Investing

Human Brain is wired for linear thinking. Learn how to shift to Non-linear thinking to gain the Edge

Shortest distance between 2 points is a straight line and our human brains are wired to think straight and linear. Decades of deep research in cognitive psychology shows that the human mind struggles to grasp nonlinear relationships. But the world is a non-linear one out there, whether its relationships, technology innovations, business growth, climate change or even making wealth.

While like in any bell curve, thinking straight and linear helps in our day to day activities which occupies 80% of our mind/ time space, we need to shift our thoughts to exponential when it comes to gaining edge in careers, innovations, businesses or networks. That shift to remaining 20% of the bell curve helps.

How to Shift to Non-Linear Thinking? Lets understand with some practical real life examples.

1. Understand Leverage (Archimedes Lever):

Story of Facebook and Threads: It took 4 and half years for Facebook to reach first 100 Million users on its platform. The same company now called Meta launched Threads to compete with Twitter (now called X). And guess what? Threads took 5 days to reach 100 Million users on its platform. How did this happen with no promotions? Threads allowed Instagram users to automatically follow their users on the new service, giving it a quick boost in amassing new signups. Meta just leveraged its massive 2 Billion user base in Instagram. This word “Leverage” will repeat a lot because its closely linked to non-linear results. One of my favourite quotes was from the most influential scientists in history Archimedes who said “Give me one firm spot on which to stand, and I shall move the earth.” 

Even ancient Egyptians used levers to lift heavy stones like 100s of tons in order to build the pyramids and obelisks. The concept of leverage can be applied across areas of life like building a business using financial leverage, building a network leveraging the connections. Concept of applying leverage simply means small changes applied at the right points in optimal balanced way can achieve super normal large outcomes (Non-linear)

2. Lindy Effect: Power of Consistency with Incremental Gains:

The Lindy Effect is the idea that the older something is, the longer it’s likely to be around in the future. And the old idea of building brick by brick consistently leading to incremental gains will never die and this idea is likely to lead the world for centuries ahead.

Examples: India`s Growth Story:  In 1820, India’s GDP was 16% of the global GDP. For over 1700 years, India was the richest country till British colonized and looted the country and left to rags. India took Independence in 1947 and the GDP of the country at that time was less than $30 Billion. It took 60 years for India to reach the First Trillion Dollar GDP. The next Trillion came in less than 5 years and the next in 3 years and the next could be in a year.

Tesla Growth Story: It took 12 years for EV leader Tesla to build its first million vehicles. Recently Tesla Just Built Its 4 Millionth Vehicle, Seven Months After It Crossed 3 Million Mark.

Whether its a country or a company, these growth stories are perfect examples of Non-Linear Applications in life.

3. Compounding (Snowball Effect):

Einstein called it the 8th Wonder of the world for a reason. Principle of compounding is difficult because human minds cannot perceive geometric progression. We can easily calculate linear progression in minds but when it comes to geometric progression, it gets extremely difficult beyond a few steps. Warren Buffett compares it to the Snowball effect.

When you push a small snowball down a hill, it continuously picks up snow. When it reaches the bottom of the hill it is a giant snow boulder. The bigger it gets, the more snow it packs on with each turn. The snowball effect explains how small actions carried out over time can lead to big results.

Compounding is mostly considered as a wealth creation phenomenon but it applies to every aspect of life. Whether it is compounding knowledge or skills or relationships or habits, this non-linear principle applies.

The best book I`ve read in recent times was Atomic Habits written by James Clear and he has best comprehended compounding in a picture. Take a look at the image below.

Crypto is back? A Dollar Cost Averaging strategy for Bitcoin that worked in 2023!

First Some basics:

Bitcoin, the first cryptocurrency was first launched in January 2009 by a computer programmers group under the pseudonym Satoshi Nakamoto. Each Bitcoin is divisible to eight decimal places. The smallest unit is a satoshi (sat), which is 1/100,000,000th of a Bitcoin. The Bitcoin supply was capped from the beginning by Nakamoto. The maximum number of coins stipulated to be in existence was 21 million. And around 19.5 Million BTCs are mined so far. The first Bitcoin real-world transaction was carried out by Laszlo Hanyecz who paid 10,000 BTC to have 2 Papa Johns pizzas delivered to him. The pizzas costed about $25. At the peak of BTC`s pricing in 2021, the two pizzas would have been worth north of $680 million.

