Friday🔥09: Just Passing Through, The Art of Execution

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Welcome to this week's edition of Friday Fire, an end of week newsletter recapping notable insights and inspirations from the past week. This week I'm unpacking inflation dynamics and why world class investors can lose money +60% of the time and still come out on top. Let's jump in!

Just Passing Through

Retail trade reports for the month of March came out yesterday.

We are staring at an eye-watering 8.5% inflation, avg ticket sizes from the pump to the grocery store have risen materially, yet apparently, consumption remains unphased!

Retail and food service spend for the month of March was up 0.5% vs last month, excluding the impact of higher prices. The American consumer remains stout amidst this backdrop of economic uncertainty.

This lends me a modicum of comfort around consumer discretionary & retail stocks currently trading at depressed prices based on fears around household penny pinching. Across the board cutbacks in spending are still very much on the table, but for now we seem to be shrugging off these higher prices.

Its interesting to overlay these observations with my day job as a securities analyst where we fixate on answering the following question when analyzing a new investment:

"What is the Company's ability to pass-through higher input costs?"

I am razor focused on who is going to be bearing the economic burden of higher input costs.

Here is an illusory example of a recent investment I was looking at:

I was analyzing a company which manufactures and assembles bicycles. The two large dollar inputs for a bicycle are the aluminum/steel for the frame and rubber for the tires.

As I speak with company executives, the management team precedes to tell me that they did not hedge their raw metal prices so they are paying current market rate for each ton of aluminum (which is up +16% year to date (YTD) in 2022).

On the rubber front, congested global supply chains have led to tire shortages at the company, so they have no excess tire inventory built-up and thus need to purchase all supply at current prices. Thankfully, the producer price index of rubber is only up a measly ~3% YTD, so not feeling the pain there.

But wait, most of the global tire supply comes from manufacturing plants in Europe and Asia which means we need to put those tires on a container ship to reach the bike assembly facility in the U.S.

Ship container rates have jumped 3x from prior year levels, Yikes!

So, after blending all the various input costs, the bike that used to cost $90 to manufacture now costs $103 (14% increase).

Going to back to my original question, "what is your ability to pass through higher input costs?"...

Unfortunately for this particular business, the answer was not inspiring. This particular business is a wholesaler (they don't own any consumer-facing retail outlets) and Walmart is their largest customer. Walmart doesn't enter into fixed price purchasing arrangements with its vendors, so now my BikeCo has to go plead with the nation's largest brick and mortar retailer to accept a price increase.

Walmart has built its entire reputation around "lowest prices, guaranteed"... so this will not be an easy conversation for my BikeCo....

We are living in a very dynamic time and the road to the higher prices we see is a long, windy one. Its fraught with multiple constituencies fighting over who ought to bear the brunt of elevated input costs.

So long as the consumer maintains its current pace of consumption, we can continue to expect that these prices will make it all the way through the supply chain to be borne by us.  

The Art of Execution

The Art of Execution is a book written by Lee Freeman-Shor, a Portfolio Manager who oversaw the investment of a ~$1bn portfolio invested in various hedge funds. Lee didn't pick individual stocks, he picked individual hedge fund managers (who would then subsequently pick stocks on his behalf)

Lee conducted a fascinating study where he analyzed the individual performance of each hedge fund manager by dissecting each trade they made over a 7 year period. This study required the review of ~30k trades, across 2,000 different stocks, selected by ~45 of the world's top hedge fund managers.

His findings? Well they are multi-fold, but the most striking to me was that these managers placed losing or break-even bets ~60% of the time... meaning that 6 out of every 10 investments in these manager's portfolio either didn't make money or outright lost money.

Despite this staggering statistic, these managers still found a way to produce above-market returns over the time horizon. So it begs the question:

How does one outperform if they are "wrong" 60% of the time?

Lee uses the book to highlight the importance and art of execution. These managers proved to be particularly adept at swiftly cutting those 6 of 10 losers, while riding the 4 of 10 winners to much higher prices than the average human could emotionally stomach.

This lesson extends far beyond the reaches of the stock market...

Its great to win, but by how much one wins is often the difference maker

Gratitude

Gratitude helps cultivate a sense of joy and appreciation along the way, and need not be reserved for the big or elaborate happenings in life.

This week I'm grateful for a high integrity business partner

What are you grateful for this week?

Update on Stock Picks:

Weekly performance update below for active stock picks

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Until Next Week,

Ryan ✌️