2024 Annual Letter

Interpretation of Results

As always, annual mark-to-market results can be largely random, so I claim neither credit nor blame for any one-year performance. Predicting short-term stock movements is outside my expertise; my focus remains firmly on the underlying business fundamentals.

This year, I performed without action; zero new long investments were initiated. Performance was primarily bolstered by British American Tobacco, detailed extensively in the last annual letter, along with contributions from several other long positions. However, there was a significant negative impact from shorts.

Exited Investments

Bank of Georgia

I decided to part ways with my long-term holding, Bank of Georgia, during the first half of the year. This was timed as the stock was in the vicinity of its all-time high following a strategic acquisition of a bank in Armenia. The investment was a multi-bagger. Key reasons for this decision included (1) the recent unsustainable high growth already factored into the share price, (2) the market sentiment reflecting an optimistic outlook towards the economy and financials, and (3) available alternative investments offering similar returns with reduced economic dependency. Similar to other significant exited investments (e.g. AerCap, Sallie Mae, Apple, Imperial Brands, etc) I anticipate the business to continue to perform well and the stock to continue to perform well, but I must concentrate investments in the most attractive assets. Although my portfolio of attractive ideas is extensive, my investment capital is finite.

One Main Financial

My investment thesis for One Main Financial proved successful. While it remains an attractive business with robust potential returns, the buoyant market sentiment and perception of a strong US economy have made financial stocks less attractive than alternative investment options with similar prospective returns and lower economic sensitivity. I sold the stock shortly after achieving long-term capital gain status.

Imperial Brands

Imperial Brands was another long-term holding I exited. The market continued recognizing the effective turnaround being implemented by its management. Concurrently, an alternative opportunity in the same sector presented a more compelling proposition, triggering the exit.

Shorts

As previously mentioned, the fund was significantly beta negative for nearly the entire year; shorts were a significant drag. However, fortunately, I decided to cover every short to avoid a potential knee-jerk reaction to the results of the US Presidential Election as the market became even more exuberant nearing this event.

Shorting is useful and a necessary component of a leveraged long/short equity portfolio; however, there is an exception. Think of shorting stocks like swimming in the ocean. In nearly all cases, it is fine; it is generally safe to swim, and even most sharks do not pose a threat much like most “scary” stock shorts may temporarily rise 50% or so — no big deal. But if you happen to see a great white shark, it’s best to get out of the water and wait, because the danger might still be lurking, and you do not want to die. That does not mean you should never swim or never short stocks; I love doing both. It just means you should be cautious during these rare but dangerous occasions. For stocks, this means when you detect an exuberance taking place that can potentially send stocks rising quickly and dramatically for no fundamental reason, you must temporarily get out of the water, which is fortunately what I did before the election.

New Investments

Historically Rare Financial Market Exuberance

In typical fashion, I would use this space to introduce new investments; however, given the current climate of financial upheaval, I feel compelled to shift focus and delve into why such opportunities are conspicuously absent.

It seems the pervasive exuberance in today’s market escapes the notice of many. When financial historians eventually turn their attention to this era, they'll likely recognize it as among the more notable periods of elevated valuations in recent market history. Allow me to illustrate my point:

