Market Dominance and the Winner’s Curse

Do we live in a winner-take-all economy?

Source: Latticeworks

Increasingly, commerce seems dominated by a few big firms. We use our iPhones to search for stuff on Google; we buy it on Amazon; and we tell our friends about it on Facebook. These tech titans provide everything we need, and they’re incredible profitable.

Normally, high profits would attract competitors, forcing down margins. Consumers would benefit, as companies vie for their business, either through lower prices, better service, or some other innovation. But that doesn’t seem to be happening. The tech giants just seem to be getting bigger and more dominant.

Our always-on, always-connected society is driving this. Network effects mean that when more people use iPhones, more developers want to create iPhone apps, which spurs demand for more iPhones. The same is true of Google: the more we use it to search, the better Google’s algorithm gets at sending us relevant information. And why bother with a social network that your friends aren’t connected to?

Winner-take-all neural network. Source: NIH

Do we need government regulation to save us from these natural monopolies? After all, when John D. Rockefeller used new technology to drive down oil prices, Standard Oil bought up or drove down its competition. But then Teddy Roosevelt signed new laws to break up the Standard Oil monopoly.

But government action isn’t always necessary. At the height of the dot-com boom, everyone was buzzing over the four horsemen of the internet: Microsoft, Sun, Oracle, and EMC. They dominated software, servers, databases, and storage. Three of these four are still around, but they’re not nearly as dominant as they were two decades ago. Despite their immense financial and personnel advantages, bureaucracy or mismanagement or bad decisions or new technology caused them to miss the latest tech trends and fall behind. The same thing has happened in retail sales or media or other areas.

Nothing fails like success. Success breeds arrogance, arrogance breeds complacency, complacency breeds failure. The dynamism of our economy comes from its constant innovation. Market dominance is like New England weather: if you don’t like it right now, stick around. It will change.

Douglas R. Tengdin, CFA

The Merchants of Venice

How do we know what a company is worth?

Photo: X. Source: Pixabay

We want to base our investments on facts, not feelings. One reason Apple is worth more than GM, even though GM has twice as many employees, is that Apple earns more – five times more – than the car giant. Both companies have iconic brands with global scale. But Apple is far more profitable .

But how do we know this? We know it because of double-entry accounting: debits, credits, income, expenses, assets, liabilities, and capital. The notion of maintaining accurate books started in the trading empires of Mesopotamia, Korea, and the early Muslim Caliphates. But a formal accounting system was fully laid out in the late 15th century, in a book written by a Florentine monk who taught math to Leonardo da Vinci.

The friar, Luca Pacioli, didn’t invent accounting so much as describe it. In his textbook on mathematics, Pacioli outlines how the merchants of northern Italy kept track of their businesses, including double-entry bookkeeping, trial balances, and balance sheets. He also explains how they used barter, bills of exchange, and standardized weights and measures to manage their enterprises. By clearly and systematically explaining how the “Merchants of Venice” prospered, he indirectly helped businesses thrive across Europe. He really was the first one to tell us how to “follow the money.”

Italian postage stamp. Source: Wikipedia

Accountants rarely get the credit they deserve for business success. After all, you can’t build an enterprise if you don’t know what you have and what you’ve done. We lionize Steve Jobs and Bill Gates, but who were their CFOs?

Douglas R. Tengdin, CFA

Decisions, Decisions, Decisions (Part 4)

What’s the best way to decide?

Photo: Judith Broug. Source: Morguefile

We’re deciding things all the time. What time to get up, what courses to take, who to hire and fire, whether to fix up the house or sell it. Our decisions depend on our thinking. And the clearer our thoughts, the better our decisions will be.

The final step in making good decisions is putting the relevant facts in place. Facts are real. They can’t be argued over or debated. Facts may support a course of action or not, you may choose to heed them or not, but they’re part of the landscape. They stand out in a sea of opinions and feelings. If you’re re-doing a kitchen, what will your materials cost? If you’re looking at a stock, what was the company’s financial performance last year?

But don’t just look for facts that go along with the way you were leaning before. Your brain will do that already – it’s called “confirmation bias.” We naturally seek out information that confirms our prior assumptions. Look for ways to disprove your hypothesis. That’s how science advances: one disproved hypothesis at a time.

Hardtop or convertible Ford Model A? Source:

One way to do this is through a technique known as “inversion.” Assume the opposite of what you think might be the case, then look for data that proves or disproves that assumption. 100 years ago, Henry Ford decided to double his workers’ wages. In My Forty Years With Ford, his CFO Charles Sorensen described Ford’s concern with the falling share of company revenues going to labor. He didn’t see how current trends could continue, and expected labor problems – as had happened in other industries. He came up with a revolutionary solution: the $5 workday – twice what the average factory worker made at the time. Doubling wages stabilized his workforce and caused productivity in the company to surge.

