Valuing the Unknowable

Spoiler Alert: You Can't

Feb 14

Investment Talk goes out to over 18,400 investors and is a reader-supported newsletter. If you enjoy the content and would like to support the newsletter, you can do so here.

Support Investment Talk

I enjoy satirical self-deprecation and playing the part of a realist; it keeps me grounded. But on the whole, I would say I am an optimist. One belief I hold that aids the persistence of optimism is that there are always unknowable unknowns lurking in the future. This can be terrifying; life can be so tragically spontaneous at times. But it can also be wonderfully random. Consider the process of applying for a new job. It feels like a numbers game; constant applications met with frequent rejection and several blows to your self-esteem. And then suddenly, after weeks of trying, you land three interviews in the space of two days. You wait for a bus and then two come along at once.

Finding a new job or changing career paths is often anxiety-inducing; the distance between points A and B can feel like a tightrope with no harness. It’s easy to let your negative thoughts dictate the day. Eventually, you make it through, and you find something; at which point you feel better. Instead of postponing happiness until after the job is secured, I try to find comfort in knowing that tomorrow is another day of opportunity. The harder you work the more luck you seem to attract or something like that.

Is it a form of self-delusion? Possibly, but you have a choice of two narratives and one will make you miserable. I suppose it’s similar to the idea of “fake it till you make it”; an aphorism that suggests that by imitating confidence and an optimistic mindset, a person can realise those qualities in their own life and attain the results they seek

. In this instance, instilling the idea that tomorrow may bring promise can calm the anxieties of the present.

“Where the hell are you going with this?”

As far as investing is concerned, there are three buckets of unknowns.

Known unknowns: Things we should be able to identify with a little bit of research.
Unaccessable unknowns: Things that we could identify, but don’t have access to it for whatever reason.
Unknown Unknowns: Things we could not reasonably identify or anticipate based on knowledge which exists today. i.e things we don’t know that we don’t know.

Let me just say right now that I think underwriting these unknown unknowns is not wise. Don’t go and buy a stock based on some wild visions for the future.

Investing (particularly the long-term orientated variety) is full of these unknown unknowns and they often have a profound influence on a company’s shareholder return, both to the upside and downside. These unknown variables always throw curveballs (and whatever the opposite of a curveball? Sorry, I don’t do baseball). Everyone knows the Amazon analogy; once an online bookstore, then an e-commerce giant. So here are a few different (but not original) examples.

Apples to Apples

An overused analogy at this point, but I don’t care; because it’s a great one. At the beginning of the 21st century, Apple’s iPod (launched in 2001) became the centrepiece of their empire alongside the Macintosh computer. I believe that the iPod played an important role in Steve Jobs’ vision for the iPhone; released six years later. Jobs famously said this new device, which to this day stands as Apple’s most important revenue generator, would be “an iPod, a phone, [and] an internet mobile communicator”. It quite literally changed the paradigm of the mobile industry.

Future innovations (iPad, Apple Watch, AirPods, et al) were not quite as revolutionary, but they still went on to become significant players in their respective fields and strengthened the relationship between the hardware and software ecosystems for both company & consumer. Was any of this world domination obvious in the years prior to the iPod launch in 2001? Was it then any more obvious in the years between the iPod and iPhone launch? History will show that it still wasn’t obvious

for several years post-iPhone launch.

While Apple is a strong business today, it’s often lamented because it “doesn’t innovate” anymore

. See my footnote for a rant on those people. Are they capable of another form of innovation on par with the iPhone? What about the iPad or the Watch? I think the latter is more likely. These were product categories that already existed

before Apple threw their hat into the ring, but they came at them with the Apple flair and carved out a significant share of the market. Is it unrealistic to assume they can replicate this success in the next product category? While I don’t believe people should buy Apple today based on how powerful their imagination is

, I think it should be acknowledged as a call option of sorts; that this business has the brand power and design capability to enter mostly any market and have a fair shot at cornering it. Even if those future revenue opportunities are things we could not reasonably identify or anticipate based on knowledge which exists today.

