Month: June 2017

Supported by Greenhaven Road Capital, finding value off the beaten path.

It was the late 1990’s and the world had gone crazy. Like other instances of insanity, it didn’t seem like it at the time. But when a small stuffed-with-beans bear sold for thousands of dollars something was terribly wrong.

In The Great Beanie Baby Bubble Zac Bissonnette tells the story of the Beanie Baby rise and fall. Before we get into some lessons, let’s brush up on the history of it all.

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Beanie Babies were created by Ty Warner after he quit/was fired from his job selling stuffed animals (plush) for another company. Warner had been an excellent salesman but thought he could do better. The cause for his dismissal was selling his own creations along with his employers. A no no.

Warner didn’t care. He thought, no he knew, he could do better. His first solo plush creation was a cat that sold well to – and this is not a joke – quilt collectors. This business was fine but grooming each longhaired cat took a lot of work and Warner searched for another option and he landed on the Beanie Baby.

Warner made repeated visits to Chinese manufacturers, talked to people at trade shows and in stores, and had a had a hyper focus on his product. Once it was finally good enough he sold them only to small store owners, believing that big box stores would put the Beanie Babies in bins and that would diminish their value. He also demanded full payment up front.

Parents bought them for their kids. Kids took them to school. The phenomenon spread through Chicago. Some parents became more active collectors. To keep track of the available Beanies some people took to sharing a checklist.

Warner continued to tinker, making changes in different lines. If something wasn’t to his liking he would order the next batch slightly different. This purposeful tinkering led to the accidental phenomenon of retirement. The early collectors started to search eBay for these “retired” Beanies and would call their friends around the country to look for them.

Warner’s production was limited. Later this was a marketing ploy but early on it was an issue of cash flow and how much credit his bank would loan for inventory. Scarcity led to increased prices and the internet led to the conveyance of this information. As some people started to make money, more people piled in. At the end of 1998, 7% of all eBay listings were for Beanie Babies. The mania continued. McDonald’s got involved. Warner wised up to the idea of scarcity and took to actively retire more Beanies and created limited runs.

The cycle continued; people saw other people make money off Beanie Babies, people joined those other people, more suppliers meant more supply and with an undifferentiated product they had to compete on price. Prices were pushed down. Warner at this time had ramped up supplies to the point that so many Beanies were being produced that everyone who wanted one could get one. By 2000 the craze was over.

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What the hell happened?

Let’s start with Warner. Unlike startups that fail, Warner understood his customers. Part of what made him a great salesman was this deep understanding. He talked to customers, store owners, and even quizzed his girlfriend’s daughters about what they liked and didn’t. Warner got his XMBA from his time at Dankin, his first plush employer. Warner was a good surfer but he also caught a great wave.

The 1990’s was the era of getting online. Warner’s sales were helped by the proliferation of the checklists and secondary sales on eBay. He was also fortunate in that there wasn’t much competition. Bissonnette wrote, “ the idea of starting a plush company in the early 1980s was no one’s idea of smart. It was a stagnant industry, fifty years past its prime, with no growth in sight.” Much like the Instagram guys or Ken Grossman, the best time to start something is when no one else is starting the same thing. Warner had some nice tailwinds to push his company along.

Another advantage was wise financing. Warner never took on debt and required his retailers to pay-in-full upon delivery. He also stocked the Beanies in airports, thinking they would be a good last-minute gift and traveling from airport to school book bag would be good marketing. In the beginning, he convinced retailers this was a good idea, in part, because of the simple product lines. Beanies retailed for $5 or $10.

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While Warner had great financial success there were some lessons on what not to do as well. For starters, Warner succeeded despite his ego. Bissonnette wrote:

“”I am the designer! I designed everything!” Controlling every aspect of the animals’ existence was a fixation, and it stood in stunning contrast to his nearly total disregard for the feelings of the people he was closest to. He carefully excised everyone else from the story of his rise: his father hadn’t gotten him his first job, he hadn’t used freelance designers to create his bears, and he’d started the company all by himself.”

Warner’s ego was helpful in that it helped him maintain a great focus. One former employee said:

“That’s the secret: focus. If this is what you want, then go for it. Nothing crosses that road, nothing gets in the way, nobody changes it. This man wakes up in the morning, and he’s thinking about the product. He goes to bed at night, and he’s thinking about the product: Should it be a blue ribbon or a red ribbon? I can’t tell you what we went through to get the eyes to be absolutely what he considered perfect. Every detail on every animal was gone over fifty times. It had to be as close to perfect as you could possibly get. Or do it again.”

Chamath Palihapitiya said about the dichotomy between too much ego and not enough: “Ego is a terrible way to make decisions, it’s really good things to have, to make ourselves feel valuable and be confident, but that shouldn’t drive our decision-making.”

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Warner’s success came from an obsessive attention to detail. From the product to the people who bought it, Warner understood what was most important. Because of this, he designed the animals using quality materials in a manner that was different from other toys. As sales grew he lucked into marketing ideas and favorable competition. He was finally brought down not by a competitor but by his own ego, believing he could roll-up (or appear to) the Beanie Baby line and replace it with a new one.

