November 22, 2014

Peter Thiel analyzes Tesla Motors

While Peter Thiel was born in 1967 in Germany, his family moved to California when he was young. Stanford was the school of his choice before he began trading derivatives at the Credit Suisse Group. In 1996, he founded the hedge-fund Thiel Capital Management, and he's also famous for being the first outside investor in Facebook. 

Peter Thiel has also donated $3.5 million to the Methuselah Foundation, which is a life-extension-research organization that believes humans will one day live to be 1 000 years old. One of the founders argued that the first human to live a 1 000 years is already born.

In 2005, Peter Thiel created Founders Fund, a San Francisco based venture capital fund. In the fund, you can find companies like SpaceX and Spotify. He has also written a book called Zero to One where he talks about his strategies. 

Peter Thiel is a venture capitalist (VC), who invests in new technology companies. It's generally difficult to follow the rules a VC has if you are investing in the public stock market, but I still believe you can learn something from some of the rules.

Venture capitalists aim to identify, fund, and profit from promising early-stage companies. But most of these companies will fail, and so will the fund. According to Peter Thiel, the biggest secret in venture capital is that the best investment equals or outperforms the entire rest of the fund combined. If you don't want to fail, then only invest in companies that have the potential to return the value of the entire fund. However, even if you find a successful company, you may still fail. For example, Andreessen Horowitz made a 312 times return on their investment in Instagram, but that wasn't enough to cover the rest of the fund because their investment was too small. 

Peter Thiel has two main rules
The value of a business today is the discounted sum of all money it will make in the future. That's why it may seem that new technology companies are extremely overvalued compared with older companies. For example, when Twitter went public in 2013, it was valued more than 12 times the Time's market capitalization – even though each employs a few thousand people, each gives millions of people a way to get news, and the Times earned $133 million while Twitter lost money. While investors expect Twitter to generate cash flows in the future, they don't believe in more traditional ways to read news.

Monopoly is the condition of every successful business. Under perfect competition, no company makes an economic profit. On the other hand, a monopoly owns its market, so it can set its own prices. Each monopoly is unique, but they usually share the following characteristics:
  1. Proprietary technology. It's impossible to replicate the product – like Google’s search engine. 
  2. Network effects. You have a network effect if a product is more useful as more people use it – like Facebook. 
  3. Economies of scale. The company gets stronger as it gets bigger. 
  4. Branding. Creating a strong brand is a powerful way to claim a monopoly.

Peter Thiel has seven questions he asks before he's investing in a company
  1. Can you create breakthrough technology instead of incremental improvements? As a rule of thumb, the technology must be at least 10 times better than its closest competitor. PayPal was 10 times better because it took 10 days faster to let buyers pay. Companies must strive for 10 times because smaller improvements end up meaning no improvement at all for the end user. 
  2. Is now the right time to start your particular business?
  3. Are you starting with a big share of a small market? Huge trillion-dollar markets mean ruthless, bloody competition. Facebook began with a big share of the small market "Social networks for Harvard University." The initial markets are often so small that they often don't even appear to be business opportunities at all. 
  4. Do you have the right team? One of the single clearest patterns Peter Thiel has noticed from investing in hundreds of startups is that a company does better the less it pays the CEO ($150,000 per year is enough). Real technologists wear T-shirts and jeans, so never invest in a tech CEO that wears a suit. 
  5. Do you have a way to not just create but deliver your product? Selling and delivering a product is at least as important as the product itself. 
  6. Will your market position be defensible 10 and 20 years into the future? For a company to be valuable it must grow and endure – even though many entrepreneurs focus only on short-term growth because growth is easier to measure. The most important lesson learned from Steve Jobs has nothing to do with design. The greatest thing Steve Jobs designed was a long-term vision. Many companies have failed because they didn't answer the question "What will stop China from wiping out my business?"
  7. Have you identified a unique opportunity that others don't see? Great companies have secrets: specific reasons for success that other people don't see. 

