Why Value Investors Need Systems Thinking
Tunnel vision is dangerous, y'all.
Why Bottom-Up V
alue Investors Need Systems Thinking
Samir Patel
- Founder/PM, Askeladden Capital - January 10
th
, 2017 -
maximumeffort@askeladdencapital.com
systems
thinking:
an
approac
h
to
problem
solv
ing
taking
into
account
the
interactions
between
a
system
and its component parts, desi
gned to better reflect second
-order, reflexive, and unintended conse
quences
.
1
Stop
me
if
you’ve
heard
this
one
before:
an
NFL
team
is
buildin
g
state-of-the-art
new
digs,
outclassing
the
other
31
with
bold
architecture
and
whiz-bang
digital
scoreboards
massive
enough
to
render
the
actual
playin
g
field
into
a
distracting
sideshow.
The
team
solicits
taxpayer
funding
by
projecting
how
the
venue
will
reinvigorate
the
local
economy.
How
could
you
say
no?
It’s
a
matter
of local pride to be the bigg
est and b
est; now it
’s appar
ently profitable to boot.
Except
by
the
time
the
project
’s
shovel-ready,
the
stadium’s
already
been
eclipsed
by
another
two
in
the
works
-
one
by
a
bitter
division
rival,
no
less.
Fast-forward
a
decade
or
three,
and
all
of
a
sudden
home
field
is
looking
pretty
sad
and
worn
down.
The
team
freshens
up
its
now-vintage
pitchbook and sticks out an ov
ersized mas
cot paw for
more bond mon
ey...
//
I’m
the
sort
of
investor
who
isn’t
terribly
popular
at
dinner
parties,
on
the
rare
occasion
I
end
up
at
them,
because
everyone’s
first
question
is
“oh,
wher
e
do
you
think
the
market’s
going
?”
Naturally,
I
reply
with
the
standard
bottom-up
value-or
iented
line:
“you
know,
I
really
don’t
have
any
useful
thoughts
on
the
market,
but
I
could
tell
you
about
this
awes
om
e
new
product
from
my
favorite
corporate
training
company
that
totally
changes
how
Chief
Learning
Officers
create
impact
journeys
for...”
Lo
and
behold,
I
look
up,
and
they’ve
abandone
d
me
for
the
lobster
samosas,
leaving me to drown my unfinis
hed sentence in a cold C
oca-Cola.
Nonetheless,
while
I
focus
on
picking
strong
swimmer
s
rather
than
predicting
the
tide,
one
potential
mistake
that
can
be
made
when
deeply
analyz
ing
individual
opportunities
(in
addition
to
over-reliance
on
exhaustive
data
collect
ion
rather
than
thoughtful
decision
making)
is
to
get
so
wrapped
up
in
company-specific
details
that
you
overlook
the
broader
systemic
context
-
the
“and
then
what?”
analytical
step
out
of
the
reductionistically
precise
comfort
of
a
spreadsheet
into
the
messy, complex real world.
Here’s
a
quick
example
of
how
you
could
be
lulled
into
a
false
sense
of
bottom-up
security
that
conflicts
with
fairly
obvious
system-lev
el
issues.
This
time
last
year,
for
reasons
I
can’t
quite
remember,
I
actually
spent
a
little
bit
of
time
working
on
brick-and-mortar
retailers.
(I
know,
I
know
-
not
one
of
my
better
time
allocat
ion
decisions.)
The
first
one
I
looked
at
had
an
interesting
story:
for
what
management
assured
investors
were
fully
controllable
reasons
around
product
assortment,
the
comp
stack
didn’t
look
super,
but
they
had
a
magic
plan:
investing
in
e-com
merce,
reducing
time-to-market
to
em
ula
te
fast-fashion
peer
s,
and
imple
menting
new
real-time
data
systems to target custome
rs and “c
hase” hot
produc
ts flying off the shelves.
1
Paraphrased from various sources i
ncl. Wik
ipedia,
this
, and S
eeking Wisdom (r
eferenced
later).
1 of 3
Why Bottom-Up Value Investors Need Systems Thinking
Samir Patel
, Founder/PM of Askeladden Capital, 01/10/2017
-
maximumeffort@askeladdencapital.com
Oh
cool
-
that
seems
like
a
reasonable
strategy.
