You instantly recognize them. Not just because of the color, but because of that iconic emblem known as the Cavallino Rampante (Prancing Horse).

Yes, I’m talking about Ferrari.

“Oh, a luxury car company,” you might say.

But not exactly.

At its core, Ferrari is a company that manages one of the most desirable brands in the world. It’s not just another automaker.

Yes, the cars are the product.

But the business is something else entirely.

Ferrari is a luxury house, more comparable to LVMH than to a traditional car manufacturer.

What Ferrari Really Does

Ferrari designs, manufactures, and sells high-performance sports cars.

But unlike most automakers, it does not compete on volume, price, or market share.

It competes on something far scarcer: desirability.

And that changes everything.

The Business Model

To survive in a highly competitive industry, most car manufacturers try to produce and sell more vehicles every year.

Ferrari is different.

It operates under a simple idea:

Always produce one fewer car than the market demands.

That decision has several consequences:

• Demand remains higher than supply

• Ferrari doesn’t need discounts to sell cars

• It can raise prices without hurting demand

“Hold your horses, Ezra… are you telling me Ferrari competes by making fewer cars?”

Yes.

Because scarcity is not a limitation of the business.

It is the product.

Ferrari doesn’t look for customers.

It builds collectors.

Its business model doesn’t end when the car is sold.

That’s where it begins.

In 2025, 84% of Ferrari’s new cars were purchased by existing Ferrari owners. And more than half of those were sold to people who already owned multiple Ferraris.

Over time, the customer stops buying a car.

They begin building a collection.

They become part of a community.

Ferrari creates a long-term relationship through:

• Extreme personalization

• Access to limited models

• Preferential treatment

• A closed community

The Invisible Asset: Resale Value

Beyond the community, one of the most important parts of Ferrari’s model is how aggressively it protects resale value.

That completely changes the buying decision.

If a customer believes their Ferrari will hold — or even increase — its value over time, the real cost of ownership becomes much lower.

In some cases, even negative.

Why does that matter?

Because it makes buying the next Ferrari much easier.

The secondary market is not a side effect of the business.

It is part of the business.

Limited production, personalization, community, and resale value are not independent decisions.

They are designed to reinforce one another.

Ferrari does not sell individual cars.

It builds a system that compounds value over time.

The Role of Dealerships

Ferrari does not own its dealerships.

But it controls them rigorously.

They are not treated as simple distributors, but as extensions of the brand itself.

Ferrari uses dealerships to:

• Control the customer experience

• Manage vehicle allocation

• Maintain exclusivity

• Protect resale value

• Serve as community touchpoints

The dealership does not simply sell cars.

It filters, nurtures, and cultivates the customer.

A Self-Reinforcing System

Ferrari’s business is not linear.

It is a system.

Racing creates visibility.

Visibility creates desirability.

Desirability enables premium pricing.

Premium pricing generates profits.

Profits are reinvested into technology and racing.

And the cycle repeats itself.

Competitive Advantage

At first glance, Ferrari’s model may appear replicable.

It isn’t.

The company is protected by several powerful shields:

• More than 75 years of history

• Continuous presence in Formula 1

• An extremely loyal customer base

• Tight control over distribution

None of this is built quickly.

And none of it can simply be bought.

Final Thoughts

To close this profile, I’ll leave you with a comment from Guy Spier, CEO of Aquamarine Capital, during an interview with MOI Global:

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If you missed Part I, I’ll leave the link below so you can read it before continuing.

But structure can emerge from other forces as well.

Not all order comes from repetition or restraint.

Sometimes it comes from rules.

Sometimes from ritual.

Sometimes from geography.

The companies in this second part operate in very different industries. Airports. Spirits. Alpine railways. Yet each is anchored to something that moves slowly, or not at all.

One operates inside contracts written decades in advance.

Another aligns with habits that outlive marketing cycles.

The third controls access to a mountain that cannot be relocated.

Low entropy takes many forms.

These are three more.

Grupo Aeroportuario del Centro Norte (OMA) — A business that operates inside fixed lines

The runway does not move.

Flights are delayed.

Passengers complain.

Airlines change routes.

But the runway stays exactly where it is.

That stillness is not just physical. It is contractual.

OMA operates under long-term concessions granted by the Mexican government. These agreements do not merely allow the company to manage airports; they define the boundaries of the business decades in advance. The network is fixed. The geography is fixed. The framework is fixed.

In most industries, companies fight to expand their territory. OMA begins with it already assigned.

That constraint creates order.

At the heart of the model lies a simple separation. On one side, aeronautical services: landing fees, passenger charges, use of gates and security infrastructure. These are regulated. Prices are capped. Returns are negotiated through a maximum tariff system.

On the other side, commercial activity: restaurants, parking lots, advertising, hotels, logistics parks. These are largely unregulated. Here, the company has flexibility.

The result is a deliberate balance. The core utility is stable but capped. The surrounding ecosystem is flexible but anchored to passenger flow.

The airport becomes less like a transportation business and more like a regulated mall attached to a runway.

Every few years, another stabilizer enters the system: the Master Development Program. Investments are not impulsive. They are negotiated in advance with the government. Expansion plans are tied to tariff adjustments. Capital spending and future revenue are linked in a structured loop.

Growth, in other words, follows a script.

This matters. Because in many capital-intensive industries, volatility comes from mistimed expansion. Too much runway. Too little traffic. OMA’s structure reduces that risk by forcing discipline into the investment cycle itself.

Even internally, the company avoids fragmentation. Its thirteen airports are not run as isolated profit centers. Profitable hubs help sustain smaller locations through a solidarity mechanism. Administrative functions are centralized. Standards are shared. The network behaves as one organism, not thirteen separate ones.

Entropy often enters when units compete with each other or drift apart. OMA’s structure prevents that drift.

Airports look dynamic from the outside. Planes taxi. Screens flicker. People rush through terminals. But beneath the motion lies a system built around permanence—steel, concrete, contracts, and regulatory formulas that move slowly.

That is the hidden advantage.

OMA does not need to reinvent air travel. It does not need to persuade customers to adopt a new habit. It does not need to redesign its core product every season. Its primary task is operational execution within clearly defined limits.

Some businesses generate complexity by chasing expansion.

Others reduce complexity by accepting their boundaries.

OMA belongs to the second group.

Its low entropy does not come from innovation or cultural ritual. It comes from operating inside fixed lines—and allowing those lines to do most of the stabilizing work.

When the rules are written decades in advance, the system has fewer ways to surprise you.

Diageo — A business built on ritual

The bottle shape does not change.

The label remains familiar.

The liquid tastes the same.

The ritual repeats.

A wedding toast.

A holiday dinner.

A quiet drink after work.

Diageo’s advantage begins there.

Unlike many consumer companies, Diageo does not sell novelty. It sells continuity. Its portfolio is built around what it calls “icons”—brands that have survived decades, sometimes centuries, without needing reinvention. Scotch, tequila, gin, stout. Categories that are less fashion than tradition.

That distinction matters.

Most consumer businesses decay when tastes shift. They chase trends, launch extensions, refresh packaging, and experiment constantly to stay relevant. Diageo’s core brands do not need to chase. They occupy rituals that already exist.

The company’s strategy reflects that understanding. Rather than focusing on volume growth, Diageo leans into premiumisation—the idea that consumers may drink less, but drink better. As incomes rise, the trade-up effect supports value growth even when total consumption stabilizes.

The system is not built on acceleration. It is built on upgrading.

Behind the label lies another stabilizer: time. In spirits, maturation is not optional. Scotch ages for years. Sometimes decades. The company’s vast inventory of maturing stock represents revenue secured far in advance. Decisions made today will only be realized years from now.

Few businesses operate with such embedded patience.

Supply chains stretch from grain fields and agave farms to distilleries and warehouses filled with aging barrels. Yet despite the scale, the model remains coherent. Diageo centralizes operational processes globally while allowing local market teams to focus on execution. The structure absorbs complexity so the brands do not have to.

Entropy often enters consumer goods through fragmentation—too many SKUs, too many campaigns, too many experiments. Diageo’s discipline lies in protecting the core. The icons remain central. Innovation happens around them, not in place of them.

Even shifting social norms are incorporated rather than resisted. As moderation trends rise, the company expands into non-alcoholic variants, preserving the ritual even when the alcohol content changes. The habit survives. The brand remains.

That is the deeper layer of stability.

Alcohol consumption may fluctuate with economics and culture, but human rituals move slowly. Celebrations persist. Social bonding persists. Identity expressed through brand choice persists.

Diageo does not need to create those behaviors. It aligns with them.

Some businesses depend on constant novelty to stay alive.

Others endure because they anchor themselves to traditions that outlive any marketing cycle.

Diageo belongs to the second group.

Its low entropy comes not from avoiding change, but from embedding itself in habits that resist rapid change. When a business is tied to ritual, time works with it rather than against it.

And rituals, unlike trends, are patient.

Jungfraubahn Holding — A business anchored to a mountain

The mountain is not moving.

Snow melts.

Tourists arrive and leave.

Currencies fluctuate.

But the mountain stays exactly where it has always been.

Jungfraubahn’s advantage begins with that fact.

The company operates railways and cableways that lead to one of the most iconic high-altitude destinations in the Swiss Alps: Jungfraujoch — “Top of Europe.” It is not simply transportation infrastructure. It is access to a fixed point in geography, carved into rock more than a century ago.

Unlike most leisure businesses, Jungfraubahn does not invent demand. It channels it.

The model is built around control of the entire service chain. A visitor does not just buy a train ticket. They purchase a journey: transport, restaurants, retail, observation decks, curated experiences. By integrating the elements along the route, the company reduces operational fragmentation. One ticket. One path. One controlled flow of people.

Order replaces improvisation.

Stability also comes from diversification, but not the kind driven by expansion into unrelated industries. Jungfraubahn balances three seasonal pillars: the high-altitude Jungfraujoch attraction, winter sports operations, and summer “experience mountain” tourism. When one weakens, another strengthens. Snow-dependent revenue is offset by year-round international tourism. The seasons hedge each other.

The system breathes, but it does not lurch.

A quieter source of low entropy lies beneath the tracks: energy. The company operates its own hydroelectric power plant, generating electricity to power its railways and cableways. In a business dependent on elevation and transport, energy sovereignty removes a layer of external volatility. The trains run because the water flows.

Centralization further tightens the structure. Through a shared management entity, marketing, IT, procurement, and technical expertise are pooled across the group. What could have been a collection of isolated mountain railways becomes a coordinated organism. Standards are uniform. Decisions are aligned.

Entropy often enters when subsidiaries drift apart. Here, they move in formation.

The most powerful stabilizer, however, remains geography. The railway climbs into a UNESCO World Heritage landscape that cannot be replicated or relocated. There is no substitute mountain next door. No alternative “Top of Europe” to be built by a competitor. The asset is not scalable—but it is irreplaceable.

That distinction is subtle but important.

Jungfraubahn does not grow by multiplying locations. It grows by improving the experience of reaching the same place. Capacity projects like the V-Cableway increase flow and reduce waiting times, but the destination remains unchanged. The company evolves around a constant core.

In a world where businesses chase flexibility, Jungfraubahn is anchored to stone.

Some companies endure because they control habits.

Others endure because they control rules.

Jungfraubahn endures because it controls access to something that does not move.

When the destination is fixed, the system has fewer ways to unravel.

Conclusion

In the first part, low entropy emerged from discipline and inevitability.

Here, it emerges from boundaries, habits, and geography.

OMA operates inside fixed rules.

Diageo aligns with rituals that change slowly.

Jungfraubahn controls access to a place that does not move.

Different industries. Different risks. Different growth paths.

But the same underlying pattern.

Each business is structured around forces larger than management decisions. Contracts. Culture. Stone.