Crypto rising back

There were many Crypto frauds that happened and a series of exchanges including Sam Bankman`s $32 Bn FTX filed for bankruptcies. A series of crypto related fiascos followed in 2022 and 2023. But finally Bitcoin has started showing resistance in its pricing and has started climbing the wall of worry again.

Bitcoin prices fell all the way to $16,500 in Nov 2022 from the peak of $65,000 in 2021. And BTC is up 82% just in 2023.

There was recent article in Barron`s that Crypto is back from dead which was relating to a favorable court ruling that a token trading on crypto exchanges is not an unregistered security as the Securities and Exchange Commission wanted crypto to be treated like a stock from a regulatory standpoint.

Bitcoin, the oldest and biggest cryptocurrency, is the only crypto that the SEC has suggested is actually a commodity. Now none of us are sure whether Bitcoin will crash again to $18,000 levels or will it hit 1 Million$ as some pundits prophesize. One thing to remember before writing off Bitcoin is that it has survived a couple of market cycles over last 13 years.

Bitcoin – Dollar Cost Averaging Strategy:

But recently I deep dived into an interesting business model followed by the BI analytics company Microstrategy company owned by Michael Saylor. He is a staunch proponent of Bitcoin just like some of other Entrepreneurs and investors like Jack Dorsey, Elon Musk and Cathy Wood. Microstrategy is the biggest corporate owning 150,000 Bitcoins in their balance sheet followed by Coinbase, Square.

Microstrategy adopted a strategy in 2020 to use Cash flows from their Cloud based BI Analytics business and buy Bitcoin in their balance sheet every quarter on almost following a Dollar cost averaging strategy. I found this quite intriguing since they have been successfully averaging out the buying price of Bitcoin since 2020.

This has helped the company build a solid BTC position in their balance sheet worth over $4 Billion over last 3 years.

Microstrategy stock is best performer in 2023 being up 216% YTD. The stock has outperformed over last 3 years basis as well outbeating FAANG, NVIDIA and all buzzing AI themes.

How it works?

Now I was never invested in bitcoin or any crypto for more than 2 months since I could never ever muster conviction to hold. I have always been agnostic about its prominence till date and am quite not sure how to value Bitcoin or any cryptos for that matter. So just like dollar cost averaging of stocks, I find dollar cost averaging of Bitcoin very interesting strategy since Bitcoin is not going to go away soon. The biggest risk in buying Bitcoin is the price volatility and dollar cost averaging helps neutralize that risk. And Microstrategy is at the forefront executing that strategy.

Carrying Value Vs Holding Value:

Digital Asset Impairment charges is a huge loss carried in MicroStrategy’s balance sheet which means under standard accounting rules, the value of digital assets such as cryptocurrencies must be recorded at their cost and then only adjusted if their value is impaired, or goes down. But if the price rises, that does not get reported unless an asset is sold. Currently the carrying value is determined based on the lowest price of bitcoin during the reporting period.

Example of Digital Asset Impairment:

On October 1, 2021, a reporting Entity acquired one unit of crypto asset for $20,000. On November 15, 2021, it was observed that the price of the crypto asset had declined to $18,000/unit. Reporting Entity deemed this a triggering event for impairment and wrote down its crypto asset to a new carrying value of $18,000 and recorded an impairment loss for the decline in value. On December 31, 2021, Reporting Entity’s year end, the price of the crypto asset increased to $19,000/unit. But still the Reporting Entity should reflect a carrying value of $18,000 for its crypto asset at year-end and report the full impairment loss of $2,000 in earnings for the period.

So for Microstrategy, aggregate cost of acquiring BTC was ~$4.2 billion and carrying value of the same was ~$2.0 billion, reflecting ~$2.2 billion in cumulative impairment charges.

On March 23, the FASB issued an exposure draft for comment that would cause in-scope digital assets, such as bitcoin, to be measured at fair value. If this gets approved, then real fair value will reflect much stronger valuation for Microstrategy with a simple conversion of holdings of 140,000 Bitcoins.

Microstrategy is also a decent business generating cash and growing:

MicroStrategy is a good business still with lots of marquee clients. They are further investing in and enhancing the artificial intelligence (AI) capabilities within its analytics platform, MicroStrategy One. The initial use cases are expected to range from natural language capabilities for generating new visualizations and dashboards, to productivity enhancements related to code, workflow, schema, and content creation. The partnership between MicroStrategy and Microsoft will also aid to their AI related growth. Their cloud based subscription services are growing north of 15% yoy.

