdings work in a regulated industry (healthcare), those companies in that industry are overseen or regulated by several federal agencies, such as the Food and Drug Administration (FDA) or the Centers for Medicaid and Medicare Services (CMS), which oversee patents, prices, product marketing, sales, and promotion, etc. 
 
Government Policy: Over time, as new congressional leadership and Presidential administrations come to power, there may be significant policy changes. For instance, the latest Trump Administration took an aggressive stance regarding tariffs, which had an enormous impact on nearly every industry. Our role as investment managers is to identify companies that can withstand and overcome numerous unforeseen challenges. 
 
Competitive Moat: Morningstar identifies five potential sources of a competitive moat: switching costs, intangible assets, network effects, cost advantage, and economies of scale. We mainly focus on network effects and switching costs when selecting portfolio holdings because most of our investments are in "asset-light” business models. Within that model, we appreciate companies that provide underlying platforms that enable the company’s relationship to extend deeply into the customer’s operations. 
 
Allocation of Capital: We believe that over time, companies that produce returns on invested capital (ROIC) exceeding the weighted average cost of capital (WACC) will deliver exceptional returns for their investors. To do so, management must be outstanding allocators of capital. This means they must avoid expensive acquisitions, investing in businesses where WACC exceeds ROIC, or investing in assets that generate inadequate returns. 
 
Free Cash Flow Growth: At Nintai, we believe the only real measure of value is the amount of future free cash an asset returns, discounted back to its present value. That amount is the basis for calculating our estimated intrinsic value. If our assumptions are off (and in the cases of these holdings, they most certainly are), then it’s likely our investment case is impaired. 
 
Balance Sheet Strength: Another key factor we look for in any investment is a strong balance sheet. We prefer no short- or long-term debt, ample cash or short-term investments, and only a small amount of goodwill as part of total assets. We want the company to be fully prepared financially for the worst-case scenario we can imagine moving forward. 
 
Some High-Level Thoughts
 
After spending considerable time working through each company’s numbers over the past five years, we’ve identified some common themes in their underperformance. These include the following.
 
There were no cases of decreased financial strength: None of the underperforming companies have seen a decline in their balance sheet strength. None have taken on any debt (short- or long-term) in the past five years. This reassures us that they can withstand an economic shock like the 2007-2009 Credit Crisis. 
 
We were significantly off in our cash flow estimates: While their balance sheets remain strong, we underestimated the free cash flow of some holdings. Six of the eight companies that underperformed have seen free cash flow stay flat or decline. In each case, we projected a (positive) growth rate for the next decade. We didn’t do a very good job with our prognostication. 
 
We overpaid in some cases: Due to our inaccurate estimates of free cash flow, we overpaid on several occasions. In others, we failed to maintain our margin of safety, which led to underperformance not reflected in our purchase price. Whether this was caused by environmental factors (such as tariffs or regulatory changes) or investing outside our circle of competence still needs to be addressed.  
 
We overestimated customer “must-haves”: Several times in our investment history, we have mistaken our holding company’s offerings as a “must-have,” not a “nice-to-have." Several years ago, we believed that Corporate Executive Board (now part of Gartner) was a must-have for their clients. It seems we have made the same mistake in recent years as well.  
 
We were poor policy prognosticators: Some of our underperforming assets have been influenced by changes in the regulatory environment. In these cases, we should have done a better job of identifying potential impacts and modeling the downside more accurately. Some impacts were unforeseen (such as conditional FDA approval), while others were fairly apparent (such as tariffs). 
 
All these reasons challenge some part of our investment research process. We are reviewing them to determine (a) why they occurred and (b) how we can prevent them from happening again. Some say that achieving 60% accuracy in your stock picks is quite good. But that only tells part of the story. What really matters is how much each holding outperforms or underperforms. In this case, our winners have been successful enough to beat our closest benchmarks - the Russell 2000 and the Russell Mid-Cap Growth Index. Unfortunately, they haven’t been enough to beat the S&P 500, though we rarely invest in large-cap stocks. 
 
Over the next several weeks, we will review each of our underperformers to identify what we got right, but most importantly, what we got wrong. We will discuss whether our investment case has been broken, and if so, why. Discussing your losers isn’t an easy thing to do, but it’s the right thing to do. We strive to continually improve our investment process, which is vital to achieving this goal. 
 

We utilize free cash flow as our primary valuation component because it is one of the most difficult statistics for a corporation to manipulate. Alfred Rappaport summed it up nicely: “Profit is an opinion; cash is a fact.” So why is free cash flow a better (or more realistic) measure? 
 

