Tom Rutledge's (CHTR) Widely Reported Equity Award Quantified

In the last two years, any discussion of Charter (CHTR) has not been without reference to the equity incentive package issued to the senior management team of the company in 2016. Greg Maffei has spoken about it to anybody who will listen (which is a lot of people because Maffei has a good track record as an investor). Seeking Alpha/VIC/COBF/etc. posts have also referenced it. But I had yet to see it quantified. Of course, there’s the headline figure of $99 million for Tom Rutledge (CEO) from the 2016 proxy statement. But serious investors know that the Summary Compensation Table in the proxy statements tells us almost nothing about the reality of compensation plans.

To really understand things, I’ve tried to make sense of that particularly large equity package granted to the management team by quantifying the pay-outs to the CEO in the event of the stock price reaching various thresholds. The results are in the following table:

Note:

I have calculated the payout at each threshold assuming Rutledge exercised all of his options at that threshold. So, for example, the 364.97 threshold assumes that options vested at 289.76 are also held and exercised (or exercised and stock held) at 364.97 per share.

It could, just as easily, be argued that the decision to hold from 289.76 to 364.97 is Rutledge’s own investment decision unrelated to any equity incentive envisioned by the BOD. However, it could also be argued that, if he believed in these targets, there is no reason he wouldn’t hold as many options as he could as long as he could. In that case, to see the maximum upside to Rutledge, we must assume that he does hold these options.

In reality, he likely does not have the type of additional liquid funds required to exercise the options, hold the underlying stock, and to pay taxes thereon. So readers can make their own changes to the calculation as needed. There are too many permutations and combinations for me to address them all here. The conclusion remains that this award package should serve to incentivize Rutledge rather well. Perhaps, more than well.

There are also further small equity awards/grants, but I have only attempted to quantify the large award from 2016 which is the largest portion of Rutledge's compensation 2016 onwards.

Disclosure/Disclaimer:

I own shares of CHTR (through LBRDK). Under no circumstances should this communication be construed as investment advice or a recommendation to buy or sell any security, whether expressed or implied. Factual statements are believed to be truthful and reliable, but are not warranted against errors or omissions. Please do your own due diligence prior to investing.

Luxury Purchases Masquerading As Recurring Revenue: Is No Price Too High For Subscription Businesses?

Venture capitalists have added a new dimension to that well known Sherwin Williams slogan by covering the earth in subscription businesses. Having a ‘subscription’-based revenue stream today makes a business worthy of investor affection, even adoration. Even established businesses are contorting themselves into subscription services. Subscription revenue (and its cousin recurring revenue) is the elixir that makes fund raising and rising valuations possible. Startups and established businesses want you to buy mobility, ‘subscription boxes’, clothing boxes, shaving razors subscriptions, meal kits, computing power, online storage solutions, etc. all on a subscription basis; or better yet, ‘as a service’. In the view of this, let’s consider two thought experiments.

If you sell a widget, is your business worth more if you sell it as a subscription than if you sell it on a traditional ‘as needed’ basis? I believe the answer is no. All told, the consumer sees the same value in the product. Take meal kits. A consumer might be willing to value a meal at $10. That won’t change just because they ‘subscribed’ to a weekly delivery. Further, food consumers, in aggregate, will not rapidly increase their consumption (they can only eat so much, subscription or not) by more than say, 1-2% a year. That is just the nature of food consumption growth. One meal-kit company might divert a little business from a restaurant to grow faster using promotions. The same could be said of clothing boxes, etc. But when the whole industry doesn’t grow, the value proposition has to be undisputable. It’s true that where a subscription is priced lower than the traditional delivery mechanism (e.g. dollar shave club), there’ll be large consumer uptake (by drawing business away from incumbents even in a low-growth market like razors). But that is not a new paradigm; it’s simply proving an old paradigm that consumers gravitate to lower prices for equivalent value. So if every business in the country/world became a subscription business would they all be worth more? Certainly not. For one, most of these industries aren’t growing as a whole (food consumption example noted above). Second, aggregate revenues (based on what the consumer is willing to pay) don’t change and aggregate expenses probably go up because of the logistics involved, which means margins are lower. Third, there exists a mass of well-funded venture-backed competitors willing to lose money. Can this set the stage for increased valuations? In my view, no.

