The Signal and the Noise

I’ve been reading statistician Nate Silver’s 2012 book The Signal and the Noise.  He makes three points that I think are useful for us as investors:

1.  Some ostensible information sources aren’t really that.

TV and radio weathermen, for example, deliberately forecast more rainy days, and amp up the amount of rain that will fall, than they actually think will occur.  Why?  People apparently like to hear about bad weather.  Also, we only get mad if the weather is worse than predicted.  If it’s better ,we regard it as a pleasant surprise.  So there’s every reason for TV and radio to have a consistent “wet” bias–and they do.

Same thing for shows on politics.  Pundits on the McLaughlin Group, for example, have a startlingly bad record at making political predictions.  The show’s many fans don’t seem to care.  Broad, sweeping views, confidently and articulately presented, are all that matters.

It seems to me the same applies to TV financial shows.


2.  The group with the absolute worst forecasting record is professional economists.  In fact, predictions about the course of the overall national and world economies are not only highly inaccurate, they’ve gotten worse over time, not better.

In other words, don’t bet the farm on a macroeconomic forecast.


3.  Foxes are better thinkers than hedgehogs.

Silver separates forecasters into successful = foxes (he’s one), and really bad = hedgehogs.

The differences:


highly specialized

“experts” on one or two narrow issues that define their careers; contemptuous of “generalists”

often in the academic world

all-encompassing theories

theory over facts

believe in a neat universe, defined by a few simple relationships

highly confident, meaning resistant to change




self-aware and self-critical

facts over theory

think the world is inherently messy

careful, probabilistic predictions.

In other words, be careful of highly confident people with overarching theories and elaborate forecasting systems.




new money market fund regulations

Yesterday, the SEC announced new rules for US money market funds, which in the aggregate hold $2.6 trillion in investors’ money.  Of that amount, two-thirds is in funds catering to institutions and high net worth individuals; one-third is in funds serving the mass market.

Why the need for new rules?  

Two reasons:

–today’s aggregate money market assets are large enough to be a risk to the overall financial system if something goes badly wrong, and

–the funds are typically sold as being just like bank deposits, only with higher yields.  However, like most Wall Street claims that  “x is just like y, only better,” it’s not really true.  The differences only become important in times of market stress, when normally sane people do crazy things, and when “yes, but…” is a sign for panic to begin.  So there’s a chance that “badly wrong” can happen.

The differences?    …bank deposits are backed by government insurance that insulates depositors from investment mistakes a bank may make.  Also, the Fed stands ready to rush boatloads of cash to a bank if withdrawals exceed the money a bank happens to have on hand.  Money market funds have neither.

Yet many holders are unaware that it’s possible for a money market fund’s net asset value to fall below the customary $1.00 per share, or that a fund might be overwhelmed by redemptions and forced to sell assets at bargain-basement prices to meet them.

the fix

Fixing this potential vulnerability has two parts:

–giving the finds the ability to halt or postpone redemptions during financial emergencies, and

–requiring funds to have floating net asset values, not the simple $1.00 a share.  This would mean marking each security to market every day.  …which would likely require hiring a third-party to price securities that didn’t trade on a given day.

The first of these would avoid the government having to step in the case of a run on a fund.  The second should reinforce that money market funds aren’t bank deposits.

the new rules

Of source, the organizations that sell money market funds have been strongly opposed to anything that would ruin their “just like…, but better…” sales pitch.  Their lobbying has blocked action for years.

So it should be no surprise that yesterday’s SEC action was a compromise measure:

–all funds will be able to postpone redemptions in time of emergency, but

–only funds that cater to big-money investors will have to maintain a variable NAV.

Personally, I don’t understand why money market funds that serve ordinary investors should be exempt from having to calculate a true daily NAV.  You’d think that this is the group that most needs to understand that the (remote) possibility of loss is one of the tradeoffs for getting a higher yield.  Arguably, sophisticated investors already know.  But the financial lobby is incredibly powerful in Washington, and this may have been the price for getting anything at all done.



Piketty on inequality

Capital in the 21st Century

Last year,  Le Capital au 21e Siècle, authored by Thomas Piketty, a researcher on economic inequality who teaches at the Paris School of Economics and who has been publishing academic articles for the past 15 years, came out in France.   Virtually no one (me included) read it.  But then it was picked up and translated into English.  It has become a runaway bestseller in the two months since then for that most unlikely of places, the Harvard University Press. Last weekend I even saw Capital in the 21st Century displayed prominently in the Bestseller rack of the only book kiosk in the San Francisco airport.