Let's apply it on Tesla Motors
The value of a business today is the discounted sum of all money it will make in the future.
Tesla's stock market value is high compared with other car manufacturers like General Motors. But that's because the investors believe more in Tesla's future profits than what they believe in the future of General Motors.

Monopoly is the condition of every successful business.
  1. Proprietary technology. It's not yet as difficult to replicate a Model S compared with what it takes to replicate Google. 
  2. Network effects. If more people drive cars from Tesla, the infrastructure around the cars (like charging stations) will improve, so more people will drive cars from Tesla because of the infrastructure. 
  3. Economies of scale. It's easier to lower the price per car if the factory is bigger, and Tesla is also building their own battery factory. 
  4. Branding.

1. Can you create breakthrough technology instead of incremental improvements?
Tesla's technology is so good that other car companies rely on it. Daimler, Mercedes-Benz, and Toyota are all using technology from Tesla. Moreover, the Model S was rated higher than any other car by Consumer Reports and the Model S became the car of the year by several magazines.

2. Is now the right time to start your particular business?
The original founders of Tesla founded the company because they saw that people were driving the hybrid Toyota Prius only because they cared about the environment and they couldn't find a true electric car. The world will also begin to run out of oil in a few years, so now is the time to sell cars not dependent on oil 

3. Are you starting with a big share of a small market?
Tesla started with the small market "high-end electric sports cars" when they designed the Tesla Roadster. They now had a little more money and a brand they could use when they designed the Model S.

4. Do you have the right team?
The current CEO of Tesla Motors, Elon Musk, described his team: "If you're at Tesla, you're choosing to be at the equivalent of Special Forces. There's the regular army, and that's fine, but if you are working at Tesla, you're choosing to step up your game." Elon Musk is also a big believer in electric cars. 

5. Do you have a way to not just create but deliver your product?
Tesla want to own the entire distribution chain where they sell and service the cars themselves without any traditional car dealer. 

6. Will your market position be defensible 10 and 20 years into the future? 
As the world is running out of oil, and Tesla believes electricity is the weapon of choice when there's no oil, there will be a big demand for electric cars in 10 and 20 years. But what about China? It's true that the Chinese are building several electric cars, but the question is how good future models are compared with a future Tesla?

7. Have you identified a unique opportunity that others don't see?
Tesla has identified that 100 percent electric cars belongs to the future. Other car companies tend to believe in hybrid cars or cars powered by fuel-cells, but Tesla will not sell any of those cars.

This article is a part of the article series Tesla Motors Stock Analysis

October 14, 2014

Somalia is back - part 2

Almost a year ago I wrote an article with the subject that Somalia might be back in business. You can find it here: How to invest in specific countries in Africa, like Somalia and Rwanda. To summarize:
  • The economy will grow by 10 percent each year 
  • 60,000 Somali refugees return each year 
  • 350 new companies are registered each year 
  • Rents and property prices have begun to increase. In 2012, a five-bedroom rental apartment was $500 a month, today it's $4,000

Today I found a new video called "Mogadishu's face lift" (Mogadishu is the capital of Somalia and was nicknamed the most dangerous city in the world). The videos shows that Somalia has continued to improve. Let's hope this trend continues. 

October 5, 2014

The secret to who is a good trader or investor is meditation

Two of my favorite books that are related to the stock market are Market Wizards and The New Market Wizards by Jack Schwager. What distinct these books from most other books related to the stock market is that they include chapters about psychology. If you didn't know it, it's very important to be aware of your own psychological limits if you are traveling the ups and down of the stock market. 

One of the traders interviewed in the book Market Wizards is Richard Dennis. He understood the importance of psychology if you want to become a better trader or investor. According to another book about Richard Dennis, The Complete TurtleTrader by Michael Covel, Richard Dennis never read any stock market news, such as crop reports or the latest unemployment numbers. What he read was the magazine Psychology Today to keep his emotions in check and to remind him how overrated intuition is in trading. While other traders woke up as early as possible so they had the time to read the latest news, Richard Dennis stayed in bed until the last minute before arriving to the exchange just as trading started. 

