Annotations (12)
“Stock-based compensation has essentially become a form of financing for these companies. If you think about stock-based compensation, that should not be an add back to cash flow from operations. That should be in the financing section of the cash flow statement. In a sense, you'd be taking down cash flow from operations by 15% to 20% for these companies. The ratio is vastly higher for smaller companies, younger companies.”— Michael Mauboussin
Financing Private Companies · p. 7
Business & Entrepreneurship · Economics & Markets · Operations & Execution
DUR_ENDURING
SBC is financing disguised as compensation
“Classic economies of scale says, as your output increases, your cost per unit goes down. What Brian Arthur introduced was demand-side economics of scale. Which says, as more users use your good, the willingness to pay goes up, because it becomes more valuable for them. If you can imagine these two curves sitting next to each other. The one on the left has this declining cost per unit, and the picture on the right has this increasing willingness to pay.”— Michael Mauboussin
The Rise of Intangible Assets · p. 11
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Supply-side + demand-side scale = huge value
“Intangible investments in 2019 for U.S. companies was about $1.8 trillion dollars. Capex was probably about $700 billion. This is separate from R&D, R&D was about $400 billion. Tangible investment was double that of intangible investment in the 1970s, and today intangible investments are 1.5x tangible investments. There's been a complete flip.”— Michael Mauboussin
The Rise of Intangible Assets · p. 9
Economics & Markets · Business & Entrepreneurship · Technology & Engineering
DUR_ENDURING
Intangible investment now 1.5x tangible, was 0.5x in 1970s
“Rival goods are goods that one person can use at a time. Your laptop, if you're on it, I can't use your laptop. By contrast a non-rival good is one that we can all use at the same time. A recipe, software, anything digital. The concept is technically called excludability. What Romer talked about was these non-rival goods that are partially excludable, which allow companies to generate huge excess rents.”— Michael Mauboussin
The Rise of Intangible Assets · p. 9
Economics & Markets · Philosophy & Reasoning
DUR_ENDURING
Non-rival + partially excludable = excess rents
“If you look at operating margins for businesses, and you break them into quintiles, you see the bottom three bumping along. They go up and down with the economic cycle. But there's not been a real market change. Where you see the action is the second quintile, and then the top quintile, in particular, pulls everything up. The average belie these weird sets of distributions underneath it. The richer are getting richer.”— Michael Mauboussin
The Rise of Intangible Assets · p. 10
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Top quintile drives all margin expansion
“The five stocks, Facebook, Amazon, Apple, Microsoft and Google, through July 30th, their market cap went up roughly by $1.8 trillion. That's bigger than the aggregate buyout industry and that's obviously multiples of the venture capital industry. Even in venture, if you look at so-called unicorns, CB Insights counts about 225 of those in the United States worth about 650 billion, just the market cap change is not quite three times, two and a half, or three times that.”— Michael Mauboussin
The Transition From Public to Private Equity · p. 2
Economics & Markets · Strategy & Decision Making
DUR_CONTEXTUAL
Scale advantage: 5 stocks > entire buyout AUM
“In 1976, there were less than 1 CFA charter holder for every public company in the United States, and today there are 27 CFA charter holders for every public company in the United States. So a lot more eyeballs on the companies that are out there.”— Michael Mauboussin
The Allocator's Perspective on Private Equity · p. 14
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
27x more analysts per company creates efficiency paradox
“Preferential access: A venture firm does well, it could do well originally by luck it doesn't have to be skill, but it does well so it builds a good reputation. You come along and you know you're a pretty good company, and you know your prospects are pretty exciting. You will attach yourself to the best firms, to get the imprimatur from them, and they want to attach with you. That creates a positive feedback, that all the best companies want to work with the same venture capitalists.”— Michael Mauboussin
Venture Capital and Buyout Returns · p. 5