In investing, we often look for innovation, disruption, and acceleration.

Perhaps we should also look for gravity.

The forces that keep systems in place.

Because when the foundation moves slowly, the business above it often does too.

And in the long run, stability can be just as powerful as speed.

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They fail because they become disordered.

Decisions pile up. Products multiply. Exceptions turn into rules. Complexity creeps in slowly, almost invisibly, until the system can no longer hold itself together. What once worked begins to require constant attention, constant adjustment, constant energy.

In physics, there is a word for this tendency: entropy. Left unattended, systems drift toward disorder. Business is no exception.

Yet some companies seem oddly resistant to this pull. They do not need to reinvent themselves every few years. They do not chase every new trend. They do not depend on precise forecasts or heroic execution. Their operations feel calm. Repetitive. Almost boring.

And because of that, they last.

These are low-entropy businesses. Not because they avoid change altogether, but because their core systems are built around forces that change very slowly—or not at all. Human rituals. Biological cycles. Structural simplicity. Fixed rules.

This essay is not about valuation, growth rates, or competitive positioning in the traditional sense. It is about structure. About why certain businesses remain ordered while others gradually unravel, even when they appear successful on the surface.

To explore this idea, we will look at three very different companies:

1. A funeral services provider built around an unavoidable human moment.

2. A materials company that operates at the pace of trees.

3. A retailer that wins by removing decisions rather than adding them.

They share little in common at first glance. Different industries. Different geographies. Different customers. But underneath, they are governed by the same principle: they are designed for a world that doesn’t need to change very much.

Service Corporation International (SCI) — A business built for a world that doesn’t change

The phone rings.

Not because the economy is booming.

Not because rates moved.

Not because a new technology launched.

It rings because someone just lost a parent.

That is where SCI begins. And that single fact explains almost everything about why it is a low-entropy business.

Most companies wake up every morning fighting uncertainty. Will demand hold? Will customers switch? Will a new product make them irrelevant? SCI doesn’t play that game. Its core service is triggered by an event that ignores markets, innovation cycles, and quarterly narratives. Death does not wait for better conditions.

That inevitability is the first source of order.

But inevitability alone does not create a durable business. What matters is what happens after the phone rings. And here is where the structure becomes revealing.

At the moment families walk through the door, they are not looking for novelty. They are looking for familiarity. Ritual. Reassurance. The service delivered today looks almost identical to the service delivered decades ago. Same sequence. Same steps. Same expectations. Human emotions change very little at moments like these, and SCI has built its entire operation around that constancy.

Repetition is not a weakness here. It is the system.

In most industries, repetition signals stagnation. In this one, it creates calm. Processes become muscle memory. Decisions shrink. Variation disappears. The business does not need to experiment; it needs to execute. Thousands of times. In thousands of locations. With very little improvisation.

That repetition drains entropy from the system.

There is another detail that rarely gets attention, but it matters. Part of this business is organized before it is needed. Families plan ahead. Arrangements are made in quiet rooms, years in advance, often over coffee rather than grief. From an operational perspective, this shifts time itself. Work is done today for an event that will happen tomorrow. Uncertainty gets pulled forward and neutralized.

Time, which usually destabilizes businesses, becomes an ally.

Compare that to industries obsessed with speed. Software companies sprint to outrun the next update. Media businesses chase attention that evaporates overnight. Even retailers must constantly adjust to shifting tastes. SCI faces none of that pressure. There is no technological shortcut around a funeral. No app can replace presence. No platform can compress the moment.

Change arrives slowly here. Almost politely.

This is what low entropy looks like in practice. Not growth charts or scale metrics, but a system where the number of decisions that truly matter is small—and shrinking. Where the core service fulfills a fundamental human need that remains constant across generations. Where the business survives not by anticipating the future, but by being largely indifferent to it.

There is something almost uncomfortable about that stability. In a culture that celebrates disruption, SCI feels anachronistic. Quiet. Unambitious. And that is precisely its strength.

Some businesses are designed for a world that accelerates.

Others are designed for a world that doesn’t.

Service Corporation International belongs firmly to the second category. Its advantage is not innovation, brand, or even scale. Its advantage is that the rules of its game barely move. And when the rules don’t move, order compounds.

Near the end of his life, Charlie Munger once remarked how little time he had left, not how much he had accumulated. That instinct—to see the world as finite, not scalable—is rare in business.

SCI operates as if it understands that instinct.

And in doing so, it has built something surprisingly durable: a business that wins not by changing faster, but by needing to change less.

Corticeira Amorim — A business that moves at the speed of trees

The tree is not cut.

That detail matters more than it sounds.

Every nine years, a worker peels the bark from a cork oak using a small axe. The tree stays standing. It keeps growing. It keeps absorbing carbon. And it will be harvested again. And again. For more than a century.

That single biological constraint sets the tempo for Corticeira Amorim. And it explains why this is one of the lowest-entropy businesses you will ever encounter.

In a world obsessed with speed, cork refuses to hurry.

Corticeira Amorim is the global leader in cork processing, but that description misses the point. This is not a manufacturing story. It is a time story. The raw material grows slowly, regenerates slowly, and improves with age. No software update can accelerate it. No breakthrough can compress it. The supply chain moves at the pace of biology.

That pace imposes order.

The company’s structure mirrors this constraint. Corticeria controls the entire lifecycle of cork, from forest management to final applications. Forests are managed decades ahead of demand. Raw material is prepared centrally. What can’t become a wine stopper becomes flooring. What can’t become flooring becomes insulation. What can’t become insulation becomes energy to power the factory itself.

Nothing is rushed. Nothing is wasted.

This is where most businesses introduce entropy: leftovers, exceptions, inefficiencies. Amorim does the opposite. Every fragment has a destination. Even cork dust is burned as biomass to fuel production. Waste does not accumulate because the system does not allow it to exist.

Order is engineered into the process.

At the surface, the company looks diversified. Wine stoppers. Construction materials. Aerospace components. Transportation. Energy. Sports surfaces. Fashion. Toys. But this is not diversification in the financial sense. It is reuse at scale. One material. One biological input. Many outcomes.

Think of cork as nature’s high-tech foam. Lightweight. Compressible. Insulating. Fire resistant. And endlessly recyclable. Corticeira doesn’t chase new markets; markets keep finding new uses for cork. From sealing a bottle of wine to protecting a spacecraft during re-entry, the material stays the same. Only the application changes.

That stability matters.

Innovation exists here, but it plays a different role. R&D is not about reinventing the business. It is about refining the material. Cleaning it better. Shaping it differently. Adapting it to new technical requirements without altering the underlying system. Innovation reduces entropy instead of introducing it.

The company’s sustainability narrative often gets framed as ESG. That misses the deeper point. Sustainability is not an overlay. It’s a consequence. When your raw material regenerates itself, and your process extracts value from every molecule, environmental alignment stops being a tradeoff and becomes a structural advantage.

The forests outlast management teams. The trees outlive product cycles.

This is why Corticeira Amorim feels almost immune to the forces that destabilize most businesses. There is no sudden obsolescence risk. No platform shift. No winner-takes-all dynamic. The competitive advantage is not technological or financial. It’s temporal.

The business changes slowly because it has to. And because it has to, it stays ordered.

Most companies fight entropy by adding layers: systems, dashboards, committees. Corticeira avoids entropy by accepting a simple truth: some resources cannot be accelerated. When you build around that constraint instead of fighting it, the entire organization settles into a natural rhythm.

Trees grow. Bark regenerates. Value compounds.

In investing, we often talk about businesses that scale. Corticeira Amorim is different. It endures. And in a world where everything seems designed to break faster, endurance may be the rarest advantage of all.

Costco — A business that wins by saying no

The store feels unfinished.

The concrete floor is bare.

Boxes sit on pallets.

Signs look temporary.

There are no aisles designed to inspire browsing.

And yet, every cart is full.

That contradiction is the first clue to understanding why Costco is a low-entropy business.

Most retailers try to win by offering more: more choice, more brands, more promotions, more personalization. Costco does the opposite. It removes options. Relentlessly. And in doing so, it creates order.

Walk into a typical supermarket and you face tens of thousands of decisions. Which brand? Which size? Which promotion? Costco cuts that chaos down to fewer than four thousand items. Often, just one version of a product. Sometimes two. Rarely more.

The customer doesn’t decide. Costco already did.

That is the system.

The membership card makes this even clearer. You pay before you shop. The transaction begins long before you reach the checkout. That single step flips the entire economic relationship. Costco no longer needs to extract profit from every item. The annual fee covers most of the overhead. Everything else can be sold at razor-thin margins.

The incentive to confuse disappears.

This is where entropy usually enters retail: markdowns, seasonal resets, promotional noise, constantly changing layouts. Costco avoids all of it by anchoring the model around trust. Members don’t come to discover new things. They come to buy known things at fair prices, again and again.

Repetition becomes a feature, not a flaw.

Behind the scenes, the same philosophy applies. Warehouses are simple by design. Products stay on the pallets they arrived on. Inventory moves fast. Handling is minimized. Complexity is treated as a cost, not a competitive advantage. The fewer steps something takes, the fewer things can go wrong.

Even cash behaves differently here. Inventory often sells before suppliers are paid. Time works in Costco’s favor, quietly smoothing the operation. Nothing flashy. Nothing heroic. Just a system that compounds small efficiencies day after day.

The same logic extends to people. Employees stay. Careers last decades. Managers are promoted from the floor. Knowledge accumulates instead of leaking out. In an industry known for churn, stability becomes another form of cost control.

What makes Costco unusual is not scale or pricing power. Plenty of companies have those. What makes it unusual is discipline. The discipline to say no to selection. No to aesthetics. No to short-term margin expansion. No to optimization that adds friction.

Most businesses accumulate entropy by adding layers. Costco reduces it by subtracting them.

The result is a company that barely needs to change. The core rules have held for decades. Members trust the price. Suppliers respect the volume. Employees understand the culture. The system runs because it is simple enough to be understood and repeated.

That simplicity is hard to copy. Not because it is complex, but because it requires restraint.

Where retailers fight for attention, Costco operates like a cooperative with a building. It doesn’t try to excite you. It tries to serve you. And because it does, the business remains calm while everything around it accelerates.

Some companies grow by expanding choice.

Others endure by removing it.

Costco belongs to the second group. Its low entropy comes not from innovation, but from consistency. From a refusal to complicate what already works. From the quiet confidence that fewer decisions—made well—are better than many decisions made often.

Conclusion

We often talk about business success as if it were a race against time. Faster growth. Faster innovation. Faster response. The assumption is that endurance comes from speed.

The companies in this essay suggest something different.

They endure because they are built around forces that do not accelerate easily. Death does not move faster. Trees do not grow on command. Habits formed through trust do not need constant redesign. These businesses do not fight time; they align with it.

Their advantage is not superior forecasting or clever strategy. It is restraint. The discipline to accept limits. The patience to repeat what works. The confidence to leave certain things untouched.

Low entropy is not about avoiding change. It is about deciding where change is allowed to happen—and where it is not.

Most organizations accumulate disorder by adding. New products. New processes. New exceptions. Over time, the system demands more energy just to stay in place. These businesses do the opposite. They remove decisions. They narrow variation. They build structures that can be run without constant intervention.

That is why they feel calm.

In investing, we spend enormous effort trying to predict what will change next. Perhaps we should spend more time identifying what is unlikely to change at all. Human rituals. Biological cycles. Simple rules that scale quietly.

Durability is not always about doing more.

Sometimes, it is about needing less.

And in the long run, order compounds just as reliably as growth.

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Todd Combs is leaving Berkshire Hathaway and GEICO to join JPMorgan.

A quiet, almost monastic investor stepping away from the house Buffett built— that alone is enough to make any long-term thinker pause.