• The storied days of the Peter Lynch PEG ratio have vanished. High-caliber companies with seemingly reliable growth prospects command multiples that seem detached from their intrinsic value. Take Cava, for instance, which trades at a price-earnings multiple in the hundreds with growth around a mere 20%, or the various larger stocks such as Apple with around a 40x multiple on high-quality earnings but predictable and lackluster growth prospects.
• Consider Dogecoin, a dog joke meme turned coin with zero intrinsic value, amassing a market cap of approximately $50 billion—a sum comparable to Latvia's GDP. Does a prudent person prefer the hard-earned contributions of nearly two million individuals which can be turned into a future endowment for their family, or would they prefer to gamble it away on Dogecoins? We believe buyers of assets without intrinsic cash flows are relying on subsequent buyers at higher prices.
• The Buffett Indicator hovers around an all-time peak. Even after adjusting for growing non- U.S. earnings, the indicator is still at record levels
• Remarkably, the Shiller P/E Ratio surpasses its pre-Great Recession and pre-Great Depression levels, approaching heights witnessed just before the .com bubble burst.
• Reportedly corporate insider sales have recently surged to a two-decade record.
• On non-fundamental news unrelated to future cash flows, stocks have spiked. For example, Workday recently surged on inclusion to the S&P 500 Index, and earlier this year Gamestop jumped based on memes posted on a Twitter account.
• Tesla's stock rose significantly during a period when, in our view, certain fundamental metrics declined. Margins are on the decline, growth is flatling, and past projections seem foregone. - One meme coin, born from a jest about oral sex, rapidly achieving a market valuation near $500 million—absurdity materialized.
• Even within the last fortnight, I've received messages surprisingly from non-idiots urging me to buy "fartcoin," a cryptocurrency whose market cap astonishingly resides in the billions. Clearly these folks are experiencing FOMO.
• Many meme stocks like GameStop, previously identified with spur-of-the-moment trading fervor, linger at inflated levels far removed from their fundamental value.
• Real estate is not immune, with valuations adrift from fundamentals, being sold and marketed at cap rates in the vicinity of the risk-free rate.
• Sovereign debt levels have soared to historic peaks.
• When I tell everyday people I am an investor, they show excitement about what should be a boring subject (investing) and ask whether they should invest in "hot" stocks such as Tesla or Nvidia.

This exuberance exists against a backdrop of 4-5% interest rates, ostensibly suggesting a stock price-earnings multiple of 20-25 if we assume zero risk premium—discordant given the historical 4-6% premium. Concurrent geopolitical tensions span the globe—from conflict in Europe, at one point looming Middle Eastern conflict prompted by Iran, to the continued U.S. and China trade and Taiwan tensions. Economic strife continues to grip major economies like Germany and the UK. U.S. GDP growth, rather than miraculous, is buoyed by unprecedented peacetime/non-recession budget deficits documented meticulously by the St. Louis Fed. The 2024 US fiscal deficit hovers around the same level as it did in the years coming out of the Great Financial Crisis (despite low unemployment). The University of Michigan Consumer Sentiment Index has been hovering at levels traditionally aligned with a recession.

As I have repeatedly asserted, I hold no interest in ordinary deals, and the slightest whiff of challenge is unappealing. I yearn for investments where the thesis is straightforward and even in the bad case scenario, results should remain favorable. These sorts of opportunities generally present themselves in times of panic rather than enthusiasm. In my judgment, despite pockets of decent value that can be safely captured while waiting for a dislocation, given what we believe to be elevated valuations, we have positioned the portfolio more cautiously than in prior periods. To quote the revered Lao Tzu:

Do you have the patience to wait

till the mud settles and the water is clear? Can you remain unmoving

till the right action arises by itself? Other people are excited,

as though they were at a parade.

I alone don’t care,

I alone am expressionless,

like an infant before it can smile.

He who rushes ahead

doesn’t go far.

Other Thoughts

Seeing Ahead

In the segment of my 2023 annual letter titled “Edges That Did & Did Not Contribute,” I focused on two distinct advantages. Today, I want to highlight an additional pair of advantages: the ability to foresee the future, empowered by deliberate lifestyle choices.

Consider a pivotal evolutionary moment: some 400 million years ago, aquatic life ventured onto land. With this transition, our distant ancestors discovered the vast potential of the open air, allowing them to see far beyond their immediate surroundings. This newfound perspective encouraged not just reaction but anticipation. As they expanded their physical horizons, their cognitive horizons broadened as well.

This evolutionary lesson resonates strongly today. Immersing oneself in diverse non-fiction subjects—particularly history—and experiencing the world firsthand enhances one's capacity to anticipate rather than merely react. Machiavelli astutely observed, “For it is not possible to surprise men with new things, because they have always been the same, and have always acted in the same way. In the course of things, the results have always been the same, because men have always been governed by the same passions.” This insight is invaluable to those leaders who immerse themselves in the lessons of the past.

Conversely, the typical investor remains anchored to their immediate environment—enclosed within the limited perspective of office walls and Bloomberg terminals. Their vision is often confined to the latest earnings, past year results, or analysts' predictions. Many let their decisions be swayed by political rhetoric, recent economic indicators, or the never-ending barrage of information from Expert Networks, drowning in the incessant churn of stimuli. On Wall Street we see human animals acting as though they are still fish.

