Just because everyone is doing it doesn’t make it right. Sometimes your way really is the best way. Just have the facts on your side.
 
“The young man knows the rules, but the old man knows the exceptions”.
 
                                                               -          Oliver Wendell Holmes Sr. 

“When the game is no longer played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were – not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand even though it might mean forgoing large, and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully, and which, possibly, could lead to substantial permanent loss of capital”.

                                                             -            Warren Buffett (Partnership Letter, October 1967) 

In February 14 1797, a British fleet of 15 ships of the line under the command of Admiral Sir John Jervis met a Spanish force of nearly twice its size off Cape St. Vincent, Portugal. Two stories mark the initiative and confidence of the English navy at the time. In the first story, Admiral Jervis (soon to be Lord St. Vincent for his victory) sends a man to the foretop to tell him the size of the Spanish fleet. The following conversation took place between the lookout and Admiral Jervis.
 
"There are eight sail of the line, Sir John" 
"Very well, sir" 
"There are twenty sail of the line, Sir John" 
"Very well, sir" 
"There are twenty five sail of the line, Sir John" 
"Very well, sir" 
"There are twenty seven sail of the line, Sir John" 
"Enough, sir, no more of that; the die is cast, and if there are fifty sail I will go through them"
 
But that wasn’t the story that really made the Battle of Cape St. Vincent so famous. Rather it was the bursting forth of Horatio Nelson’s genius that stole the day. At a critical moment in the battle, when Jervis signaled for his ship to tack in succession (this maneuver called for each ship to turn through the wind in the same place as its leader and was a traditional ship handling instruction for the past 200 years), Nelson realized that such a maneuver would place the latter part of the English fleet in danger. He wore (the opposite of tacking) clearly in violation of his orders and proceeded to take on 6 of the largest Spanish ships with only his 64 gun Captain. This group included the Santísima Trinidad, the largest ship afloat at the time and mounting 130 guns, the San José, 112, Salvador del Mundo, 112, San Nicolás, 84, San Ysidro 74 and the Mexicano 112. Amazingly, Nelson succeeded fighting alone for 20 minutes and captured both the San Nicolas and the San Jose. It was the beginning of what was to be called the “Nelson Touch”.
 
Now that I’ve prattled on about maritime warfare in the early French Revolutionary wars, I wanted to discuss why both Nelson and Jervis’ rule breaking hold a great lesson for value investors. Many times, value investing isn’t dissimilar to heading into a fleet action like the Battle of Cape St. Vincent. There are many variables that impact decisions (the direction of the wind compared direction of market sentiment), the fog of war can be thick, loud, and disconcerting (think of the din of cannon fire and dense smoke and compare that to watching a re-rerun of any trading day in the two weeks following the collapse of Lehman Brothers), and the heightened emotions of winning or losing (think of the emotion of watching one of your fleet strike its colors versus seeing a portfolio holding drop 35% in two hours). The ability to stick to your process, and keep your emotions in check are as important today in front of your computer screen as it was on the quarterdeck of a flagship in the Age of Sail.      
 
Training Your Mind, Mastering Your Process  
One of the reasons why Admiral Jervis was so confident taking on the Spanish fleet (even if it numbered 50 ships) was the knowledge that his crews were the best trained in the world. Every ship was a well-oiled machine that Jarvis knew could hold its own against any two Spanish ships. This type of training and discipline is required in value investing as well. When a stock price drops dramatically, a value investor knows their process inside out and has the discipline to act only when it meets his or her criteria. For instance, at Nintai when a stock on the watch list drops by 5% or more in one trading day we know exactly what steps to take - read up on the latest corporate releases, search for competitive news stories, rerun the valuation model with any new inputs, etc. It’s a set process that we can run in less than 2 hours which gives our team the necessary facts to make a decision. Step two is having the discipline to follow the facts to their logical conclusion – a decision based on solid criteria we’ve followed for over a decade. The last thing a successful value investor does is run around and haphazardly purchase stocks because of Mr. Market’s manic moods. The discipline to find the right shares, at the right price, for the right portfolio are all earmarks of the tight discipline of a value investor.     
 