Or
at
least
it
did,
until
I
looked
at
retailers
#2,
3,
and
4...
and
discovered
that,
whether
due
to
social
proof
or
some
other
factor,
they
were
all
taking
pretty much the same approach.
My
mind
automatically
jumped
to
the
system
level
-
unit-wise,
the
apparel
TAM
is
more
or
less
a
zero-sum
pie,
insofar
as
anyone
not
named
“Dez
Bryant”
or
“your
wife”
is
only
going
to
buy
so
2
3
many
pairs
of
shoes
between
now
and
next
Christmas.
(
So,
so
many.)
Quips
aside,
retail’s
obviously
a
mature
market
where
achiev
ing
robust
growth
necessitates
either
differentiated
product
to
the
extent
of
pricing
power
,
or
stealing
volume
from
competitors.
Mathematically,
share
gains
by
LULU/Gildan/et
c
necessitate
commens
urate
share
losses
by
Levi’s/Hanes/etc.
Implementing
real-time
sales
tracking,
a
more
robust
e-commer
ce
platform,
and
a
supply
chain
with
shorter
lead
times
certainly
seems
like
a
valid
compet
itive
strategy
with
a
reasonable
shot
at
success...
until
you
figure
out
all
your
compet
itors
are
pursuing
the
same
approach,
which
means,
on net, any one player will achiev
e zero increment
al compet
itive advantage.
With
another
year
in
the
books,
my
suspicions
were
confir
med
-
new
data
systems
couldn’t
salvage
comps
for
any
of
those
sad-sack
retailers.
Admit
tedly
you
can’t
blame
retail
executives
for
trying;
after
all,
if
they
didn’t
make
those
moves,
they
might
be
holding
their
next
earnings
call
on
their
way
up
the
steps
of
bankr
uptcy
court.
However,
investors
blinded
by
“cheap”
valuation
metrics,
hoping for improving comp
s and mar
gins, should’v
e known b
etter. Value trap 101.
Of
course,
I’m
not
breaking
any
new
intellectual
ground
here
-
this
is
exactly
why
Buffett
stopped
buying
cigar
butts
with
no
compet
itive
advantage.
Keeping
with
the
apparel
theme,
here
is
a
pithy
explanation from Charlie M
unger:
“[in
a
commodity
ind
ustry],
all
the
advanta
ges
from
great
improvements
[will]
flow
through
to
the
customers.
The
peo
ple
who
sell
the
machinery
-
and
by
and
large,
even
the
internal
bureaucrats
urging
you
to
buy
the
equipm
ent
-
show
you
projections
with
the
amount
you’ll
save
at
current
prices
with
the
new
technolog
y.
Howe
ver,
the
y
don’t
do
the
second
step
of
the
analysis
-
which
is
to
determine how much
[wi
ll] sta
y hom
e and how
much [wi
ll] just flow through to the customer.
I’ve
never
seen
a
single
projection
incorpor
ating
tha
t
second
step
in
my
life.
And
I
see
[su
ch
projections]
all
the
time.
Rathe
r,
the
y
alwa
ys
read:
“Thi
s
capital
outlay
will
save
you
so
much
money
that
it
will
pay
for
itself
in
thr
ee
years.”
So
you
keep
buying
things
that
will
pay
for
themselves
in
three
years.
And
after
20
years
of
doing
it,
som
ehow
you’ve
earned
a
return
of
only
about 4% per annum
. Tha
t’s the
textile business.”
4
2
http://www.star-telegram.com/spo
rts/nfl/dallas
-cowb
oys/cowb
oys-corner-blog/article112413027.html
(Knowing Dez Bryant owns 3,000+ Jor
dans makes me mar
ginally les
s ashamed of my s
even-color collection of hightop Chucks.)
3
Statistically speaking, I am writing
to an ov
erwhelming
ly male audience, s
o you’r
e more likely to find this amusing than offensive. If
you are the exception, please accept
my apolog
ies, enjoy
this study
about how women ar
e better investors than men, and note that I am
an equal-opportunity humorist who als
o made a s
elf-depr
ecating joke about my own fr
ivolous rack of shoes. =)
4
Via pages 228-229 of Peter Bevelin
’s excellent
Seek
ing Wi
sdom
. An awes
ome b
ook that you should go read.