1. FCF accounts for changes in working capital, such as accounts receivable and payable, which can affect a company's cash position. Earnings may not fully reflect the effects of these changes on cash flow. 
2. Earnings encompass items such as depreciation and amortization, which are non-cash expenses that do not represent actual cash outflows. FCF, in contrast, emphasizes the actual cash a company generates, offering a more realistic view of its financial health. 
3. FCF considers capital spending on items such as property, plant, and equipment, which are vital for maintaining and expanding operations. Earnings may not fully capture the cash needed for these investments, while FCF does.
4. FCF helps investors assess a company's ability to reinvest in its operations, pursue strategic initiatives, and sustain long-term growth. It also offers a clearer view of a company's financial health and its ability to endure economic downturns.

 
Why Free Cash Flow and Not Earnings?
 
Earnings, also known as net income, refer to the profit a company generates after subtracting all expenses from its revenue. It is calculated on the income statement by deducting expenses such as the cost of goods sold, operating expenses, interest, and taxes from gross revenue. Earnings can encompass both cash and non-cash items. For example, depreciation, which is an expense that reduces earnings, does not involve an actual cash outflow. Earnings are reported on the income statement. It’s essential to remember that earnings focus on profitability, whereas cash flow emphasizes liquidity—the ability to access cash. So why do we use free cash flow rather than earnings in calculating value in potential or actual portfolio holdings? Here are a few areas that can help illustrate the differences between earnings and cash flow:
 
Reporting Sources
Companies primarily use three financial statements to assess their overall performance and health: balance sheets, cash flow statements, and income statements. The cash flow statement records the company's accounts payable and accounts receivable. It helps reconcile the other two statements by illustrating the company's financial activity, like a checkbook; however, it doesn't always provide a complete view of all expenses and activities. The income statement reflects earnings, displaying the company's profits over a specific period. Income statements can provide a broader perspective on a business's performance and growth potential since they show profits after deducting expenses and costs.
 
How It’s Calculated
Another key difference between earnings and cash flow is how they are calculated. To determine earnings, accounting and financial professionals subtract a company's expenses from its revenue. Expenses include costs such as labor, supplies, rent, taxes, and interest. They can use these calculations to display earnings over a specific time frame, such as a quarter or a year. For cash flow, the calculation focuses solely on the company's actual inflows and outflows of cash. Any transactions occurring on a non-cash basis will not appear in the cash flow statement. The statements serve as an ongoing ledger that reflects the company's cash balance as of the end of a period.
 
The Two Can Create Two Distinct Views
When investors and shareholders conduct business valuations, they consider the company's price in relation to its earnings, cash flow, book value, or equity value. Therefore, both earnings and cash flow represent crucial figures to comprehend, as they provide unique insights to stakeholders. To achieve long-term, sustainable success, organizations must maintain both profits and positive cash flows. However, success in one area does not always equate to success in another. For instance, a company may be profitable yet still lack sufficient available cash to cover essential expenses, such as payroll or supplies, especially if it is waiting for customer payments or has not yet sold its inventory. In this case, profitability does not necessarily mean positive cash flow, and cash flow becomes a more critical figure for stakeholders. 
 
Similarly, a company may temporarily enhance its cash flow by securing loans or selling assets. However, if its earnings are not adequate to generate profit, achieving profitability becomes increasingly crucial. Therefore, it is vital for companies to achieve profitability to ensure their ongoing operations.
 
Conclusions
 
Nintai is not entirely averse to using net income/earnings to evaluate a holding. Free cash flow is a more applicable measurement tool because cash is king. Our results in the 2007-2009 Credit Crisis have further strengthened FCF’s appeal in our research and valuation methods. We should note that this can require considerably more research time as we convert a company’s quarterly earnings report into a free cash flow quarterly report. But we think the effort is worthwhile. 
 
FCF represents excess cash generated by a company that is available for distribution to investors, debt repayment, or reinvestment in the business. Because of that, our role as a shareholder and fiduciary for our investment partners means we are acutely interested in how cash will be deployed. If a company can achieve greater returns on invested capital by deploying funds toward strategic acquisitions or expanding existing operations, then we fully support such efforts. However, this is only if those returns exceed what Nintai, or its investment partner, can achieve independently. If the latter is accurate, we would like to see the capital deployed in the form of dividends. Additionally, if the company’s shares are trading at a significant discount to our estimated intrinsic value, then share buybacks might be the best use of cash. Free cash flow can assist us in any of these calculations where net income might not provide us the insight to recommend them. 
 