In contrast, I don't feel the compulsion to react to every earnings update or headline. As I noted last year, I have eliminated “noise” from my professional life: no news subscriptions, no Bloomberg Terminal, no television, nor spreadsheets or PowerPoints—no rigid office environment complete with its uncomfortable and irritating uniforms, no defined hours or days or holidays (neither religious nor secular), no assistants, and no Expert Network calls. My strategy is to cultivate an environment free from distractions, refining my focus to essential stimuli.

Flipping The Script

You've probably heard the notion that good ideas often come while showering. But have you ever heard of someone coming up with a brilliant idea in the shower while in the company of their significant other(s)? I propose that these eureka moments have little to do with the shower itself. Instead, they arise because it is one of the few times in busy days when minds are finally free for solitary reflection.

Many investment managers spend their days mired in office routines—adjusting spreadsheets, absorbing earnings calls, consuming news (often just a synonym for propaganda), and spending mealtime with colleagues. When they finally return home, their minds continue on autopilot as they interact with family and manage chores. It’s only during that solitary shower time, either in the evening or morning, that they reclaim their mental space.

I aim to flip this script. I invest my time in learning through reading and diverse experiences, but also deliberately carve out most of my life for thinking in solitude. My gym sessions often stretch for many hours, not because of physical exertion, but due to the deep contemplation they foster. I often linger in the shower for over an hour; in my summer camp days, my bunkmates would douse me with cold water due to my lengthy showers. I ponder while stretching, or on multi-hour-long contemplative strolls. Entire days spent in museums or reading books are not just about learning, but about deliberate, creative rumination. Solitary meals are times of peaceful thought. Much of my life is transformed into a sanctuary for thought, akin to how many see their brief daily shower.

Every so often, a spark of an idea emerges. I then delve into intense research, and occasionally, this idea finds its way onto my watchlist. On exceedingly rare occasions, it might even garner a capital allocation.

The Importance of a Broad Perspective on Speculative Assets Lacking Intrinsic Value

In the landscape of speculative assets—like Bitcoin and others lacking intrinsic value—it's essential to broaden one’s perspective to include historical context. Human values shift with time, and many assets once valued greatly have faded into obscurity. This highlights the ephemeral nature of such investments and compels one to question their long-term sustainability.

Gold has captivated civilizations for millennia, with its history as a symbol of wealth and power stretching back to 2600 BCE in Egypt. During the New Kingdom (circa 1550–1070 BCE), pharaohs like Thutmose III and Ramesses II capitalized on the rich Nubian mines, propelling Egypt into its "golden age," where gold not only adorned temples and tombs but also cemented Egypt’s influence on the ancient world. However, the value of speculative assets can fluctuate dramatically. For several centuries in ancient Egypt, silver was considered more valuable than gold due to its rarity. This shift continued when Lydia (circa 600 BCE) introduced coinage, standardizing gold and silver as currencies. In classical Greece, silver took center stage, fueled by the massive output from the Laurion mines, which underpinned Athens’ economic and military might. The resulting oversupply eventually diminished silver's value, allowing gold to regain its position as the premier store of wealth.

Gold and silver are historically unique speculative assets, yet they have still experienced dramatic price fluctuations and poor real returns. A plethora of other speculative assets once deemed precious tell much worse stories. For example, pearls, synonymous with luxury in ancient Rome, lost their luster by the 16th century as new pearl beds were discovered in the Americas, diluting their market value. Silk is another illustrative example; originating in ancient China, it was once so prized that it was used as currency. However, as production spread and the Silk Road connected traders, silk lost its status as an exclusive luxury item. Spices, which once triggered the Age of Exploration due to their vast value, ultimately diminished as global trade routes matured. Even the 18th-century obsession with cochineal, a red dye extracted from insects, saw massive demand until synthetic dyes rendered it largely obsolete. In the Victorian era, ornithological specimen collecting became a speculative craze, where rare bird skins fetched prices akin to today’s luxury items, only to collapse from regulation and increased supply. Even consider the Beanie Babies bubble of the 1990s. These small stuffed animals were feverishly collected, at one point believed to be future treasures, yet eventually plummeted to near worthlessness.