According to CNBC, JPMorgan hired him to lead its new Security and Resiliency Initiative, looking for direct equity investments across defense, aerospace, healthcare, and energy.

Yes, the industries that matter when the world becomes unpredictable.

When someone like Todd moves, he isn’t chasing headlines.

He’s redirecting a process.

A worldview.

A philosophy.

And that philosophy might be one of the clearest frameworks for thinking about businesses and investing today.

Below are the timeless lessons I’ve taken from his writing — particularly from his introduction to Security Analysis — and from studying how he actually works. Because if you understand Todd’s process, you understand why he succeeds in environments where others get lost in noise.

Start With Facts, Never With Stories

The first principle of Todd’s philosophy is almost austere:

When done well, investing involves learning how to process information in order to determine when the odds are in your favor; the goal is to make educated bets based on facts and not stories.

That sentence alone explains why Buffett hired him.

Todd avoids the trap that captures so many smart analysts: beginning with a narrative and then gathering evidence that confirms it.

He works in the opposite direction.

His process always starts with primary sources:

• SEC filings

• Annual reports

• 10-Ks, 10-Qs

• Trade journals

Never with:

• Management narratives

• Sell-side research

• “Channel checks” from biased insiders

• Consensus stories

Opinion last. Facts first.

Because once you adopt a story, you unconsciously begin protecting it.

Great Businesses Reveal Themselves Through Their Economics, Not Their Story

Todd breaks analysis into the first of his three major buckets:

1. Find a good business

What does “good” actually mean?

According to Todd, a great business has:

• A wide moat

• Low capital intensity

• Pricing power

• Recurring revenues

• Staying power

• The likelihood of long-term growth

And you can only confirm these traits by ripping the business “down to its studs.”

His sequence is always quantitative, then qualitative:

a) Start with the balance sheet

The balance sheet tells you how the business funds itself, how much risk it carries, and how fragile it truly is.

b) Cash flow statement second

Cash flow reveals how much oxygen the business produces without illusions.

c) Income statement third

Think in terms of a dollar of revenue that flows into a business and runs through the cash flow statement, then the balance sheet, and last the income statement. This is ultimately how we derive a company’s return on invested capital, which is usually a reliable shorthand for the quality of the business.

Todd doesn’t want to know how a company performed.

He wants to understand how each unit performs — a store, a subscriber, a policy, a widget.

It’s business reality, not spreadsheet reality.

Start with facts and not opinions. If you start with opinions, it’s very easy to become wedded to them even when the facts run counter to the popular narrative.

The Second Bucket: Great Management Actually Matters

Most investors underestimate management. Todd does not.

The importance of good management is almost universally underestimated, yet it is one of the most crucial determinants of a company’s intrinsic value. As Graham and Dodd said, “You cannot make a quantitative deduction to allow for an unscrupulous management; the only way to deal with such situations is to avoid them.”

He evaluates leadership as if he were buying the entire company himself.

How does Todd judge management?

Not by charisma.

Not by interviews.

Not by investor days.

He studies:

• Incentives (via the proxy statement)

• Capital allocation decisions

• Use of leverage

• Whether the CEO acts like an owner

• Whether they plant seeds for the future or borrow from it

He goes deeper through scuttlebutt — talking to people who have actually worked with or for the CEO.

• Are they honest?

• Do they break teams?

• Do they oversimplify?

• Do they confront reality or avoid it?

In Todd’s eyes, CEO incentives predict outcomes better than CEO words.

While we know that a long-term perspective is crucial in running a business, there are often unfortunate incentives to become overly short-term oriented. The private owner of a great business isn’t worried about quarterly earnings, meeting market expectations, stuffing sales channels, pursuing aggressive accounting treatments, or withholding long-term investments to improve reported short-term results.

The Third Bucket: Price Still Matters (More Than Ever)

A great business with a great CEO is still a bad investment at the wrong price.

This is where Todd’s discipline shows.

He insists on three valuation ideas:

1. Owner earnings > EBITDA: EBITDA, especially adjusted EBITDA, is a shortcut Todd distrusts. He focuses on owner earnings — the cash left after maintaining the business.

2. Capital structure matters. A company dependent on leverage is fragile, even if earnings look strong.

3. Margin of safety. Todd reminds us: We know far less than we think.

Perfect information does not exist; there are only confidence intervals. This is, of course, at the heart of why a margin of safety matters so greatly in investing. If you start with the premise that there is only so much one can know, of course you need a margin for error. The less you know, the greater the margin needed.

What We Can Learn From Todd Today

Here are the lessons I return to most often:

1. Start with facts. End with opinions. Never reverse the order. The moment you start with a story, you’ve already lost.

2. A spreadsheet is not business reality. Cash flow, incentives, and unit economics are reality.

3. Management quality is not a narrative — it’s a set of behaviors. Incentives > charisma > presentations.

4. The right price matters more than the right narrative. Good businesses are terrible investments at the wrong prices.

5. Humility compounds. You cannot know everything. But you can design a process that works despite that.

Conclusion

I believe Todd Combs didn’t leave Berkshire to become a different investor.

He left to express the same principles in a world where those principles are desperately needed.

And that’s the point:

A great investor doesn’t chase outcomes.

A great investor builds decisions.

Decisions that survive uncertainty, noise, and time.

Investors must find a way to navigate through uncertainty and randomness. There are decisions beingmade every day, and sometimes made decades earlier, that are still affecting outcomes today in every business and industry.

That’s the Todd Combs philosophy.

And there has never been a better moment to study it.

I’d love your take: what’s the most important idea you’re taking from this essay?

Let me know in the comments.

If you’d like to keep reading pieces like this one, I’d be glad to have you as a subscriber.

Ezra’s Notes is free, and it helps me write more essays worth your time.

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Glad to have you here!

Ezra.

Stealing an idea from my friend this edition is all about visuals.

And in a way, it works as a companion piece to my recent essay on the AI mania—where I argued that every technological boom is really a story about how humans react to accelerating change.

If that essay explored the narrative side of the cycle, this post looks at the evidence behind it.

The scale of capex, the shifting economics of hyperscalers, the power constraints, the geographic and sector winners, the capital loops between OpenAI, Microsoft, Nvidia and everyone orbiting them… When you see the data laid out, the magnitude of the moment becomes much clearer.

So today’s post is simple: 19 visuals that explain the AI boom better than a thousand takes.

Capex, returns, sectors, beneficiaries, risks—everything in one place.

Let’s dive in.

If this added value to your day, give it a like and share it with someone who enjoys long-term thinking. Thanks for supporting the newsletter.

how we react when the future seems to accelerate faster than our ability to understand it.

AI triggers hope, fear, ambition, and vertigo in equal measure. And from the inside, everything feels inevitable, logical, even obvious… until it no longer is.

In recent weeks, I read four Q3 2025 letters written by investors I respect —Wedgewood Partners, Praetorian Capital, Greenlight Capital, and Hayden Capital— each of them observing the same fever from a different angle.

Rather than trying to decide who was “right,” I was interested in understanding what we could learn by comparing their perspectives.

These four letters didn’t just teach me about the current state of AI.

They taught me about the way investors interpret a mania.

Lesson #1 — (Wedgewood Partners): The Scale of the Boom

“Manias feel inevitable when the numbers get so big they stop having meaning.”

Wedgewood Partners was the first to remind me of something uncomfortable:

Behind every boom, there is a point where enthusiasm stops acknowledging arithmetic.

Their letter includes an observation that perfectly captures the current moment:

“Artificial Intelligence (AI) stocks long continue to be darlings of Wall Street… yet, to try to grasp the ever-growing forecasts of trillions in the necessary infrastructure to support the current insatiable demand does give an investor pause — particularly given how crowded the ‘AI trade’ has become.”

What’s interesting is the idea beneath that sentence:

The notion that AI is not only absorbing capital, but also the collective imagination.

To articulate that feeling, the Wedgewood team turns to an unexpected cinematic metaphor: The Blob.

Just as that creature devoured everything in its path, today’s investment in AI is creating a growing mass of CAPEX, credit, and hype—within which economic logic begins to dissolve.

The numbers explain why:

• The tech sector—traditionally “asset-light”—is mutating into a capex-heavy, debt-dependent model.

• For two decades, data centers were funded with internal cash flow; yet in 2025 alone, the tech giants raised US$150 billion in debt to sustain the AI fever.

• According to Bain & Co., the US$500 billion in required CAPEX will demand US$2 trillion in revenue to be justified.

Figures that, in Wedgewood’s words, defy analytical comprehension… and yet, the market is cheering.

But the most unsettling part isn’t the magnitude of the spending—it’s the speed.

The GPUs powering the revolution depreciate in 3–5 years, while NVIDIA is already accelerating toward annual upgrade cycles.

This means massive amounts of capital could become obsolete long before recouping their investment.

Wedgewood calls this a potential wave of depreciation-driven earnings compression.

And then there’s another constraint people discuss far less: energy.

Some data centers consume as much electricity as an entire U.S. city.

Wedgewood warns that the real bottleneck won’t be technological, but political.

Without a massive expansion of the power grid—and possibly water access—AI will run straight into the physical limits of the system.

Lesson #2 — (Harris Kupperman of Praetorian Capital): When the Math Doesn’t Add Up

How much revenue is needed to justify the current level of capex spend and give AI investors a return on their capital??

Harris “Kuppy” Kupperman of Praetorian Capital describes something unsettling.

After speaking with insiders in the data-center ecosystem, he discovered that many of them—the very people building the AI infrastructure—are confused.

They don’t understand how these projects are supposed to generate economic returns.

And the most concerning part isn’t that they don’t understand it. It’s that investors don’t either.

Kuppy agrees with Wedgewood on a critical point: GPUs become obsolete in 3 to 5 years, precisely as NVIDIA accelerates its upgrade cadence.

This means that to reach a reasonable breakeven, the industry would need roughly US$1 trillion in revenue—an amount that turns any financial model into an act of faith.

Then comes the uncomfortable question he raises: hyperscalers have spent years subsidizing money-losing businesses to pull users into their ecosystem.

Kuppy wonders whether AI is simply another one of those businesses that, strategically, can lose money indefinitely.

Part of the market believes these costs will be offset once AI replaces highly skilled jobs.

Harris isn’t buying it: that disruption—if it arrives—is years away and will require technology far more advanced than what exists today.

His diagnosis is broader: without U.S. government intervention, and without the investment boost created by AI, the United States would already be in a recession. In fact, he argues that the AI bubble may represent more than 100% of recent economic growth.

To illustrate the phenomenon, he turns to the 19th-century railway bubble: a transformative industry, enormous promise, insiders convinced that investment had to continue endlessly…

Yet the cycle still blew up multiple times, triggering financial panics and sending many companies into bankruptcy.

In his sharpest line, he compares the two eras:

Raising capital for a money-losing business is hard. Back then, you got a free train trip. Now you get the free use of an LLM.

This investor is also skeptical of the circular investment patterns among Big Tech: companies investing in one another to justify growth—alarmingly similar to what happened with fiber-optic networks during the dot-com bubble.

Finally, he warns that this bubble won’t burst because of a technical signal, an obvious metric, or a sudden narrative shift.

His conclusion is human, almost psychological:

Like all bubbles, it implodes when people get tired of funding it.

Lesson #3 — (David Einhorn of Greenlight Capital): The AI Spending Delusion

There is a good chance that 25 years from now, AI will turn out to be even more important than we currently imagine. But, the path from here to there is likely to be very bumpy for investors.

David Einhorn of Greenlight Capital arrives at conclusions eerily similar to Kupperman’s: He too sees a deep disconnect between the enormous sums being allocated to AI and the basic arithmetic required to justify them.