For all these reasons, in addition to the previous analysis of FCF compared to earnings, we dedicate a significant amount of time to examining a holding’s FCF figures. We believe that, over the long term, a company’s share price will closely follow its free cash flow numbers. 
 
I hope this provides you with a solid overview of why our valuation spreadsheets, along with many other documents, use FCF as a fundamental measure. Please don't hesitate to contact us with any questions or comments. My best wishes. 
 
DISCLOSURE: Nintai Investments does not own shares in any company mentioned in this article. 
 
  
 
 
 
 

“I firmly believe that acquisitions are an addiction, that once companies start to grow through acquisitions, they cannot stop. Everything about the M&A process has all the hallmarks of an addiction. If you look at the collective evidence across acquisitions, this is the most value destructive action a company can take.”
 
                                                                             -      Aswath Damodaran 

Earlier this week, Dollar Tree announced it was spinning off its Family Dollar unit, which it acquired in 2015. Companies spinning off holdings aren’t uncommon. In fact, companies divesting units acquired within the past decade also aren’t unusual. But most importantly (and sadly), companies selling off former acquisitions at significant losses are incredibly common. We will get into those details later, but let's first take a look at the Dollar Tree/Family Dollar debacle. 
 
In 2015, the Dollar Tree Board of Directors issued the following statement to the management of Family Dollar. 
 
“The Board of Directors of Dollar General is pleased to submit a proposal to you and the Board of Directors of Family Dollar that offers Family Dollar shareholders $78.50 per share in cash for all outstanding shares, providing them with superior value and immediate and certain liquidity for their shares. Not only is our offer superior in price, it is 100% cash, as compared to the mix of cash and stock being offered by Dollar Tree.

Our proposal provides Family Dollar’s shareholders with approximately $466 million of additional aggregate value over Dollar Tree’s offer and represents a premium of 29.4% over the closing price of $60.66 for Family Dollar stock on the day prior to the Dollar Tree announcement.” (Emphasis is mine)
 
The concept was that by partnering with Family Dollar, Dollar General could create a low-cost giant that significantly expanded its customer base, achieved cost savings through those elusive “synergies, " and kept Dollar General in check. The latter had made an earlier bid for Family Dollar. 
 
The acquisition worked out poorly from day one. The synergies the company thought could be achieved were a mirage. Family Dollar stores were in extremely poor condition, plagued by inadequate maintenance, high refurbishment costs, and excessive overlap with Dollar General locations. How this could not be foreseen is a mystery. Too put a punctuation point on how badly the Family Dollar maintenance had fallen, the company was forced to pay $42M in fines after regulators found a supply warehouse overrun by live, dying, dead, and rotting rats. Wall Street started to lose confidence in the deal and the company’s management at the same time. Over the past three years, Dollar General’s stock has declined by 63% in value.  

After attempting to staunch the bleeding by closing hundreds of locations and investing considerable capital to upgrade the Family Dollar brand and shopping experience, Dollar General raised the white flag and announced this week that it is selling the entire Family Dollar brand to private equity groups Brigade Capital Management and Macellum Capital Management for approximately $ 1 billion. If you calculate the cost of $78.50 for every publicly traded share of Family Dollar in 2015, Dollar General paid around $9 billion for its acquisition. It should be emphasized that they paid in cash. The Dollar General Board issued the following statement earlier this week to announce the sale:
 
“The Dollar Tree leadership team and Board of Directors determined that a sale of Family Dollar to Brigade and Macellum best unlocks value for Dollar Tree shareholders and positions Family Dollar for future success.”
 
It may have been better if the Board had rephrased the statement to indicate that they had determined the sale would result in a $900M cash loss instead of unlocking value for Dollar Tree shareholders. 
 
M&A: A Destructive Addiction
 
KPMG (the consulting/accounting behemoth) examines acquisitions annually to assess their success and questions whether they have generally been effective or ineffective at creating shareholder value. The short answer is that they are not effective at all. However, that information doesn’t reach the C-suite or boardrooms. There is a significant disparity between management's perception of their success rate and the actual rate. This “perception gap” is remarkably wide - 93% of companies surveyed by KPMG believed their deals enhanced value, and over a third stated they would not approach their next deal any differently. Yet, KPMG's objective analysis of whether deals enhanced or reduced value revealed that only 31% of these deals actually enhanced value.[1] Wow. Even after all these statistics, most Boards wouldn’t change a thing regarding conducting acquisitions. 
 