Yet, today companies are twisting themselves to fit a subscription model. Why? Because a sound idea (this time taken from software businesses) has come to dominate thinking in spaces where it just doesn’t apply. Subscriptions are used to tout customer “LTV”. Then LTVs are used to justify the need to invest NOW (before competitors invest) with venture raised funds rather than reinvesting capital generated by the business. But why the hurry? Why not prove the concept and then re-invest profits to grow the business? The thinking goes, “We cannot wait. E-commerce is a winner take all market. We better dominate before our competitor does”. In reality, there are very few winner-take-all markets. Internet Search is one of them. The credit card networks are another example. Meal kits are certainly not winner-take-all markets, though that didn’t stop HelloFresh from claiming that it was. There is no need for all consumers to order from the same provider. Same can be said for the growing list of clothing boxes, online storage companies, and market places. But consider how easy it is to sound like you have a network business… “Well, we will lose money to acquire a mass of customers. When we have a lot of customers, we can afford to have a lot more widgets (whether clothing options, meal recipes, data storage, or any other item), which means we can have yet more customers attracted to the growing choices now available. And no one will be able to steal customers from us, due to our scale. This means customers will not leave us…which means our LTV is large, which means we better lose money now to acquire customers.” This type of a sales pitch is happening daily in the VC/incubator/angel world. What are essentially luxury purchases afforded by the few are marketed to many in the upper reaches of an economic boom by the use of promotion subsidies (funded by VCs). The reality of Blue Apron, BirchBox, Chef’d, etc. would make one think the backyards of VC firms seem should be knee deep in dead subscription/network businesses. That reality has not been reflected in investment decision making.

The second thought experiment is comparing subscriptions to leases. When calling something a subscription business, it’s helpful to compare it to a lease. Leasing companies do not generally trade at the kinds of generous valuations afforded to ‘subscription’, ‘marketplace’, or ‘recurring revenue’ companies. Why? Because they are financing companies, subject to the vicissitudes of the economy, credit quality, unemployment, defaults, etc.

One thing a lease shares in common with a subscription is recurring payments. But there’s a big difference. While a lease is a legal contract requiring payments, a subscription is ‘at-will’ and cancellable with little notice. Leases also generally finance ‘expensive objects’ which are sold once and paid-for over time. But in services (meal kits, delivery, or mobility), there is no object; the service is continuously provided. This seems like a big difference and is the reason why financing components of, say, John Deere are easily separated for analysis. However, I believe the second difference is only cosmetic. The company is agreeing to keep providing the service (which means they must keep incurring related expenses) and the subscriber is agreeing to buy it, until they stop buying it. What makes some subscription businesses better than others is that the nature of the product keeps the customer from cancelling. For e.g., ERP software. This makes is kind of like a lease (but even better), an almost-certain stream of payments from the consumer that is unlikely to get cancelled baring the unthinkable. This is why the concept of LTVs made a lot of sense is some types of software. However, that is certainly not the case with a meal kit, a Netflix subscription, or even in-app purchases. At the first hint of trouble to the consumer, the meal kit, the clothing box, and other ‘subscriptions’ are as likely to be shown the door as a meal out at a restaurant and a shopping trip to Nordstrom. Leases will fare much better as they did during the GFC because of their contractual nature. And if we value lease companies with the fear of credit quality, economic fluctuations, and default, then these should be considerations for ‘subscription’ businesses also, which are already structurally weaker as noted above.

This extends even to established platforms like Apple. While services revenue is growing at a nice clip, will it be too difficult for end users to switch to free Google Photos (or other storage) from iCloud in the event of a little belt tightening? This line of thinking applies to even phone sales which, having stagnated, are now reliant on price increases. Many customers finance their phones (a true lease, not ‘communications subscription’) as you would a big ticket appliance (the phone almost replaces the ‘home computer’ of yesteryear). As a result, in a less forgiving economic environment we should expect the sales of high-end phones to show the similar (though less severe) character as sales of homes or cars, i.e. consumers make the old ones last longer are loathe to take on (and do not qualify for) new financing. I’m simply using Apple as an example. I don’t think this factor should have a big bearing on Apple’s valuation because Apple’s valuation is quite reasonable and some of this appears priced in unlike in the subscription unicorns of the world.