Just on sales basis, MicroStrategy is valued at 9-10 times which excludes any Bitcoin holding value on the balance sheet which gives the cushion for downside from this levels.

Asymmetric Bet with Long Term Prospects:

And even better the stock is currently valued at $5.8 billion at par with their Bitcoin holdings of 150,000 which is worth around $4.6 Billion. This might be an asymmetrical bet with low downside but high upside for long periods to come due to factors like:

  • Very low upside due to cheap valuations if fair value reporting comes into effect for Bitcoin pricing
  • Huge upside for many years to come due to a strong underlying cloud based business (AI and Analytics) that generates cash
  • Price Derisking with Dollar cost averaging strategy for buying BTC
  • Multiple tailwinds for Bitcoin ahead like 4th Halving, Fair value approval, Regulatory streamlining, Corporate adoption, Wide scale Sovereign adoption ( US is the largest holder of Bitcoin among all countries by the by)

Disclaimer: This post is just a discussion on the successful strategy of Dollar cost averaging of Bitcoin and should not be construed as any investment advise. The author might have vested interest or holding in any of the discussed assets or securities.

Why Hitting Rock Bottom Is The Best Thing That Can Ever Happen!!

THE IMPEDIMENT TO ACTION ADVANCES ACTION. WHAT STANDS IN THE WAY BECOMES THE WAY — MARCUS AURELIUS

Hitting the rock bottom would mean facing any type of adversities in life and it is not easy for anybody to face adversities. But stoic philosophy teaches otherwise as I began this post with a quote by the famous Roman emperor Marcus Aurelius. The stoics guides us that adversities are the greatest opportunities in life. Again that could really be true when we remember all the adversities that has happened in our own lifes but in hindsight.

Am not delving further into philosophy. Now time for a physics concept that we have all learnt. That`s Newton`s second law of motion which states that the rate of change of a body’s momentum is equal to the net force acting on it. Hold this thought for a while.

Am an investor and am going to explain how to benefit from this concept of handling rock bottoms. I love this work of investing because it is multi-disciplinary by nature. Now if we apply these concepts in Investing, there can be huge wealth created. But how?

George Soros is definitely the best investor the world has ever seen whose fund generated an average annual return of 30% over a 30-year period from 1970 to 2000.Though am not a fan of the billionaire investor Soros who pocketed $1 billion by betting against the British pound in 1992, I have always followed one of his quote in my investing process which goes by “The worse a situation becomes the less it takes to turn it around, the bigger the upside”.

But what happens when investors face the worst situations? Most common human reactions are panic and extreme fear during adversities in the markets. When markets hits the rock bottom, that is exactly the point of extreme pessimism and lowest expectations. When the expectations are the lowest, it takes a small trigger of positive impulse (net force) to turn around and the upside could be biggest, if the law of momentum sustains.

Consider Meta (Facebook) stock that saw the most dramatic devaluation in November 2022 as the stock hit the rock bottom of $88. The whole Wall street community called it the end of social media giant. Now that was really the rock bottom and it took few harsh measures from the management to turn it around and the stock saw the highest upside. Meta stock went up 3X in 6 months !!

The Only Way is Up

The good news is, once you’ve hit rock bottom, you know you can’t possibly go any lower. You realize the bottom is actually a great springboard from which to push yourself up. This is true whether its in investing or any other aspect in life. So next time we face any adversity, the point where we feel our weakest, just understand this -> things can only change for the better. The only way is UP !!

Looking Rich Vs Being Wealthy

We all use 2 words ‘Rich’, ‘Wealthy’ interchangeably to describe people who have a lot of money. Lets look at the below pictures and hold your thoughts. For a minute we will conclude that the guy in the first picture as filthy rich and second as a middle class person trying to meet ends. Cant blame us “what is exhibited will only be sold“, isnt it?

Society evaluate your wealth based on the car your drive, house you live in, watches you wear, the vacations you take, the corporate title you hold, the school your kids go to and so on. A person driving a $15,000 used car but owning assets worth $5 Million is considered broke whereas a person driving a $100,000 car and living in an expensive neighborhood but with a net worth of $150,000 is considered rich. Human beings are susceptible to social influence and validations from our evolutionary days and we will always strive to maintain a social identity.