Examining the history of mergers and acquisitions reveals that Dollar General’s disastrous acquisition of Family Dollar is merely typical of Wall Street’s M&A activity. Here are some interesting facts.
 

1. Dollar General’s recent announcement that it is spinning off Family Dollar only seven years after acquiring the company isn’t particularly surprising - half of all mergers are reversed within 10 years. 
2. McKinsey reports that approximately half of acquirers significantly fail in their due diligence work. In one of their latest studies (M&A Insights, February 2025), the company reveals that nearly three-quarters of recent technology M&A encounters have failed during the due diligence research. 
3. Trends pushed by large consulting firms drive much M&A activity. A case in point is the latest surge in artificial intelligence (AI) merger activity. KPMG featured the headline: “KPMG and HP make M&A integration easier by harnessing AI and automation technologies.” Gartner reports, “GenAI MActivity will lead the way.” Lastly, OutSystems states, “AI M&A: The Biggest Deals Yet?”

 
At a Columbia Business School symposium, a presenter noted that M&A completed in any given year’s “hot/fad” markets had a 2-3 times greater chance of failure than those in more stable markets.  
 
Conclusions
 
Dollar General’s acquisition of Family Dollar was typical when it was announced. The company grossly overpaid after conducting inadequate due diligence. In its press release, you can almost hear the frantic panting of management fearing it would be outdone by Dollar Tree. The spin-off of Family Dollar earlier this year marks the conclusion of a saga that severely damaged Dollar General’s financials, consumed far too much attention from the company’s C-Suite and Board, and inadvertently aided its competitor through its misstep. 
 
At Nintai Investments, we typically sell a holding if it announces a large M&A deal. We feel even more strongly when they use words like transformative, synergies, or maximizing shareholder value. A recent example is Masimo’s (MASI) acquisition of Sound United. Masimo possessed an exceptional business with a moat developed around its oximeter technology (the device you place on the tip of your finger to measure your oxygen saturation rate), generating high returns on invested capital and maintaining a balance sheet with no short- or long-term debt. Management went out and acquired a consumer electronics company with the intent of transforming (there’s that word!) their business model into an ambulatory home health company. Less than two years later, the company announced it was splitting into a consumer audio and a consumer healthcare company. It appears much like the two companies did before the acquisition. The announcement included the typical “maximizing shareholder value” language. We sold a few weeks after the acquisition announcement was made, viewing it as a method of destroying a perfectly wonderful small-cap, wide-moat company. We’re very happy we did. 
 
Whenever you hear management announce an M&A deal that promises to transform the business or achieve significant cost savings through synergies, consider carefully whether you want to partner with that management. Ultimately, they are likely to change the company, though not in the way they envisioned. As Mr. Damodaran mentioned, this kind of addiction can be very costly for the company’s and acquisition’s employees, their management, and most importantly, their shareholders. 
 
Disclosure: Nintai Investments does not own any shares in the companies mentioned in this article and does not intend to purchase them in the next 60 days since publication. 
 


[1] “The Morning After: Driving for Post-Deal Success,” KPMG Transaction Services, 2024

We thought with everything we've seen over the past several months with the Magnificent Seven stocks, we'd revisit a piece we did on why Nintai tries to avoid the fear-of-missing-out (FOMO).

"If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles, and when opportunities came along, you pounced on them with vigor."
 
                                                                                           -     Charlie Munger 

During a press conference, President John F. Kennedy was asked whether he got impatient at being unable to accomplish everything he wanted. He smiled and discussed how important it was to be ready to act when an opportunity came along to further his goals. He then told the following story. 
 
“The great French Marshal Lyautey once asked his gardener to plant a tree. The gardener objected that the tree was slow-growing and would not mature for 100 years. The marshal replied: ‘In that case, you better plant it this afternoon.’”
 
A Tale of Two Returns
 
For those who have invested in the markets over the past several years, many have noticed a trend of bifurcated returns. The so-called Magnificent Seven (Microsoft, Nvidia, Google/Alphabet, Apple, Meta, Amazon, and Tesla) accounted for roughly 92% of the total gains of the S&P 500 in 2023 alone. As shown in the graphic below, the returns of the Not-So-Magnificent 493 were not impressive. (Please excuse the rather gaudy nature of the Goldman graphic!)

​Examining the returns of the Magnificent Seven (M7) over the past several years makes it clear that investing in multiple stocks from this group is essential to outperform the S&P 500. Beating the S&P 493 would be much easier; however, that's not the index in question, whether it's a fortunate or unfortunate situation depending on your investment stance. 
 