If Your Strategy is Sound, Follow Through With Everything You’ve Got
If you feel your investment strategy and process meets your goals and provides you with the best chance at outperformance, then never fear being aggressive in your actions. If you expect your results to be different than the major indexes, then your actions must be - by their very nature - different than those indexes. You can do this in several ways - have different portfolio holdings, have similar holdings but in very different percentages, or a combination of the two. Many successful value investors have been quite focused in their portfolio designs holding sometime as few as 5 stocks. At Nintai we generally hold no more than 20 holdings in our portfolios. We do this for several reasons. First, there simply aren’t that many companies that meet our investment criteria. Second, even fewer trade at enough of a discount to our estimated intrinsic value to meet our required margin of safety. Last, we want each position to be large enough to have a meaningful impact (both good and bad) on our performance. Several years after Horatio Nelson died, one of his “Band of Brothers” recalled “Nelson was entirely his own creature. People called his approach ‘The Nelson Touch’. It really was HIS approach. Nobody else could copy it. And no one achieved anything like his results after he passed from the scene.” Like Nelson, at Nintai we have our own unique investment methodology. Over time - and with the success we’ve had (though past performance is no assurance of future returns!) - we remain aggressive in our portfolio design. In the final analysis, our returns will certainly be our own. We are quite proud of that.     
 
It’s Not About Quantity, It’s About Quality
I’ve found over time that long-term success requires long-term quality. In the beginning of his career, Warren Buffett certainly had success with companies that meet the cigar-butt criteria. But Charlie Munger has argued the real investment successes at Berkshire Hathaway have come later, particularly after the tectonic shifting purchase of See’s Candies. At Nintai we drifted in a similar way, starting with the one-puff wonders we bought in March and sold in April after a 15% gain. Over time, I began to realize my more natural state was not the nail biting, manic purchasing and selling, constantly on the lookout for bad news, dyed-in-the-wool value investor of the 1950s-1960s. Rather I was far more slothful, indolent, and upbeat to really be able to enjoy that type of investment life. I learned – much like Nelson – that a smaller force made up of the highest quality could generate enormous success. It wasn’t just about the quality of my holdings though. It also was about the quality of my successes.  I had many small 5-10% gains with my cigar butts, but I found the 5 and ten-baggers were high quality companies that I bought and held for a decade or more. Simply put, quality companies mean higher quality successes.      
 
Conclusions
 
So what happened to Nelson after he violated Jervis’ orders? Old Jarvy was known for breaking an officer who willfully didn’t follow orders and there was certainly no clearer case than this. It is said that after climbing on to the deck of the Victory (Jarvis’ flagship), Jarvis hugged Nelson in a most un-seamanlike manner. Jarvis’ flag-captain - in a pique - after seeing a disobeying officer receive a hug (a hug forsooth!), complained to the Admiral that Nelson’s actions were a clear violation of his orders. Jarvis turned to him and said, “It certainly was so, and if you ever commit such a breach of orders, I will forgive you also.” Nelson went on the become a Knight of the Bath and win crushing victories in the Baltic, at the Nile, and of course his masterpiece, the Battle of Trafalgar which cost him his life.    
 
By following your own convictions and strategies in investing, it’s unlikely to cost you your life (or at least let’s hope so!). But the outcomes can certainly put your name in a book of rarified names. Not everybody who lives by their own rules will succeed like Nelson. But many of the greatest investors  - Warren Buffett, Jack Bogle, Michael Steinhardt, Charlie Munger, etc. - have withstood tremendous pressure to conform and give up their independent thinking. If your technique works for you (and that’s really the definition of success) then continue playing by your own rules. In the end, it’s really all you got.     
 
As always I look forward to your thoughts and comments.
 
DISCLOSURE: None

“When we control a company we get to allocate capital, whereas we are likely to have little or nothing to say about this process with marketable holdings. This point can be important because the heads of many companies are not skilled in capital allocation.  Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics. Once they become CEOs, they face new responsibilities.  They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered.  To stretch the point, it's as if the final step for a highly-talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve.”
 
