Success and Leverage (Oddball Stocks blog)

[Liberty]

I found his examples strange, since I personally would not complete any of them the way he did.

 

You've just found out you are not like most random people off the street. Congrats. This can be good or bad.

 

Thanks.  8)

 

I knew it already. I'm not even like most random people on CoBF.  8) This is good and bad.  ::)

 

Join the club.

[original mungerville]

I imagine that many of you ride bikes on the road (as does Mohnish), where your margin of safety is the thickness of your lycra.

 

Mortal risk.

 

I was just thinking about ERICOPOLY as an example of asymmetric risk-reward payoffs. This, to me, is the way to proceed.

 

Now, I have no fuckin' clue about the bike riding reference - can you elaborate on what you are getting at? Do you mean that many on this thread are too risk averse in various areas of life but not risk averse enough in others - like biking? Or something else?

[shalab]

I read the post by oddball with interest, sent him a PM as well. He has some very good points but I think he has overloaded the term leverage. However, I agree with original mungerville's articulation of scale and asymmetric bets - it is not leverage. There are some other mental models involved here - some are articulated in Poor Charlies Almanack - but it is not just leverage that is at play.

 

I know of mechanical leverage, financial leverage and operating leverage. However, I don't think the analogy of sizeof AUM or scale to leverage is correct, there are advantages of scale which IMO is different than leverage.

 

Essentially the concept of leverage ( as I imagine ) is akin to the one noted here which is what Archimedes articulated a while back. It applies to different fields but the basic principle is the same.

 

http://en.wikipedia.org/wiki/Lever

 

 

Operating leverage is vital.  To go back to Nate's comments on the lawn mowing business.  No matter how good you are there is little scalability.  You probably can't charge much of a premium for doing a better job.  A barber or beautician is in a similar situation.  The person who gains wealth looks for scalable businesses with fat margins.  Asset management, software, franchising, royalties, etc.  I often hear people say I should start x business and it almost always is a business with little upside beyond a regular job.  Most of the time it is much worse - more time consuming, no benefits, and less pay.  No matter how hard they work it is marginally profitable.

 

I agree. You need scalability, otherwise why bother - the upside will be relatively limited. What you really want is not leverage as that usually cuts both ways, instead you want asymmetric pay-offs like call options. Putting effort into a scalable business is asymmetric: your down side is limited to the opportunity cost of your time while your upside is huge. A serial entrepreneur trying to make a bunch of very asymmetric situations successful should eventually get a very large pay-off.

 

I have a good friend/business partner. He isn't rich, but don't talk to him about something that can make a million or two, he doesn't get out of bed to make a million, his head space is always "Ok, my minimum goal is $100 million by xx date, can this get me there". He is very risk averse yet very focussed on this huge upside goal. He wants big scale with no to limited downside. That's basically all he thinks about.

[ERICOPOLY]

I imagine that many of you ride bikes on the road (as does Mohnish), where your margin of safety is the thickness of your lycra.

 

Mortal risk.

 

I was just thinking about ERICOPOLY as an example of asymmetric risk-reward payoffs. This, to me, is the way to proceed.

 

Now, I have no fuckin' clue about the bike riding reference - can you elaborate on what you are getting at? Do you mean that many on this thread are too risk averse in various areas of life but not risk averse enough in others - like biking? Or something else?

 

The bike riding reference is an allusion to our troubles as humans.  We worry the most about exotic risk.  You'll find people who are afraid to swim at the beach because of sharks, but they don't plan their daily life around driving fewer miles on highways.  They would feel safer driving across the country and fell more relaxed in the face of that greater risk.

 

Personally I'm terrified of riding a bike on the road.  I focus too much on the downside.

 

But I go in the water at the beach, I drive on the road, ski, skateboard.  I used to hike alone in the wilderness.  And I used options for leverage.

[ERICOPOLY]

However. Despite risking our lives, we as investors can congratulate ourselves as being naturally risk averse if we put our money in the lifeboat before our bodies.

[original mungerville]

I imagine that many of you ride bikes on the road (as does Mohnish), where your margin of safety is the thickness of your lycra.

 

Mortal risk.

 

I was just thinking about ERICOPOLY as an example of asymmetric risk-reward payoffs. This, to me, is the way to proceed.

 

Now, I have no fuckin' clue about the bike riding reference - can you elaborate on what you are getting at? Do you mean that many on this thread are too risk averse in various areas of life but not risk averse enough in others - like biking? Or something else?

 

The bike riding reference is an allusion to our troubles as humans.  We worry the most about exotic risk.  You'll find people who are afraid to swim at the beach because of sharks, but they don't plan their daily life around driving fewer miles on highways.  They would feel safer driving across the country and fell more relaxed in the face of that greater risk.

 

Personally I'm terrified of riding a bike on the road.  I focus too much on the downside.

 

But I go in the water at the beach, I drive on the road, ski, skateboard.  I used to hike alone in the wilderness.  And I used options for leverage.

