Andy Kessler – Investor Profile

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This article is part of our ‘Guru’ series – investor profiles of those who have succeeded in the markets, with takeaways for the private investor in the UK.

You can find the rest of the series here.

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Andy Kessler

Andy Kessler was a Wall Street research analyst and investment banker and wrote about this in his first book – Wall Street Meat.

He then co-founded hedge fund Velocity Capital Management, which turned $80M into $1bn in five years. He wrote about this in Running Money.

He got out of the market at the top of the dot-com boom and became a financial journalist and author.

You can find out more about him on his website.

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Signposts in the Fog

Kessler’s chapter in John Mauldin’s book Just One Thing – which asks twelve successful investors to describe their one big idea – is called Signposts in the Fog.

Kessler uses a metaphor of climbing Mount Washington, on a clear day that suddenly turned to fog, obscuring the trail.

Kessler and his climbing partner relied on marker rocks painted yellow. As they reached each one, they could just about see the next, 10 to 15 feet away. But they made it to the top ((Where there is a restaurant – apparently most people drive or take a funicular railway to the peak ))

Kessler says that the correct price for a stock is the net present value (NPV) of a company’s future earnings. So all you need to know is:

• how much is the company earning today
• how fast it is growing, and
• what discount rate should you apply to future earnings to the NPV

For example:

• Widgets `R’ Us earned a dollar per share last year
• its growth rate was 12 per cent
• the ‘inflation deflator’ is 2.83 per cent

So the stock is worth $18.42, according to the textbook formula. So if the price is $20, you should short it, and if it’s $15 you should buy it.

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Standing in the sunshine

Kessler thinks you can’t do anything with the information that everybody has. He calls this ‘standing in the sunshine’.

Things won’t stay the same in the widget business – they could get better or worse. The company won’t grow at 12% a year. The inputs to the valuation model change all the time, even for a stock where everybody agrees on the prospects.

Kessler would rather be in the fog, where nobody knows anything, looking for a yellow rock.

He doesn’t mean being contrarian, he means seeing things before others, spotting trends before they are all around you.

You still have to keep on top of the news, the information fire hose. You have to know what everybody else knows – you have to know if your ideas are already out there.

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Elasticity in the markets

In 20 years on Wall Street, Kessler only really found two big signposts:

1. Elasticity: lower cost creates its own huge markets
2. Intelligence moves out to the edge of the network

Back in the mid-1980s, Kessler was a semiconductor analyst. He read an article suggesting that as the price of EPROMs – Eraseable Programmable Read-Only Memories – fell, they would be used in more devices.

This is elasticity – as the price falls, demand increases. ((Kessler contrasts this with fags and booze, which are inelastic – people will buy them no matter what the price))

It was Moore’s Law made flesh. ((Gordon Moore was the founder of Intel and famously said that microchip density would double every 18 months ))

Kessler was lucky enough to spot this during a downturn for tech stocks, so he was the only one saying this. When he started his hedge fund ten years later, he was still milking the elasticity theme.

If he and his partner couldn’t figure out how the company could scale and benefit from tech elasticity – and in particular, bandwidth – they didn’t invest. For about three years, this kept their firm ahead of the competition.

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Intelligence at the outer edges

The second trend was intelligence at the outer edges, which is really a byproduct of elasticity.

Networks (phones, cable TV etc) were historically managed from the centre. Rules are set by government committees, prices are often set by collusion. Innovation is stifled. Users come last behind moguls and shareholders.

As an example of the new wave, Kessler uses Skype – free phone calls (from PC to PC) without a phone contract.

The beauty of the internet is that it’s stupid – it just sends packets of data around. The intelligence is at the endpoints. Which means that new features can be added without upgrading the central network.

It’s not quite that simple – the Web and all its pages sit on servers that are centralised in data centres and searched and organized for the most part by Google. But when you call something up on your smartphone, it feels like intelligence at the edge.

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Quotes

You invest in companies with great long-term prospects.

The stock of the greatest company in the world is crap if every investor already thinks it is the greatest company in the world.

Wealth comes not just from taking risk but from constantly taking risks.

You can’t make money standing in the sunshine. I’d rather be out in the fog where nobody knows nothin’.

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Conclusions

Kessler’s investment approach is basically to look for trends that other people currently underestimate, extrapolate them out a few years, and see which companies will be the winners.

This is a frustrating ‘system’, because it feels at the same time that it is too easy, and yet almost impossible to apply.

• Back in the 1980s, few people would have predicted or believed that Moore’s law would hold for 40 years.
• And then in the late 1990s, sentiment went the other way, and anything connected to the internet became wildly overvalued.

It’s revealing to me that Kessler stopped being a money manager at the peak of the dot-com boom – a very good call – and is now a financial journalist.

It’s hard to see a way for a private investor to apply his ideas today.

• Apple is now the largest company on the planet, and jam-tomorrow firms like Tesla and Netflix already have sky-high ratings.
• Tech firms are also coming to market much later in their life cycle when the spectacular gains have already gone to founders and to venture capital.

Kessler’s approach is a good one, but it’s unlikely to make you rich today

Until next time.

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