To be clear, I haven’t read C21C,  and I have no present intention of doing so.

But I have seen it and I thought about buying it.  That’s the next best thing to having it on my bookshelf  …which is pretty close to having turned the pages   ….which is the next best thing to having understood the arguments.   That’s why I don’t feel so bad about writing about Prof. Piketty’s work this morning.

The book is almost 698 pages long in English, close to 1,000 in French–and probably a zillion as an e-book.  It also has a technical annex available online that contains all the supporting data used (whose validity has been questioned in a front page, above-the-fold article in the Financial Times–no response from M. Piketty yet).  The detailed annex is thought to be the book’s best feature.

The main theses of C21C are:

–over the past fifty years there has been a steady rise in the percentage of a given country’s wealth being captured by the already rich.   This can be seen everywhere there are records of wealth available.  The rich continue to get richer, the poor, poorer

–this phenomenon is just the way it is in the capitalist system

–the best (only?) way to remedy this bad situation (for 99% of us) is for government to tax the rich heavily and redistribute the money it collects to everyone else.


What grabs my attention is the uproar that C21C has created in the English-speaking world. I think this shows that inequality is a much bigger hot-button issue than I had realized.

I can understand why C21C is popular.  Prof. Piketty presents a simple, universal framework for understanding the complex problem of how to provide equal opportunity for all citizens.  More than that, no one is at fault for the way things are now.  Inequality isn’t due to bad schools or discrimination, to the failure of corporate boards to rein in CEO pay, or to regulators’ failure to thwart the perfidy of crooked traders at commercial banks.  It’s just the way capitalism works (just as churning out 700-1000 pages to present a few simple ideas is the way academia works).

There’s also a simple, politically popular solution–redistribution.

It may well be that C21C will prove a flash in the pan, and that the book will take its place on bookshelves alongside other unread (I typed “undead” initially–must be my unconscious in overdrive) tomes like Alan Greenspan’s The Age of Turbulence or the Steve Jobs biography.

On the other hand, it may stimulate a useful public policy debate on inequality in the US.  The only worrisome outcome, to my mind, would be that its conclusions might be taken uncritically as a justification for policies that don’t seem to have done a whole lot of good so far for France.  Great for the US, though, if all the French techies who have decamped to Silicon Valley are any good.


No one wants to buy Barnes and Noble?

That’s what the Bloomberg news service said the other day, citing interviews with five (count ’em, five) unnamed sources knowledgeable about the auction of the company that’s now underway.  It appears potential buyers–at least seven, according to Bloomberg–have all lost interest as they have had an opportunity to study the company and its financials more deeply.

What could be their concerns?

Well, for one thing, BKS is a big-box retailer with a lot of real estate under lease that it has to pay for.  And big-box retailers are all trying to shed floor space as fast as they can.   They are suddenly realizing that this floor space has been rendered much less valuable by the rapid growth of online sales.

For another, BKS sells books, a merchandise category that is showing little, if any, growth.  In fact, the company most similar to BKS, Borders, has just gone into bankruptcy, illustrating the parlous state of the industry.  Potentially more relevant, Chapter 11 will likely allow Borders to free itself of many financial burdens and to streamline operations very quickly, presumably turning it into a much more formidable competitor as it reemerges from bankruptcy.

Finally, BKS is a force in internet sales, both of physical books and of e-volumes readable on the firm’s proprietary e-reader, the Nook.  While this puts BKS in a strong competitive position vs. Borders (which has neither kind of online presence), it also puts the company directly into the sights of two larger, much better capitalized, aggressive digital competitors in AMZN and AAPL.

That’s not good.

For one thing, a recent survey by the Boston Consulting Group suggests that, although digital is the future of publishing, most people want to buy tablets, not e-readers.  Score one for AAPL.  For another, the accord that the publishing industry forced on AMZN about a year ago compelled the e-tailing giant to stop competing on price in the digital book industry.  That didn’t mean competition in digital books ceased, as I think the publishers thought.  It just meant AMZN had to shift the focue of competition to another arena, namely, the price/performance of the e-reader.  At the moment, BKS’ color Nook may be in the lead.  But AMZN has much more R&D money to toss around than BKS.  Score one for AMZN.