                                                                                       -        Warren Buffett 

When my partners and I first came up with the idea of starting our second company, (which eventually went on to become Nintai Partners - a healthcare-focused consulting firm) we spent a great deal of time thinking about the areas of the business we performed poorly or in areas we simply didn’t perform at all. We eventually chose 3 areas to focus on:
 
Employee Ownership: We felt the strongest performance we saw in our field was driven by employee ownership. We didn’t mean stock options that represented 0.01% of the firm that vested after a ridiculous number of milestones had been met. We felt ownership should be achieved in a straight forward, substantial, and timely manner.
Compensation Driven by Customer Satisfaction: Most consulting firms have a pretty uniform approach. Partners create and maintain relationships that led to the largest engagements possible, middle-management/project leads look for as many project amendments that help beat revenue goals, and project staff work ridiculous hours in a controlled panic to achieve seemingly impossible project deadlines with little incentive to create long-term value. We designed a firm that compensated staff on long-term value created by their project. 
Retain Earnings to Drive Book Value: Our goal was to retain earnings and use them to create an internal investment fund. This fund would be the main driver of value for company shareholders. Owners could log on and see exactly how much each share was worth and calculate the value of their share of ownership.   
 
After several years of growing the business, attending Board meetings, and managing the internal investment fund, it suddenly became clear that I was engaged in an activity that no academic program had even remotely touched on - allocation of capital. It took several more years to define that role, create a process that could assist in making better decisions (there are no “best” decisions), and work with the Board to find a way to measure how successful we were in our efforts. Much like Warren Buffett’s comment, none of us in senior management had any real training or experience in allocating capital. One of the partners was great in sales and marketing, I was trained in operations management, and the other partner we used for their connections in the local business community. Each Board meeting turned out more excruciating than the last as one particular member hammered home that my job as managing partner was to “allocate capital - pure and simple”. When that job was complete he said, then I could hopefully return to my shareholders and convince them I had worked in their best interest. It was certainly a different way of looking at things. 
 
Allocating Capital: Everyday Life of the CEO
 
In the course of daily living, we are constantly making decisions about allocating capital. Ranging from whether that membership at the gym is worth it to deciding when to replace the old car with a new one, how we allocate our hard-earned dollars is a vital part of our daily life. Yet somehow - through the course of getting all that corporate in-house training or attending classes for that professional license  - many managers seem to have lost their ability to calculate whether that corporate porterhouse steak is more valuable than the filet they looked at last week. That’s truly unfortunate, because senior executives are faced with how, when, and where to allocate capital on a fairly regular basis. In the corporate world, allocation focuses on four major capital categories - mergers and acquisitions (M&A), capital expenditures (CapEx), dividends and share buybacks, or research and development (R&D).
 
It’s important to remember that not all capital allocation is equal in either complexity or impact. For instance, some CapEx is allocated specifically to grow the company. An example might be a new plant to increase manufacturing capacity. Staying with that example, replacing equipment in an existing plant might be solely for the maintenance of current manufacturing capacity. This distinction is vital when it comes time to calculating return on capital for the year. As a senior executive once said in a meeting to discuss capital spending “I don’t like to pay for the privilege of standing still. If I’m going to lay out some serious cash, let’s make sure we aim to grow and to win”.   
 
Management are better at certain types of capital allocation than others. For instance, we know the record for mergers and acquisitions is quite poor. Management has a tendency to get the animal juices flowing and the next thing you know we’re looking at a shiny new toy obtained at nose bleed prices. Management also does a relatively poor job when it comes to stock buybacks. Over time, we’ve come to see that management buys back shares when they are at their most expensive but stop buying when share prices drop. The link between price and value seems to be obscured if not entirely forgotten during these times. As Warren Buffett pointed out “the first law of capital allocation - whether the money is slated for acquisitions or share repurchases - is that what is smart at one price is dumb at another.”
 
