Riding The Wave

Waves Can Be Deceiving And Confuse You

Sometimes you get into a business, or get into a trade and after you get in a big wave floods in and propels you to places you didn’t think you’d get.

Waves fool you.

Warren Buffett opined when they go out, you see what everyone actually looks like and it often isn’t pretty.

I have gotten into trades or made investments where I was ahead of a wave. All of a sudden, there is big-time momentum behind my investment. The wave rolls. Your mental state can change. Instead of relying on the initial research and insight you had when you made the investment, you get caught up in the wave. You start making decisions based on the wave, and not on business fundamentals.

My gut tells me Peloton was exactly that.

Their timing was amazing. As they were ramping up, Covid happened. Stay-at-home orders were the huge wave. My friend Nilesh posted this and it is a brutal takedown of the CEO. Nilesh is a pretty sharp early stage investor.

The first part of the Powerpoint shows why Peloton is an attractive business. It reads like a venture capital pitch. Peloton had characteristics that VCs salivate over; Large addressable market, recurring revenue model, sticky network effects via a social network.

The next part of the presentation goes into the terrible decisions the CEO made which tanked the value of the stock. Some of the decisions that tanked the stock were made pre-Covid. For example, leasing a lot of office space and increasing your fixed costs 6x looks stupid in the rear view mirror. But, they leased it in 2018.

However, the total lack of discipline in decision making by the management team does make them culpable.

For example, should Peloton have spent resources to get into the apparel business? If so, should it have been a money loser? If so, why? Where were they going to make up that lost money? By the way, why was the CEO’s significant other head of the apparel business? Was she the best person for the job? What was her experience level prior to taking the job?

I look at this presentation, and I contrast it with presentations from CEO’s of well-run businesses. It’s a stark contrast.

When you find yourself in a wave, your decision-making process often changes. You get greedy. You think you are smarter than you really are. You get sloppy.

Pro tip: when you hear about activists complaining about CEO salaries, show them this presentation. The decisions of C-level executives have more impact on the appreciation or depreciation of shareholder value than any other factor. That’s why they make the big bucks.

An old trader once told me that one of the worst things that could happen to someone was making a lot of money on a trade. You might get hubris from it which the market will quickly sniff out and check. You might think you are smart when all you did was get a little lucky.

I remember someone approaching me about investing in a Cryptocurrency hedge fund. I have been approached by more than one person by the way. I am invested in one crypto fund, and I happen to be on the hedge fund’s advisory board. I am not interested in investing in any more funds so don’t flood my inbox.

This person had done well by being early in Bitcoin. I asked them what their “edge” was. Why them? Why would they beat the market? How were they creating their own edge, and was it sustainable?

They couldn’t answer so I didn’t invest. They had found out about Bitcoin early and gotten remarkably lucky by riding a wave.

Sometimes you do get lucky when you invest. However, my experience is the people who get lucky also put in a lot of work and have a sustainable successful investment strategy that has played out over time. They are incredibly ritualistic and disciplined with many of their habits. At the same time, that ritual and discipline allows the the freedom to really explore innovative and new ideas.

If you don’t have discipline, you are rolling dice.

The “Why them?” question is one you need to ask at every stage of investment. It’s the most important one we answer at the seed stage. But, it turns out even with established companies that have been public, management matters. Just look at General Electric after Jack Welch left. Recently, CNN got rid of its CEO and if you look at CNN ratings over the past several years, they suck. The management team there reflects it. So does the content but that is another issue.

Political parties do this too. They overplay their hands and quit listening to their constituents. They don’t realize it until it is too late. Or, they are so entrenched, they have built thick walls so they are unable to hear.

The presentation my friend Nilesh posted is compelling. The educational takeaway comes in the later slides. The structure of the company is wrong. How many dual shareholder class companies need to fail before the market and venture capitalists decide it is not a good structure? Sure, there are some successes like Facebook. But most of these don’t do so well.