The latest example of the luxury good masquerading as a subscription service is, of course, Peloton. The company raised $550 million just a few days ago at a valuation of $4.15 billion. Just 16 months ago, this valuation was $1.25 billion. According to Fortune, “Peloton will use the money to expand internationally, bring a treadmill to market and establish itself as the premier source of fitness-related content. The company will open in Canada and launch five retail locations in the U.K. this fall, its first moves beyond the U.S.”

The proposition goes like this: you buy a $2000 stationary bike. This can be financed in a ‘true lease’. Then you pay an additional $39 per month ‘subscription’ to access their library of training videos. “The Peloton Monitor only shows Peloton content. Without the subscription, the bike will have 3 pre-selected classes and will show the metrics while riding, but will not track them to your profile”, according to the company. In other words, the Peloton bike is useless without the subscription. Even at a 0% APR, the cheapest package costs $58 per month for the bike (for 3 years!) and another $39 for the subscription, for a total of $97 a month before taxes. (The newly coming treadmills will sell for $4000, so the cost will be almost double for runners). Now this total of $97 is more than the monthly cost of many gym memberships, which come with live classes. If gym memberships didn’t have great persistence when consumers suffered last time, what gives confidence that Peloton costing many times as much will? The company wishes to establish a ‘platform’ by signing up fitness content (like Netflix) to be transmitted through the Peloton monitor. Needless to say, with normal stationary bikes retailing on Amazon for $200 and free availability of YouTube classes, the value proposition is seriously in question.

Also not to be ignored by investors are the omni-present competitors in a capitalist economy such as Flywheel, NordicTrack, and Echelon. Part of the recent capital raise will be used to fight these competitors, which is generally not a positive-return activity. However, this is a season where no price is too high. Accordingly, the company is looking to go public in 2019, notwithstanding the fate of Soul Cycle whose IPO was cancelled last May due to ‘market conditions’.

The CEO has said the company is profitable, though it’s not known on what basis…GAAP, non-GAAP, EBITDA, Adj. EBITDA, or EBITDA before customer/marketing expenses (seriously, this exists). Certainly, Peloton isn’t profitable enough to fund $400 mm on its own or in the debt market. But, when a $4.15 billion valuation is placed on a company with $700mm in revenues, unreliable profitability, a small target market that solely resides in large cities with high incomes and small dwelling, it seems ‘subscription’ based ‘platforms’ are a better sales pitch to investors than $4000 treadmills might be to consumers. Investor enthusiasm at this price, which has already tripled in 16 months was best captured in a NY Times article,

Jay Hoag, general partner of TCV, compared the business model to Apple’s iPhone and App Store. And he said Peloton’s repeat revenue from subscriptions reminded him of Netflix, where he’s a board director, and of Spotify, a TCV portfolio company. “They have a similar-sized opportunity to reshape fitness,” he said.

An example of bubble valuation, Netflix

Continuing the theme of the previous post…

Let’s take the example of Netflix (NFLX), a company known to most readers which also happens to be currently popular with the investing public. I think Netflix is a great product, possibly even a good business when stabilized, but it is likely to be a disaster as an investment given the current price of $420 (i.e. a market cap of $175 billion) supported by earnings of $0.6 billion last year and no free cash flow. It is argued that scripted programming streaming services are a “winner take most” market and, thus, it makes sense for NFLX to lose a copious sums of money to “land grab”. Profits are expected to come when the company doesn’t need to invest as much in programming as it does today, presumably after all of the land has been grabbed. Price increases are also expected to increase earnings.

Here are a few reasons why the investment is not likely to work out. Before I list the reasons I would like to restate a simple fact that is sometimes overlooked in the jargon-filled investment frenzy that is the current VC/tech environment. To be valuable, a company needs earnings in the foreseeable future. And for a company to have earnings (or to create them if it doesn’t), revenues need to exceed expenses.