If you look for facts contrary to your assumptions and you find them, though, there’s a technical term for that. It means your assumption is wrong. If you look for flaws in your plans and you find them, you have to work through the problems. Ask yourself: what could go wrong? Then make your plans – or revise them.

AB test example. Illustration: Maxime Lorant. Source: Wikipedia

Data driven decisions are typically more effective than those we make by intuition or “from our gut.” By gathering facts and testing them, we’re much more likely to make the right choices. And in knowledge industries like investments, medicine, and law, our decisions are our product. Good decision making is our quality control.

Douglas R. Tengdin, CFA

French Revolution?

How does the French election figure into this crazy season?

Photo: Benh Lieu Song/ Source: Wikipedeia

France’s weekend’s election prompted markets to rally around the world – a development some have called, “Le Phew.” The French stock market rose by 5% – the equivalent of 1000 points on the Dow. Other markets also rallied: Germany was up 3, London 2%, even Japan rose at least 1%. There has been a global “risk-on” trade, because the most radical outcome – a France that rejects the Euro – seems to have been averted, at least for now.

But there’s the rub. This reprieve is at best temporary. Marine Le Pen isn’t going away, nor are the forces that brought her to such prominence. In their open first-round of the election process, at least 41% of French voters chose someone who is opposed to France’s participation in the Euro. While Le Pen has dominated the headlines, Jean-Luc Melenchon – a communist candidate and admirer of Hugo Chavez – received just under 20% of the vote. Between the winner Macron, who comes from outside the political establishment, the radical Le Pen, who will be his challenger in the run-off, and the far-left candidate Melenchon, there is a sizable plurality of French voters who wish to see fundamental change in the system, even if most of them want to keep the Euro.

Source: New York Times

The challenge is now for Emmanuel Macron to consolidate his gains, win the run-off election on May 7th – less than two weeks from now – and form a governing coalition. Because he is from outside the system he may be able to effect his “positive revolution.” But he would come into power without a party, without the normal mechanisms of governance. His movement, En Marche!, was created less than a year ago, and seems more like a tech startup than a classic political party.

So even if Macron wins, France won’t go back to its statist status quo. Between Brexit and Trump and the French elections, there’s little of the old order left. France is turning the page. It’s an open question as to how the next chapter will read.

Douglas R. Tengdin, CFA

Decisions, Decisions, Decisions (Part 3)

What resources do we need to improve our decisions?

Source: usafacts

We all use facts to make our decisions. We also act on what we know – of ourselves and of the situation. We can look into a problem and we can seek help. Where we look and who we turn to are both resources.

Encyclopedic resources are straightforward and easily accessible. They present humanity’s collective knowledge about a subject. They might answer a question like what symptoms are linked to a disease or the financial performance of a company at the end of a quarter. You might conclude that you have the disease or that you should buy that stock, but the resource itself cannot tell you that.

For confirmation, we turn to a personal resource, someone we trust to use encyclopedic knowledge to help us out. Personal resources also provide support, whether it’s your doctor working with you on a treatment or an organization that sends someone to sit with you while you are alone.

The rise of the internet and the explosion of resources has altered the landscape of decision making. There are so many resources now that we have changed the way we interact with them. Americans used to say they got their information through a specific method: television, newspaper, radio, internet. Now, they are more likely to name a specific source which is accessed across multiple methods: The New York Times, Fox News, Buzzfeed. The pendulum has swung from gathering information to trusting the source to tell you what you need to know.

To be fair, the element of trust has always played a role in using resources. Whether it’s a person, book, or organization, at the end of the day we trust to some extent what is presented before us. We trust that our doctor’s education was rigorous and that they keep up with developments. We trust that the stock quotes reflect the actions in the market that day.

But as Mrs. Weasley admonishes her daughter at the end of Harry Potter and the Chamber of Secrets, “never trust anything that can think for itself if you can’t see where it keeps its brain.” The same can be said of anything with a collective brain.

Veronica Peterson

Decisions, Decisions, Decisions (Part 2)

How can we improve our decision-making?

Source: Quora

Most of us live in “react-mode.” We’re like thermostats – the temperature goes up, and we try to cool things down. It gets a little chilly, and we turn up the heat. We don’t deliberate, we just do something because it makes us feel better. But reacting to circumstances doesn’t change the underlying situation. It just makes us a little more comfortable, for a little while.