The most revealing part is that not even the protagonists themselves know how they’re supposed to earn back what they’re spending: Tim Cook (Apple), Mark Zuckerberg (Meta), and Sam Altman (OpenAI) have all failed to articulate a clear path to economic returns in the face of this massive wave of CAPEX.

Their answer is always the same: “This will eventually pay off.”

But the key word is “eventually,” and Einhorn wonders how long that eventually can last.

In his letter, he cites a McKinsey study projecting something monumental: by 2030, global AI-related CAPEX could reach US$6.7 trillion—with US$5.2 trillion going to data centers alone.

The question he raises is simple and brutal:

Where will those nearly US$7 trillion come from?

His analysis is straightforward: the math doesn’t add up.

Not even the “Mag Seven” —the most profitable companies on the planet— generate enough free cash flow to finance this vision of the future.

Collectively, they produce around US$500 billion in FCF per year.

Half of that is already committed to stock buybacks and dividends.

Their total book equity is roughly US$1 trillion — a fraction of the spending required.

Even if Wall Street, private equity, and venture capital emptied their coffers, there would still be a multi-trillion-dollar gap that could only be filled with massive new debt.

To justify all this spending, AI would need to generate about US$2 trillion in annual revenue by 2030—equivalent to the combined size of today’s global market for advertising and software subscriptions.

Einhorn’s question is obvious: Is that even remotely plausible?

He then dives into something even more troubling: the illusion of revenue.

He describes how much of the “AI revenue boom” doesn’t come from real customers, but from AI companies buying products from one another.

His line is precise:

Much of the revenue in AI simply comes from AI companies buying products and services from each other.

He even walks through a concrete example:

A single dollar spent on a ChatGPT subscription can turn into eight dollars of “reported revenue” along the chain—OpenAI to Microsoft, to CoreWeave, to NVIDIA—without a single dollar of net economic value being created.

It is, quite literally, the same dollar inflating multiple income statements.

This dynamic, he warns, creates a false illusion of growth while masking value destruction, overcapacity, and a fragile structure dependent on cheap capital.

Einhorn’s other critical point is the almost religious faith in AGI (Artificial General Intelligence).

He challenges the belief that we are close to machines that “think” or improve themselves.

Current models, he argues, are statistical systems that mimic patterns; they do not understand, reason, or make real inferences.

To illustrate this excess of optimism, he points to the case of self-driving cars: for a decade, they were always said to be “one year away.” And yet, that year never arrived.

The expectation of imminent AGI, he argues, is not technology.

It is wishful thinking, amplified by financial incentives.

Lesson #4 — (Fred Liu of Hayden Capital): Bubbles as Engines of Progress

Not all bubbles destroy. Some prepare the ground.

In contrast to the skeptical tone of the other managers, Fred Liu of takes a different stance:

Stop looking at the trees and step back to see the forest.

He doesn’t focus on whether we are or aren’t in a bubble.

He proposes something more interesting: to ask what kind of world is being built by this wave of AI investment.

His thesis runs counter to market intuition:

Bubbles are a feature, not a bug, of technological progress.

Instead of seeing them solely as financial tragedies, Liu sees bubbles as mechanisms of civilizational advancement: periods of excess that finance critical infrastructure, massive experimentation, and new mental models.

To explain this, he turns to three illuminating historical examples.

1. “Canal Mania”: The Infrastructure That Survived the Speculation

In the late 18th century, the British financed thousands of miles of canals in a speculative frenzy. Many companies went bankrupt. Many investors lost everything.

But the country was left with a network of 4,000 miles of canals that drastically reduced transportation costs, enabled the movement of fragile and heavy goods, and became the logistical backbone of the Industrial Revolution.

Liu highlights something fascinating:

Canal transport became cheaper after the bubble burst because the collapse erased the original capital costs and forced competition among overbuilt routes. New owners could price at marginal cost instead of the much higher, original construction cost, turning canals into near-free public goods.

The capital was lost.

The infrastructure remained.

And with it, a new economy became possible.

2. The Railroad Boom: The Excess That Unified a Country

In the late 19th century, the United States experienced another wave of euphoria: railroads.

In 40 years, the nation went from 30,000 to 200,000 miles of track—the largest railway system in the world.

It was a period of extreme overinvestment: fares fell 80%, competition was brutal, and a quarter of all rail lines went bankrupt.

But the country emerged more unified, more industrialized, and with new industries that would have been impossible without that excess:

• national catalogues (the original Amazons),

• industrial-scale agriculture,

• unified markets,

• mobility and economic expansion.

Financial chaos gave way to an unprecedented productive leap.

3. The Dot-Com Bubble: Overbuilding That Created the Modern Internet

This one is closest to our memory.

The dot-com bubble produced:

• excess fiber-optic cable,

• unused data centers,

• massive bankruptcies,

• delusional expectations,

• “dark fiber” sold for ridiculous prices.

But that excess became the backbone of the modern Internet:

• cheap broadband,

• ecommerce,

• streaming,

• SaaS,

• cloud computing,

• smartphones.

Liu describes it as a process of parallel experimentation:

New browsers, search engines, ecommerce models, and most importantly:

An entire population coming online, creating the cognitive foundation necessary for the digital economy that would dominate the following decades.

Conclusion

What changes is the technology.

What doesn’t change is how we react to it.

AI can be a bubble, an opportunity, or a revolution. It’s likely a bit of all three.

What is certain is that the challenge remains the same as always:

To think calmly in a world that keeps accelerating

I’m curious: which of the four perspectives resonated most with you?

Let me know in the comments.

If you’d like to keep reading pieces like this one, I’d be glad to have you as a subscriber.

Ezra’s Notes is free, and it helps me write more essays worth your time.

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Everything is condensed into clear notes you can read in minutes.

1. Industrial

• Softening fundamentals: Demand cooling and excess supply from the last boom.

• Temporary NOI boost: Rent catch-up effects from COVID surge are masking slowing growth.

• Market inefficiency: Plymouth Industrial’s buyout offer (~$24/share) exposes valuation gaps in REITs.

2. Office

• Uneven recovery: “Flight to quality” driving gains for top-tier properties.

• Leasing rebound: Sunbelt Class A assets and NYC leading recovery; AI demand lifting West Coast markets.

• Oversupply risk: Costly new developments in Midtown Manhattan could hurt landlords.

3. Multifamily / SFR

• Sunbelt weakness, coastal strength: Rent growth still negative YoY in the South but improving.

• SF rebound: Bay Area rents rising sharply amid AI-driven hiring and capital inflows.

• Housing slowdown: Single-family home starts expected to weaken further in 2H 2025.

4. Retail

• Top performer: Retail showing strongest fundamentals among CRE sectors with ~3–4% NOI growth.

• Low new supply: Minimal construction supports landlords.

• Tariff risk easing: Legal challenges have tempered the threat of new import tariffs.

Credit to

of Warden Capital for this amazing update on the CRE market.

Subscribed to his newsletter!

See you next week with more timeless notes.

Until then, keep compounding knowledge.

— Ezra

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Everything is condensed into clear notes you can read in minutes.

These are my notes from a recent interview that David did with Chris Davis.

Enjoy!

I think all investing is value investing. And if it isn't, it's it's either gambling or speculating. And investors should recognize that the biggest threat to their generating a return over time is their own behavior.

• All true investing is value investing; anything else is speculation or gambling.

• Focus on earnings power and intrinsic business value, not market psychology.

• Growth is part of value—profitable growth adds intrinsic worth. The false dichotomy of “growth vs. value” misleads investors.

• Rejects momentum investing, which relies on rising prices rather than fundamentals.

• Let value compound gradually rather than chasing immediate payoffs.

• The greatest threat to investor returns is **their own behavior** (buying high, selling low).

• On Mag 7: Each company is unique, but high valuations require heroic assumptions (e.g., 20% growth for a decade, >50% margins).

• Don’t predict, prepare — invest with the expectation of enduring shocks.

• Not just buying “$1 for 50¢” but preferring durable, compounding businesses even at fair prices.

• A growing, resilient company may justify paying more upfront.

• Avoid emotional trading, or hire an advisor who enforces patience.

• Systematic investing (regular contributions over time) is more powerful than trying to time markets.

• Value investing suits those with patience, discipline, and a research mindset.

• Success comes not from being right often, but from making outsized gains when right and limiting losses when wrong.

I had a business card, it would say analyst on it that that's still my full time job. It's a part of the job I love. I love visiting companies. I love, you know, this idea of business people. I spend a lot of time visiting companies. I love that that part part of the job. I like going out and traveling.

See you next week with more timeless notes.

Until then, keep compounding knowledge.

— Ezra

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Everything is condensed into clear notes you can read in minutes.

These are my notes from Howard Mark’s latest memo.

Enjoy!

Howard Marks - The Calculus of Value

• Value is derived from fundamentals and earning power (current and future).

• Price is what investors pay, largely determined by psychology, optimism vs. pessimism, and sentiment.

• Investment success depends on paying the right price relative to true value.

• Short-term market moves are driven more by sentiment than fundamentals.

• Price tends to gravitate toward value in the long term, but can diverge wildly in the short term.

• Bubbles and crashes are born when psychology pushes prices to extremes.

• S&P 500 forward P/E near 23, well above historical averages.

• Historical data suggests such valuations often result in weak (~0–2% annually) long-term returns.

• Market cap-to-GDP ratio (Buffett Indicator) at record highs.

• Stocks trading at 3.3x sales, another all-time high.

• Signs of euphoria: high valuations, narrowing credit spreads, and “meme stock” activity (again).

• Risk tolerance elevated; spreads on corporate debt near historic lows.

• Relief rallies fueled by optimism despite tariffs, inflation risk, and debt concerns

• Strong recent gains concentrated in the “Mag 7” tech stocks (Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, Tesla).

• AI enthusiasm and belief in U.S. market supremacy are reinforcing bullish sentiment.

• Optimism and FOMO outweigh concerns about tariffs, inflation, and deficits.

• Fundamentals have deteriorated (tariffs, inflation, U.S. fiscal concerns), yet asset prices are higher.

Compared to the past, today’s S&P 500 is increasingly made up of companies that (a) grow faster, (b) are less cyclical, (c) require less incremental capital to grow, enabling them to generate more free cash flow, and (d) have much stronger competitive positions or “moats.” Thus, they deserve above average p/e ratios.

Read the full memo

See you next week with more timeless notes.

Until then, keep compounding knowledge.

— Ezra

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Everything is condensed into clear notes you can read in minutes.

These are my notes from Todd Comb’s “Introduction to Part IV” of the new edition of Security Analysis.

Enjoy!

In investing, and in life for that matter, you can’t choose outcomes, but you can choose the decisions that may get you the outcomes you want.
— Todd Combs

• The goal in investing is to make educated bets based on facts and not stories.

• A great analyst has the ability to keep things simple and determine what matters most. Its willing to rip a company down to its studs and understand each part before they reassemble it.

• A spreadsheet is not business reality.

Todd’s three buckets

1. Find a good (great) businesess

In determining if a business is great, I like to start on the quantitative side: I focus on the balance sheet, accounting practices, and unit economics, and then turn to cash flow generation. Meanwhile, the qualitative side involves reference calls to assess the quality of management and channel checks to reveal how a company’s products are selling in real time.
— Todd Combs

According to Todd, a good (great) business has:

• A wide moat

• Low capital intesity

• Pricing power

• Recurring revenues

• Staying power

• The likelihood of long-term growth

Investment process

• Start with facts and not opinions. “If you start with opinions, it’s very easy to become wedded to them even when the facts run counter to the popular narrative.”

• SEC filings, annual reports, trade magazine articles (NO management or colleague’s narratives or sell-side reports.

• Don’t look at earnings (worse: adjusted earnings)

• Instead, start with the balance sheet and the cash flow statement.

• Think about the business in terms of unit economics: “Think in terms of a dollar of revenue that flows into a business and runs through the cash flow statement, then the balance sheet, and last the income statement.”

