Weekly Thoughts

Here are three things that caught our eye this week:
 

Valuation and Narrative

This week we spent time watching (via webcast) NYU Stern Professor Aswath Damodaran deliver the keynote address at a CFA Institute Conference in Boston. Professor Damodaran teaches a class on valuation and his presentation emphasized that numbers matter for valuation, but only in the context of the narrative behind the business. Your narrative is what guides the assumptions that go into your model.

To illustrate his point, he walked through the example of Uber and noted that if you think about it as a taxi company limited to urban areas with increasing competition, the business is worth only $6 Billion or so. On the other hand, several prominent VC’s (and clearly the market given the reports of its valuation in recent funding rounds) are promoting the narrative that Uber will become a global logistics company that will draw new users to its services and could even replace car ownership for large portions of the population. In such a scenario the company could be worth $50 Billion or more. Professor Damodaran posted a breakdown of these two narratives on his blog:

In the small business space, financial reporting varies greatly, which causes problems when trying to compare companies on an apples to apples basis. This makes the use of narrative crucially important when evaluating any opportunity in the space as any model will be heavily assumption driven. Moreover, when managing a business, we will need to design metrics around our narrative for a portfolio company to evaluate our progress. Professor Damodaran summed this up best:

“If you view value as narrative overlaid with numbers, there are implications for both the founders/managers of businesses and the investors in these firms. To attract capital, managers need to develop coherent narratives about the firms that they run, convey these narratives to investors/markets effectively, and act consistently. To manage that capital well, they need to identify value drivers, set yard sticks that measure how the narrative is unfolding and change in response to unforeseen events, both positive and negative.

For investors, the lessons are just as profound. They need to find companies that have compelling narratives, convert these narratives into value and make sure that they are not paying too much. They need to spread their bets across several good narratives and be open to changes in narratives and numbers. It is true that having a great narrative and the numbers to back them up is not a guarantee of investment success. The best laid plans of mice and men can go to waste, but to not plan at all will guarantee that waste.”

Presentation, Narrative and Numbers, Possible, Plausible, and Probable, How to Miss By a Mile
 

Frugal Innovation

The Harvard Business Review published an interesting article this week on the topic of Frugal Innovation. Building on lean start up principles, the authors highlighted that many companies are beginning to view resource constraints not as a liability but rather as an opportunity to promote agility and constant iteration. In doing so they highlighted a few keys for success that we have touched on in this space previously. From the article:

“Companies must be frugal with time, the most valuable resource in business. To save time and gain agility, companies must learn to flex their assets — not just physical or service assets, but also human assets. To address customer needs faster and better, CEOs must simplify organizational structures — by eliminating bureaucracy, empowering employees, and cultivating a flexible mindset in its workforce…

Jeff Immelt, CEO of GE, has promoted a “culture of simplification” within the company that draws on the lean start-up ethos. The company has built FastWorks, a set of tools and principles to help it marry scale and efficiency with speed and agility. GE has trained over 40,000 employees to build minimum viable products that quickly solve well-defined customer needs. Rather than over-engineering “optimal” solutions with complex and expensive business models, GE’s employees are learning how to design and launch “good-enough” solutions, get quick user feedback, and then fine-tune their ideas as they go along.”

The authors also highlighted the importance of developing key performance indicators (KPIs) to enable performance tracking at all levels of the organization and the potential for crowd sourcing as an innovation center. Most importantly though they emphasized that management needs to “evangelize the ‘do better with less’ mantra”. We think this is the biggest take away from the article and we aspire to lead from the front as we initiate change.

Frugal Innovation, The Lean Start-Up Changes Everything, The Lean Start-Up
 

Abundance Without Attachment

“’Swami, is economic prosperity a good or bad thing?’ I held my breath and waited for his answer.

‘It’s good,’ he replied. ‘It has saved millions of people in my country from starvation.’
This was not what I expected. ‘But you own almost nothing,’ I pressed. ‘I was sure you’d say that money is corrupting.’ He laughed at my naïveté. ‘There is nothing wrong with money, dude. The problem in life is attachment to money.’ The formula for a good life, he explained, is simple: abundance without attachment.”

We found this to be one of the most powerful sections of a recent op-ed by Arthur Brooks, president of AEI, who we have had the privilege of speaking to on several occasions. In the article, he describes his meeting with a swami named Gnanmunidas at the Swaminarayan Akshardham Hindu temple in New Delhi. Since large portions of our days are spent contemplating the merits of different cash flows and the corresponding IRR’s they are likely to produce, we found the discussion of attachment-free abundance as a welcome break. Moreover, as we move into the holiday season we, like many others, focus on ways to improve in the year to come, and we found Brooks’ suggestions for achieving the swami’s ideal very helpful. From the article:

“First, collect experiences, not things.

Material things appear to be permanent, while experiences seem evanescent and likely to be forgotten. Should you take a second honeymoon with your spouse, or get a new couch? The week away sounds great, but hey — the couch is something you’ll have forever, right?

Wrong. Thirty years from now, when you are sitting in rocking chairs on the porch, you’ll remember your second honeymoon in great detail. But are you likely to say to one another, “Remember that awesome couch?” Of course not. It will be gone and forgotten. Though it seems counterintuitive, it is physically permanent stuff that evaporates from our minds. It is memories in the ether of our consciousness that last a lifetime, there for us to enjoy again and again…

Second, steer clear of excessive usefulness.

Our daily lives often consist of a dogged pursuit of practicality and usefulness at all costs. This is a sure path toward the attachment we need to avoid. Aristotle makes this point in his Nicomachean Ethics; he shows admiration for learned men because “they knew things that are remarkable, admirable, difficult, and divine, but useless.”

Countless studies show that doing things for their own sake — as opposed to things that are merely a means to achieve something else — makes for mindfulness and joy.”

Finally, Brooks suggests getting to the center of the wheel, a reference to the rota fortunae in medieval churches, the edges of which were meant to convey the cycle of victory and defeat that everyone experiences throughout life. At the center of the wheel was faith, “the lodestar for transcending health, wealth, power, pleasure and fame — for moving beyond mortal abundance.” Again from the article:

“even if you are not religious, there is an important lesson for us embedded in this ancient theology. Namely, woe be unto those who live and die by the slings and arrows of worldly attachment. To prioritize these things is to cling to the rim [of the wheel], a sure recipe for existential vertigo. Instead, make sure you know what is the transcendental truth at the center of your wheel, and make that your focus.”

While we acknowledge upfront that we are unlikely to fully realize the swami’s vision, we hope to keep these practices in mind as we seek to be better versions of ourselves in 2015. Plus, a second honeymoon doesn’t sound so bad!

Arthur Brooks Article

Weekly Thoughts will return on January 2nd, 2015.

Happy Holidays,

Your Chenmark Capital Team