Invest in MASS, not GAS

This week I’ve been read­ing The Black Hole War by Amer­i­can the­o­ret­i­cal physi­cist Leonard Susskind. Fun­ni­ly enough, it got me think­ing about invest­ing.

As you might expect from the title, he’s talk­ing a lot about black holes and the rela­tion­ship between mass, grav­i­ty, accel­er­a­tion, and Ein­stein’s Gen­er­al The­o­ry of Rel­a­tiv­i­ty. As I’m read­ing it, analo­gies to invest­ing keep jump­ing out at me.

Finding the Mass

When think­ing about how we invest in QAV, I think of our ide­al tar­gets as being mass-heavy busi­ness­es. Mass, in this case, is their intrin­sic val­ue and qual­i­ty as a com­pa­ny.

One of the key mass met­rics we look at is the com­par­i­son between their Price and their Oper­at­ing Cash Flow. We like a busi­ness that gen­er­ates cash. Cash is king. Cash is mass. It’s the cash flow that attracts us. It cre­ates a grav­i­ta­tion­al pull. Com­pa­nies with strong cash flow have options: they can rein­vest, acquire, return cap­i­tal to share­hold­ers, or weath­er down­turns. Gas com­pa­nies have only hope.

A typ­i­cal QAV tar­get looks like a large plan­et that’s bil­lions of years old. It has a func­tion­al ecosys­tem that’s been evolv­ing over mil­len­nia and is pre­dictable. It might be bor­ing when com­pared to new­ly-formed plan­ets that are still a ball of hot molten met­al, giv­ing off lots of heat, but we pre­fer to set­tle on some­thing that is up and run­ning. That does­n’t mean it can’t have prob­lems, but it’s proven its abil­i­ty to make mon­ey. It’s what physi­cists call a Low Entropy sys­tem: it’s ordered, dis­ci­plined, and pre­dictable.

Some QAV tar­gets are big­ger than a plan­et. They are a star sys­tem, “star stocks”. We don’t end up with many of those, because usu­al­ly they are over­val­ued, but occa­sion­al­ly they turn up on our buy list (MQG, QAN, etc). They don’t just have an inter­nal ecosys­tem, they have an entire solar sys­tem of val­ue cre­ation sur­round­ing them.

Of course, not every busi­ness we invest in is a giant plan­et or star. Some are small­er, “cig­ar butt” types that have seen bet­ter days but are still gen­er­at­ing some mass. Some are turn-arounds: busi­ness­es that have had some major chal­lenges and had to re-invent their own physics.

But they still have cash. Either from reg­u­lar oper­at­ing activ­i­ties or, in some cas­es, from sell­ing off busi­ness units and cash­ing them­selves up. I’m par­tic­u­lar­ly think­ing of TUSK, the com­pa­ny I did a pulled pork on this week for QAV Amer­i­ca. An expe­ri­enced man­age­ment team will use that cash wise­ly and it will bring in even more mass.

Don’t Bet on Gas

On the oth­er hand, the com­pa­nies that get the most atten­tion in the finan­cial media are gas enti­ties. You have the “Gas Giants” and you have the “Comets” rac­ing through space. Gas giants look impres­sive to look at. They gen­er­ate a lot of hype but haven’t devel­oped any seri­ous mass. Their share price is often pred­i­cat­ed on pre­dic­tions of future earn­ings, which are most­ly gas. We strug­gle to jus­ti­fy the buy price when we look at their cur­rent intrin­sic val­ue (i.e. their actu­al mass).

At its peak in ear­ly 2021, After­pay hit a mar­ket cap of around ~$39 bil­lion AUD while report­ing rev­enue of ~$920M and with­out being prof­itable. Their val­u­a­tion was entire­ly based on “we’ll mon­e­tise this user base even­tu­al­ly”. Clas­sic gas giant. Huge, impres­sive-look­ing, but the price was all pre­dic­tions about future dom­i­nance in BNPL, not cur­rent cash gen­er­a­tion. Square (now Block) bought them for $29B USD in 2021, and the acqui­si­tion has been (let’s say) under­whelm­ing for Block­’s share­hold­ers.

In the Amer­i­can mar­ket, WeWork was val­ued at $47B in 2019 despite nev­er turn­ing a prof­it. Pre­sent­ed itself as a tech com­pa­ny when it was real­ly just a real estate sub­lease busi­ness haem­or­rhag­ing cash.

Even gen­uine stars can be over­val­ued. The Mag7 com­pa­nies gen­er­ate real mass, but their stock prices have inflat­ed into gas clouds: trad­ing at P/Es of 25–46 when our val­ue approach typ­i­cal­ly tar­gets much low­er mul­ti­ples. We’re not pay­ing $46 for $1 of cur­rent earn­ings, no mat­ter how bright the star.

Nobody knows for sure if the future will come to pass. The ana­lysts are just guess­ing (or… gassing).

Then you have the Comets. A comet is a small­er, fast-mov­ing icy body that warms up and begins to release gas­es when pass­ing close to the Sun: a process called “out­gassing.” They look spec­tac­u­lar. They are pret­ty and we wish upon them at night. But invest­ing isn’t about wish­ing. It’s about sci­ence. It’s about find­ing mass, not bet­ting on gas.

And don’t even get me start­ed on Cryp­to. If Future Earn­ings are Gas, Cryp­to is Plas­ma. It’s the fourth state of mat­ter: high-ener­gy, elec­tri­cal­ly charged, and com­plete­ly lack­ing a fixed shape or “Rest Mass.” It looks like a sun while the social “heat” is high, but it has no inter­nal grav­i­ty to hold it togeth­er. When the mar­ket heat turns off, the plas­ma does­n’t just shrink: it van­ish­es back into the vac­u­um. You can’t land a ship on plas­ma… but you might get burned.

The Event Horizon

While a lot of com­pa­nies we invest in con­tin­ue to grow in mass every year (see KOV, up near­ly 400% since we bought into them in 2020), some­times com­pa­nies we invest in dis­ap­pear.

When a star becomes dense enough, it cre­ates a Sin­gu­lar­i­ty: it col­laps­es in on itself and becomes a black hole. The star dis­ap­pears. When a com­pa­ny becomes dense enough (mean­ing the val­ue is high but the price is low), it can also dis­ap­pear.

Quite often, this takes the form of an acqui­si­tion or pri­vati­sa­tion. We see that hap­pen with a lot of QAV stocks. AHX was sus­pend­ed last week after a takeover approval and PPM surged this week on a buy-out bid. In these sit­u­a­tions, we tend to do quite well, as the Sin­gu­lar­i­ty takes the form of a rapid re-rat­ing of the price.

Alter­na­tive­ly, a com­pa­ny might descend into high entropy: chaos and bad deci­sions that burn through its cash. That kind of sys­tem does­n’t become a black hole, it just becomes a dead plan­et and delists. That’s usu­al­ly not a good out­come for investors and it’s why we need to under­stand our escape veloc­i­ty, our Sell Trig­gers (3PTL, Rule 1, etc).

So we’re like Cap­tain Kirk and the Enter­prise. We’re out there search­ing for sys­tems with a lot of mass. We zoom on past the gas giants, the comets, the major stars and the balls of hot plas­ma, acknowl­edg­ing how pret­ty they are to star-gaz­ers, but not deem­ing them wor­thy to land on. We’re going to land on plan­ets with a lot of mass and maybe meet a nice green alien lady to talk to. Just be care­ful of the Trib­bles.

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QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
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