So what are we to do if so many managers are so bad when it comes to allocation of capital? It’s not an idle question. Adam Weiss of Scout Capital pointed out that if you buy something with a 10% free cash flow yield and hold it for 3 years, management will be responsible for allocating a third of the intrinsic value of the company over that time. After ten years that jumps to 60%. As a shareholder, what could be more important than that? The answer is not much. So its beholden to shareholders - and through them Board members - to speak up and make sure senior managers understand its importance. At Nintai, we think there are three areas where focus  - through training and incentives  - should be applied. 
 
Establish a Link Between Price and Value
In many cases, senior management can lose sight of the requirement that value be commensurate with price when it comes to capital allocation (meaning you get a dollar – or more – back from the dollar you’ve allocated). An example of this is the history of value destruction through managements’ M&A activity. Until corporate boards make the link between what management pays and the value created (or not create in most cases) by acquisitions, it is likely we will continue to see deals driven solely by ego, empire building, and false hopes. In the words of Robert Fuller “tsk….tsk…what a way to run a railroad!”. 
 
Reward Management When Long-Term Value is Created
To reinforce the relationship between price and value, corporate boards should be looking for ways to compensate management for such value creation. Ways to measure such success should be left to board compensation committees, but it would seem to me several issues should be addressed in these awards. First, value creation should be focused on the long term. Second, a distinction should be made between value created by cutting costs and value created by growth. Third, value should be of a permanent nature, meaning growth isn’t transitory but multi-year in scope.
 
This Isn’t Just for the C-Suite
Understanding the link between price and value isn’t a concept for just senior management. Mid-level managers and line employees should be trained to think in such a manner from day one. If the expectation is that employees with strong performance records will find their way up the greasy pole, then corporate leadership should be thinking about training for all aspects of the business. A great example of this is training by Boston Consulting Group in their “CFO Excellence Series” (an overview can be found here). When one becomes aware that capital allocation is one of the most critical means of translating corporate strategy into action, then training can’t begin soon enough.
 
Not All Allocation of Capital is Created Equal
 
As I mentioned at the beginning of this article, there are four major ways that management can allocate capital - M&A, CapEx, Dividends/Buybacks, and R&D. Each of these require their own form of expertise. For instance, M&A center on two completely different - yet connected  - skill sets. In the first, management should have strong internal mental models on calculating valuation. Second, management should have extraordinary self-control that allows them to sit and take 20 pitches in one at bat without taking a swing. While these may seem mutually exclusive, the two skill sets actually are quite complimentary. In this case, the whole is greater than the sum of its parts.
 
 A distinction is made between capital allocation that is necessary to keep the doors open (defined as working capital) versus capital allocated to facilitate growth. Working capital is a simple calculation: current assets less current liabilities. It is possible that a company might have positive current assets - or even by technically profitable - but be forced to cease operations as it has insufficient liquidity. Because Nintai doesn’t invest in companies with such type of balance sheets or cash flows, there isn’t any reason to spend much time on this type of situation. 
 
But we are definitely interested in the distinction between allocating capital for growth and allocating capital for maintenance. At Nintai we generally avoid capital intensive industries. Examples are industries that require steady capital injunctions to simply keep up with competitors or keep the business running. This might include the railroads or the steel industries in the 1970s. Another example is industries that require significant R&D to simply find replacements for an ever evolving list of non-patented direct-to-consumer product. In both cases, capital is employed to maintain market share and less to drive growth.
   
Asset Light or Capital Light Models
 
At Nintai, we have a bias towards businesses that are asset light or capital light in their strategy or structure. These are businesses that require little capital to maintain the business. Any new capital can either be used to grow the business or be passed on to shareholders. Examples of this include Nintai holdings SEI Investments (SEIC), Veeva (VEEV), or Manhattan Associates (MANH). Each of these companies share similar capital structures – little-to-no-debt, low average weighted cost of capital, high return on capital, and very low capital needs.
 
Another aspect of these companies (it’s unclear which came first - the competitive moat or the asset light model. One thing is certain though - they intertwine) is the deep competitive moat surrounding each of them. Not only does it take little capital to maintain their outstanding business characteristics, but also their respective leads in their markets. For instance, Manhattan Associates currently fields a return of return on capital of 68% - rising steadily from 12.8% in 2010. As Manhattan has dug its moat deeper and wider it has achieved an increasing return on capital.
 