 

Thanks for reading,
Mike

 

Supported by Greenhaven Road Capital, finding value off the beaten path.

Brian Stout joined John Mihaljevic on The Zurich Project podcast to talk about his journey to value investing.

1/ Deliberate practice. “The way that I learned things was deliberate practice. You can’t read about things or hear people talk about them and know how to do them. There’s a large amount of the learning process where you just have to go out there and do it. It’s like riding a bicycle. You can’t watch someone ride a bicycle and ride a bicycle for the first time.”

This is especially true writes Michael Mauboussin in areas with a strong skill component. Pilots, surgeons, and accountants can all use deliberate practice to get better. These domains can also use small sample sizes, checklists, and let history be their guide. Stout has used deliberate practice to get better at value investing and math, two areas where success is based much more on skill than luck.

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2/ Epiphany.  “When I read The Intelligent Investor I had that moment that value investors talk about which was, this made so much sense that it was like an epiphany.”

Lightbulb moments are the first step in finding an idea to follow the rest of your life. The second part is if you have the right attitude to do the work. Stout did, “pouring through a lot of information and thinking through problems resonated with me.”

If we combine the ideas of Mohnish Pabrai, Charlie Munger, and Cal Newport we get this:

What rare and valuable skills do you have the disposition to develop such that you choose to do that rather than go see the newest movie?

These skills don’t need to be hidden. Stout’s two areas of focus, value investing and mathematics, continue to be rare and valuable. Why haven’t these opportunities been whittled away?

“We’ve all heard that argument from various people and my response is, ‘you’ve taught students just as long as I have, how many times have we given them a textbooks that tells them how to do all these computations, and we teach them how to do it in the classroom, we give them homework on it and they still take a test and can’t do it. Even though you present all the information and show them how to do it doesn’t necessarily mean people will do it.”

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3/ Two tools. “When I think about my investing framework there are two principles; there are some psychological principles that are very scientifically established and then there are some mathematical principles that are very relevant.”

In the summer of 2017, my daughters were wondering why they had to read and do math before using their iPads. I told them that reading and math were important because, in reading, you learn about people and in math, you learn about computers.

Jeff Annello gave us the toolbox metaphor for mental models. While Stout calls them principles we can think of them as containers too. In the “MATH” toolbox we have as many valuation equations as screwdrivers, or if you’ve been to IKEA more than once, hex wrenches. In the “PSYCHOLOGY” toolbox we have ideas like recency, availability, and inertia. Rory Sutherland told Shane Parrish that we sometimes forget about this set of tools. “It’s always more acceptable to spend money on infrastructure than to spend money on psychology.”

Like tools, skills are only as helpful as your ability to use them.

 

Thanks for reading,
Mike

 

 

Supported by Greenhaven Road Capital, finding value off the beaten path.

The last one of these was way back in September 2016, so this post will be an update and quick primer for anyone interested.

I (too) record a podcast. It comes out on Thursday mornings. It includes ideas that are either too small for the blog, audio versions of the posts, or ‘thinking out loud’.

The most recent episode is from June 1st. Each episode opens with a quote and then dives into some number of points.

The opening quote is from Startup and Jerry Kaplans 1987 (!!) meeting at Apple to see the precursor to Newton which was the precursor to the iPhone/iPad. It took over twenty years to build something they thought would take only a few.

1/ I quoted from Chris Cole’s Star Wars convexity. Convexity isn’t an idea that comes naturally to me, or most, writes Cole. This short pdf explains it in terms that I can better understand.

2/ Checklists are fun! An idea that’s bubbled up repeatedly is the value of checklists and part-of-the-reason may be our enjoyment crossing things off lists and completing them. For example, here’s what Tracy Kidder wrote about his time with Paul Farmer:

“On the wall beside his desk, Farmer has taped up three sheets of yellow legal paper, on every line a task to be completed, and beside each of those a hand-drawn box, in Creole a bwat. I’ve noticed that if he completes a chore that he forgot to put on the list, he writes down the chore, makes a bwat beside it, then puts a check in the box. This seems to give him an inordinate amount of pleasure, and I must admit that I feel some myself, completely unjustified, when he says, ‘We’re getting a lot done.'”

3/ Base rates on motorcycles. I first heard about the idea of base rates from Michael Mauboussin, and much like convexity, I didn’t understand it. Tynan wrote a blog post titled Analyzing Risk where he explained the inside and outside view.

“In some cases, they’re (risks) fairly universal. My risk of dying in an airplane crash is the same, per mile, as anyone else’s….But some statistics can be very accurate for a population yet way off for an individual. When I began riding a motorcycle I looked carefully at what actually caused motorcycle accidents. Alcohol was a factor in 50% of crashes, and since I don’t drink I can eliminate that.”

Mauboussin instructs to start with the base rate/outside view. Then, figure out the inside view. This is the ‘well sure it happened to them but it won’t happen to me’ phase. After that consider how much you can move the needle. It helps to understand the two-jar model and how much of results are luck and how much are skill. Then adjust the expected outcome.

4/ The stories we tell ourselves. Scott Alexander wrote about aliens in Budapest. The whole post is interesting but in the podcast, we just touched on our story-telling nature.

Again, thanks for reading,
Mike