An Abundance of Common Sense
The world's most underrated "investor"?
Preamble
True and original insight has always been rare, but it seems to be a tad bit rarer these days. We live in a golden age of data and information, and yet we seem to struggle more and more everyday to separate the signal from the noise. Sadly, the search for truth seems to have been sacrificed for other more mundane objectives.
That’s why I pay close attention whenever I stumble upon someone that is unfazed by the prevalent direction of the wind. These individuals often operate in a way that allows them to focus on the truth, not on what others want to hear.
Tony Deden is an “investor”, but his principles go far beyond the practice of investing. The 2-hour interview linked below is a masterclass in developing, adapting, and mastering a framework rooted in common sense. By the middle of my third viewing I realized this was a nugget of wisdom I needed to share, not for reads or likes, but for the potential deep and positive impact it could have on the viewer, as it had for me.
Below are also some of my favorite insights from the interview, but I strongly encourage you to watch the whole thing. I can’t do it justice with my brief write-up.
Managing a portfolio
“If you’re on a ship that is going down and you have 5 minutes to leave, and you look at your possessions and think ‘what is worth taking with me?'‘ Not many things.” - Tony Deden
Irreplaceability of capital
As illustrated by the previous quote, Tony operates from the idea of exclusion “to the point of absurdity”. This stems from his view of capital as irreplaceable. For his clients, it represents a lifetime’s worth of savings, so he must avoid the kind of error that would put them out of business. In what is perhaps my favorite quote of the interview, Tony dissects the essence of a fiduciary relationship:
“The focus should be not in trying to impress your customer, but in trying to protect what he has spent years accumulating.” - Tony Deden
He made the interesting point that it is easier to make money than to keep it. This was something that I sort of knew, but I had never thought deeply about. Making money requires very specific skills, but if one wants to grow and preserve their wealth for multiple generations then that’s an entirely different focus. Hardly anyone works for future generations anymore because it requires deferring consumption. People want to consume what they have. A low time preference is not as common as is was decades ago.
Tony’s answer? To deploy irreplaceable capital into what he considers irreplaceable assets. More on those later.
What I love about Tony’s principle of exclusion is that it can be applied across disciplines. On any given day, there are really very few activities, tasks, or even people that are truly worth one’s time and effort. In investing, it closely relates to Warren Buffet’s idea of only swinging at pitches that come right into his sweet spot. If you view savings as sacrosanct and as the fruits of one’s labour, then very few things will fit into that narrow view.
A portfolio as a collection of assets
Tony views a portfolio as a collection of assets. Not only must the portfolio itself have a purpose, but also each component of the portfolio must have a sub-purpose of its own. This purpose should be long-term, rooted in a low time preference. Because of this he views the practice of determining target sectoral weights or underweighting this or that, as madness.
He nailed one of the biggest flaws of the modern asset management business: the urge to show some activity or commentary (any activity or commentary), in order to showcase their big brains. The reality is that nobody has a clue. Nobody can predict which countries, or sectors, or industries will perform best over a short period of time, but it gives investment managers an opportunity to sound really smart and to seemingly justify the fees that they charge. Charlatanism is not exclusive to asset management either, but sadly we live in a world were feigning expertise goes a long way. It reassures others to their own detriment.
John Maynard Keynes put it best:
“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
Risk
Speaking of reassuring others, it is fairly common (and it has been for quite some time) for asset managers / financial advisors to design portfolios based on the specific needs and preferences of an individual. Tony argues that this is a nonsensical approach. This is because most people’s definition of risk is mistaken.
According to Tony, risk to most people is the uncertainty of the unknown or prices going down. They have defined it, and quantified it, as volatility. However, the notion that the degree to which an asset’s price moves up and down is a fair determinant of its risk is quite frankly nonsense. The fact that most people treat the stock market as a casino does not mean that it is a casino. And if stock prices represent an ownership stake in a real business, then clearly the real risk stems from the development of the business, not from the movements in its stock price.
To Tony, risk is the idea of losing your capital permanently with no ability to ever recover. Hence he was always more interested in what can go wrong than what can go right. Not as much in a financial or quantitative nature, but more so in the kind of decisions that one makes and the impact those decisions have on the whole.
“The unseen and the unmeasurable are more important than the other kind. The things that kill you are often things you cannot measure and you cannot see, generally with respect to people.” - Tony Deden
Participations, not investments
“When you buy for the purpose of selling you don’t need to understand what can go wrong. You see everything in terms of price.” - Tony Deden
“What can go wrong is even more important than what can go right. You don’t know what anything is worth until you know what can go wrong.” - Tony Deden
For some time, I have (somewhat arrogantly I have to admit) considered myself superior because I am an investor, as opposed to a trader or speculator. While I still think approaching the stock market as an investor is more conducive to success than to engage in trading or market prognostication, I’ve been humbled by Tony’s approach to the practice.