It should be stated that while some asset light companies achieve high returns on capital, not all do. Bausch Health Companies (BHC) - the former Valeant Pharmaceuticals - created an asset light business based on raising prices and in-licensing orphan drugs. While that worked for a while – the company grew revenue per share from $5.46/share in 2004 to $30.48/share in 2015 - the inevitable bill came due on $30 billion in debt - and the company saw return on capital collapse 34% to -2.4%. After teetering near bankruptcy for a short will and a fire sale of assets, the company is slowly righting itself.
 
What Bausch Health and Manhattan Associates can tell us is that allocation of capital can bring either long-term success or long-term failure. A company simply can’t be successful when managers are poor capital allocators. As the former Valeant - now Bausch - shareholders can tell you, if your managers aren’t successful at allocating capital, then its shareholders won’t be successful investors. Traders may succeed - but not long-term shareholders.
 
Conclusions
 
At Nintai, we’ve learned over time (and through painful experience sometimes!) that our most successful investments have been with managers who created a business whereby they could generate high returns on capital and – in the long term - generate significant shareholder value. The characteristics of those businesses are:

• The company is run by managers who understand the link between price and value;
• The company’s average cost of capital far exceeds its return on capital;
• The managers create/sustain a business with a wide competitive moat;
• The company can employ capital internally to create additional growth, market share, and shareholder value

 
Given these characteristics, management can create a virtuous cycle that consistently - and profitably - grows the company creating long-term value for its shareholders. As Warren Buffett pointed out in the beginning, most managers aren’t trained to create and run such an investment gem. When you find management capable of creating and sustaining such a model, then hang on and let them do all the heavy lifting. The only real question is why do anything else?
 
As always I look forward to your thoughts and comments
 
DISCLOSURE: Nintai Investments has a long position in MANH, SEIC, VEEV

At a macroeconomic level, Nintai has never tried to divine exactly where the equity markets, US economy, or global economies are headed. It’s a loser’s game if an investor feels they can time their exposure to any of them. We have always tried to find companies with deep competitive advantages where their product and services are vital to their customers strategy and value proposition. Balancing that with incredibly strong financial performance and pristine balance sheets, we think our portfolio holdings will do well in nearly any market. 
 
Certainly Wall Street disagrees with Nintai’s methodology. An enormous amount of sweat and treasure goes into calculating exactly where the economy will be 18 months from now, or what the Federal funds rate will be after the next Board meeting, or how the slowdown in Chinese auto imports will affect US-based auto parts stores. There are thousands of very bright individuals who work day and night trying to gauge the impact on individual stock prices or even the broader market indexes. In this article, I thought I’d share Nintai’s thoughts on the role macroeconomics can play in portfolio management, why most data are irrelevant for the average investor, and what data are actually critical to a value investor.  
 
Geopolitics and Its Impact on Calculating Value
 
The recent events surrounding the Chinese/US trading relationship is an example of the complexity that macroeconomics can present in calculating a portfolio holding’s intrinsic value. A note before I begin: this discussion will inevitability wander into the realm of politics. In the context of value investing, I have little interest in our current political environment with the exception of what impact it might have on my clients’ portfolios. I ask that any comments avoid purely political views or opinions.
 
The current administration made it clear in both their campaign and through current policy that existing US policy towards trade with China needed to change dramatically. The big issues include the current trade deficit, intellectual property rights, market access, government industry subsidies, and currency exchange rates. At Nintai, the first step we take after identifying the core issues is to ascertain which holdings could be impacted by geopolitics. In this instance we might ask several questions that would help us identify these companies.