One of the best ways to improve our decisions is to slow down. Think about the underlying dynamics of what’s going on. In Thinking Fast and Slow Nobel prize-winner Danny Kahnemann posits that our brains use two cognitive systems. System 1 thinking is fast, intuitive, and emotional. System 2 thinking is slow, deliberative, and logical. System 1 thinking is important for survival. When three deer jump onto the highway 50 feet in front of you, you don’t have much time to figure out what to do. You step on the brakes!

Photo: M Prinke. Source:

But usually we have time to pause and reflect. Not all decisions need patient deliberation, but a lot do. Buying deodorant doesn’t require much planning. But buying a pet does: pets are effectively family members, requiring care and attention. A new puppy or kitten can change many aspects of your life – how you travel when you get home, what kind of vehicle you need. The long-term effects can be profound.

So think about the consequences. It may be emotionally satisfying to yell at someone who cuts you off in traffic, but it’s a good idea to close your windows, first. Successful people and organizations don’t react, they act. They pause and think before they take action. The process of stopping and thinking almost always improves the quality of our responses. United Airlines CEO Oscar Munoz probably wishes he had reflected a little more before writing that first email.

Lord Acton once said that if it is not necessary to decide, then it is necessary not to decide. And if the decision can’t wait, you can at least count to ten.

Douglas R. Tengdin, CFA

Decisions, Decisions, Decisions (Part 1)

How can we make better choices?

Photo: Colin. Source: Wikipedia

Let’s face it: the world is constantly changing, and we face important decisions every day – where to live, what to do, how to show our friends and family that we care. We’ve never been so interconnected, and yet people have never felt so isolated. It’s never been easier to find out who organized the Seneca Falls Convention on women’s rights in 1848 or why the British keep ravens in the Tower of London. But it’s never been harder to order our lives so that the most important things stay on the top of the pile.

But most of us slip into a comfort zone when it comes to making decisions. We fall into familiar patterns and jump to simple conclusions. This is especially important when it comes to investing. We think: “This is a good company. I should buy the stock,” when we ought to consider other factors, and perhaps think, “This is a good company, but everyone else thinks so, too. I don’t think it will be as profitable or grow as quickly as everyone else does, so I should sell the stock.” When we invest, we need to consider both fundamentals and prices.

One critical way to make better decisions is to look at the longer-term effects of what we do and say. At the extremes, a hopeless drug addict will only try to figure out where they can get their next hit. But folks who are second or third-generation wealthy are often intensely future-oriented. They have a perspective that looks decades or even generations forward. There are layers of second and third-order effects that flow from our choices. We can never really do just one thing.

We can’t envision every bounce of the billiard ball across the table, but we need to try. Obviously, some decisions are more important than others. But – like the lion who spared a mouse who later freed him from a snare – sometimes a small kindness can have can have big consequences down the road.

Photo: Charles Hutchins. Source: Wikimedia

This isn’t easy. But as Charlie Munger once said, it’s not supposed to be easy. Anyone who thinks it’s easy … isn’t thinking.

Douglas R. Tengdin, CFA

Putting Fun Into Finance

Can personal finance be fun?

Photo: Melodi2. Source: Morguefile

For most of us, money matters are unpleasant. They involve budget issues and trade-offs and hard choices that frustrate everyone. So we need to encourage ourselves, to set up some kind of incentive program.

For example, estate planners say you should update your will every three years or so. So: think about what would be a special treat—like eating at a favorite restaurant, or going to a special show—and reward yourself when you update your plan. Similarly, you should look at how you are doing against your budget quarterly. Find a special activity that you can look forward to, and treat yourself when you do a review. (Just be sure it doesn’t break the budget.)

This may seem hokey, but it works. We like to do things that are fun for us, and we avoid the stuff that’s unpleasant. If couples fight over money, they tend to avoid dealing with those issues, which usually makes any problem worse. If they can find some way to make money matters less daunting or more enjoyable, they’ll probably address these problems more faithfully.

Photo: Pexels. Source: Pixabay

Not everyone finds balance sheets and cash-flow statements boring or intimidating, (although most folks do). But everyone responds to incentives. By encouraging ourselves to act responsibly, personal finances can change from being a chore to being something to cheer.

Douglas R. Tengdin, CFA

Follow the Leader

Do we suffer from an “expert” bias?

Photo: Christopher Michael. Source: Flikr

We tend to trust the views of experts, especially when it’s about something we haven’t experienced ourselves. If I haven’t travelled to Antarctica, I’ll generally trust someone who’s actually been there – even if they travelled to the islands on the Antarctic Peninsula, and I’m headed for the South Pole – over 1500 miles away.