With this simple framework, let’s compare Netflix with the traditional cable networks. The traditional networks routines report EBITDA margins of around 40%. This is achieved with 90-100mm subscribers paying from $0.5 to $7 per subscriber per month. The range is wide because of outliers; most networks seem to command between $1 and $3. Traditional network metrics suffer from the distortions of bundling. Not all of those 90-100mm subscribers necessarily watch each channel. They receive it as part of their ‘video bundle’, that great Achilles heel of traditional video model. So, for example, if 1/3^rd of the ‘customers’ actually watched a given network, the economics would stay the same if the network charged 3 times as much, so $3 to $9. This would be the appropriate comparison to Netflix. The rub is that no one really knows (though there are guesstimates) what the actual ‘true penetration’ of a given cable network is. There’s another way to think about the issue.

Netflix has 55 million subscribers in the US. Let’s say it gets to 100 million subscribers, i.e. every household that once watched linear TV now subscribes to Netflix. This is envisioned in some bull cases. This would necessitate Netflix replicate all of the varying tastes and preferences of all of its customers currently provided by the cable bundle. Let’s assume that such tastes and preferences are captured in the top 20 cable networks and scripted programming from OTA broadcasters. Not many folks watch some of the fringe channels that are crammed down their throats by the cable network owners. The top 20 channels and scripted programming from OTA alone would be responsible for approximately $20 per month in programming costs (and that’s being conservative). To run a 40% EBITDA margin on this number would require a monthly bill of $50 (in cable networks some of this is lowered due to advertising, which Netflix doesn’t do). Of course, Netflix has other expenses which cable networks don’t since Netflix is a content owner/licensor and ALSO a distribution platform with the attendant costs of advertising, customer service, billing, etc. So the bill could look even higher. This would be revenue side of the ledger.

But why should Netflix try to earn margins equal to cable networks? Could it be okay with less? To say that Netflix can run with margins less than traditional cable networks could work for Netflix as a company, but not for the $180 billion valuation placed upon it by the investors. My point is that the company can do fine even as investors grow poorer. A $180 billion valuation means Netflix needs to earn at least $8-9 billion at most 3-5 years out. This cannot happen without higher margins. Increased margins can come from two sources. First, more customers without an increase in content spend (i.e., people join Netflix to watch older shows). Second, price increases.

As to the first, I believe content life is shorter than many investors assume. The company needs to keep buying (like all media companies) and the so called “moderation” in content-spend is not in sight. As noted above, Netflix will find itself needing to invest to replace the total content production of the top 20 cable networks and OTAs if it is to indefinitely retain their customers.

Further, the company WANTS to keep buying globally to drive subs. The need to drive global subscribers is self-inflicted. If Netflix was just a US platform, I don't think they'd necessarily face a threat from some platform in China or India (unlike social networks, payment systems, etc. which have demonstrable cross-connections across geographies). But people (and management) say that shows from other countries are watched in the US and vice-versa which subsidizes costs of production by driving higher audience. But there are only 24 hours in a day! So for each person that watched a German show in the US, that person didn't watch an American show (on that day). So the American might've subsidized the German show but the German subsidized the American show. We simply cannot create something out of nothing unless people increase their TV viewing time (which is not happening according to reported figures). By trying to have a platform that's a little something for everyone, cost-wise, it starts to sound similar to the cost of a 20 channel bundle, but sold for $8-10 per month. In other words, Netflix will have to increase prices substantially.

On that $8-10 per month, it’s also unclear whether this will work very well in India (part of the bull case). That's a lot of money for most Indian people. Maybe in the cities it works for a small segment. But the competition (Hotstar) charges only $3 and the film/production industry ("Bollywood") is very advanced in India; they don't need to import shows. So why would a satisfied Hotstar customer move to Netflix to pay double? Perhaps for the occasional international show or Netflix Original. But password sharing (very common in India as it is here) will take care of that so penetration could be an issue.

As to the second source of increased margins, i.e. pricing, what seems to make today's valuation work out is a price of $25 or so (in addition to the linear TV, which customers will have to buy separately, that gives them sports and news, absent from NFLX). I don't know if people will pay that in the US, let alone in other countries. I'm not sure a price like that could be justified by "we have a lot more content that we invested in", again given just 24 hours in the day, people can only watch so much and many are focused on the latest releases (which happens to be what their friends are watching and what is on social media) and maybe something from two-three years back. Even the viewership of the great hits of just 3-4 years ago (Breaking Bad, etc.) doesn't seem that good (anecdotally).