• Which holdings have the highest percentage of revenue generated overseas with a focus on mainland China? (Further research might entail which competitors would also be impacted, finding local Chinese-based companies that would not be impacted, or the stickiness/depth of the Chinese relationship)
• Which companies have supply chain or key outsourced partners in mainland China? (Here we would look to ascertain the complexity of the supply chain, number of subcontractors required, and location of alternate supply chain companies)
• How important are each of the five key issues listed above. For instance, which holdings are reliant upon intellectual property rights? This might be either in revenue generation (examples might include biopharmaceutical drug patents or author copyrights) or in operational costs (examples might include patent in production process or a technology patent in a product component).
• Which companies can find offsets to increased tariffs and what is the nature of those offsets? (examples might include passing them off further down to distributors or consumers or relocating parts of the supply chain)  
• Last - from a policy standpoint – which holdings are in industries most (or least) likely to have the financial and political wherewithal to seek (and get) exemptions from any possible new tariffs or regulatory policies such as non-importation bans? (An example might be Apple which received a waiver from the Trump Administration)

 
Answering these questions should give an investor a relatively comprehensive (but high level) view of the risks facing each of their respective holdings. Will it - or can it - give an investor enough information to make detailed changes in their estimated intrinsic value estimates? It’s unlikely. But can it answer the “bigger than a breadbox, smaller than elephant” when it comes to potential impact? Certainly. Answering these questions can give an investor broad enough knowledge to know which holdings are at risk, how big the risk is, and whether there are tools or processes that can help mitigate that risk.   
 
A Working Example: Skyworks Solutions
 
To show the difficulty in trying to define both the risk (where you can define possible outcomes) and uncertainties (where you cannot define possible outcomes) in a macroeconomic setting, I thought I’d use the China/US trade issues and look at current Nintai portfolio holding Skyworks Solutions (SWKS). Starting with President Trump’s statement in March 2018 that “trade wars are good, and easy to win”, the current Administration has made over 200 statements that a trade agreement with China is “very, very close”, “separated by the narrowest of margins”, “just about done”, “a done deal” to be compared with the less far less enthusiastic “a pretty significant gap”, “not much progress”, “they are going to have to give”. This isn’t making any judgment against the Trump Administration (though we might quibble with the idea that trade wars are easy to win). The whiplash from so many contradictory and misleading statements by administration spokespeople has made any of their predictive qualities useless going forward. With threats of tariffs ranging from 5 - 15% on everything from auto imports to flamethrowers (flamethrowers? Yup. Take a look at the full list here), it’s very difficult to make long term profit projections. It’s particularly hard if you do the bulk of your business in the international markets.
 
Skyworks has faced a double blow with the government’s on-again off-again tariff threats with China (theoretically resolved with the “Phase 1 Agreement” agreed to on December 13 2019) and its equally confusing approach to large Skyworks’ customer Huawei. The stock price over the past year has a range from $60 - $103 per share. Which price is closer to intrinsic value? Utilizing macro-economic issues, it’s pretty difficult to come up with any solid number. For instance, in its recent earnings call (November 2019) management stated earnings would have been 20% higher with business from Huawei (the company is currently banned by the U.S. government from purchasing chips from Skyworks).
 
Between the risk of certain tariffs (which we can define by products affected, tariff rates, etc.) and the uncertainty (we simply cannot measure the probabilities of the Trump Administration implementing such tariffs) of the US pressing forward, it is very difficult to estimate the possible impact on our estimated intrinsic value. What we can do is summarize some of the bigger issues and keep an eye on certain high level risks and uncertainties.

• Skyworks generates a significant amount of revenue from overseas markets. In particular, the company works with some of the largest players in 5G based in Asia. Any tariffs implemented with China would have a moderate impact on Skyworks’ revenue and thus our valuation.
• 47% of FY2018 revenue was from one customer - Apple (AAPL). As stated earlier, Apple received a waiver from the Trump Administration in relations to tariff’s placed on Chinese imports. This helps mitigate the impact of any tariffs that center on Apple products.
• Skyworks’ is limited in its ability to offset any additional costs related to new tariffs or regulations. The company will likely offset these with a blend of increased costs to customers and cost savings generated within the supply chain.
• Last, Skyworks faces threats in two of the five issues cited earlier. This includes intellectual property rights (China requires access to proprietary information as part of many contracts) and supply chain location (the greatest threat here are new tariffs proposed by the Trump Administration on Mexico).

 
In most cases I don’t go beyond this in terms of research. I’ve learned that great management is many, many steps ahead of me in identifying where the economy might be headed and how this might impact their core strategies, product development, competitive landscape, etc. Going forward, I will look for how management has addressed these issues and how successful their efforts have been.        
 