I heard this funny quote somewhere recently, not sure who said it ““We buy things we don’t need with money we don’t have to impress people we don’t like.” There is a fundamental difference between what is perceived as wealth (external) and what is a true wealth (internal). People looking to get wealthy should understand why they need that wealth? is it for materialistic reasons or is it inner happiness? It might not be our natural wiring to seek the latter, but we can change our mindset through practice.

True wealth could be any of the following combinations in our life:

  1. Freedom to do the work we love everyday
  2. Ability to support causes that we really care about in the world
  3. Good house with a lot of loving family members
  4. Pursue new passions whenever we want like learning to sing, preparing for a hike, learning golf etc
  5. Great healthy body without illness (not six pack !!)
  6. Loving to travel around and create great memories

And it could be luxury cars or even houses, nothing wrong with that. But that has to be affordable well within your means. A person with a sound financial networth of $10 million can easily buy a $500,000 car might be perfectly ok. But for 95% of common people who do a job to make a living should prioritize being wealthy than trying to look rich. This means deferring gratitude and buying things when it is well within our means. Especially avoid taking debt to buy things to appear rich in front of the society. We sell our future by 20 or 30 years when we take debt to cover these expenses.

Let me recommend a great book for reading over weekend covering this topic in detail if you have not read already. Its called The Millionaire Next Door: The Surprising Secrets of America’s Wealthy by Thomas Stanley and William Danko.

Why Investing Is Hard?

There was a great company that Forbes once proclaimed it the fastest-growing company in history. Google had offered $6 Billion to buyout this company in 2010 but they spurned down the offer and decided to continue alone. The company am talking about is Groupon, once a global leader in ‘Daily deals’ touted to have access to 150 Million customers a decade ago. A year later after turning down Google`s buyout offer, Groupon did then second biggest Internet IPO in US (after Google in 2004) listing at a nosebleed valuation of $13 billion in 2011 (twice the valuation Google offered in 2010). It was not even a bull market in 2010-11 and stocks were trading at low valuations in general.

Groupon was growing at an astounding rate. In 2010, it’s revenues grew by 22,000 % to $713 million. And in the first quarter of 2011 (IPO year) alone, it nearly matched all of its revenue from previous year with $644 million in sales, up 13,575 percent from a year ago. The annualized annual run rate was around $3bn in 2011 which appeared to be sustainable for next 5-6 years at that point of time. Gross profits were up about 24,600 % in 2010 to $280 million, from $10.9 million the year before. But they were burning cash every year at the rate of around $500 million and the company management was completely focused on Growth during that time. Any investor who heard about the success of Internet companies like Amazon, Google would have been tempted to pounce on this fastest growing IPO in 2011.

Competitors soon nipped at its heels, results started to falter, company fired their CEO, did a lot of restructuring but never came back to its glory days of growth again. The stock which started at $13 Billion valuation in 2011 has been decimated to a mere $215 Million losing 98% of its value. If an investor had put $10,000 in Groupon stock during IPO will be left with just $165 after holding a decade. Buy and hold for long period would have obiliterated its investors.

Now take the recent example of Meta (Facebook) stock, another legendary hailed company touted to have 3 billion users, strong Moat of network effects, strong social media brands like Instagram, Facebook, Whatsapp. If an investor had bought the stock during May 2012 IPO at a price of $38/share, would have just multiplied the capital by 3 times over last 10 years. That’s a meager 11% compounding on par with S&P 500 index which also multiplied by 3 times over last 10 years. Facebook stock has underperformed Nasdaq index which has multiplied by 4 times over last 10 years.

I can go on with hundred more examples like Alibaba in China, Paytm in India and so on. 10 years down the line, we will be talking about Tesla probably as one such example.

Now let me get to the core topic of today, “Why investing is so hard for common investors? Why are less than just 0.1% of the investors successful in stock markets?” Anyone who is given the great fundamental growth stories of Groupon, Facebook would have been impressed to invest in these companies during IPO. Valuation was expensive but not to the extent to be decimated this levels. What really happened was the business fundamental deterioration to such levels that growth has slowed down like anything.

Where most investors usually falter is entering the stocks at high valuations during bull markets. But there are investors who falter by investing in great businesses a point in time, only to see their returns being wiped away. Investing is really hard but most of the people think that anyone can do this due to the ease with which they can buy or sell stocks on information or news on TV channels.

Investing is no easy way to build wealth. If there were, everyone would already be rich. Let me end this week`s letter with a quote from legendary investor Charlie Munger about Investing and getting rich: “It’s not supposed to be easy. Anyone who finds it easy is stupid.” There are no shortcuts. Period.