Simple is the Gold Standard for an Investment Thesis
Focusing on the pressure point provides clarity for investors
“In candy, as in stocks, price and value can differ; price is what you give, value is what you get.” - Buffett, 1983 Letter
I’ve heard it described that the best investments are “hit you over the head” obvious. Entailed in this description is a mandate of simplicity. In other words, an investment thesis should boil down to a few key inputs, or pressure points. This reflects reality because generally only a small number of essential elements are required for a successful outcome in life, regardless of the activity. A good pasta only requires a few ingredients. Given this dynamic, it’s imperative all of the ingredients are high-quality, otherwise a low-quality ingredient will be accentuated.
In distilling an investment thesis into a key pressure point(s), you’re able to tune out the noise of the news cycle and better exploit short-term fluctuations in the market. Or make quicker, more intelligent sell decisions if the pressure point is impaired.
Buffett illustrates the above concept when discussing their investment in the Buffalo Evening News. The backdrop for the following quote was the 1981-82 recession that hit Buffalo’s economy hard, reducing spend among consumers, and consequently, newspaper advertising spend among retailers:
Within this environment the News has one exceptional strength: its acceptance by the public, a matter measured by the paper’s “penetration ratio” - the percentage of households within the community purchasing the paper each day. Our ratio is superb: for the six months ended September 30, 1983 the News stood number one in weekday penetration among the 100 largest papers in the United States.
For Berkshire, the lynchpin of its Buffalo News investment is the paper’s penetration ratio:
We believe a paper’s penetration ratio to be the best measure of the strength of its franchise. Papers with unusually high penetration in the geographical area that is of prime interest to major local retailers, and with relatively little circulation elsewhere, are exceptionally efficient buys for those retailers. Low-penetration papers have a far less compelling message to present to advertisers.
The reason the penetration ratio is the most important measure is because it’s what powers the growth flywheel: the higher the penetration ratio, the more attractive the value proposition for advertisers because it means they’re reaching the widest possible audience. More advertisers means more revenue for the paper, which it can reinvest to produce more high quality content for readers, increasing the customer value proposition.
Focusing on pressure point provides clarity
By simplifying and focusing on the key pressure point(s) of a business, investors are able to better tune out the noise and make more level-headed decisions, whether that’s a buy, hold, or sell decision. Staying on the Buffalo News thread, the following quote shows an understanding by Buffett about the factors that drive the penetration ratio (a change in any of these factors would presumably trigger a discussion about the health of the investment):
In our opinion, three factors largely account for the unusual acceptance of the News in the community.
(1) Both emigration and immigration are relatively low in Buffalo. A stable population1 is more interested and involved in the activities of its community than is a shifting population - and, as a result, is more interested in the content of the local daily paper. Increase the movement in and out of a city and penetration ratios will fall.
(2) The News has a reputation for editorial quality and integrity...This reputation was enormously important to our success in establishing a Sunday paper against entrenched competition…
(3) The News lives up to its name - it delivers a very unusual amount of news. During 1983, our “news hole” (editorial material - not ads) amounted to 50% of the newspaper’s content...Among papers that dominate their markets and that are of comparable or larger size, we know of only one whose news hole percentage exceeds that of the News. Comprehensive figures are not available, but a sampling indicates an average percentage in the high 30s. In other words, page for page, our mix gives readers over 25% more news than the typical paper. This news-rich mixture is by intent. Some publishers, pushing for higher profit margins, have cut their news holes during the past decade. We have maintained ours and will continue to do so. Properly written and edited, a full serving of news makes our paper more valuable to the reader and contributes to our unusual penetration ratio.2
While getting to a single metric, such as a penetration ratio, may not be feasible for every investment, it should be the gold standard.
Very perceptive insight about the nature of local newspapers. It’s no wonder that the internet, which has unquestionably made populations less stable and more global, has decimated local newspapers. Facebook has become the “local” newspaper for the world.
This flywheel, in which revenues are reinvested to continually improve the customer value proposition rather than extract profits, gets at the idea of scaled economies shared.
Thanks David. The Buffalo News example brings up another point, especially relevant these days - Anti-fragility. Having the highest penetration means that they will be the last paper to loose ad revenue. As competitors fall by the wayside, the News would likely see higher gains when good times return.
We still see stocks priced as though we done with interest rate rises. We can't predict the future We can choose investments that do well despite adversity.