One common psychological mistake most novice traders and investors make is that they are buying stocks and other assets when "everyone" else is buying, like during the so-called tech bubble at the turn of the century. When the stock market began to fall, after the burst of the tech bubble, they who had earlier bought expensive stocks were now afraid of buying cheap stocks because everyone else was as afraid of losing more money as they were. 

Another common mistake is called confirmation bias (Wikipedia has the full list if cognitive biases). Let's say you've invested in gold. It's common that you will read information saying gold is a good investment and you confirm what you already know, but you also tend to reject all articles saying gold is a bad investment. 

So how can you control your emotions? It's super-easy to read about psychology, but it's much harder to remember and apply what you've read when you are losing all the money you've saved throughout your life. One solution to this problem can be meditation. 

According to the podcast The Tim Ferriss Show, where Tim Ferriss interviewed Joshua Waitzkin, the secret to who is a good trader or investor and who is not is actually meditation. Joshua Waitzkin is coaching the top hedge fund managers. When Tim Ferriss asked him the question "What are some habits that you've observed that you find interesting?" Joshua Waitzkin answer was: 
"First of all, meditation. Meditation is as deep and as powerful tool as I can possible describe. Maybe six or seven years ago when I was first talking about meditation with guys in the finance world it seemed like some strange thing for them to take on. But as more and more people are integrating it into the process, you wouldn't believe how many of the most powerful players in the world are meditating very deeply."

According to this Bloomberg article, hedge fund managers like Ray Dalio, Paul Tudor Jones, and Michael Novogratz, are fine-tuning their brains with meditation. But what's meditation? Meditation used to have this reputation as a hippie thing, but Samurai practiced meditation to become killers that are more effective. You've probably seen those Buddhist monks who are sitting with their legs crossed and their eyes closed. They are not praying and meditation is not a religion – what they are doing is they are trying to focus on the present. Focusing on the present is actually very difficult. Next time you are brushing your teeth, try to focus on brushing your teeth. But you will probably notice that your mind will wander away and you will think thoughts unrelated to brushing your teeth. 

If you can focus on the present, you will be able to move away from your other thoughts and make better decisions. If the stock you've bought is falling through the floor, you have to ignore your bad thoughts to not panic and try to remember the cognitive biases to not sell the stock just because it's falling.

August 11, 2014

SolarCity Stock Analysis


SolarCity (Ticker: SCTY) was founded in 2006 and has been a public company since 2012. One of the founders was the entrepreneur Elon Musk, who has also founded (or co-founded) companies like PayPal, Tesla Motors, and SpaceXThe other founders were his cousins, Lyndon Rive and Peter Rive, and today they are running the company. SolarCity's business idea is to sell and install solar energy systems to both individuals and companies at prices below utility rates. A customer can either buy the system or lease it. About 90 percent of the customers chose to lease it and they will pay cash to SolarCity each month for about 20 years. SolarCity can also sell to the customer energy-related products and services that further lower the customer's energy costs. The vision is to: 
Transform the way energy is delivered in the 21st century through cleaner, more affordable distributed generation.

