Beyond The Headlines
Zeromania. From a trillion to zero in 10 days?
The speed, the distance, the time…
How long is a skydiver’s free fall? Do you ever wonder?
A free fall usually lasts under a minute, I’m told, even if you start at 15,000 feet (or 3,650 meters) of altitude.
Two great contemporary companies hit milestones recently. Apple reached an astronomical trillion-dollar market capitalization, which is as remarkable as US Steel’s first billion-dollar valuation a century ago. Meanwhile, Facebook lost 120 billion in a day (comparable to the annual gross domestic product of Warren Buffett’s home state of Nebraska). That must have felt like a skydiving free fall to shareholders. It brought back long-forgotten memories of $50B-$90B daily free falls for some tech stocks when the internet bubble burst almost 20 years ago.
As my physics professor used to teach us if we know the speed and the distance, we can figure out travel time. That made me realize that at Facebook’s record free-fall speed, Apple would need less than 10 days to get to zero… or even less time until a parachute would come in handy!
Zeros, zeros and more zeros
Numbers can behave strangely. What’s a million dollars? How much room would it take up in nice stacks of crisp one-dollar bills? And how about a million of those million-dollar stacks – in other words, a trillion dollars?
A “million” translates well across cultures. A million is always a one followed by six zeros, but a trillion is a different story. It’s an even more confusing number for those of us who learned elementary math outside the UK or the US, where a trillion is one million million million or one followed by 18 zeros (known as “long scale”) rather than 12 zeros (“short scale”) as it is for the British and the Americans.
When I was a kid taking English language classes, the measurements of miles, yards, feet, inches, pounds and ounces and the Fahrenheit temperature scale seemed harder than mastering vocabulary or grammar. I didn’t know yet that the Anglo version of trillions would add to my confusion!
But I had to grow comfortable with many zeros far sooner than many of my worldwide contemporaries. In the early 1990s, my parents began earning salaries in the tens of millions rather than the thousands. This wasn’t because we discovered oil in our backyard, but because of hyperinflation created in Poland by the transition from a centrally planned economy to a free market economy. Money lost value faster than we could spend it.
Zeros come and go, that’s what I learned as a teenager. We dropped 4 zeros from our banknotes, tied the currency to a hard currency, (the US dollar at the time) inflation slowly dissipated, and after a while people started to trust Polish money again. The entire episode might be just a footnote in the history books now, but it wrought widespread financial havoc and led to sudden wealth destruction on a huge scale. In those days the dollar was as revered as gold is today.
How about a quadrillion?
Speaking of historical milestones, big numbers, and inflation, a few years ago Japan’s government debt hit a quadrillion yen ($10 trillion USD). If you add 3 more zeros to a trillion, you’ll end up with a quadrillion (or 1 with 15 zeros – US scale/short scale). Japan is struggling with the opposite problem that Poland had in early 1990s: they seek to prevent prices from falling by printing and borrowing more currency.
How did they get to so many zeros and an exchange rate vs. the dollar of 1 to 100? Yes, you guessed – inflation! Japan experienced a spike in inflation in the 1970s, reaching 23% annually in 1974. Poland decided to drop 4 zeros from their banknotes, Japan kept theirs. Their central bankers are creative though, and that quadrillion-yen debt is disappearing. Japan is paying its own debt with more new money, effectively writing it off. Zeros come and go.
Making a trillion
My childhood experience taught me that the fastest way to mint new paper millionaires is hyperinflation. That’s also the fastest way to turn former millionaires into paupers. As a figure, a million might be a million everywhere, but clearly, its purchasing power can fluctuate.
Is Apple’s trillion-dollar market capitalization a product of printing presses running too hot? Perhaps. Zero-rate easy-money policies have certainly helped fuel asset price inflation, along with some of the excitement in the high-growth tech world in the last decade or so. Still, there is more to the story.
Apple successfully raised itself from the ashes in the last 20 years and then conquered the world, selling almost $250 billion worth of iPhones, iPads and Macs every year. Its annual sales trail only Walmart, Exxon, and Berkshire Hathaway, but it is the profits that make all the difference. Apple generates over $50 billion in profits every year, which is 4 times as much as Walmart and twice as much as Microsoft or Google. In other words, if you combined the profits of Walmart, Microsoft and Google, the total would come close to matching Apple’s.
In the long run, any company should become more valuable as its earnings potential grows. Apple’s earnings grew steadily over the last 20 years, and are up about 25% in the last 2 years. Yet the stock price didn’t go up just 25% since 2016 – it doubled. Big share purchases shrank the share count by 10%+ in that period, but that still doesn’t justify a share price hovering around $200.
The secret is in the valuation. The multiple of earnings expanded from a little over 10x to closer to 20x. That metric is a function of many factors, but usually the faster the earnings grow, and the more stable they are, the higher the multiple can be. Again, the future is the only thing that matters in investing.
Apple might deserve to be a trillion-dollar company today, but its future is a different question. The only way to make money on its stock henceforth is if it continues to grow, and if the market assigns it even higher earnings multiple.
Infinite investment horizon
As investors we need to answer one big question: what is our investment horizon? We have to answer it honestly, without considering outside opinions or trying to make ourselves popular. The horizon is an essential element in every investment decision.
In our practice of investing fortunes for families and entrepreneurs, we believe that their investment horizon is infinite because the fortunes span generations. Our goal is to weigh the risks and rewards of each investment, and compound wealth over many decades. We believe that our exceptionally long-term investment horizon is our biggest advantage. We doubt we can build better financial models or read annual reports faster or better than the next guy. What we can do is exercise patience in buying, holding and selling assets. In our field we’re not sprinters; we’re marathoners, ultramarathoners to be precise with 100 mile or a 100-year mark in mind.
The current challenge we see is the short and shrinking shelf-life of assets. The largest companies stay at the top of the market for shorter and shorter spans, especially compared with the middle of the last century. Only ten percent of Fortune 500 companies have been on that list since its inception in 1955. What this tells us is that buying and holding stock in the most successful contemporary company may not prove to be the surest way to preserve capital.
Why not? As investors, we buy earnings of companies or cash flows. We pay a multiple of earnings, 10x, 20x, or 30x, and we hope to receive the current amount or higher from the moment of purchase until the theoretical end of time. We discount all future cash flows of the company to today, and there we go, we have its value. Although the past record of any company is informative, its future record is where the value hides.
If the life of a company is not infinite like our investment horizon, we need to exercise extra caution. I’ll say it again: we value longevity more than speed getting to the top of the rankings.
Apple is unquestionably a huge success today. Yet as a disruptor in the phone and computing world, it may be disrupted itself, especially if we extend the study period (and investment horizon) from the next 4 quarters to the next 4 generations or 100 years.
Making it, and keeping it
A trillion dollars is a huge sum and $120 billion is a massive one-day stumble. It’s also a wakeup call to remind us how quickly paper wealth can disappear when the market changes its mind.
Apple, Facebook, and others are just a sign of the times. We all get excited about their novelty and their amazing performance in the market. However, we must remember that the same forces that created fortunes can destroy them just as fast. Ideally, we’d all like to capture the wealth creation on the upswing then transfer our gains to assets where change happens at a glacial pace. That’s the ultimate dream of any long-term investor.
The biggest winners of the internet bubble days weren’t those who turned nothing into billions overnight — but those who kept what they earned. We are in the business of wealth preservation, and as much as we celebrate new highs for the tech darlings, we don’t want to forget that making money and keeping it is not the same.
The difference has never been more striking than it is today.
Happy investing! We will see you at the 100-mile mark!
Bogumil Baranowski | Cozumel, Mexico
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.