 

Gotcha.

[randomep]

I imagine that many of you ride bikes on the road (as does Mohnish), where your margin of safety is the thickness of your lycra.

 

Mortal risk.

 

Yes, I imagine that many of us have been hit by cars too.

 

But the goal isn't to minimize mortal risk, but to minimize financial risk given that we live.

 

 

[randomep]

Working for an employer is like diversifying your entire portfolio into a single stock.  The problem is how well you work or how hard you work doesn't always matter.  A friend told me recently the best person in his department was fired because a new manager was hired and their personalities didn't match.  That best worker didn't have a choice in who was hired, and it wasn't like they could change their or the new boss' personality.  They were 100% concentrated in a stock and ended up on unemployment, yet they were the best.

 

 

 

This statement makes no sense to me. It may apply to marriage, if you marry the wrong person your screwed. After that you cannot really start off with a clean slate.

 

But if you lose your job, just get another one. What have you lost? just a bit of time and stress and aggrevation, but otherwise you are exactly where you started before you got the job. With investing you are risking principle for the chance of a good gain. So job and investing are totally different scenarios.

 

Also over a lifetime you have many jobs, so you have diversified over time. One job is a waste of time but eventually you realize that and you either quit or get laid off and once you get a better job you are glad it happened.

 

 

[oddballstocks]

Interesting comments on here.  A few thoughts

 

1. My intent wasn't just financial leverage, but leverage of all types.  This seems to be missed by a few calling my thoughts some segue to getting rich quick.  Leverage is the concept of being able to do a lot with a little.  You move a large object by using a lever and smaller amount of power.  You move a lot of money via a small amount etc.

 

2. Asymmetry - This was a point that was implied.  Look at my shoe factory example, you spend $1m for a machine with the potential for 10s or 100s of millions of earnings.  How is that no asymmetry?  Operating leverage is asymmetrical, but just because something is asymmetrical doesn't mean loss isn't possible. 

 

3. On a job.  If you have a job in a hot market it might be easy to get another job.  But what if you are specialized or are over 50 etc?  Have a friend who is a ceramics engineer.  Extremely specialized and he's been looking (while working) for more than a year.  There are only a handful of openings a year.  Many of the openings are at companies he has worked at in the past and left.  Not everyone is a Java programmer or Financial Analyst or Accountant that are hired by the thousands.

 

4. My post was specifically about financial success.  I wholeheartedly agree with whoever posted that a person can be successful without money.

 

5. I've thought of one example that runs counter to my thought: a high paid executive.  There are a few top students who somehow climb the corporate ladder and pay themselves extravagantly.  They have a typical job yet outsized pay.  I'd put many US corporate execs in this bucket.  These are the guys getting paid millions to drive companies straight into the ground.  For 99.9% of the population these jobs are unobtainable and my post applies.  But for the .1% this might be a good path to wealth.

[randomep]

Oddball,

 

Regarding your statement about working.

 

Getting a job is working for consitent pay. The company that hires the employee, and like you say, the company has operational leverage, but that company is not sharing the financial benefits of the operational leverage. The flip side is that the company pays for various overhead and will pay about the same during times when it isn't doing well. It is just a different compensation scheme. As for your 50yr old ceramics engineer friend. Well, that happens all the time, if you are a business owner you may not be able to boss everyone around and will leave day to day tasks to someone else when you are 50.

 

The problem I see with your ceramics engineer friend is that he didn't apply leverage in the past. When times were good say when he was starting out and didn't have so much responsibility, he should have worked on the operational/financial leverage by socking his money away to buy a business or investing. Then by the time he is 50 maybe he can just invest full time for example. In this way his financial reward may be the same as if he was a serial entreprenuer all his life.

 

I have been thinking about the same general topic as you but I didn't use the phrase operational leverage. To me the key between working for someone else and working for yourself is the compensation. The compensation is lower because 1) a large organization is inherently inefficient and 2) they are paying you immediately for your labour as opposed to reinvesting it on your behalf.

 

But you can still work for someone else but just don't let the corporate culture lull yourself into a sense of complancency. So I myself remedy this by working 2/3 as hard as someone else to get the same stuff done in my job. And use my extra spare time to focus on investing. I am boostraping my job to be my personal financial consultant.

[oddballstocks]

randomep,

 

Right, those are good points but don't quite apply.  My friend is two years older than me, 35.  So to say he wasted his best years would be false.  He worked for the company that's powering your computer and now works at an extremely well known industrial in R&D.  He's been tasked with reducing the energy for the aluminum making process.

 

The problem is one of specialty.  I'm sure there are a number of PhD's on the board and maybe they can related.  This guy is very intelligent, maybe too intelligent.  He will go a mile or two deep on a specific subject and is clearly an expert.  But knowing how ceramic liners for for a single industrial process isn't very transferable.  I've talked with him about creating a consulting company and looking at his job from a 30,000 ft view.  He overhauls processes.  He could easily sell something like that to other companies for a nice price.  He gains almost no leverage except he would move from 100% salaried to billable, and billable means he'd get paid for the 70+ hours he works.