But you don’t have to broaden your perspective too much to realize how remarkable the returns have been with the Magnificent Seven. If you examine the next 42 companies - not 493 - here’s how they compare to the M7. 

Compared to the next most extensive 42 stocks, the M7 appears inflated in terms of market value, sales, and profitability. These companies have 2.5 times the sales and twice the profitability.
 
Fear of Missing Out (FOMO) Syndrome
 
I bring this up because Nintai Investments has been one of the investment companies focusing on a much smaller market cap portfolio mix (unfortunately, in our case!). Not all of our underperformance over the past few years can be attributed to this, but it certainly hasn’t helped. Watching day after day as the M7 companies reach new price highs, year after year, hasn’t been the easiest experience. I must admit to feeling a slight tinge of Fear-of-Missing Out Syndrome (FOMO). That said, I believe that not experiencing FOMO is probably one of the top characteristics of successful investors. It is nearly impossible to maintain your investment strategy and invest for the long term when influenced by it.    
 
In this age of Bloomberg and CNBC's 24/7 business news, Reddit stock boards, and meme stocks, it seems that FOMO has become a driving force in modern 21st-century investing. It appears unlikely that an investor (are they really investors? Or would “ gambler “ be a better description?) who puts money into GameStop (GME) stock and observes its daily price fluctuate from $17.46 per share on May 1, 2024, to $30.45 on May 13, $48.75 on May 14, $39.55 on May 15, $27.67 on May 16, and finally $22.21 on May 17 (continuing down to $18.32 on May 23), will be able to outperform in the long run. 

If ever there was a case of FOMO driving a stock price, it would be MEME stocks like this. I would argue that much of the Magnificent Seven gains have been MEME stock-like writ large. 
 
Conclusions
 
As an investment manager, your primary goal is to outperform the greater markets over the long term. To meet that objective, sticking with the process that has brought you 
 
 
success is critical. Sometimes, that process will underperform. As I’ve said many times, to outperform, it is occasionally necessary to underperform (unless your name is Bernie 
Madoff). However, chasing returns driven by FOMO is an almost certain way to pursue highly volatile, short-term gains. This can lead to increased trading costs, a larger tax bill, and the loss of opportunities to let compounding work effectively. At Nintai, our first four years in business were exceptional, delivering significant outperformance nearly every year. The last three years, however, have shown a roughly mirror image. Nevertheless, we refuse to alter our methodology or start investing heavily in M7 stocks like Nvidia (NVDA) or meme stocks such as AMC Entertainment (AMC). Instead, we will heed President Kennedy’s advice from Marshal Lyautey and continue researching our long-term holdings like Veeva (VEEV) and iRadimed (IRMD). In fact, we’ll likely begin this afternoon. 
 
As always, we look forward to your thoughts and comments.
 
DISCLOSURE: Nintai Investments currently has holdings in Veeva (VEEV) and iRadimed (IRMD). We do not, nor do we intend to take a position, in Microsoft, Nvidia, Google/Alphabet, Apple, Meta, Amazon, Tesla, Berkshire Hathaway, Broadcom, JP Morgan Chase, United Health, Eli Lilly, GameStop, or AMC Entertainment. 

I've gotten quite a few requests to republish an article that I wrote roughly a decade a go about the power of inverted thinking and Abraham Wald. I republish it here in full. I hope you enjoy it.

Mutual Fund Survivorship: The Revenge of Abraham Wald
 
The story of Abraham Wald and the study of WWII bomber casualties is one of the more enlightening stories from the field of operational research. During the early days of the Allied strategic bombing campaign the amount of bombers not returning from their missions reached an unacceptable rate. In a desire to find out why, the USAAF completed a study on where the damage was taking place and where additional armor could be placed to make each bomber safer. Here Wald enters our story. Taking one look at the methodology and findings, Wald told the team they were looking at the problem the wrong way. By studying the planes that came back the researchers were seeing where the planes could withstand damage. The more interesting facts should be about the planes that didn't make it back. By analyzing where all the bullets holes and damage were on the planes that made it back, he proposed strengthening the areas where there were no bullet holes. Through his report thousands of bomber crewmembers were saved through the course of the war. Wald’s report and methodology can be found here.
 
