Friday, November 12, 2021

There's Levels To This

A followup to my Overton Window post – see here.

In video games, such as my favorite, Super Mario Bros, there are levels: stages of incrementally increasing difficulty you must chronologically pass through in order to progress in the game.

In investing, specifically in company valuation metrics, there similarly exist these “levels”. In recent years, as Silicon Valley startup darlings have taken over markets, it seems as if the game creators have updated the game with more levels. Long gone, it seems, are the days of simply searching for “Intrinsic Value” and investing in companies that generate “Free Cash Flow”. To be fair, Old Man Buffett is probably on the more conservative side. But still, when was the last time you heard the words “P/E ratio”? 

See above: Lucid Group, Inc. ($LCID), an EV startup. What is a good P/E ratio for an electric car company, one might ask? Many such cases. 

At the time Amazon was founded, a main gripe of its detractors was that they would be putting their money in a company that was “pre-profit” (AKA Losing Money). A mere quarter century and +$1.5T in AMZN’s market cap later, it seems like “pre-profit”, “pre-revenue”, “pre-customer”, and even “pre-idea” (okay maybe I’m exaggerating) are "pre-requisites" (haha) a company must meet, in order for an Legendary Partner (LP) at a Venture Capital Fund to invest in them. Currently, in corporate finance, the three main valuation methods used (DCF, precedent transactions, and comparable companies) commonly rely on a seemingly middle-ground Enterprise Value/EBITDA multiple to value companies. Yet, in the absence of EBITDA, some tech companies and startups have gone from a relatively tame “EV/Revenue” to now trading off "multiples of forward ARR" (next year’s expected annual recurring revenue), or "multiples of bookings" (SaaS contract commitments), or even "discount-to-ultimate-value" (X% of market leader's market cap as a base case)… wait what??

Naturally, as access to actionable investment information becomes more uniformly accessible to all, it makes sense that investors scour the lands to find potentially world-breaking and uniquely innovative companies (the Google of Web3 (what does that even mean)) as early as possible, to get in at a cheaper price (see Overton Window). The search to find these 100-baggers1 is a grueling battle only Peter Thiel’s strongest warriors can endure, making their very own Holy Crusade from Sand Hill Road to downtown SF to dole out term sheets to “founders” (ex-Stanford, ex-FAANG, sometimes ex-McKinsey in their LinkedIn bios).  

Certainly, all this is not to say that being “pre-idea” necessarily makes a company bad, nor does being “profitable" make one good (see Enron2). As technology advances, and investors become smarter and more capable of identifying moonshots earlier and earlier, it is inevitable that more derived “levels” of valuation arise and slowly become the norm. All the more power to investors who are able to make successful investment decisions with less information to work on. I only write to hopefully discourage this from happening: 

The classic "what? you're breaking up. I can't hear you, I'm going through a tunnel"... on live TV. By the way, this was the exact top for $UPST. 
Disclaimer: I am an $UPST hater. See my writeup here.

As we stray farther and farther from GAAP every day, Benjamin Graham is no doubt rolling in his grave. But as the investor’s metaphorical Overton Window moves, perhaps different multiples or levels are needed as new measurements for a new world... until they aren't. That's all to say: there’s levels to this.



1.      100-bagger” is a term used to refer to an investment that appreciates 100 times in value, often used by venture capitalists and investors to pat themselves on the back for an impressive investment

2.      Enron infamously claimed it was profitable (net-profit), while in reality they were committing massive accounting fraud, using offshore accounts to hide significant losses and liabilities from their financial statements. Even with fraudulent Net Profit numbers, it's hard to fake cash flow. See below:




Sunday, May 23, 2021

Chasing an Alpha High (Overton Window)

These are worth ~$10,000-20,000 btw. Each. 

If we define 'investing' as buying and selling an asset for a gain in value, a (shortened) table of contents of a book about the history of things "invested" in might look something like this:

Part I: Tangible Assets
Chapter 1 (Ancient Babylon, c. 1700 BC): Land (real estate)
Chapter 2 (Lydian Empire, c. 600 BC): Gold and shiny rocks found underground
Chapter 3 (Thales of Miletus, c. 600 BC): Olive trees/presses

Interlude: invention of Paper Money (real money?) 

Part II: “Fake Money”
Chapter 4 (Dutch East India Company, c. 1600 AD): Stocks and bonds in companies
Chapter 5 (Drexel Burnham Lambert, c. 1980 AD): Junk bonds 
Chapter 6 (internet investors, c. 2008 AD): Cryptocurrency
Chapter 7 (internet investors, c. 2021 AD): .JPG images of (arguably) fashionable monkeys

Looking at these “chapters”, we can see that ancient civilizations started out relatively tame, exchanging “real assets” that they could tangibly feel, such as olive trees in Thales’ case, for other real assets such as cattle and livestock. This evolved into paper money, which symbolized an exchangeable value for an amount of a real asset. Further on, we invented equivalents to paper money, that represented stakes in businesses, and started trading those as well.  

It is not surprising, psychologically, that humans gradually over time seek superior returns. As technology and society advance, it is not surprising either that the realms of speculation also evolve. Yet, with every “this time is different” and “my neighbor’s uncle’s goldfish made $5k staking AAVE”, you may be inclined to wonder if, truly, this time is different.  

In politics, the Overton window, as proposed by Joseph Overton, states that political ideas popular at a time lie within this “window”, and so proposed ideas do better the closer they conform to the window. Naturally, over time, politicians push ideas slightly outside of the range of the window, but just outside enough to be accepted – and policy slowly changes. Thus, the underlying idea also supported by the Overton window is that over time, society slowly becomes more progressive, as people become gradually more open to (accept) ideas laying outside the norm.

Within the box = generally accepted at this point in time. h/t David Perell

I see a similar trend in investing; after all, investing is simply buying things that society has attributed "value" to (society has accepted as being worth something), and reselling for a higher amount of this "value". Between the collapse of ancient Roman civilization, and the COVID booster shot release, we have gone from exchanging these real assets for money to levels of “trading” and speculation of assets that are increasingly questionable. But, if someone is willing to pay more than what you paid for something, does it even matter what exactly it is you are buying and selling? In the past few months, with crypto “staking” and other eye-opening, novel methods of generating returns hitting the mainstream, I see the Overton window in play: investors’ collective movement of becoming more inclusive of what they can peddle. Every time I open up Pancake Swap and think whether I should stake PoopooCoin or PeepeeCoin at 6900% APY, I remember the stories my dad tells me of and other spectacular dot-com failures (the PoopooCoins of his generation), and I realize, humans haven’t changed. There’s just a new shiny object on the horizon.



1.        There is no free lunch. At least I think.

2.        The olive tree “option” trading story is my favorite trade of all time. See reference 3

3.        TLDR of this post: "...But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions?" - Alan Greenspan