 

This board is filled with high achievers and overachievers.  It's a community of people who sought out others for help so they could improve themselves.  This is rare and I think sometimes our bias shows.  The average Joe doesn't care much about improving themselves.  They are happy to go to work punch in at 9am and punch out at 5pm.

 

I firmly believe investing is leverage, maybe one of the best types.  With the small purchase of shares the efforts of dozens/hundreds/thousands of people are working for your benefit the shareholder.  Your course of action is great, get your work done quickly and research stocks.  That's a VERY well worn path, and given time and patience results in success.  I'd say the large majority of self-retired investors on this board took that path.  But this is leverage.  You're also building a safety net and in a way proving my point.  You're diversifying away your income from a single source to multiple sources. 

 

We probably agree more than we disagree on this.

[randomep]

Oddball,

 

Yes we are in agreement 90%, I am just nitpicking about the statement that being very good at something and working for someone as a individual contributor cannot be beneficial.

 

I say this precisely because I am very specialized, I have worked many years (in my early 40s) and I have a PhD.  I don't feel your friend nor myself wasted our lives doing what we do. I for a fact feel fulfilled in a lot of ways but now it is time to redirect my focus, in what others often call a second act. Still, I can see myself doing my job for many more years and even if my net worth goes to say $3M.

 

I am very very specialized doing the same type of coding for so long, I can do it with my eyes closed and still be leagues above 95% of coworkers. But I realize that society tells me ya that's nice, good job, but big deal. It's not that operationally I cannot in theory make the company so much more efficient by leveraging my knowledge. It is that in practice achieving this is impossible because much of engineering is dumbing thing down so that VP's and managers can understand in a meeting and then rally the troops to follow.

 

So I have learned a few years ago not to try to fit a square peg in a round hole and I have redirected my focus in investing. And that's around when I started my blog. Opportunities are hard to find but they exist.  I think I have found mine.

 

 

[ERICOPOLY]

I imagine that many of you ride bikes on the road (as does Mohnish), where your margin of safety is the thickness of your lycra.

 

Mortal risk.

 

Yes, I imagine that many of us have been hit by cars too.

 

But the goal isn't to minimize mortal risk, but to minimize financial risk given that we live.

 

There are investors who are self-proclaimed "naturally risk averse".  They are wired to avoid risk they say.

 

But looking into their lives, this is not true.  There are places where their natural wiring is failing them.

 

So I wonder if people who have an addiction to investment risk could be made more "naturally risk-averse" if they were introduced to road biking, or skiing, or hang gliding.

 

Some sort of non-financial outlet for their adrenaline.

 

My option trading was risk-averse to a degree.  There are times when I'm terrified to use leverage, and there are times when I use it.  I don't rely on it for adrenaline all the time.  I have other places in my life where I get that.

 

So perhaps when looking at people who blew up their portfolios, they disproportionately lack outdoor pursuits in their lives.

[randomep]

So perhaps when looking at people who blew up their portfolios, they disproportionately lack outdoor pursuits in their lives.

 

Ohhhh, in that case the easiest remedy is to take up poker to get the rush.

 

Actually I don't know if playing poker tames risk taking or fuels it, but it definitely trains our mind on evaluating risk.

[ERICOPOLY]

So perhaps when looking at people who blew up their portfolios, they disproportionately lack outdoor pursuits in their lives.

 

Ohhhh, in that case the easiest remedy is to take up poker to get the rush.

 

Actually I don't know if playing poker tames risk taking or fuels it, but it definitely trains our mind on evaluating risk.

 

http://www.cnn.com/2012/11/21/health/cnnheroes-exercise-addiction/

 

One of his first preclinical studies on the subject showed lab rats that had access to an exercise wheel in their cage were much less likely to self-administer cocaine than their sedentary counterparts.

 

 

Other addictions, like gambling (probably the driver of indiscriminate leverage for many people), are perhaps managed similarly.

[randomep]

So perhaps when looking at people who blew up their portfolios, they disproportionately lack outdoor pursuits in their lives.

 

Ohhhh, in that case the easiest remedy is to take up poker to get the rush.

 

Actually I don't know if playing poker tames risk taking or fuels it, but it definitely trains our mind on evaluating risk.

 

http://www.cnn.com/2012/11/21/health/cnnheroes-exercise-addiction/

 

One of his first preclinical studies on the subject showed lab rats that had access to an exercise wheel in their cage were much less likely to self-administer cocaine than their sedentary counterparts.

 

 

Other addictions, like gambling (probably the driver of indiscriminate leverage for many people), are perhaps managed similarly.

 

poor rat!

 

but seriously, thanks for the idea, this definitely makes me think.......