• Review the last 10 years and examine the changes in retained earnings, debt, and overall capital intensity as compared to the top-line growth of the business itself.

2. Find good (great) management teams

The importance of good management is almost universally underestimated, yet it is one of the most crucial determinants of a company’s intrinsic value.

— Todd Combs

• Don't assess management based on conventional marketplace narratives. Go deeper.

• When analyzing management's track record, examine their incentives; how the spend their time, and perform scuttlebutt research. (Not presentations or meetings with management).

• Persistent tailwinds can also make a corporate management team seem smarter than they are.

Good capital allocation is crucial; a wonderful business and a talented CEO is not enough to offset poor capital allocation

• Yes, capital allocation is one of the most important parts of the track record that must be examined.

• You want management teams focused on long-term and not short-term results (not quarterly earnings, meeting market expectations, stuffing sales channels, pursuing aggresive accounting treatments, or withholding long-term investments to improve reported shor-term results).

• CEO focused on running the business, not spending months on the road promoting the company or meeting with investors.

Ask yourself, if this were your family business, wouldn’t you want your CEO single-mindedly focused on running the business? I want to back CEOs who are focused on substance, not collecting style points.

• Scuttlebutt research on CEOs: speak to current and former executives who have either reported to the CEO. The goal? Go deeply into their personalities to gain context. Are they toxic? Are they intense as a leaders?

A quick checklist to assess management's incentives

Read the proxy statements and look for changes year to year:

• Is the basis for management compensation and stock option awards sensible?

• Are they being measured for enduring accomplishments or instead for favorable short-term share price fluctuations that could be purely the result of luck or even manipulation?

• Do they reward actual returns on capital or simply profitless growth?

• Do they create asymmetric upside for the CEO for taking outsized risks?

• Is the CEO regularly selling his or her shares for “personal reasons,” or are they acting like a true owner and fiduciary?

• If the company were private, how different would the structure of the CEO’s compensation and incentives be?

3. Find a the “right” price

The best businesses are anti-fragile; that is, they continue to thrive and even deepen their moats in times of adversity and volatility, such as when competitors get in trouble and their best customers and employees may be up for grabs.

— Todd Combs

• Start by your own. Do not base your analysis on someone else's opinion, story, conference calls. "he danger of this process is that it often leads to the formation of an opinion based on someone else’s perception and analysis, rather than your own."

• Assess a moat. Not the quick and easy way (long track record of high ROIC); go deeper to see if the moats of the company are strong or porous.

• Business moats are not static and come with different characteristics—brands, low costs, convenience, and network effects all constitute real but very different moats.

• Do channel checks: talk to customers, suppliers, and former employees. Ask yourself: " if I were considering putting 100% of my net worth in this business, what would I want to know?"

Moats checklist

• Does the business have a sustainable and/or expanding moat?

• What are the weakest links over the next five years?

• Are there hidden path dependencies?

• Does the business have pricing power, and how has it been exercised?

• How (anti) fragile is the business, and will it thrive in the next downturn?

• What would it take to replicate this business?

• Will the business be in a better position with an even wider moat five years from now?

Remember that simple is usually better; in investing, there is no extra credit for degree of difficulty.

Valuation

• A business is worth the sum of its discounted cash flows in perpetuity.

• Find a capital light business that can grow for prolonged periods of time.

• The worst business is one taht grows and consumes increasing amounts of capital at returns that fail to exceed its cost of capital.

Great businesses can be terrible investments at the wrong price, and an average business can be a great investment at the right price. Fast-growing businesses can be attractive, but only at the right price.

• It's not growth at all costs. Price still matters.

• Always have a margin of safety

• Focus on owner earnings, NOT EBITDA (or even worse - Adjusted EBITDA)

• Take into account the company's capital structure.

To finish, some Todd’s great quotes

Human beings constantly process complex information about the world and simplify it to make sense of it and put it into context.

Investors attempt to look behind the curtain of a company’s operations, but they often realize how little they actually know.

Even extensive research will uncover only a small fraction of what one can possibly know about a business.

Investors must find a way to navigate through uncertainty and randomness. There are decisions being made every day, and sometimes made decades earlier, that are still affecting outcomes today in every business and industry.

Perfect information does not exist; there are only confidence intervals. This is, of course, at the heart of why a margin of safety matters so greatly in investing. If you start with the premise that there is only so much one can know, of course you need a margin for error. The less you know, the greater the margin needed.

See you next week with more timeless notes.

Until then, keep compounding knowledge.

— Ezra

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Why Buffett dislikes Real Estate Investing

Well, in respect to real estate, it’s so much harder than stocks in terms of negotiation of deals, time spent, and the involvement of multiple parties in the ownership. Usually when real estate gets in trouble, you find out you’re dealing with more than just the equity holder.

There have been times when large amounts of real estate have changed hands at bargain prices, but usually stocks were cheaper and they were a lot easier to do. Charlie did more real estate. Charlie enjoyed real estate transactions, and he actually did a fair number of them in the last 5 years of his life. But he was playing a game that was interesting to him.

I think if you’d asked him to make a choice when he was 21 – either be in stocks exclusively for the rest of his life or real estate for the rest of his life – he would have chosen stocks. There’s just so much more opportunity, at least in the United States, that presents itself in the security market than in real estate.

In real estate, you’re usually dealing with a single owner or a family that owns a large property they’ve had a long time. Maybe they’ve borrowed too much money against it. Maybe the population trends are against them. But to them, it’s an enormous decision.

When you walk down to the New York Stock Exchange, you can do billions of dollars worth of business, totally anonymous, and you can do it in 5 minutes. The trades are complete when they’re complete. In real estate, when you make a deal with a distressed lender, when you sign the deal, that’s just the beginning. Then people start negotiating more things, and it’s a whole different game with a different type of person who enjoys the game.

We did a few real estate deals that came our way in 2008 and 2009, but the amount of time they would take compared to doing something intelligent and probably better in securities –there was just no comparison. In a real estate deal, every sentence is important to the person. In stocks, if somebody needs to sell 20,000 shares of Berkshire and they call us and the price is right, it’s done in 5 seconds and it closes right away.

The completion rate for working on anything in stocks, assuming you’ve got a meeting of the minds on price, is essentially 100%. In real estate, the negotiation just begins when you agree on deals, and then they take forever. For a 94-year-old, it’s not the most interesting thing to get involved in something where the negotiations could take years.

Real estate transactions have parties on both sides that aren’t ready to act. We find it much better when people are ready to pick up the phone and you can do hundreds of millions of dollars worth of business in a day.

On the importance of being patient when investing but also acting quickly

There are times when you have to act fast. In fact, we’ve made a great deal of money because we’re willing to act faster than anybody around.

The trick when you get in business with somebody who wants to sell you something for $6 million that’s got $2 million of cash, a couple million of real estate, and is making $2 million a year, is you don’t want to be patient at that moment. You want to be patient in waiting to get the occasional call. My phone will ring sometime with something that wakes me up. You just never know when it’ll happen.

That’s what makes it fun. So patience is a combination of patience and a willingness to do something that afternoon if it comes to you. You don’t want to be patient about acting on deals that make sense, and you don’t want to be very patient with people talking to you about things that will never happen.

The main thing is you have to be willing to hang up after 5 seconds and you have to be willing to say yes after 5 seconds. You can’t be filled with self-doubt in this business.

One of the great pleasures – it is the great pleasure actually in this business – is havingpeople trust you. That’s really why I work at 94 when I’ve got more money than anybodycould count. It means nothing in terms of how I’m going to live or how my children are goingto live or anything else.

Our financial condition continues to hold a lot more in cash and treasuries than I would like, but that’s simply a question of when opportunities occur. If you get real opportunities every five or six years, you have to be patient.

Charlie always pointed out that we made most of our money out of about eight or nine ideas over 50 years. We talked about it every day and read every report and did everything else. But if you think you can get an idea a day from listening to your broker or reading financial information, forget it. Every now and then you get extraordinary opportunities, and most of the time you don’t have much of an edge.

About investing in foreign currency

Well, we always have – the Japanese situation is different because we

intend to stay so long with that position and the funding situation is so cheap that we’ve attempted to some degree to match purchases against yen-denominated funding. But that’s not a policy of ours. In fact, that’s the first time we’ve done that. We’ve owned lots of securities in foreign currencies.

We do nothing in terms of its impact on quarterly and annual earnings. We don’t do anything based on its impact on quarterly and annual earnings. There’s never been a board meeting I can remember where I’ve said, “If we do this, our annual earnings will be this, therefore we ought to do it.” The number will turn out to be what it’ll be. What counts is where we are five or 10 or 20 years from now.

If you start focusing on what number you’re going to produce, you will quickly get tempted to play around with the numbers and sometimes seriously play around with the numbers. I’ve seen people I trust in all kinds of other ways, but they regard playing around with numbers as perfectly okay. That’s just not something we do – we just don’t think about that.

So currency value is a scary thing, and we don’t have any great system for beating that. We do in this particular Japanese position because we expect to hold it for 50 or 100 years or more, and we’ll be owning something denominated in yen and easily predictable. As long as the carry on it is right, we’ll attempt to issue Japanese-denominated liabilities, but that’s not because of anything we care about in terms of quarterly or annual earnings.

Charlie always felt that if he had to pick an area outside of stocks in which to invest – and he knew a lot about bonds, real estate, and other things – he thought he could make a lot of money in foreign currency. But we’ve done it once. It’s not inconceivable we would do it again, but it’s unlikely.

There could be things happen in the United States that would make us want to own a lot of other currencies. I suppose if we made some very large investment in a European country, there might be a situation where we would do a lot of financing in their currency. But it’s not a regular activity. It was something that was obvious to do in theJapanese situation where we had the ability to borrow at a very low carrying cost, and we felt very good about the income we’d be receiving from these securities.

On copying the Berkshire Hathaway model

I think there are people that want to copy Berkshire’s model, but usually

they don’t want to copy it by also copying the model of the CEO having all of his money in the company forever. They have a different equation – they’re interested in something else. That’s capitalism, but they have a whole different situation and probably a somewhat different fiduciary feeling about what they’re doing.

Sometimes it works and sometimes it doesn’t work. If it doesn’t work, they go on to other things. If what we do at Berkshire doesn’t work, I spend the end of my life regretting what I’ve created. So it’s just a whole different personal equation.

There is no property casualty company that can basically replicate Berkshire. That wasn’t the case at the start – at the start we just had National Indemnity a few miles from here, and anybody could have duplicated what we had. But that was before Ajit came with us in 1986, and at that point the other fellows should have given up.

Advice for young investors

Who you associate with is just enormously important. Don’t expect that you’ll make every decision right on that, but you are going to have your life progress in the general direction of the people that you work with, that you admire, that become your friends.

I mentioned a few fellows that have died in the last couple years. All of those people were people that, if we were working together on something one-ten-thousandth the size of Berkshire, they’d be the kind of people you’d choose. They’re people that make you want to be better than you are. You want to hang out with people that are better than you are and that you feel are better than you are because you’re going to go in the direction of the people you associate with.

That’s something you learn later in life – it’s hard to really appreciate how important some of those factors are until you get much older. But when you’ve got people around you like Tom Murphy and Sandy Gottesman and Walter Scott, you’re just going to live a better life than if you just go out and look at somebody that’s making a lot of money and decide you’re going to try and copy them.

I would try to be associated with smart people too where I could learn a lot from them, and I would try to look for something that I would do if I didn’t need the money. What you’re really looking for in life is something where you’ve got a job that you’d hold if you didn’t need the money, and I’ve had that for a very long time.