To sum it up, I view new content as mostly ongoing customer acquisition and maintenance cost, which is similar to any other media company. But other media companies don't over-produce shows and charge little for them. So Netflix is going to have to price similar to any other media company, or continue to spend as they have and come up with reasons why free cash flows don't matter. Why this is so actually has to do with the phenomenon that launched Netflix itself: multiple distribution points for video (v/s the past) and the golden age of TV. The competition for the OTT ‘land grab’ has increased costs of video to a point that had made it unaffordable for the public. Whether the unaffordability flows through cable pipes or through Netflix (which currently subsidizes the unaffordable product in the capital markets by consistently raising debt from a currently-avuncular bond market) shouldn’t matter. I just don't see a "first mover advantage" for this industry. Customers are free to switch/cancel when the price gets too high or content reduces (due to moderation, if it is actually done), both part of the bull thesis.

Moving on to valuation, it is doubtful the company will generate free cash flow on any reasonable timeline that would support its current $420 per share valuation as shown above. Even if all works out as hoped by the bulls, the multiples are STILL high!

Update: In late July, BTIG put out a research report which calmly calculates a 17x EV/EBITDA multiple to the 2022 EBITDA which is expected to quintuple from 2018's EBITDA. So even if the most bullish case comes true, this is the multiple applied to it for the price of $360 (at the time of their report). Their PT is $420, which requires a 2022 EV/EBITDA of 20 and the same quintupling of EBITDA."

A Possible Bubble In Venture Capital

As much as I like Amazon and admire Jeff Bezos, I believe Amazon’s success (combined with the zero interest rate policy of the Fed) kicked off a type of thinking that, in my view, has now led to a bubble in Venture Capital and some areas of publicly traded tech companies (though not all; notably Google, FB are highly valued but within fair zone, Apple even has a bargain ‘multiple and growth combination’). Amazon was the initial (and possibly the only surviving) pioneer of this idea which took root in the late 90s and generally goes, "We are investing for the next 50 years, hence, earnings don't matter, we are building scale, gaining first mover advantage, profits will come later, we are plowing all our earnings into growth investments, etc.” It might be true for Amazon. But, as always, first the pioneers, then the imitators.

What has happened is that today this logic gets thrown around by every newly formed highly valued company as an excuse for losses (witness Softbank's grand 300-year plan and its investees equally grand losses). It's almost as if profits are anathema for a company with a big plan and grand dreams. Exhibit A: Uber, Lyft, WeWork, Slack, Spotify, Square, Shopify, etc. What started off with the companies has now been seized upon by investors to justify buying something (anything?) that they want to buy. The scooter companies (Lime, Bird) are the latest, but by no means the only, examples. Bird's latest valuation is $2 billion as of June 2018 funding....compared to a March 2018 valuation of... $300 million. So a 6.6x in three months. Uber invested in the rival to Bird, called Lime, and bought another scooter company called Jump. So unicorns investing in unicorns, all without profit. It started with a good idea but, in my view, we are now squarely sitting in the crazy territory where anything goes. The rationales given for losing money can even be made to sound legitimate to those only paying casual attention, to those blinded by the possibilities of high returns (drawing, of course, from the bottomless well that is past returns), to those who have not studied history, and to others who desperately want to believe. As an example, see this explanation of their investment strategy given by Softbank's investment professionals (http://fortune.com/2018/07/17/softbank-vision-fund-capital-investment-strategy/). Softbank not only justifies large valuations on companies with gargantuan losses, but also believes that putting more money into a loss making company actually serves as a competitive advantage (which strikes me as bull market thinking). Since only companies with large losses need large external capital raises, theirs seems to be a roundabout way of saying the more money you lose the better!

I think it's a great case study of social proof, commitment tendency, and authority principals at play. At the extremes, investors even WANT to be fooled, i.e. they might agree it's not okay to just focus on DAU, MAU, subs, etc. but as long as everyone else is focused on it, they might feel that's what the company should do so that the stock/valuation can go up quickly.