The Devil is in the Details
 
Having discussed why I place such limited concern and effort on macroeconomic issues, there is one large caveat to apply – a very small amount of macroeconomic data is essential to calculating intrinsic value. It’s not a lot and it doesn’t require an enormous amount of work to gather it and apply it to your valuation tools. But one of the most important legs in the value investing stool - calculating intrinsic value - is impossible without it. Here are the macroeconomic data I follow closely.
 
Interest Rates and Cost of Capital: Federal Reserve policy can have a huge impact on short and long term interest rates. This directly impacts a portfolio holdings’ average weight cost of capital (if they need to tap the debt markets). This in turn has an enormous impact on return on capital and investment value generation. I’ve discussed this in greater detail several times, but it’s important enough to summarize it again. When utilizing a discounted free cash flow model to generate intrinsic value, even the slightest change in Federal Reserve policy can move valuations by 5 – 10%. This can be the difference between an adequate margin of safety or not.
 
Regulatory and Compliance: Over time, changes in the macroeconomic environment can lead to significant changes in state and federal regulatory oversight. As an example, the crash in the credit derivatives market during the Great Recession forced the Federal Reserve and Congress to implement sweeping changes in the financial markets including new capital requirements and the elimination of several core business lines in the largest banks. At Nintai, we are always looking for macroeconomic data that might directly impact financial and valuation models specific to any of our portfolio holdings.  
 
Conclusions
 
I was once having a conversation with several co-workers when the issue of spousal jealousy came up. After several individuals bemoaned their lot in marital life, one individual said “our therapist said that jealousy is like paying interest on a loan you never took out”.  I’ve found that in most cases spending time worrying about macroeconomic issues is much like the therapist’s advice. In most cases, the data really aren’t that helpful in ascertaining how much investor value can be generated over the next decade or two. In those limited cases (such as the Fed funds rate) a simple check on the latest 10-year Treasury will tell you everything you need to know to get started on generating the company’s average weighted cost of capital. The most important thing is to understand which data can help you focus on truly important issues (such as calculating the company’s value) and disregard the rest. Over time you will be amazed how much time can be spent on company-specific research. Much like the therapist’s couple, you will be surprised how much easier life will be when you focus on the things that matter.
 
As always I look forward to your thoughts and comments.
 
DISCLOSURE: Nintai Investments LLC is long Skyworks Solutions.

"We have so much to be thankful for in this time of economic growth and prosperity. The markets keep going on their upward trend, jobs are plentiful, and opportunity is there for any who want to make a difference. In essence - be thankful, humble, and honored to be living in these most bountiful times.” 
 
                                                                                          -         Gerald Nye 

“All through life there are opportunities in allocating capital - it might be your own time or money in personal development. It might involve investing capital – with time, money, or something else - in the company you work for. Or it might be investing capital into our country or system - building new companies, new products, changing the world. In a capitalistic-based system like the United States, we have a 230 year history of generating enormous returns on capital. Being part of that process is a remarkable opportunity and honor”.
                                                                                         -        Sam Hallowell  

In 1973 my family came across the Canadian border as part of an agreement to become United States citizens if my father would transfer his service to the United States Army. On that long car ride, I remember reading Lincoln’s Emancipation Proclamation and hearing the phrase “all persons held as slaves within any State or designated part of a State, the people whereof shall then be in rebellion against the United States, shall be then, thenceforward, and forever free”. It gave me goose bumps then and still does today.
 
During this holiday season, I give thanks for several events in my life that made so much of my later success possible. The first is coming to the United States at the height of its influence as a young white male. Demographics and timing made a huge difference in my life. Second, I had parents who insisted that all their children attend the best schools for their abilities. My attendance at an Ivy League school opened an enormous network to me. Third, right out of college I was introduced to the American system of capital allocation. I’ve never faltered in my thinking - though it is dented and tarnished these days - there is no better system in creating long-term value.
 