SolarCity ($SCTY) Stock Chart

Table of Contents 
Why solar power?
Peter Lynch analyzes SolarCity
Warren Buffett analyzes SolarCity

August 4, 2014

Warren Buffett analyzes Tesla Motors

To analyze Tesla Motors with the help of Warren Buffett (no introduction needed), we are going to use the book Money Masters of Our Time by John Train. Buffett has never written a book about how he invests in companies. So we have to trust someone who has analyzed the shorter writings by Buffett and has summarized the findings. Elon Musk, the CEO of Tesla Motors, admires Buffett. The Giving Pledge is a philanthropic campaign by Buffett and Bill Gates, and Elon is one of twelve billionaires who has signed it and will give at least half of his wealth to charity.
Compared with the growth investor Peter Lynch, Buffett began as a true value investor. According to Wikipedia, it can be defined as:
Although value investing has taken many forms since its inception, it generally involves buying securities that appear under priced by some form of fundamental analysis. As examples, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios.
But after many years, Buffett began to like growth at reasonable price. Buffett himself described his strategy:
All we want is to be in businesses that we understand, run by people whom we like, and priced attractively relative to their future prospects.
The 83 years old Buffett is still an active investor, so the short answer to the question if he would like to invest in Tesla is: No! (Because he hasn't invested in Tesla). But that doesn't mean Tesla is a bad company from an investing point of view. We will see that Buffett's analysis depends on a series of question. The answers to these questions depends on the investor itself.

The analysis 
According to the book, there are a number of characteristics of a wonderful business Buffett prefers to invest in. Notice that I will use Coca Cola to make an example. One interesting side note here is that one of the reasons Elon Musk's grandfather decided to move from Canada to South Africa was because he had received death threats from what he believed was Coca Cola. So without Coca Cola, there wouldn't have been an Elon Musk, because his father is South African, and no Tesla Motors. 
  • They are understandable. Do you understand the company? To test if a business is understandable, Buffett closes his eyes and tries to visualize how the company will look like ten years hence. Compared with a company like Coca Cola, it's more difficult to understand Tesla. You have to understand the car industry and why we need cars not powered by oil. How will Tesla look like in 10 years? How many cars will they sell? How much money will they need to sell those cars? 
  • They see their profits in cash. The company shouldn't have to reinvest all profits just to stay in business. Tesla Motors is still a young company and their strategy is to reinvest all cash made from a car model to be able to design a new car model. They began with the Roadster, and the profits from that model was used to design Model S, and the profits from Model S will be used to create Model X. The profits from both Model S and Model X will be used to create Model III. 
  • They have strong franchises and thus freedom to raise prices. The key to a good business is its business franchise - the extent to which it is surrounded by a so called moat. To test if a company is surrounded by a moat, you can ask yourself: "Can I compete with this company if I have $1 billion?" Or as Buffett said: "If you said, 'Go take the Wall Street Journal apart,' I would hand you back the billion dollars. The real test of a business is how much damage a competitor can do, even if he is stupid about returns." This is why Buffett invested in Coca Cola - you can't take $1 billion, build a company, and take a substantial market share from Coca Cola. Buffett said no-one could do it even with $100 billion. So can a competitor take $1 billion and compete with Tesla? The answer today is yes. Tesla can't raise prices because people will then buy gasoline cars or other electric cars. You have to remember that Tesla is a young company and young companies tend to not have any moats. But if Tesla builds more Superchargers and they become the standard charger for all electric cars, then that is a moat. Or maybe if they design so good battery packs that all other car manufacturers are buying them, then that is a moat. 
  • They don't take a genius to run. Compared with a company like Coca Cola, Tesla design and manufacture electric cars which is more complicated. 
  • Their earnings are predictable. They should be so predictable that you would be happy with owning the company even if the stock exchange closed down for the next ten years. Coca Cola has produced the same basic beverage for more than 120 years. Tesla's earnings are not predictable as the company is young and there are still many question marks. How many cars will Tesla build in ten years? No one will know for sure. Will we still use batteries in ten years - or will we use fuel cells which Tesla has dismissed? Maybe we find a large oil source or discover a way to "manufacture" oil? 
  • They are not natural targets of regulation. Tesla is not selling cars through a traditional dealership - they are using their own stores and the Internet. How you sell cars is regulated in some US states. In some US states, it's not legal to sell cars through anything else than a dealership that's not owned by the car manufacturer. 
  • They have low inventories and high turnover. Tesla is only building cars as the customers have ordered them - except for the few cars they need for display purposes in the stores and galleries. Their factories are also using Japanese manufacturing technologies to minimize inventory. But there's a resale value guarantee that 5 200 Model S buyers used in 2013 (about 40 percent of all US customers). If the value of a Model S decreases, then these customers will send back their cars to Tesla. 
  • The management is owner-oriented. The CEO Elon Musk earns no salary. But he has performance based options he can make money from if certain milestones are met. One milestone is met when Model X is finished. So these milestones are not related to the performance of the stock - and that's a good thing according to Buffett. Elon Musk invested in Tesla because he believes that the world is running out of oil and this is something he really cares about. He invested in the company SolarCity that installs solar panels because he needed to power the cars with clean energy. So he want Tesla to succeed and is not working just to make a large CEO salary. 