There is no basis in history that would allow engaging in this type of behavior without penalty. Examples include the Nifty Fifty of the late 60s and early 70s, the 1999 tech bubble, and others. If history remains a faithful guide and laws of mathematics (particularly time value of money) remain in place, there is every reason to expect that new investors will learn old lessons again.

In the next post, I take a specific investment to further illustrate this point.

Ross Stores, A Good Investment

I recently wrote an article for a financial publication discussing why Ross Stores (ROST) represents a good investment. At a high level,

1. Ross has has been around for about 35 years and their 'formula' has worked quite well for that entire duration (with occasional ups and downs that face all businesses). All of its growth has been 'organic'. Yet, Ross is currently in 38 states with dd’s DISCOUNTS in 17 states. There's a long runway.

2. Return economics on new stores are terrific, which translates to a very high return on equity. (Ross does not have material intangibles). Hence, the above-mentioned long runway can be pursued profitably.

3. Same store sales are good and will continue to be so.

4. Excess cash flow is used to pay dividends and repurchase shares. Since the business is attractive, the valuation is reasonable, both these uses leave shareholders better off. Lack of M&A reduces chances of misapplication of capital.

5. Even though the valuation is 'fair' and not cheap (at $77 per share), the current price will likely provide better than market returns over time.

For more details, including numbers, please see link below:

Mental Biases At Work In Tesla/Edison Feud

Recently, discussion of biases, mental models, "thinking about thinking", etc. has become popular among investors. The theories are credible and examples are good. In sciences, theory sometimes precedes practice. In many situations this is a good way to go. In other situations, "doing is learning" seems more applicable (sports or applied sciences, for example, or when an accident or experiment gives the results first, and then you hunt for the theory). When it comes to behavioral finance, it's fun to read the theory and examples, but trying to spot biases in situations (our own or others') turns it into a more practical device than simply knowing the theory of what these biases are. 

I recently read about the rivalry between Edison and Tesla. The whole story is fascinating but one observation relevant to the topic of this post is that even Thomas Edison suffered from biases. Tesla meeting Edison and presenting a case for alternating current (v/s Edison's direct current) might sound something akin to Andrew Left visiting Bill Ackman to present a short case for Valeant in support of his employment application. But Edison was much more forgiving and actually employed Tesla, even though he did not believe in alternating current. How it all turned out (General Electric was later born out of this feud) is well known so I won't recount it here. But I think the presence of certain "influences" in the whole situation is worth commenting on.

Edison most likely had a blind spot when it came to AC. Tesla presented both theory and experiments, but Edison simply could not bring himself to believe that AC could work better than DC for transmission, despite AC’s high voltage. Edison had already built factories and power plants reliant on the DC model. JP Morgan’s investment in Edison Electric was already in tens of millions of dollars (in today’s dollars). The idea of scrapping that entire effort (as sunk cost) and retooling and rebuilding with AC equipment must not have been an easy one to digest. It doesn't take too much imagination to see what kind of commitment tendency might be at play when millions of dollars (in today's money) have been spent with a particular technology in mind. Even JP Morgan could not be convinced (yet). It seems similar to having been confronted by opposing evidence to one of your largest positions which is down about 35% (and hence is, now “simply too cheap not to own”). Keeping an open frame of mind ought to be difficult in this situation for anyone, including Edison and JP Morgan. So they avoided the evidence and persisted in trying to “beat” the AC technology.

As Representative Carter once said, “It would be the height of folly for us to defer action until it is forced upon us by the imminence of panic.” Yet, as is so often the case, Edison & JP Morgan did not espouse AC transmission until it was “forced upon them” by their losses at the World’s Fair at Chicago in 1893 and The Niagara Falls Power Project. Even so, Edison remained adamant. JP Morgan, having then kicked Edison out of Edison Electric, made the switch to AC power and used the Morgan “play book” of consolidating several electric companies to form General Electric. So, in the end, JP Morgan did cut his losses and ‘pivot’ to the better business. This rational behavior by Morgan, even though it came late, perhaps is one reason (among others) why he was much more successful in the electricity business than either Edison or Tesla.