As I worked my way up the greasy pole in the investment world, I began to realize nearly everything I did - from personal development to professional training to my role as an investment manager, was really about allocating capital. Whether it was my personal time and money, or my client’s hard earned capital being deployed into the markets, my job has been to maximize return on capital. Now that I’m older and wiser, I realize that while all that is true, the real blessings have been that I have lived in a time and place that made that type of career possible. Sitting around the house having survived another delicious meal, watched another badly played football game, solved all the world’s problems in a series of increasingly emotional arguments, I usually come to feel a great deal of thanks for several key factors in my life.
 
We Still Have the Best Capital Allocation System
Over the years I’ve written extensively about some of the issues I’ve seen developing in our capitalistic system. Whether it be Jack Bogle’s wonderful analysis of the shift from owner’s capitalism to manager’s capitalism[1] or the constant battle fought over fees, I’ve taken some rather heavy pot shots against our current capitalistic system. Having said that, I still believe our current economic system gives the most people the best opportunity at achieving financial success. Every day, millions of citizens get out of bed with the intention of starting a new business, deciding where its best to allocate their company’s capital, or where to allocate their assets as they think about retirement. Is the system perfect? Absolutely not. Can it use a real deep cleaning? You bet. But every morning as I prepare for the work day, I know I’m building a company that provides my investment partners with the chance to see their capital put to work and make their portfolio  - and their country - a little bit stronger.   
 
As Shareholders We Have Rights….Use Them!
Along with the ability to freely choose how, where, and when I allocate capital comes the responsibility to act as an owner. Each corporate share I own is a piece of an outstanding business that has passed my investment criteria. Being an owner comes with responsibilities – reading corporate documents, voting for my board candidates, and speaking out when I agree or disagree with a substantive issue. I am grateful that I have the chance to exercise this control, though sadly it is a responsibility badly neglected these days by individual and institutional investors alike. Much like voting in political elections, most of the work is done for you as a voter. Ballots are frequently mailed to you or available online. If one expects to be a successful investor, then you need to be a successful owner. Be thankful you have the rights of an owner….and use them!
 
We Are A Nation of Laws
If you look around the world – both the developed and underdeveloped – there aren’t many countries where investors have a near implicit faith in the underlying legal, regulatory, and policy structures that support individual businesses and the greater markets. That exception (though again somewhat battered and beaten down) would be the United States’ capitalistic system. Though it isn’t perfect, investors in the US can be confident that contract law provides legal protection, that regulatory agencies (generally) look out for owners, shareholders, and other stakeholders in a fair and just manner. Anybody who has tried to work in other countries where the political system is a single-party monopoly or the courts are mouthpieces for the powers that be, have found investing - or even simply doing business - is an act of risk of the highest order. During this holiday, be thankful that - even if a handshake isn’t as solid as it was - contract law remains as a solid foundation of the US economy as it ever has been.
 
Conclusions
 
As another year winds down and my family gathers to celebrate Thanksgiving, it’s important that we give thanks to living at a time, in a country, and in system that allows us to fully participate in the economic life of the country. Whether it be investing in a rental property, being a silent partner in a friend’s new restaurant, or being the smallest investor/owner of the largest operating company on Earth, we are blessed to be part of the greatest, most successful experiment in capital allocation the world has ever seen. After all the left overs are gone, the long naps been taken (along with all that antacid!) and the in-laws have driven home, roll up your sleeves and be prepared to get back to work. Being an investor is both a privilege and responsibility. There is much to be grateful for at this time. Accepting that - and being aware of all that requires of you - is the beginning of a tremendous journey that will educate you and be profitable in far more ways than dollar and cents. We hope everyone had a wonderful Thanksgiving and wish everyone a happy and safe upcoming holiday season.  
 
DISCLOSURES: NONE
  

[1] Jack Bogle, former CEO of Vanguard argued that over the past several decades, ownership has shifted from a traditional owner’s model where the owner put up 100% of the capital, took 100% of the risk, and received the vast majority of the rewards. In the manager’s capitalism model, the manager puts up little capital, takes on little risk, but receives a great amount of the reward. Bogle felt (and I completely agree) this greatly distorted the values, ethics, and financial outcomes of the capitalistic system.