2 of 3
Why Bottom-Up Value Investors Need Systems Thinking
Samir Patel
, Founder/PM of Askeladden Capital, 01/10/2017
-
maximumeffort@askeladdencapital.com
A
third
and
final
example,
coincident
ally
also
retail-related,
is
the
bull
thesis
on
Seritage
Growth
Properties
(SRG)
-
i.e.
slicing
up
and
redeveloping
erstwhile
Sears
boxes
at
substantially
higher
rental
rates.
I’ve
seen
multiple
detailed
writeups,
none
of
which
addressed
my
basic
system-level
5
question:
which
tenants
can
gener
ate
sustainable
profits
in
B/C
space?
Fellow
big-box
anchor
J.C.
Penney
has
issues,
the
venerable
Macy’s
is
slashing
jobs,
and
I
don’t
think
new
Barnes
and
Nobles
are
in
the
cards.
The
long
list
of
smaller
-format
retailers
that
have
gone
from
“hot”
to
“not”
includes,
but
is
not
“
Limited
”
to:
Hot
Topic,
Quiksilver,
Aeropostale,
J.
Crew,
Express,
and
essentially
all
of
Ascena’s
brands.
Even
cleats
and
clubs
aren’t
safe:
Sports
Authority
went
so
bankrupt
that
creditors
chose
to
liquidat
e.
And
it’s
not
as
if
these
stores
are
closing
into
a
6
supply-constrained
market
-
Jones
Lang
LaSalle
notes
the
U.S.
has
as
much
retail
space
per
capita
as “
France, Denmark, Finl
and, P
ortugal, S
pain, It
aly, a
nd G
ermany com
bined.”
7
None
of
this
is
to
say
that
Seritage
couldn’t
work.
But
imaginably,
the
counterparty
(Simon?)
to
those
other
downsizing
retailers’
leases
probably
also
wants
to
redevelop
space...
implying
what
for
pricing
and
utilization
in
an
oversupplied
market
with
shrinking
demand?
This
system-level
view
raises
critical
questions
I
consider
“too
hard”
-
i.e.
unknowab
le
and/or
unpredictable.
So
I
passed
Seritage
by
in
favor
of
a
much
more
clearly
under
priced
REIT
I
actually
had
an
angle
on.
(A
small
position and not my favori
te idea, b
ut in an expens
ive market, I’ll take value where I can find it.)
//
Most
of
the
time,
systems
thinking
helps
you
avoid
dangerous
pitfalls
-
take
the
standard
B-school
example
of
terminal
growth
rates
-
if
you
assume
a
business
will
grow
at
20%
forever,
you’re
gonna
have
a
bad
time
,
because
SnackApp
can’t
be
bigger
than
global
GDP
in
2035,
it
just
can’t,
I
don’t
care
how
many
selfies
your
cousin’s
cat
is
sharing
on
it.
Math
says
no.
At
a
more
sophisticated
8
level,
incorporating
systems
thinking
can
help
bottom-up
value
investors
mesh
deep
business
understanding
with
the
broader
industry
and
customer
context
to
obtain
a
more
reasonable,
realistic set of expectations for
how b
usiness performance will ev
olve over time.
That
said,
sharp
thinkers
reading
between
the
lines
of
my
first
two
examples
might
also
spot
a
categorically
attractive
fishing
pond
for
potential
ideas.
I
came
close
with
one
line
on
the
second
page,
but
didn’t
explicitly
spell
it
out,
because
where
would
be
the
fun
in
that?
If
you’re
up
for
the
challenge,
email
me
with
your
thoughts.
If
you
make
a
valiant
attempt,
I’ll
share
my
hypothesis...
and
if
you
mention
that
you
tweeted/Link
edIn-ed
/emailed/otherwise
shared
this
paper, I may even throw in an act
ionable small-cap inv
estment idea related to my premise. :)
5
Example:
https://www.valueinvest
orsclub.com/idea/S
ERITAGE_GROWTH_PROPERTIES/137107
6
I am taking some editorial license h
ere (and t
hroughout) and you could quib
ble with the way I’m describing some/all of these
situations. I do not claim to be an ex
pert on any of t
hem. T
he point
is basically t
hat despite widespread agreement for half a decade that
Amazon is eating bricks and mortar
retail, inv
estors are somehow per
petually s
urprised that it
keeps happe
ning.
7
http://www.us.jll.com/united-state
s/en-us
/news
/3775/life-lib
erty-and-t
he-pur
suit-of-retail-space
8
#teamdogpeople
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