Wald’s technique would later be summarized quite pithily by Charlie Munger when he advised, “Invert. Always invert”. The use of Wald’s methodology can be applied in the investment world in many ways. Perhaps the greatest use is the study of mutual funds. Investors spend an inordinate amount of time studying mutual funds with fantastic records (such as Bill Miller’s Legg Mason Capital Management Value Trust fund during the 1990’s). Put in Wald’s context, these are the funds that made it home. But what about all those funds that didn't survive? The funds that didn't make it home? What can be learned from these? 
 
Before we get to that, let’s take a look at the numbers of mutual funds and find out their general survivor rate. In 2013 Vanguard released a study on fund survivorship (which can be found here) studying mutual funds from 1997 through 2011. At the start of the study period there were 5,108 funds available. By the end of 2011 2,364 of these funds had been closed or merged leaving 2,744 funds (or 54% of all funds) that survived for the entire period. In that period from 1997 through the end of 2011 roughly 1 out of 2 funds didn't make it home. Of the funds that didn't make it, roughly 80% (or roughly 1900) were merged away while the remaining 20% (roughly 470) were closed entirely. 
 
It’s how the funds performed where the story gets very interesting. Let’s start with the funds that existed for the entire period (or the funds that made it home). Of the 2,744 funds roughly 1/3rd ended up outperforming. So during the period of 1997 - 2011 if you could divine which fund might actually survive, you still had roughly a 2/3rds chance at underperforming the market.  

Let’s take a look at the funds that didn’t survive the period (or the ones who didn't make it home). Here the story is far more depressing. Roughly 9 out 10 funds underperformed before they were either merged away or simply closed. A loss that would have staggered Wald himself. It’s hard to imagine that trained professionals - with a wealth of technology, analytics, and treasure behind them - couldn't exceed the batting average of an AA baseball team third stringer. In fact it’s hard to imagine that throwing darts at a list of stocks and bonds couldn't have produced better results. For the investors who received such terrible returns from their investment managers, all they received was a letter quietly delivered to their mailbox informing them of the merger of their fund with an entirely new - and no doubt exciting and outperforming - investment opportunity. 

​What Would Abraham Wald Say?
 
Wald approached the problem of aircraft losses very differently than the original assessment team. His ability to flip (or invert) the model allowed him to address the problem with an entirely fresh (and as it turns out - correct) approach. If we apply his methodology to the mutual fund industry there are several points which jump out that go far beyond the usual Wall Street talking points. 
 
It’s Not About Succeeding……. It’s About Not Failing
 
In the investment world action represents success. In reality active management (or action) represents a losing proposition. There’s an old adage that 90% of success is just showing up. It would seem the same rings true in investing - but with a twist. 90% of success is showing up, investing, and doing nothing.  Actively managed funds have demonstrated they have very little chance at beating the market indices. Indeed, if you add in the silent results of the funds that never made it, the odds of outperforming the markets are roughly 2 in 10. Active management - in general - is a loser’s bet. As personal investors this has equal import. By not making the simple mistakes - overpaying, trading too much, etc. - we can achieve remarkable returns. By not failing we can provide our investors an invaluable service. 
 
Evaluate An Investment Backwards
 
Many of us have a formalized process for evaluating investing opportunities. Some might use a DCF model while others use a dividend discount model. All too often we find comfort in using this process and we get lulled into a false confidence in our stock picking. At Nintai we frequently ask ourselves why we wouldn't invest in a certain company. By being the devil’s advocate we get a pretty good understanding of potential impairments to our investment case. Another tool is to build into your model the exact opposite assumptions and see where you end up. For instance if you project 8% FCF growth over the next 5 years, what would it look like if the company had -8% FCF growth instead. What impact would that have on EPS, balance sheet, etc.? Finally, we step away from our assumptions and become a competitor. What could I do strategically to beat the company? What new products could I develop? Do I have the financial ability to acquire them? All of these (and others) allow us to view our prospective investment from very different angles than our normal proprietary process. 
 
Conclusions
 
Abraham Wald saved tens of thousands of flight crew lives during World War II. His ability to see things from a different perspective allowed him to solve a critical failing in the Allied war effort. More importantly he demonstrated the power of survivorship bias and how it can lead us to misguided assumptions. For investors – both mutual fund and individual – we can be blinded by our successes and not take sufficient care to understand and protect against the downside. That’s a shame. Sometimes there are more learnings from a mistake than a success. I encourage everyone to take a long, hard look at his or her failed investments and find out what went wrong. Sometimes simply getting these corrected is far more powerful than looking for the next Microsoft. In the final analysis the solution can occasionally be blindingly clear with a simple move to the left or right. Just ask Abraham Wald. 
 
As always we look forward to your thoughts and comments.