Meta (the artist formerly known as Facebook)

The company, but more specifically the Facebook platform, endured many hurdles in its lifetime. For several years prior to its IPO in 2012, Facebook was undergoing a transition from web→mobile; one that many felt they would not succeed in. It was in 2008 when Facebook eventually launched on the iOS app store. The answer to their problems, Instagram, would not be created until 2010. At this point, there was no way anyone would have known that they would acquire Instagram for $1 billion because it didn’t yet exist. The move was later met with ridicule. The fledgling social app had ~30 million users and 13 employees when Facebook acquired it in 2012. Many felt Zuckerberg overpaid. There were also lingering concerns of saturation for big blue, which had recently surpassed 1 billion users.

Fast forward to today and the boomer-infested blue app just surpassed 2 billion daily active users. Whatsmore, the company have since acquired companies like WhatsApp and Reality Labs and are now more of an advertising conglomerate than a standalone platform. While the performance of Meta has been lacklustre of late, investors at the bottom of 2012 saw a return of over 1,000% before the Cambridge Analytica scandal in 2018 and as much as 2,000% before the all-time high in September 2021. Today, the facts have certainly changed and the reevaluation of sentiment is warranted, but that’s another story. My point is that between 2012 and Facebook’s pivot to “Meta” in 2021 there were several unknown unknowns that dramatically increased the value of the business. Ironically, Meta may now be witnessing a reversal of this same theme; whereby the pivot ultimately leads to the destruction of shareholder value over time.

Greggs, a UK Favourite Gone Global

In an earlier memo, I talked about Greggs, the UK’s leading bakery chain. The thesis for Greggs rests upon incremental growth within the UK, the only nation they sell goods. At present, they are aiming for 3,000 stores. I believe they can eventually reach 4,000 stores but there will come a time when they saturate the market and become an ex-growth company plodding along at the rate of GDP.

Something nobody discusses in the same breath as Greggs in the current day is international expansion. After a failed attempt in Belgium

decades prior, the last time it was mentioned was during the company’s 2021 Investor Day:

“I mean basically, all we've done is create a small research team that will go away to examine that and take that first step. We're in no rush to do it. We've no need to because the potential for expansion here in the U.K. is very good. But at some point, we believe Greggs can venture into international markets. We don't know where yet. And so we've set up a small team to begin to do some serious research into that.” - Roger Whiteside, former CEO of Greggs, 2021

Whiteside had previously acknowledged

that "eventually - beyond 2025 - there’ll come a point where we’ll need to look beyond the UK for growth or beyond Greggs for growth". He said this in 2020 and is no longer CEO after retiring in 2022. But the point stands. At some point, perhaps ten years down the line, Greggs probably expand internationally. Whether that actually works or not is another question. But assume it did. It's not unfathomable to imagine a version of reality 30 to 40 years into the future, where Greggs has several thousand stores located in international waters. The store count could even surpass their domestic market. Sure, the margins would not be as attractive; one of Greggs's superpowers is its vertically integrated domestic supply chain; which affords them luxurious 63%+ gross margins. They'd have to build that from the ground up if they expanded outside the UK. It’s also not difficult to imagine an alternate reality where several years down the line Greggs ultimately fails in their international efforts. After saturating their domestic market and decimating several hundreds of millions of pounds in CapEx, the sentiment likely sours.

The point is, nobody knows. You’d be hard-pressed to develop an accurate projection of Greggs as an international brand for several reasons

, the most important are these; you don't know when, you don't know where, and you don't know what the aggressiveness of such a strategy will be. Benefitting from these unknowns is largely attributable to luck, but as I alluded to earlier sometimes luck is the byproduct of preparation and/or the creation of environments that are conducive to luck.