Given my description, why would anyone even consider bidding for BKS?  A growth investor like me wouldn’t, even though I was a very big holder of BKS fifteen years or so ago.  But deep value investors are another breed entirely, with a very different–and somewhat counterintuitive–investment philosophy.

I look for healthy companies where I think the consensus has seriously underestimated their growth rate.  Deep value investors, on the other hand, look for mediocre companies, or worse, where they think the consensus has seriously overreacted to the bad news that’s in plain sight.  They hope to find assets worth 100 that they can buy for 30 and sell for, say, 60.  This is a tough business, where you’ve got to be very sharp to survive.  But it’s also one where the chance to acquire a company fitting my description above would have such investors rubbing their hands in anticipation.

To my mind, the surprise isn’t that value investors have started to investigate.  It’s that they’ve apparently all lost interest.  This implies they’ve found something in doing their due diligence that wouldn’t be obvious from the SEC filings and that makes them think the situation is riskier than they had imagined it would be.

What would such a risk be?  In my experience, deep value investors are most comfortable with mature businesses.  They tend to like basic industries (like cement or pulp and paper) and simple manufacturing, where the world changes slowly.  They also tend not to like, or to do well with, technology.

So I think their new-found worries come in the digital side of BKS …that once they peeked under the hood they concluded that BKS is in a more fragile condition there than they had estimated.  My guess is that the bone of contention is the cost/market position of the Nook, not the state of actual e-book sales.  The auction is supposed to be over in a couple of weeks.  We may learn more then.

bankruptcy of Borders Group: implications for Barnes & Noble (BKS)

Borders’ bankruptcy

Last week BGP filed for a reorganization under Chapter 11 of the Bankruptcy Code and announced it had subsequently received new financing from GE Capital.

This wasn’t a big surprise, given that BGP had been reported for some time to be withholding payments to book publishers and to its landlords in order to conserve cash.  What would it be “conserving” this cash for?   –to pay salaries and keep the lights on in the bookstores and warehouses, for one thing  It’s also possible that some of its suppliers had noted Borders’ deteriorating financial condition and were asking for cash payment before shipping new merchandise.

Chapter 7 vs. Chapter 11

Bankruptcy in the US generally comes in two flavors:

–Chapter 7, or liquidation, where the debtor is considered defunct.  In this case, the bankruptcy action consists in selling the assets and distributing proceeds to creditors.

–Chapter 11, or reorganization with the debtor remaining in control. The main thrust is to put the enterprise into position to have a second chance at success.  The firm continues to operate while it restructures.  It may terminate or renegotiate contracts, including leases, under the supervision/assistance of the bankruptcy judge.  Typically, common shareholders and trade creditors are wiped out completely.   Debtholders exchange their obligations for stock in the revamped company that emerges from from the bankruptcy proceeding.

To some extent, bankruptcy can become a self-fulfilling prophecy.  Suppliers typically study the finances of their customers carefully.  They may reduce–or even stop completely–shipments at the first whiff of trouble.  Or they may ask for cash upfront instead of extending credit.  And why not, since their receivables are most likely a total loss once a customer files for bankruptcy.  The result, however, is that the store in question may no longer have the best merchandise, or the former large variety, in stock  …which means more customers stop coming.

reports of the Borders plan

Reports in the blogosphere and in newspapers suggest that book publishers want Borders to shrink its floorspace by about a third in its reorganization.

positive news for BKS?

The stock did go up about 10% last week, as the rumors of an imminent Chapter 11 filing by Borders swirled. So someone must think this is a big plus for BKS..

My guess, however, is that the demise of the current Borders will do little good for BKS.  Three reasons:

1.  Borders will continue to operate, although in about a one-third smaller form.

2.  In a case that I think is very similar to Borders/Barnes&Noble today, in 2009 consumer electronics retailer Circuit City went into liquidation.  How fast are the revenues of rival Best Buy growing today, without competition from Circuit City?  In the US, they’re not growing much  at all.  In fact, on a comparable store basis, they’re actually declining.

How so?  Circuit City’s customers didn’t all flock to Best Buy.  As I see it, the chain’s demise accelerated the trend of consumer electronics sales to a newer technology, the internet, and to the big discounters like Wal-Mart.

In the bookstore instance, the biggest effect of Borders’ shrinkage in size may well be a speeding up in the adoption rate for e-readers.   My feeling is that most of the new business will go to Amazon, not Barnes and Noble, although thee may be some shifting of Barnes and Noble’s bricks-and-mortar customers to the Nook.