This is natural. When we’re in unfamiliar territory, we want a guide. We look for someone to give us direction and clarity. It’s a version of the “halo effect”: if we have a good feeling about a person in one area, we put a “halo” around other more ambiguous aspects of their lives. If someone looks good, we may assume that they’re successful as well. We then notice evidence that confirms our outlook. We play “follow the leader.”

Photo: Christopher Michael. Source: Wikipedia

This can be dangerous. Just because someone is an expert in one area doesn’t make them experts everywhere. Linus Pauling received multiple Nobel Prizes (Chemistry, Peace), but then he went off the rails and started advocating mega-doses of Vitamin C for everything from colds to cancer to heart disease. People who followed this medical advice ended up spending time, money, and energy on an approach later shown to have a marginal effect.

It’s also dangerous when it comes to finance. There’s a lot of quantitative work being done today by big firms filled with PhDs that’s accepted by the financial press as the latest key to understanding (and outperforming) the markets. This research can be filled with partial differential equations and multivariate matrices. We often don’t understand the math, but we’re persuaded by the writing style of the author’s picture or the reputation of the site where we find it. We extend a halo around the work, and accept their conclusions. We even invest on these premises. Sometimes it works out.

Black-Scholes Model. Source: Wikipedia

Published research in finance is often like a back-test. It’s rarely published unless it supports the sponsor’s current views or existing products. Thus, Jack Bogle touts indexing, Fidelity encourages using easily accessible mutual funds, and TD and other brokers encourage stock-picking. For my own part, I support an all-of-the-above approach, building portfolios like I would a dinner at a Swedish smorgasbord: a little of this, a little of that. Everyone is human, and entitled to market their own business.

Just be aware of their biases, and don’t believe everything you read. We’re all human. If you don’t understand the process behind something, it never hurts to be a little skeptical.

Douglas R. Tengdin, CFA

Free Education!

Should college be free?

Photo: Kelly Martin. Source: Wikipedia

There is a move, politically, to make college less expensive. And with tuition and fees at private institutions running $60-70 thousand per year, it’s understandable why people get concerned: most of us don’t have half a million dollars just lying around to pay for our kids’ college. Moreover, tuitions that high make the idea of “working your way through school” seem ridiculous. Twenty hours per week at a work-study job pays for less than 20% of a private school.

The college’s usually respond by saying that no one really pays full freight – most of their students get some kind of financial aid. But that often works out to be one more progressive income tax and a penalty on prudence. In the “Expected Family Contribution” formula that financial aid offices use, they calculate that every penny of a student’s accumulated savings will go towards their school’s expenses. And when the schools evaluate the parent’s income, they don’t use taxable income. They use our adjust gross income – line 37 on Form 1040. No deductions are allowed when colleges come calling.

Source: St. Louis Fed

One approach to all this expense and complexity is to chuck the whole thing out, and make college free for everyone – or at least, expand public funding to middle-class families. That’s what New York is doing with its Excelsior Scholarship, which can pay up to $26,000 of tuition per year for public college – if the student stays in New York after graduating. Families that earn less than $100,000 per year are eligible.

This is a bad idea. It layers more complexity onto an already Byzantine system. Completing the FAFSA every year – for families that have students in college – ranks right up there with doing taxes as an unpleasant, tooth-pulling experience. But unlike taxes, the FAFSA calculations are shrouded in secrecy. Presumably, the Excelsior Scholarship will rely on FAFSA forms to determine eligibility.

Also, this approach creates perverse incentives. State schools will now receive applications from more and more students, making them more selective. That may help them in the US News college rankings, but it won’t help poorer students, who are often less well-prepared. They usually can’t afford SAT tutoring services. In addition, mid-range private colleges will now have to compete with “free” public schools. This can push them into a “death spiral” of higher tuition and lower enrollment. We know where that ends: bankruptcy and fewer educational choices. Public funding ends up crowding out private educational diversity.

Really? Source: US News

In addition, there is an endowment effect in education. Not the school’s endowments: we’d all like to have a large asset base to pay some of our operating expenses! No, kids have an endowment effect when they pay to go to school. Students who work to pay even a small percentage of their college expenses are more likely to work hard at their studies and graduate. As the cost of attending college falls to zero, so does the perceived cost of dropping out. But when you put your own cash into your own education, you’re more likely to finish that degree. People value what they pay for.

There’s a network effect where we all benefit from a better-educated populace. But the folks who receive an advanced education benefit the most, in the form or higher lifetime earnings. Why shouldn’t they have some skin in the game?

Douglas R. Tengdin, CFA