His approach stems from the fact that there is a substantial distinction between people who are investors and people who are owners of businesses. Investors buy something with the hope that it will go up in value and they will be able to sell it at a higher price. On the contrary, no owner of a business wakes up every morning asking himself what he is worth. Owners are concerned with their products, employees, suppliers, and customers. Owners are busy building substance, building the productive base of the company, and recapitalizing the earnings. Regarding some concepts that are in vogue today, Tony states that owners don’t need to be reminded to be “responsible”. Acting sustainably is implicitly ingrained in the mind of an owner that wants his business to endure.
Balance sheet
Because an owner is laser-focused on enduring and surviving, his balance sheet is more important than his income statement. Tony aptly points out that the ability to endure and survive is based on the strength of the balance sheet, and on the nature of the assets on the balance sheet (not all assets are made equal!). This compares to the strong emphasis on the income statement that exists today, whether it relates to revenues and revenue growth for earlier stage companies, or EBITDA and EPS for more mature firms.
Tony also criticized the very common practice (especially in the USA) of leveraging the balance sheet to repurchase shares and increase EPS. The idea of having a fragile balance sheet for the purpose of getting a higher share price doesn’t lend itself to the idea of ownership. In general, Tony is very critical of the fact that these days companies see their stock price as their product. This is clearly reflected in the idea of forward guidance, with its sole purpose being the price of the stock. It turns things into a game. The focus is then not on how to make something, but how to make money. In Tony’s words: “it’s bollocks”.
EBITDA and compounding
It’s fair to say that Tony is not a fan of EBITDA. According to him, it exists only on account of financing acquisitions through credit. Without credit creation there would be no EBITDA. Real owners don’t think of the value of their business as a multiple of earnings before everything.
Earnings are very important in that a company must be profitable, but it has to generate cash. In one very nuanced point, Tony prefers profitability measures that incorporate balance sheet components because the compounding of earnings in book value per share is far more important for a company’s ability to compound. And that is what wealth is. Wealth is the compounding of earnings.
Value
Value in financial terms, such as Price-to-Earnings and Price-to-Book ratios, refers to accounting terms. They reflect what happened in the past. Tony does mention that a P/E ratio can be somewhat meaningful, but it’s not so essential in terms of value, because profitability on any one period to another is a function of temporal events.
Furthermore, people make the error of considering anything with a bid to have value. Here Tony makes the distinction between financial value (i.e., something has a bid) and economic value (i.e., something satisfies the needs of customers). Economic value itself can be temporary, as the market is consistently evolving. No company has the right to succeed indefinitely.
It’s pretty clear to me that the essence of investing successfully lies in the qualitative traits of a business and of the people running and owning said business. This is why approaching markets with an owner’s mindset helps to identify the key drivers of both value and risk, and discard the noise.
“There’s no such thing as valuation metrics based on some standardized formula unless you see it in connection with other issues. Measuring and assessing value is subjective. It’s simple, but it isn’t easy.” - Tony Deden
Scarcity, permanence, and independence
When pressed with the quandary of defining the essential characteristics of his practice, Tony narrowed it down to 3 ideas: scarcity, permanence, and independence.
Scarcity
“Scarcity is the most important law of economics, and it is a natural law. There’s scarcity in resources, material goods, real savings. There’s also scarcity in skillsets. There’s also scarcity among the characteristics in character that make a man attractive.” - Tony Deden
This is a fact of life that unfortunately many people fail to grasp. Resources are limited, and scarcity is the fundamental limiting factor in economics. If you need to deploy capital, finding those scarce assets, those irreplaceable assets, will be fantastic for growing and compounding their value.
Scarcity can be mismanaged though, so you need economic agents that recognize its importance and act accordingly.
Permanence (endurance)
Tony is interested in the kind of policies, practice, and purposeful behavior that is designed to endure, rather than “merely grow”. You can grow but become fragile in the process. You have to ask yourself: what are the ingredients that contribute to the endurance of companies that have survived 100, 150, 200 years? If you think about those who have survived the test of time you can identify commonalities to look for elsewhere. This goes back to the balance sheet and its importance in gauging the resiliency of a company.
This is not exclusive to companies either. You can ask yourself what are the characteristics that have allowed a few individuals to stay at the top of their fields for a long time, or what has allowed certain families to build and preserve their wealth across generations. If you can answer that, you know where to start.
Independence
“Dependence makes a system fragile. The more independent an organism is from external weaknesses the more likely it is to add to its endurance.” - Tony Deden
Tony highlights that most things today are inter-dependent on external factors. Businesses can depend on key suppliers, on one key customer, on government either through subsidies or regulation, or even on the financial system itself. The importance of independence is partly the reason why he doesn’t invest in banks or insurance companies, or why he keeps his firm’s reserves in physical gold. He doesn’t want to depend on others; he doesn’t want his assets to be someone else’s liability.
In my view, this lack of independence that Tony highlights is also a major weakness of any company that makes its stock its main product. When the stock market (or venture market) dictates how you manage your business you’re essentially a slave to market psychology.
I highly encourage you to listen to the interview. The points above are my main takeaways, but I learn something new every time I re-listen to it. I also left out many of Tony’s incredible anecdotes, as well as his views on the media, gold, and the finance industry, just to name a few things.