3.  Another, somewhat older–but still pertinent, I think–pattern of industry development comes from toy retailing.  As I interpret the data, every year in the first half of the Nineties big discounters like WMT and TGT took market share from Toys R Us.  But every year, Toys R Us took market share away from small independent toy retailers, so it was relatively unaffected by the loss of customers was experiencing.  But then, sometime in the mid-Nineties, there were no more small independents left for Toys R Us to take market share from.  Toys had killed all the ones who were going to die.  The competitive situation had therefore been reduced to Toys R Us vs. the big discounters.  From that point on, TRU was in trouble.

I think that we may be seeing the same mid-Nineties situation emerging in the book industry, with BKS playing the role of Toys R Us, Borders and small independent bookstores the part of the small toy retailers, and Amazon and WMT being the equivalent of WMT/TGT.  If Borders and the small booksellers (who appear to be enjoying a resurgence, by the way) have no more market share to give up, then the new competitive dynamic is between BKS and AMZN.  Of course, AAPL may take some market share as well.

Given that different e-reader systems are mutually incompatible, would you feel more comfortable buying one from a company with a market cap of $84 billion (AMZN) or $1 billion (BKS); with $8 billion in net cash (i.e., after repaying all debt) on the balance sheet (AMZN) or a comparable number we won’t know for sure until reporting time, but which is probably going to be only mildly positive (BKS).  In this case, I think size will count for a lot.

Barnes and Noble (BKS) is putting itself up for sale. Why?

BKS’s announcment

Earlier this week, the board of directors of BKS announced it was considering putting the book retailer up for sale. The stock, which has been a severe laggard recently, jumped by about 20% in the following day’s trading. The straightforward interpretation of this market movement is that Wall Street feels the company would be better off economically in someone else’s hands. Zin this case, however, it may equally well reflect strong confidence that there is a wealthy buyer foolish enough to make the purchase at a substantial premium. There are, of course, already two significant holders of stock, Leonard Riggio with a 20% holding and Ron Buckle with 19%.  Mr. Riggio has already expressed interest.

What’s going on?

Securities analysts are often forced to make mountainous theories out of molehills worth of information. It goes with the territory. But like any scientist would, we outline our assumptions and conclusions based on the data we have, and then look for information that could prove our resulting theories false. BKS is a case in point.

Here’s my theory:

Three or six months ago, the board of BKS may have been debating selling the company. But it didn’t do anything before now. So it seems reasonable to me that some recent development has either focused their minds or tipped them over the edge toward sale. What could that be?

I don’t think it’s just the recent weak bookselling environment, since this unfavorable development can’t have come as a complete surprise. Nor is it likely the bad blood between the two significant holders of the company’s stock, since this too has been around for a while. Instead, I think the factor involved is an unintended consequence of the move by publishing houses, in concert with AAPL, to force AMZN to raise the price it charges for e-books.

As I’ve written in another post, I think the publishers saw AMZN’s aggressive e-book pricing—it was paying the publishers around $12.50 for a hardcover bestseller and retailing it for $10, thus losing $2.50 a copy—as a threat to mom-and-pop bookstores. The publishing houses’ fear was that the low price would spur rapid adoption of e-books by consumers, shifting business away from mom and pop and destroying a valuable distribution network. That, in turn, would leave AMZN in the very powerful position of controlling a major part of the book distribution network.

For its part, AMZN could afford to use e-books as a loss leader because, although it began as an online bookseller, it has long ago established a thriving online business selling all sorts of other stuff, both for itself and as an agent for others. The contrast between it and BKS is stark. BKS, a purely bookseller, will have cash flow around $250 million this year. AMZN, books + other stuff, will have cash flow of around $1.7 billion, or 7x BKS’s.

What the publishers did was compel AMZN to charge $12.50 a copy for e-books and keep 30% of the revenue and return 70% to the publisher. This is the same deal they offered to AAPL, and is modeled on the standard arrangement with independent bookstores. Note, also, that in using the new system, the publishers were receiving less than AMN was willing to pay them for e-books. So boosting the near-term bottom line was clearly not the reason the publishers were doing this.

Raising the AMZN e-book price by 25%, they apparently reasoned, would slow e-book adoption, preserve small booksellers’ profits and give the publishers some breathing room to figure out what to do next. Things haven’t worked out that way, however.