All the fellows I named had it, and they also always did more than their share and never sought more than their share of the credit. They behaved the way you’d like anybody you work with to behave. When you find them, you treasure them, and when you don’t find them, you still keep doing whatever enables you to eat. But you don’t give up on looking around, and you will find people who do wonderful things for you.

The best manager I ever knew – and there’s a lot of contention for who that would be – butactually was Tom Murphy Sr., who lived to almost 98. I’ve never seen anybody who could getthe potential out of other people more than Murph. If you wanted to become a better person, you’d want to work for Tom Murphy. There are all kinds of successful people that don’t bringthat to the party. I’m not saying that’s the only way to succeed, but I think it’s the mostpleasant way to succeed for sure.

On the importance of the balance sheet

I spend more time looking at balance sheets than I do income statements. Wall Street doesn't pay much attention to balance sheets, but I like to look at balance sheets over an 8 or 10 year period before I even look at the income account because there are certain things it's difficult to hide or play games with on the balance sheet than with the income statement.

Neither one gives you the total answer on anything, but you should understand what the figures are saying and what they don't say and what they can't say and what the management would like them to say that the auditors wouldn't like them to say. You learn more from balance sheets in my view than most people give them credit for.

On why to invest when there is pessimism

We will make our best deals when people are the most pessimistic.

Over my lifetime I’ve had fabulous opportunities sometimes, and they happen because humans are human. I don’t get fearful by things that other people are afraid of in a financial way. The idea that if Berkshire went down 50% next week – I would regard that as a fantastic opportunity and it wouldn’t bother me in the least. Most people react differently.

It’s not that I don’t have emotions, but I don’t have emotions about the prices of stocks. Those decisions get all the way to my brain, whereas emotions can get bogged down some other place.

On the importance of teachers

The teachers you get in your life have this incredible impression on you, and a lot of them are the formal teachers you have, but some are informal teachers too. I’ve learned from certain employers so much. You really hope you're learning from everyone you find who's well-intentioned and has had a lot of experience. I had a lot of good luck in that.

I would say that where I was really lucky was my dad was in the investment business. So I would go down on Saturday and I'd wait for him to go to lunch, and I'd read the books that were around there that nobody else ever read. Numbers talk to me, and I could never get my fill of them.

Then I discovered the public library and I read every book there was on investments, literally, in the Omaha public library. I enjoyed learning about that. Unlike Charlie – if Charlie was reading about electricity, he would want to have known everything that Thomas Edison knew and more, and go through the same thought processes and understand how everything worked. I didn't care how it worked. I just cared whether it worked. That's a limitation – I'm confessing here, I'm not bragging.

As Charlie would say, people would always ask, “If you could only have lunch with one person living or dead, who would it be?” And Charlie said, “I’ve already had lunch with all of them because I’ve read all their books.”

I was lucky to find something that fit me very early on. If my ambition had been to become aventriloquist or whatever it might have been, it wouldn't have worked. I just spent hours and hours and hours on investing.

People that teach, in general, love having a young student who's actually really interested in the subject, and they'll spend extra time with you. I ran into that. I had Graham and Dodd at Columbia. Dave Dodd treated me like a son basically. But I was interested in what they were saying and they found it kind of entertaining that I was so interested, so I would look around at what really fascinates you. I wouldn't try and be someone else.

Miscellaneous

I look at the financial statements of about 50 or 60 of our companies every month.

You get a few breaks in life in terms of people you meet who just change your life dramatically. If you’ve had a handful of those, you treasure them. We’ve had them on this board of Berkshire – Tom Murphy, Sandy Gottesman, Walter Scott, Bill Scott – we’ve made lifelong assets out of people that are the right sort, with incredible talent, who are lots of fun to work with, always doing more than their share.

You really want to work at something you enjoy. I’ve had five bosses in life and I liked every one of them – they were all interesting. I still decided that I’d rather work for myself than anybody else. But if you find people that are wonderful to work with, that’s the place to go. I’ve told my kids basically that you don’t get lucky like I did when I found what interested me at seven or eight years of age. It could have taken a lot longer, but you want to find what you love.

If very stupid things are happening around you, you do not want to participate. If people are making more money because they’re borrowing money or participating in securities that are pieces of junk but they hope to find a bigger sucker later on, you have to forget that.

The world is not going to adapt to you. You’re going to have to adapt to the world.

The world makes big mistakes, and surprises happen in dramatic ways. The more sophisticated the system gets, the more the surprises can come out of left field.

That’s part of the stock market, and that’s what makes it a good place to focus your efforts if you’ve got the proper temperament for it and a terrible place to get involved if you get frightened by markets that decline and get excited when stock markets go up. I don’t mean to sound particularly critical – I know people have emotions, but you’ve got to check them at the door when you invest.

Charlie was probably the best person you could imagine in what he learned. Charlie was never satisfied with just superficial things about any subject. He really wanted to understand it and he always would tell me that you shouldn’t take a position on anything until you can describe the arguments against it better than the person who is arguing with you – that you should be able to argue their case better than they can. He was a remarkable teacher.

If we want to do it with our own money, we can do it, but we’re not going to do things with your money that we think are stupid. You ought to get rid of us if we do. It’s easier to do stupid things with other people’s money than it is with your own.

Greg Abel on Buffett

Warren is obviously a remarkable teacher and I benefit from that every day and for many years. I’m fortunate that if I had to be remembered as something right now, I’d want to be remembered as a great father, but equally a coach. And that goes to family, friends, and just being involved with the kids I coach in hockey or baseball or whatever it may be. I think we’ve got a great opportunity to give back to them at a very young age.

I love thinking of Warren truly as a teacher and I get the opportunity to continue to learn every day. Warren and I have strong dialogue every week and we’re always talking around opportunities in Berkshire or things that are going on globally or in the US, and each one’s truly a learning moment.

Greg's perspectives on capital allocation at Berkshire Hathaway

We will remain Berkshire and will never be dependent on a bank or some other party forBerkshire to be successful. With allocation of capital comes management of risk andunderstanding risk. That falls upon all our managers, insurance and non-insurance, but we’llbring that across Berkshire.

The other value I would touch on relates to where I’m going: ultimately we have a great set ofoperating companies that produce significant cash flows, be it in the insurance companiescreating float or our various non-insurance companies producing significant cash flows on anannual basis. We intend to continue to ensure that’s a strength of Berkshire going forward.

With those cash flows and with the float, and with significant resources already on ourbalance sheet, we’ll continue to move forward with a very similar philosophy. It’s an identicalphilosophy to what we’ve had currently and for the past 60 years.

We’ll start by looking at opportunities within our business – are our insurance and non-insurance businesses properly capitalized and do they have the opportunity to manage theirbusiness? They’ll operate in an autonomous way, but Berkshire still manages the capital thatwill go into those businesses or what potentially will come out of them.

The next opportunity is to acquire businesses in their totality, 100%. There are great timeswhen we can do that. Warren touched on the $10 billion acquisition in the last quarter. Butthe value relative to the risk have to be right. If it’s right, we want to own it. If it’s not the time,there’ll be another time to own assets like that.

Then there’s the opportunity to own pieces of companies through equity. But as Warren’salways highlighted, though we own a piece of a company, we own a piece of that cash flow,a piece of their balance sheet. It’s not just a share certificate. We’ll approach it with thethought that we’re going to own this company for the long term.

We need to thoroughly understand what the economic prospects of those companies willlook like – as Warren said earlier – 5 years from now, 10 years from now, 20 years from now.If we don’t have a view of that, we won’t be investing, be it 100% or 2% of a companythrough equities. We have to thoroughly understand what those prospects look like and theunderlying risks of the businesses. It’s really the investment philosophy and how Warren andthe team have allocated capital for the past 60 years. It will not change, and it’s the approachwe’ll take going forward.

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NVR’s Business Model

NVR's unique business model, particularly its use of lot options and a pre-order system, has been a key driver of its dramatic growth. Here's how this model differs from traditional homebuilders and how it has fueled NVR's success:

• Lot Option Strategy: Unlike typical homebuilders who directly acquire land, NVR secures option contracts on land with developers. NVR only exercises these options once a homebuyer's mortgage is approved. This approach significantly reduces NVR's capital expenditure, as they only commit to buying land when they have a qualified buyer.

• The upfront deposits on the lot purchase agreements (LPAs) are usually around 10% of the total price of the land.

• This strategy also allows NVR to maintain 'control' of the land within its markets while employing much less capital.

• Pre-Order System: NVR only starts construction of a home after an order is placed with a deposit. This "pre-order" method further reduces working capital requirements and risk. NVR develops a model home in the center of a neighborhood to serve as a sales center, rather than developing homes speculatively.

• Capital Efficiency: The combination of lot options and the pre-order system makes NVR extremely capital efficient. This approach allows NVR to make $1 of earnings with much less capital than what other homebuilders would need to make $1 of earnings. This capital efficiency is a significant driver of NVR's higher returns on capital.

• Reduced Risk: NVR's model reduces the risk associated with land ownership. If a market downturn occurs, NVR can simply let the lot options expire, limiting their losses to the deposit. This provides a significant advantage over companies that own land outright. NVR's reduced risk also allows it to maintain higher margins and a cleaner balance sheet.

• Faster Inventory Turnover: NVR's integrated model and focus on simple designs, along with its use of pre-manufactured housing components, contributes to a faster inventory turnover. NVR boasted an average 86 day home completion rate in 1992. NVR’s assembly line approach in this manner makes NVR the “In-N-Out Burger of homebuilders”.

• Strong Market Positions: NVR's focus on maintaining strong market positions in select cities has allowed it to establish a streamlined network for construction. In many of these markets, NVR has a number one or two position. This concentrated approach allows it to achieve economies of scale.

• Moat: This unique business model, which is difficult for competitors to replicate on a small scale, has enabled NVR to generate ROE of 20-40%, which is 2x to 3x more than most large competitors. NVR's size, scalability, and experience makes it hard for smaller homebuilders to enter as well.

The company's consistent execution of this strategy over decades has resulted in significant returns . Even during the GFC, NVR was the only homebuilder among its peers to remain profitable, due to its options-based model. This unique approach allows NVR to be protected in housing market downturns as it is able to renegotiate and even withdraw from land options. This strategy also explains NVR's high returns on capital, which is further enhanced by a disciplined capital allocation strategy that includes share buybacks.

From Near-Bankruptcy to 1,000-Bagger

NVR's transformation from near-bankruptcy to a 1,000-bagger was driven by several key factors, including a strategic shift in its business model, disciplined management, and favorable macroeconomic and demographic trends.

Strategic Shift in Business Model

• Move to an Options-Based Land Acquisition Model: Instead of directly purchasing land, NVR began using options contracts, which allowed them to control land for a small percentage of the cost and exercise the option only when a home was sold. This drastically reduced their capital expenditures and risk .

• Pre-Order Construction: NVR shifted to a pre-order system, constructing homes only after a sale was made. This further reduced working capital requirements and risk.

• Financial Subsidiary (NVR Finance): The establishment of NVR Finance allowed the company to finance a large percentage of its home sales, increasing earnings.

Disciplined Management

• Conservative Use of Leverage: After experiencing the negative impacts of debt in the early 1990s, NVR’s management became conservative with leverage. They focused on maintaining a healthy balance sheet.

• Focus on Returns on Capital: NVR prioritized returns on capital, which is seen in their lot option strategy and the resulting high ROE compared to peers.

• Strategic Market Entry: Management focused on developing a strong presence in specific markets rather than pursuing rapid expansion.

• Aggressive Share Buybacks: NVR’s management used share buybacks to reduce outstanding shares, increasing earnings per share and shareholder value. They reduced their outstanding shares by roughly 50% over the past 20 years.

• Incentive System: NVR's management compensation is tied to performance and stock options, which creates an incentive for long-term, shareholder-friendly decisions.