Psychology & Behavior · Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Brand attracts quality, quality reinforces brand
“There's a chart from Steve Kaplan, University of Chicago, where they show on the x-axis, EV/EBITDA multiple, from lower to higher. And on the y-axis is PME, public market equivalent, low to high. What you see is almost a perfect looking downward sloping chart. Which is to say, the more you pay, the less the PMEs are in the future. In 2019 the average EBITDA multiple paid was 11.5 times, that was a record high.”— Michael Mauboussin
Venture Capital and Buyout Returns · p. 6
Economics & Markets · Strategy & Decision Making
DUR_ENDURING
Higher entry multiple = lower future returns
“In 1969, there were 720 IPOs. Which is 20% of the number of public companies today. The IPO market from the mid-1970s through 2000, the average was about 280 per year. Since 2001 through 2019, the average dropped to 115. The age of a company at IPO has also increased very significantly. It was just a little under eight years in that early period, and today it's closer to just a shade under 11 years.”— Michael Mauboussin
Venture Capital and Buyout Returns · p. 3
Economics & Markets · Business & Entrepreneurship
DUR_ENDURING
1969: 720 IPOs. 2019: ~115. Age at IPO: 8y to 11y
“EBITDA adjustments: In 2019 we had a record year of companies that have EBITDA adjustments, north of 40% or more. These adjustments are things like, we're going to take into consideration future cost savings. They're giving themselves the benefit of the doubt before they get going. These are the kinds of numbers they're using when they're talking to their creditors. A couple of years later, a lot of these companies miss those EBITDA forecasts by a meaningful amount.”— Michael Mauboussin
Venture Capital and Buyout Returns · p. 6
Business & Entrepreneurship · Economics & Markets
DUR_ENDURING
40% of deals adjust EBITDA up before closing
“You have to play the cards that are there. You have to deal with the world as it is, not as you want it to be, or you wish it to be, or how you think it should be. Don't complain about the world, figure out a way to thrive in it.”— Michael Mauboussin
Recommendations and Areas of Interest · p. 17
Philosophy & Reasoning · Strategy & Decision Making
DUR_ENDURING
Adapt to reality, don't lament it
Mental Models (8)
Positive Feedback Loops
Systems ThinkingA positive feedback loop is a self-reinforcing cycle where an effect amplifies its own cause. In ven
In Practice: Explaining why venture capital returns show persistence
Demonstrated by Leg-mm-001
Paradox of Skill
Strategic ThinkingAs the absolute level of skill in a competitive domain increases, the relative differences between competitors shrink, making outcomes more dependent on luck. In investing, as more skilled analysts examine public companies (27 CFA charter holders per company vs. less than 1 in 1976), the information advantage any single investor can gain decreases, making excess returns harder to achieve consistently.
In Practice: Mauboussin explaining why increased analyst coverage makes alpha generation more difficult
Demonstrated by Leg-mm-001
Compounding
MathematicsSmall advantages accumulated over time produce exponential rather than linear results.
In Practice: Comparing absolute dollar value creation in public markets vs. private equity returns
Demonstrated by Leg-mm-001
Non-Rival Goods
EconomicsA non-rival good is one whose consumption by one person does not reduce availability for others. Software, recipes, and digital goods can be used simultaneously by unlimited users without depletion. Combined with partial excludability (the ability to prevent unauthorized use), this creates the conditions for companies to generate extraordinary excess returns that would be impossible with traditional rival goods.
In Practice: Explaining Paul Romer's framework for understanding intangible asset economics
Demonstrated by Leg-mm-001
Demand-Side Economies of Scale
EconomicsTraditional economies of scale reduce costs per unit as volume increases (supply-side). Demand-side economies of scale increase customer willingness to pay as user base grows, because the product becomes more valuable to each user as more users adopt it. Network effects create demand-side economies of scale. When combined with supply-side economies, companies can simultaneously reduce costs AND increase prices, creating exceptional value capture.
In Practice: Mauboussin explaining Brian Arthur's contribution to understanding increasing returns
Demonstrated by Leg-mm-001
Power Laws
MathematicsIn power law distributions, a small number of events account for a disproportionate share of outcomes.