“I’m a great believer in luck, and I find the harder I work the more I have of it.”

However, relying on luck in the stock market is a fool’s errand. So how can we optimise for getting lucky? I think the answer lies in searching for companies that are naturally creating the environment for luck to occur. The folks at Ensemble Capital

summarise this well:

“We’ve - seen these factors lead to unpredictable value creation at companies like Google, Apple, and Charles Schwab. These companies were lucky, but they also provided fertile ground for innovation. By focusing our research on what we consider to be wonderful companies – those that have or are building a moat, are long-term focused, are great places to work, etc. – we think we can increase our odds of benefiting from unpredictable value creation.”

This is the stuff that ultimately matters in the long run. Not the fluff that is so often debated in mainstream media. The world would be a much quieter place if investors only spoke when they had something genuinely insightful to say. But the media is not run by investors, it’s run by investment commentators.

The majority of investment commentary is plain pseudo-intelligence; the parroting of public information; bearing little critical judgment or analysis. Speaking for the sake of speaking. Alain De Botton has a funny quip about this when he talks about 19th Century French novelist, Gustave Flaubert’s disdain for the news:

“Flaubert couldn’t stand newspapers. He belonged to a generation that had experienced the rise of mass-circulation newspapers at first hand and believed that these were spreading a new kind of stupidity – which he termed ‘la bêtise’ (idiocy) – into every corner of France. Idiocy wasn’t the same as ignorance for Flaubert, because it was compatible with knowing a lot of things – it just meant understanding nothing”.

“The modern idiot could routinely know what only geniuses had known in the past and yet he was still an idiot - the news had, for Flaubert, armed stupidity and given authority to fools”.

- Alain De Botton

You may notice that once every month or so, there is a new “thing” in the media. It could be Sam Bankman-Fried and FTX, Chinese spy balloons or ChatGPT. At which point everyone suddenly becomes an expert on accounting fraud, then military warfare & international relations, and then artificial intelligence. What you’ll find is that the individuals who work so tirelessly to collect these cub scout badges:

Often have little to no experience in the subject, outside of the news articles they just read and;
Will spend their time flitting from one topic to the next, developing a shallow puddle (not deep enough to drown an ant) of comprehension in each.

Think of it like climbing to the point where peak ignorance meats peak confidence on the Dunning Kruger scale and then saying “job done” before moving on to the next provocation.

Is there something wrong with being interested in trends? Certainly not. Accounting fraud, military warfare, international relations, and artificial intelligence are fascinating. But “knowing stuff” is not the same as “understanding stuff”. If you want to know stuff, watch the news. If you want to understand stuff, ignore the noise and get learning.

Thanks for reading,

Conor

Results can vary…

I don’t think it ever was “obvious”, I am simply reusing the word for dramatic effect.

I find fault in this argument and believe that most people who suggest this struggle to understand what innovation is. It’s a spectrum; on one side there is incremental innovation, and on the other is radical innovation. They are both forms of innovation and the most sought-after (radical) tends to come in waves. Typically when a new market is opened by some force of radical innovation, the initial years are flooded with further ground-breaking innovations, but ones that tend to be diminishingly less impressive than the initial burst of innovation that incepted the new space. What follows is then incremental innovation. I willingly pooh-pooh the folks who say that Apple is no longer an innovator.

For reference, the smartphone market did exist prior to the iPhone, but because this was such a groundbreaking marriage of hardware and software, I view the pre and post-iPhone markets as separate ones.

Here I refer to the possibility of Apple entering the mixed-reality hardware market, but it could be the next adaptation of the smartphone, or some other wildly advanced piece of technology nobody knows exists yet.

Greggs set up 10 bakeries in Brussels and Antwerp as a “low-cost experiment” and later shut them down in 2008

He spoke with reporters at Reuters in 2020

I find the idea that an investor can accurately project earnings decades into the future laughable.

In a 2018 article, here.