Favorable Macroeconomic and Demographic Trends

• Economic Recovery: After declaring Chapter 11 bankruptcy in 1992, NVR’s rebound coincided with a recovering American economy.

• Housing Demand: The company benefitted from an underbuilding of housing units and population growth.

• Millennial Household Formation: As Millennials began to form households, they drove demand for suburban homes.

• Low Unemployment: Low unemployment rates support consumer confidence and the capacity to buy homes.

NVR's 1992 Bankruptcy

Several factors contributed to NVR's Chapter 11 bankruptcy filing in 1992. These factors include:

• Tax Law Changes: The Tax Reform of 1986 reduced the tax benefits that NVR had previously thrived under. This made it more difficult for NVR to access capital.

• Oversupply of Houses: Due to the same tax law changes, many similar companies experienced similar problems leading to an oversupply of houses in many U.S. regions.

• Economic Recession: A slumping economic recession around 1990 caused interest rates to rise sharply into double digits, which led to a significant decrease in demand for homes. Industry-wide housing completions fell by more than 50% through 1991.

• Financial Losses: As a result of the previously listed factors, NVR experienced an earnings loss of $260 million in 1990. Sales decreased from $1.15 billion in 1988 to $600 million in 1991, roughly a 50% decrease. Additionally, NVR's assets lost a significant amount of market value, decreasing from $2.4 billion in 1988 to $1.6 billion in 1990, a 33% decrease.

• Decreased Housing Production: In 1991, NVR built only 3,831 housing units compared to 5,240 in 1990, a 27% decrease.

• Leveraged Buyout Debt: NVR had also incurred a lot of debt from the leveraged buyout of Ryan Homes in 1987.

• "Easy Capital": NVR had also pursued a strategy of taking on debt to buy land during the 1980s when capital was easily accessible. The company's land holdings became a liability when the housing market declined.

These factors combined to create a severe financial crisis for NVR, which led to the unavoidable bankruptcy in the early 1990s. The Chapter 11 filing allowed NVR to restructure its debts and operations while continuing its core functions. The bondholders agreed to trade their debt claims for equity in the reorganized company, which improved the balance sheet and avoided the possibility of the company's liquidation under Chapter 7.

NVR's Capital Allocation

NVR's capital allocation decisions have been crucial to its transformation from a struggling company to a highly successful homebuilder. Over time, NVR has strategically allocated its capital to maximize returns, reduce risk, and enhance shareholder value.

• Early Years: Leveraging for Growth (1980s): In its early years, NVR, then known as NVHomes and later NVR L.P., utilized leverage to acquire land for future development. Under the favorable tax laws of the 1980s, real estate limited partnerships (LPs) benefited from the ability to write off losses, which enabled NVR to tap into 'easy' capital. Dwight Schar used this leverage to buy a lot of land for future use. However, this strategy proved to be risky when the tax benefits were reduced and the economy slumped.

• Post-Bankruptcy Reorganization (1992-1990s): Following its Chapter 11 bankruptcy in 1992, NVR made a significant shift in its capital allocation strategy. Recognizing the dangers of holding large land inventories and high debt levels, NVR adopted an options-based business model, which allowed the company to secure land with minimal capital outlay. Instead of purchasing land directly, NVR started using option contracts with developers, exercising them only after a homebuyer's mortgage was approved. This was a key decision that reduced NVR's capital needs and risk exposure.

• NVR also established NVR Finance, a financial subsidiary to finance about 75% of NVR home sales, allowing the company to realize more earnings from its core operations.

• Focus on Share Buybacks (Late 1990s - Present): NVR began a heavy buyback strategy in the late 1990s, significantly reducing its shares outstanding. For example, in 1994, NVR had 16 million outstanding shares, which was reduced to 8 million by 2001, and further to 4 million by 2015. By the end of 2024, the company had approximately 3 million shares outstanding. This consistent repurchase of its own stock has been a central feature of NVR's capital allocation strategy and a major contributor to the company's increasing EPS.

• Conservative Approach to Debt (2000s - Present): After the 1992 bankruptcy, NVR's management became highly conservative with leverage. During the GFC, NVR strategically used its resources to pay off debt. By 2010, NVR's notes and loans payable had decreased to $90 million, down from $350 million in 2006. Today, NVR has a negative net debt, which is indicative of a very healthy balance sheet with a significant amount of cash.

• Strategic Reinvestment (Ongoing): NVR reinvests in its business by expanding into new markets while maintaining strong positions in core areas. The company focuses on building market presence in key cities, which allows them to leverage their streamlined network for construction. NVR is strategic in its market entry, choosing locations where they believe they can establish a strong position, rather than chasing every hotspot.

• Shareholder Friendly Incentives (Ongoing): NVR has a shareholder-friendly incentive system where top executives are required to hold a significant amount of their salary in NVR stock, aligning their interests with those of the shareholders. Named Executive Officers (NEOs) receive options that vest over four years that are tied directly to ROC performance. To fully vest, the company must rank among the top three public homebuilders in ROC, which further incentivizes management to focus on returns on capital.

  Value Investors Club NVR Investment Thesis

Norbert Lou's (Punch Card Capital) investment thesis on NVR, presented on the VIC forum in 2001, highlighted the company's unique business model and its potential for significant growth:

• Unique Business Model: Lou recognized that NVR was not a typical homebuilder. Instead of being a 'land speculator' that directly purchased land, NVR used an options-based model, which was a significant differentiator. NVR negotiated options on land with developers, only exercising those options once a home buyer's mortgage was approved. This approach meant NVR didn't tie up capital in land inventory for years and could avoid the risks of declining land values in market downturns. Lou realized that NVR's returns were exceptional because it made more earnings with less capital.

• Capital Efficiency: Lou understood that NVR's option strategy made the company extremely capital efficient because it could generate the same amount of earnings with much less capital than other homebuilders. Additionally, NVR only started construction of a residential unit once an order was placed with a deposit, which further reduced working capital requirements and risk.

• Moats: NVR benefited from cost advantages in its concentrated markets, such as Washington D.C. and Baltimore, due to its large scale in manufacturing, advertising, and hiring subcontractors. Lou recognized that NVR had a wide moat within these cities. He also noted that NVR's reputation in these exclusive markets gave it a competitive edge.

• Protection During Downturns: Lou emphasized that in a market downturn, NVR could simply let its land options expire, limiting losses to the initial deposit. In contrast, traditional homebuilders that owned land outright would be burdened with debt and declining land values. This feature allowed NVR to be much more responsive to demand changes. This insight highlighted NVR's ability to pick up market share during economic downturns where other businesses failed.

• Valuation and Growth Potential: Despite its unique and resilient business model, NVR traded at a low earnings multiple of 7x. Lou noted that NVR had little debt, was a low-cost provider for a basic necessity, had been in business for decades, was growing rapidly, and was aggressively buying back its own stock. He also took note of the company's backlog. He recognized the company's potential for growth, particularly as it was also riding an early rise in the housing boom.

• Share Buybacks: Lou highlighted NVR's share buyback program and understood that this would help drive the share price higher because it meant that the company was generating a solid amount of cash and returning it to shareholders. He had been looking for a company that was buying back stock and noted that NVR had declared that it would initiate a $100 million buyback over 4 years, while its market cap was only $275 million. He considered this a positive sign.

• Contrarian View: Lou's thesis was contrarian because the market generally viewed homebuilders as risky due to their boom-and-bust cycles. However, he understood that NVR's unique business model made it less vulnerable to these cycles.

• Focus on Returns on Capital: Lou recognized that NVR's return on tangible capital was 55% at the time, and this demonstrated that NVR could make more earnings with less capital. Lou's analysis drew from the DuPont analysis to show that NVR's returns were much higher than other homebuilders.

In summary, Lou's thesis focused on NVR's capital-efficient, low-risk business model, strong competitive advantages, protection during market downturns, and growth potential, all while trading at a low valuation. He recognized the importance of share buybacks and high returns on capital.

Read the full deep dive

https://restructuringnewsletter.com/p/nvr-deep-dive-in-detail

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The Rise of TSMC

Morris Chang, the founder of TSMC, received a letter in 1997 from Jensen Huang, the CEO of Nvidia, who was seeking a foundry partner. Chang was initially annoyed that the TSMC San Jose office had ignored Nvidia's request, which led him to personally contact Huang. Nvidia was a small company of 50-60 employees at the time and facing bankruptcy, while TSMC was a 10-year-old company with a revenue of over $1 billion. Chang's visit with Huang led to a crucial partnership where TSMC manufactured chips designed by Nvidia.

Nvidia's 2009 Dispute Resolution

Morris Chang resolved the 2009 dispute with Nvidia after returning as CEO of TSMC by taking several key actions. The dispute arose from manufacturing and quality problems with the 40 nanometer node, which was causing delays and financial issues for Nvidia. Here's how Chang addressed the situation:

• Immediate Action: Upon retaking the CEO position, Chang identified the ongoing dispute with Nvidia as a priority problem. He personally called major customers, including Jensen Huang of Nvidia, to understand the situation.

• Investigation: Chang thoroughly familiarized himself with all aspects of the 40 nanometer problem, including the manufacturing issues, quality concerns, and the financial impact on Nvidia.

• Financial Settlement: After weeks of work, Chang decided that the issue was primarily a matter of money. He devised a financial offer, amounting to over $100 million, to compensate Nvidia for the damages they had suffered.

• Personal Meeting: Chang emailed Jensen Huang to schedule a meeting at his home in Silicon Valley, starting with a casual family dinner before discussing business.

• Clear Offer: At the meeting, Chang presented the offer and made it clear that the offer was effective for only 48 hours. He stated that if Nvidia didn't accept the offer within that time, they would have to go to an arbitrator, as Jensen had previously suggested to the former CEO.

• No Negotiation: Chang emphasized that there would be no further negotiations or bargaining, ensuring a quick resolution.

• Acceptance: Jensen Huang accepted the offer within the 48-hour timeframe.

TSMC's Pure Play Foundry Strategy

TSMC's initial strategy regarding competition with customers was centered around a "Pure Play Foundry" model, which meant that it would not compete with its customers by designing or selling its own branded chips. This strategy was a deliberate choice by Morris Chang and was key to TSMC's early success and its ability to become a leader in the semiconductor industry.

Here are the key aspects of this strategy:

• No in-house chip design: TSMC focused solely on manufacturing chips for other companies and did not have its own design division. This was a significant departure from the traditional model of integrated device manufacturers (IDMs) like Intel, who designed and manufactured their own chips.

• Serving all customers: By not competing with its customers, TSMC positioned itself as a neutral and reliable manufacturing partner. This allowed it to attract a wide range of customers, including both established IDMs and emerging fabless companies.

• Building trust: The pure-play model fostered trust among customers, who were more willing to work with TSMC knowing that it would not compete with them. This was particularly important for fabless companies that needed a reliable manufacturing partner to bring their chip designs to market.

• Focus on manufacturing expertise: TSMC concentrated its resources and expertise on improving its manufacturing processes and technologies. This allowed it to provide high-quality manufacturing services and remain at the forefront of semiconductor manufacturing.

• Acknowledging limitations: TSMC recognized it did not have the capability to design chips like Intel. So, rather than attempt to compete directly, it focused on its strength, which was manufacturing. This allowed them to leverage their manufacturing expertise without competing with their customers in the chip design market.

This strategy was not just about avoiding competition; it was also a recognition of the changing dynamics of the semiconductor industry. Morris Chang anticipated the rise of fabless companies that would specialize in chip design and would need a dedicated foundry to manufacture their products. By adopting the pure-play model, TSMC positioned itself to benefit from this trend and became the leading foundry in the industry.

TSMC's pure-play strategy was also about recognizing their own limitations. They did not have the capabilities to compete with established companies like Intel, so they decided not to try. Instead, they focused on manufacturing, which they could do well, and allowed them to forge a different path to success.