In Practice: Describing superstar firm phenomenon and margin dispersion
Demonstrated by Leg-mm-001
Optimism Bias
PsychologyThe tendency to believe that we are less likely to experience negative events than others.
In Practice: Discussing EBITDA adjustments in buyout transactions
Demonstrated by Leg-mm-001
Price Determines Return
EconomicsFuture investment returns are primarily determined by the price paid relative to intrinsic value. The perfect negative correlation between EV/EBITDA multiples paid and subsequent PME returns in buyout data demonstrates this iron law. Overpaying is the most common cause of poor investment returns. No amount of operational improvement can compensate for dramatically overpaying at entry.
In Practice: Discussing Steve Kaplan's research on buyout entry multiples vs. returns
Demonstrated by Leg-mm-001
Connective Tissue (2)
AT&T 1908 Annual Report describing network effects
AT&T's 1908 Annual Report explicitly laid out the concept of network effects 110 years before the term became common in tech circles. The report described how the value of telephone service increased as more users joined the network. This demonstrates that network effects, while newly popular as a concept in software and platforms, have been understood and documented for over a century in communications industries. The mechanism is identical: each additional user makes the service more valuable for all existing users.
Mauboussin describing historical precedent for network effects in discussion of modern platform businesses
Stoic philosophy of accepting reality
Mauboussin's advice to deal with the world as it is, not as you wish it to be, directly echoes the Stoic principle of focusing on what you can control and accepting what you cannot. Marcus Aurelius wrote extensively about this in Meditations. The Stoics distinguished between things within our control (our actions, judgments, reactions) and things outside our control (external events, market conditions, others' behavior). The investor who complains about Fed policy, indexing, or market structure is wasting energy on externalities. The parallel is precise: both Stoics and successful investors focus energy on adaptation rather than resistance to unchangeable conditions.
Mauboussin closing advice about not lamenting market conditions but thriving within them
Key Figures (4)
Brian Arthur
3 mentionsEconomist, complexity scientist
Paul Romer
2 mentionsEconomist, Nobel laureate
Carol Corrado
1 mentionsEconomist, intangible capital researcher
Leading academic researcher who has documented the shift from tangible to intangible investment from the 1970s to present.
- Documented that intangible investment has flipped from half of tangible investment in 1970s to 1.5x tangible investment today
Steve Kaplan
1 mentionsProfessor, University of Chicago
Glossary (3)
imprimatur
VOCABULARYOfficial approval or sanction; mark of quality or legitimacy
“You will attach yourself to the best firms, to get the imprimatur from them.”
rival goods
DOMAIN_JARGONGoods that one person can use at a time; consumption reduces availability for others
“Rival goods are goods that one person can use at a time. Your laptop, if you're on it, I can't use your laptop.”
excludability
DOMAIN_JARGONThe degree to which a producer can prevent unauthorized use of a good or service
“The concept is technically called excludability.”
Key People (4)
Steve Kaplan
University of Chicago professor
Luminita Enache
Academic who segregated SG&A into maintenance vs. investment components
Paul Romer
(1955–)Nobel Prize-winning economist
Brian Arthur
(1945–)Economist who identified increasing returns
Concepts (6)
EBITDA adjustments
CL_FINANCIALPro forma modifications to earnings; often includes projected future cost savings
PME (Public Market Equivalent)
CL_FINANCIALMetric comparing private equity returns to what would have been earned investing in public markets over same period
stock-based compensation
CL_FINANCIALEmployee compensation paid in company equity rather than cash; acts as financing by issuing shares
intangible assets
CL_FINANCIALNon-physical assets like software, brand, R&D; investment typically expensed not capitalized
network effects
CL_ECONOMICSWhen value of a good or service increases as more people use it; demand-side economies of scale
CFA charter holder
CL_FINANCIALProfessional designation from the CFA Institute indicating expertise in investment analysis
Synthesis
Synthesis
Migrated from Scholia