Maybe higher prices did slow the rate of adoption, but if so the consensus wildly underestimated what that the adoption rate would prove to be.

But I think they also stopped AMZN from making a strategic blunder with e-books and redirected it onto a much more effective long-term path.

To me it’s not surprising that AMZN would be willing to lose money while it established its e-book market position. After all, it spilled red ink for years in its online original book business, propped up only by the billions it cleverly raised from internet-crazed investors in the late Nineties, before the bubble burst. And that turned out ok.

AMZN’s mistake, I think, was to focus on using the book price and not on the readers as a way of gaining market share. Given that the publishers forced AMZN to make a profit on bookselling, they eliminated that option. More than that, they gave AMZN all that “found” cash flow that it could direct into its other strategic e-book weapon–developing better and cheaper e-readers. The first in what I expect will be a series of innovations have just come out. You can now buy an e-reader with better screen resolution (wi-fi only) for $139—or at least be put on the waiting list for one—which is about half the price of the older models a couple of months ago.

BKS is a bookseller. AMZN is a technology behemoth, running mammoth server networks for itself and renting space to other “cloud computing” users. BKS might be able to compete in a battle about who can sell the most books. I think it has decided it can’t compete in a war over who has the best e-reader technology. So it’s sending up a white flag.

It’s maybe too early to tell for sure, but a good guess that the book publishers have accidentally precipitated the demise of BKS. Given the weak condition of Borders and the likely fading away of mom and pop bookstores, this action may also have given AMZN a decisive edge in the battle for book-reading customers.

developments on the e-book front

There are two interrelated struggles going on over the potential revenues from e-book publishing.  One is among the sellers of dedicated e-readers, like the Kindle, the Nook or the Sony e-reader–each with one another, and all with AAPL, the creator of the iPad.  The last is a general internet content consumption device that hopes e-books will be one of many profitable sales opportunities for it.

The second is between authors and their publishers over who possesses the e-book rights to older “backlist” titles, whose contracts don’t spell out explicitly who owns them.  This “software” situation is at least as muddled as the “hardware” one.  Some literary agents and publishers have made their negotiations public; most have not.

The ones I know about on the publishing side seem to separate into two camps:  Random House and everyone else.  The issue is the royalty rate at which authors will be paid for backlist titles sold as e-books.  Authors’ agents point out that the incremental cost of selling an e-book is negligible, and that the e-book question is not addressed in the book contracts.  They conclude that their clients should get a higher percentage of such sales revenue than their contracts specify, since those implicitly factor in a physical publishing cost element.

Smaller publishers have been quietly striking deals with agents.  Random House has not.  It has taken the stance that it already owns the e-book rights to older titles because the contracts don’t explicitly exclude them.  It has also been conducting a gentle op-ed campaign to suggest that a book is really a collaboration between author and editor–and that the final product may be far different from the original manuscript acquired by the publisher.  I take it the suggestion here is that the book may not be the sole intellectual property of the author, to do with as he pleases, even if Random House were to be eventually found in court to have misinterpreted its older book contracts.

Last week, both battles reached a higher public profile when powerful literary agent Andrew Wylie, who represents a stable of hundreds of prominent authors, agreed to sell the exclusive e-book rights to twenty classic novels, including Norman Mailer’s “The Naked and the Dead,” Philip Roth’s “Portnoy’s Complaint,” and Salmon Rushdie’s “Midnight’s Children” to Amazon for the Kindle.  These are all titles under contract to Random House.

Random House has responded by stopping all new English-language book negotiations with Wylie.

This will be an interesting situation to watch.  The Wylie action only includes twenty books.  The Amazon deal is for a limited, two-year, time.  Presumably Wylie has chosen the titles with care–meaning authors/estates with the weakest ties to Random House.  So it is more a shot across the bow than a declaration of all-out war.  Random House’s action seems to me to be an overreaction.

Both moves may have unintended consequences.  I don’t see what Wylie has to lose, however, or what Random House has to gain, from their current positions.

Suppose sales of the twenty titles through Kindle are much better than anyone expects?  Then more authors will want to jump on the Kindle bandwagon and Random House will either have to backtrack or make a more draconian response.  If the latter, will it risk angering Wylie clients and losing them permanently to other booksellers .

Suppose sales are awful?  This is the “good” outcome for Random House–discovering that the e-book rights it is so ardently defending have no value.  I suspect this won’t be what happens, though.