There's also another book about Buffett called The Warren Buffett Way by Robert G. Hagstrom. The conclusions from that book is similar to the checklist from Money Masters of Our Time. But the author has also found a few so called "Financial Tenets" that Buffett is using when analyzing a company from a financial point of view. They are: 
  • Focus on return on equity - not earnings per share. A business should achieve good returns on equity while employing little or no debt. A good return on equity is maybe 20 percent, but Tesla's return on equity is -18 percent. But Tesla's return on equity has improved if you look at the overall trend.

  • Calculate owner earnings to get a true reflection of value. Owner earnings are basically the cash flow from operating activities minus the capital expenditures. The latter is how much of the year's earnings must the company use for new equipment, plant upgrades, and other improvements to maintain its economic position and unit volume. As Tesla is still growing very fast, the capital expenditure is still large. For example, they need cash to build the Gigafactory, so owner earnings are today basically zero. 
  • Look for companies with high profit margins. To get a sense of what high profit margins are, Buffett invested in Coca Cola when the profit margin was 19 percent. Tesla's profit margin is still negative but has improved if you look at the overall trend. 

  • For every dollar retained, has the company created at least a dollar of market value? The basic idea behind this metric is to test if a company uses the profits in an optimal way. If for every dollar retained, the market value hasn't increased with that amount, maybe it would have been a better idea to give that money to the shareholders in form of buying back stock or as a dividend. You can't apply this thinking to Tesla. They reinvested the cash from the first car, the Roadster, to create the Model S. What if this metric said it would have been a better idea to give away all money from the Roadster to the shareholders instead of making the Model S? 

Now we know if Tesla is a businesses that we understand and run by people whom we like. Now we need to know if Tesla is priced attractively relative to their future prospects. Tesla's current market value is about $29 billion. Is that a low or high value? Should we compare the number with Toyota's market value of $186 billion? Let's ask Buffett:
To properly value a business, you should ideally take all the flows of money that will be distributed between now and judgment day and discount them at an appropriate discount rate. That's what valuing a business is all about. Part of the equation is how confident you can be about those cash flows occurring. Some businesses are easier to predict than others. We try to look at businesses that are predictable.
So can we predict Tesla's future cash flows? Buffett said he doesn't have a clue how to estimate Microsoft's future cash flows. Estimating Tesla's future cash flows is also difficult. The company has said they will deliver 500 000 cars in 2020. But how many will they deliver in 2025? How much money will they make from Powertrain Components and Stationary Energy Storage Applications in 2018? Will they have enough materials to build batteries for all electric cars in 2023? There's a lot of lithium available, but only if the price of lithium increases. What happens if the resale value guarantee backfires in 2021? We can try to make a very rough prediction of Tesla's future primarily based on how many cars they will sell in the future. 

Based on this prediction, Tesla's market value should be $69 billion. But are we confident that those cash flows will occur? The answer is no! We are not confident that Tesla will make 760 000 cars in 2023, while their production in 2013 was 23 000 cars.

But don't forget that the final decision is up to you!

This article is a part of the article series Tesla Motors Stock Analysis