Historical examples, such as the Tulip Mania of 1637 in the Netherlands, further illustrate this phenomenon. Tulip bulbs were once traded at prices higher than houses, only for the market to collapse dramatically within weeks. Today, one can draw parallels to Bitcoin, which has approached prices rivaling housing, surpasses the median household income in America, and is valued at approximately 30 years of the median global household income.

The South Sea Bubble of 1720, the Mississippi Bubble of 1719–1720, the Florida Land Boom of the 1920s, the 1929 stock market crash, The Panic of 1837, The Panic of 1873, the Japanese Asset Price Bubble of the 1980s, and the Dot-Com Bubble of 1995–2000 further underscore the dangers of overconfidence in rising speculative markets.

Today, Bitcoin and other digital assets (and meme stocks) are often likened to gold as modern stores of value. However, history reminds us that even gold's status has wavered. What makes gold unique is its enduring appeal, supported by thousands of years of trust. Comparatively, what are the odds of Bitcoin or any speculative asset becoming as enduring as gold? More likely, they fall in line with silk, pearls, silver, spices, cochineal, Beanie Babies, and countless other boom-bust speculative assets.

While it's impossible to predict Bitcoin's exact value trajectory, a historical "zoom out" suggests that with the rare exception of gold, speculative assets are dramatically devalued over time, and gold itself has not even been a particularly attractive long-term investment. No one knows whether these digital (and non-digital) speculative assets involved in today’s mania will go up for another 100 years or collapse tomorrow, but eventually the bubbles pop. Prudent investors should avoid being caught in the frenzy when the music stops. Instead, a wiser strategy is to invest in productive assets and continuously reinvest the returns they predictably generate to ensure a sustainable flow of income over the long haul.

Individual Investing vs Investing as a “Team”

Choosing between individual and team investing is akin to the creation of art. Consider your favorite masterpiece; was it the creation of a committee or the vision of one artist? While adding Leonardo da Vinci might elevate an average artist's work, even pairing two maestros like da Vinci and Monet could result in a piece less compelling than what one might create alone. Their singular talents might clash or dilute the other's vision. In the financial realm, this perspective parallels the wisdom of da Vinci's reputed sentiment, “When you are on your own you are all your own,” as shared by Will Durant in his "The Story of Civilization" masterpiece. Stanley Druckenmiller, too, advised George Soros that “you can’t have two cooks in the kitchen."

This year’s lack of new investments illustrates why investment teams might hinder performance. Imagine attending an investment committee meeting every week or two merely to say “no ideas” while critiquing others'. The pressure to conform often prompts individuals to generate ideas just for the sake of appeasement. Most people are innately conformist, aligning with the religion of their birth and mirroring the moral views prevalent in their community. Statistically, the probability of independently arriving at the same beliefs is low, given the diversity of thought both geographically and across time. Yet, nearly all adopt the ideologies of the place and time they are born into, not through independent reasoning but due to societal and familial conformity. Therefore, they lack independent thinking.

Personally, I strive to maintain originality through thoroughly independent thought.

Despite Druckenmiller’s insights, many firms deliberately choose large teams—not to harness collective brilliance but to conceal a lack of standout talent. This diffusion results in predictable mediocrity that appeases asset managers, who often leverage robust sales teams rather than exceptional investment acumen. Such an approach prioritizes stable management fees over exceptional returns. Unfortunately, allocators driven by personal interests often prefer the security of average performance, which safeguards their professional standing, personal status, and stable compensation over delivering stellar results to those they are meant to serve. They might cloak their motivations in jargon or strategic justifications, but the underlying truth is a preference for mediocrity that ensures their survival and prosperity within the industry.

Few organizations, like Citadel, masterfully orchestrate talent to create a great whole. However, in most cases, singularly talented investors are better positioned to achieve extraordinary outcomes.

Philip Equities as a Business

When it comes to investing, my primary goal is to maximize long-term returns adjusted for the risk of permanent loss of capital, as that's the hallmark of a skilled capital allocator. My focus is not on increasing assets under management (AUM). Instead, my focus remains on forever honing my skills and abilities, so I am ready to manage any amount of capital with competence. Thus, the journey goes on...