As an aside, when Tesla quit working for Edison (and before he teamed up with Westinghouse), he had to support himself by doing odd jobs (such as being a ditch digger). Eventually, two investors hired Tesla to build some devices (and fired him after he had done his work). One of the governing factors behind them backing Tesla was that “he had worked for Edison”. This brings up another influence-tendency of ‘authority’, i.e. “If Edison thought he was good, he must be good”. Perhaps it’s a stretch, but does this not sound too similar to what goes on in the investment world with “Warren Buffett bought this…”, or “Such and such is a ‘Tiger cub’”, “s(he) worked at XYZ fund”, “This startup fund manager worked with Bill Ackman”, etc.?

Dealing With Market 'Uncertainty'

In the aftermath of the election and Brexit, market participants have raised a familiar question, “There is so much uncertainty. Should we simply sell everything until things become ‘a bit clearer’?” This question isn’t unique to this election or Brexit. The same question was asked in the last five years (and every year before that) in 2011 (downgrade of the US debt rating, contagion in Europe), 2012 (fiscal cliff debate, US Election), 2013 (government shutdown, debt ceiling standoff, QE taper, sequester), 2014 (emerging markets currency crisis, Russia’s annexation of Crimea), and in 2015 (oil prices, Swiss currency cap removal, Chinese currency devaluation).

Uncertainty is always present. In habitual routines of life, people don't think about the ever-present uncertainty until a non-routine event reminds them of it. Uncertainty was present on November 11, 1963, the day before JFK’s assassination. It was present on December 6, 1941, before Pearl Harbor, it was present on October 17, 1987, the day before the stock market fell 23% in a one day, and also on September 10, 2001. It was also present the day before Brexit and before the recent election. All of the factors contributing to these developments were present. Market participants simply didn’t ‘feel’ uncertain as they had assigned a low probability to such events and they had been right in the past. Then a seminal event forced recognition of the fact that we do not truly ever know the future.

Further, it is often an event perceived as negative which reminds people that the future is always unclear. An uncertainty which positively breaks our way doesn’t cause our stomachs to drop. As an example, if GDP and corporate earnings rise terrifically, and stocks go up 40% many people would be happy. But that positive surprise does not invite the same level of gut sinking induced by stocks falling 40%, even though both occurrences deviate from expectations. The human brain seems to be wired this way. Thus, in the aftermath of something seen as negative, feelings of uncertainty are much stronger. In fact, one is least likely to consider ‘uncertainty’ when the going is very good.

Since uncertainty is always present, it is no more (or less) important to consider uncertainty now than at any other time. However, to respond to uncertainty does not require heroic forecasting ability or towering intelligence. In fact, I do not know of any one person who forecasted all of the above events. Even if someone had seen them coming and sold all of their investments, they would have paid a huge opportunity cost as the market today stands higher than at the time of all of those events. So predictions were not only difficult but unnecessary and totally unproductive.

The solution, in my view, is to quit forecasting and to accept that the world is always uncertain. The way to protect oneself is to fight the always-present uncertainty with an always present margin-of safety (buying a $1 for 50 cents rather than 98 cents). Margin of safety is the real protection against uncertainty. A margin of safety serves as a shock absorber for investments. That is not to say that prices of investments couldn’t temporarily go down. But a permanent loss of capital is avoided with a sufficient margin of safety. If we consistently buy with a margin of safety and stick to areas that we understand, then prosperity truly is around the corner.

To be sure, if particular policies of a new administration or new agreements drafted by Britain have any bearing on a particular company, they need to be considered in its valuation. But I’m advocating against a large scale shuffling (buying or selling) of equities based on some feelings regarding the unknown. It is better to simply buy when a security is available with an adequate margin of safety and sell when warranted by valuation or management factors.

I will conclude with an example. In 2006, MasterCard went public and anyone could purchase the stock for a split-adjusted price of $4.6. All of the attractive aspects of MasterCard's business are well known so I won’t repeat them here. Let’s say a prescient investor had seen the great financial crisis coming and avoided purchasing the stock which was reasonably priced in 2006. Such an investor paid a truly huge opportunity cost. Even at its recession lows, MasterCard stock was more than triple its 2006 price. As of this writing, it stands at a whopping 23 times its price in 2006 for a compounded annual total return (including dividends) of about 35.2%, compares to 7.5% for the S&P 500. This is despite all of that ‘uncertainty’ of the intervening 10 years!