This strategy, though initially developed as a way to avoid direct competition, inadvertently created a more collaborative ecosystem where many companies could specialize in different parts of the semiconductor value chain, while relying on TSMC's manufacturing capabilities.

TSMC's 28nm Investment

Several factors contributed to TSMC's decision to heavily invest in the 28-nanometer node, marking a pivotal moment in the company's history and establishing its leadership in the semiconductor industry. These factors include:

• Increased R&D Budget: Morris Chang, after returning as CEO, made a significant decision to set the R&D budget at a fixed 8% of revenue, regardless of economic conditions. This was a strategic move to ensure consistent funding for research and development, which was previously negotiated each year. This commitment to R&D provided the necessary resources and stability for TSMC's engineers to focus on developing leading-edge technologies.

• R&D Team's Recommendation: The R&D team, empowered by the increased budget, identified the 28-nanometer node as a "sweet spot" in technology development. They presented compelling technical reasons to Chang, who, based on his trust in his team, decided to support their recommendation. This internal confidence and technological insight was a crucial factor in the decision-making process.

• Market Forecasting and Business Development: TSMC had a well-established market forecasting group and a business development department that provided strategic insights. The marketing group, in particular, helped identify the market potential and strategic importance of the 28-nanometer node. This combination of technical expertise and market awareness was a driving force behind the decision.

• Anticipation of Market Demand: While the specific details of the smartphone market's explosive growth were not fully anticipated by Chang himself, the business development team may have had more detailed visibility. Nonetheless, the market intelligence available to TSMC at the time suggested that the 28-nanometer node would be very significant. This anticipated demand was a key consideration in the decision to invest heavily.

• Strategic Timing: Chang quoted Shakespeare, noting that "there is a tide in the affairs of men, which taken at the flood, leads on to fortune". He saw the 28-nanometer node as the opportune moment for TSMC to capitalize on its capabilities and secure a leading position in the industry. This strategic vision and sense of timing was a factor in pushing for the heavy investment.

• Building on Previous Successes: TSMC had built up a good infrastructure and organizational capabilities, as well as market forecasting, which allowed it to leverage previous experience and insights for the 28 nm node. This built-in advantage allowed for more confidence in the investment.

• Capital Expenditure Increase: The decision to increase capital expenditure to almost $6 billion in 2010 was essential for manufacturing the 28nm chips. The board questioned this increase but Chang was able to convince them, making the large financial bet necessary for success.

TSMC and Apple: A Partnership Forged

TSMC secured Apple as a major customer through a combination of strategic actions, technological capabilities, and a bit of serendipity:

• Initial Contact through a Third Party: The initial contact between TSMC and Apple was facilitated by Terry Gou, the founder and CEO of Foxconn. Gou, who is also a second cousin of Morris Chang's wife, Sophie, brought Jeff Williams, Apple's Chief Operating Officer, to dinner at Chang's home in 2010. This unexpected visit was the start of the formal engagement between TSMC and Apple.

• Jeff Williams's Pitch: During the dinner, Williams initiated a pitch for TSMC to manufacture chips for Apple. This was a significant opportunity for TSMC, but it also came with specific requirements from Apple.

• Initial Pricing Discussion: Williams mentioned a 40% gross margin, which Chang considered low at the time, since TSMC's margin was already 45%. However, Chang did not immediately engage in a detailed pricing discussion, recognizing that there were more important issues to discuss.

• Apple's Request for 20nm Node: Apple surprised TSMC by requesting the 20-nanometer node instead of the 28-nanometer node, which TSMC was about to begin production on. This was a diversion, as TSMC had planned to move from 28nm to 16nm, which made the Apple request a "detour."

• TSMC's Financial Planning: To meet Apple’s demands, TSMC had to figure out how to fund the additional capital expenditures, after already investing heavily in the 28nm node. After consultations, they decided not to cut dividends or sell new stock, but to borrow money instead.

• Negotiating the Order: TSMC decided to only take on half of Apple’s order to mitigate the risk associated with such a large demand [4]. This decision was initially met with skepticism by Apple's purchasing team, but ultimately, Chang convinced Jeff Williams during a meeting that TSMC was prudent in taking half the order.

• Temporary Pause Due to Intel: In February 2011, Apple paused discussions with TSMC for two months because Intel had approached Tim Cook, the CEO of Apple, and asked to be considered as a supplier. At this point, Intel was a major supplier for Apple's Mac line, which was built on Intel's x86 architecture.

• Tim Cook's Assurance: Morris Chang then reached out to Apple to see if they still wanted to do business. In a follow-up meeting, Tim Cook assured Chang that Intel did not know how to be a foundry, indicating that Apple was still committed to working with TSMC.

• Overcoming Technical and Logistical Challenges: TSMC was able to resolve differences with Apple on yield and pricing. This included a personal visit from Jeff Williams, who negotiated pricing with Chang.

• Commitment to Technology Leadership: Despite the initial detour, TSMC ultimately delivered on the 20-nanometer node. While this decision delayed the 16-nanometer node development, TSMC's ability to produce high-quality chips and meet Apple's requirements solidified its position as a crucial partner.

• Long-Term Partnership: After TSMC began producing the 16-nanometer chips, Apple committed to buying the majority of their chips from TSMC, as they had promised, cementing TSMC’s long term value to Apple.

TSMC's Competitive Strategy

TSMC's competitive strategy is multifaceted, combining a unique business model with a focus on technology, customer relationships, and operational excellence. Here are some of the key aspects of its strategy:

• Pure-Play Foundry Model: TSMC's most distinctive competitive advantage is its pure-play foundry business model. Unlike integrated device manufacturers (IDMs) such as Intel, TSMC does not design or market its own chips. This focus allows TSMC to avoid competing directly with its customers, which are often chip design companies. By being a neutral manufacturer, TSMC can serve a wide range of customers without creating conflicts of interest.

• Customer Trust: TSMC's commitment to not competing with customers has fostered a high level of trust. Customers know that TSMC will not use their designs to create competing products, which is a significant concern with IDMs that also have a foundry business. This trust is a crucial factor in attracting and retaining major customers like Apple and Nvidia.

• Technological Leadership: TSMC has consistently invested in R&D, establishing itself as a leader in advanced semiconductor manufacturing technology. This focus on technology has enabled TSMC to offer leading-edge manufacturing processes that meet the demands of high-performance applications like smartphones and AI. The company's ability to innovate and produce cutting-edge technology is a key differentiator that attracts customers.

• Strategic Investments in R&D: TSMC's strategy of allocating a fixed 8% of revenue to R&D, regardless of economic conditions, has empowered its R&D team to pursue ambitious projects and identify key technological opportunities. This consistent investment has enabled TSMC to stay at the forefront of semiconductor manufacturing technology.

• Focus on the Learning Curve: TSMC leverages the concept of the learning curve, aiming to achieve the lowest cost per unit by maximizing production volume. This involves starting with lower prices, even at the expense of early profits, in order to secure large orders and move rapidly down the learning curve. This approach allows TSMC to offer competitive pricing and attract more customers.

• Ecosystem Engagement: TSMC's location within the Hsinchu Science Park in Taiwan and its engagement with the ecosystem that is located there with its suppliers and customers creates an advantage. The close proximity of equipment vendors like ASML, design software companies like Cadence and Synopsis, and its customers facilitates collaboration and rapid innovation.

• Capital Expenditure: TSMC makes massive capital investments in manufacturing capacity to achieve economies of scale. The company has proven to be able to manage these massive expenditures, which are required to compete at the leading edge of semiconductor manufacturing, while also managing to maintain profitability.

• Customer-Centric Approach: TSMC has demonstrated a willingness to accommodate customer-specific needs, even when those needs deviate from the company's standard roadmap. For example, TSMC agreed to develop the 20-nanometer process for Apple, despite its original plans to move directly from 28 to 16 nanometers. This flexibility and willingness to work with customers distinguishes it from other foundries.

• Talent Management: TSMC has a unique culture that prioritizes its employees. It avoids layoffs, even in times of economic downturn. TSMC’s talent strategy aims to retain their knowledge base and expertise and helps promote a culture of stability that is beneficial to the company’s goals.

Watch the full interview

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Political Stability and Inflation Outlook

• Einhorn found the election outcome unexpectedly decisive, which he sees as beneficial for political stability.

• His fund has increased its bets on inflation, predicting another rise due to the administration's expansionary policies.

• He expects inflation to be higher than consensus forecasts, around 3.5% to 4.5%, but not at previous peaks of 7-9%.

• Expansionary policies, tax cuts, full employment, wage growth, and immigration policies will contribute to inflation.

The FED and Fiscal Policy

• He highlights that while the Fed is "independent," its primary responsibility is ensuring the Treasury market functions properly.

• He suggests the U.S. is nearing fiscal dominance, where monetary policy is dictated by fiscal policy.

• The bond market is not fully pricing in the risk of ballooning deficits, despite an expansionary policy environment.

Stock Market and Greenlight’s Strategy

• David acknowledges that the market is the most expensive he has seen since founding Greenlight Capital.

• Despite high valuations, he is not outright bearish, as overvalued markets can persist for long periods.

• He finds hidden value in forgotten stocks—businesses that are cheap but unloved.

• His strategy balances finding value in beaten-down stocks while shorting overvalued and deteriorating companies.

Current Long Positions

CNH Industrial (Case New Holland)

• A tractor and combine manufacturer.

• Currently in a cyclical downturn, but trading at 10x trough earnings.

• Pays a 3-4% dividend and is buying back 5-6% of shares.

• Einhorn expects an agricultural equipment upcycle in 2026, potentially doubling the stock price.

Peloton (PTON)

• Trading 95% below its peak with 3 million engaged subscribers.

• He sees significant cost-cutting opportunities, as the company previously overspent.

• A leaner cost structure could double profits, while the bull case requires growing new subscribers.

Third Position (Undisclosed)

Einhorn did not reveal his third major long position.

Value Investing is Being Eroded

• Einhorn argues that fundamental, long-term value investing is being eroded in today's market.

• Short-term data points and expectations management dominate stock trading, reducing valuation-based investing.

• The market has become dysfunctional, favoring momentum and growth stocks at extreme valuations.

• However, he finds opportunities in unloved sectors where companies return capital via dividends and buybacks.

The Death of Active Asset Management?

• Active management is shrinking, particularly long-term fundamental investing.

• Passive investing dominates, with little regard for valuation, making the market less efficient.

• Many active managers focus on quarterly beats and misses, rather than intrinsic value.

Watch Einhorn’s full presentation

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Industry Growth and Decline

From 2011 to 2021, the video gaming industry experienced significant growth, with spending increasing by 150%, from $80 billion to $200 billion. This growth outpaced the rate of world real GDP, emphasizing the industry's robust expansion during this period.

However, post-2021, the industry faced a downturn, with spending decreasing by about 3.5% in 2022 and showing minimal growth in 2023 and 2024. The expected acceleration in growth did not materialize, and the industry’s revenue fell tens of billions short of forecasts.

Market Challenges

Several factors contributed to the industry’s stall, including the end of console and GPU shortages and a strong content release slate that did not translate into expected financial success.

The video gaming market also experienced a contraction in player engagement and spend, indicating that previously reliable growth engines (like mobile gaming and live services) were becoming less effective.

Venture capital (VC) funding for gaming content saw a dramatic reduction, decreasing by 77% from late 2021 to early 2022, reverting to levels last seen in 2018-2019.

Technological and Competitive Landscape

Mobile gaming, which had been a significant growth driver, faced challenges from new privacy regulations (like IDFA changes) and intense competition from social video platforms such as TikTok, which absorbed a significant portion of potential mobile gaming time.

Established franchises and platforms struggled to maintain their market position against new entrants and technological shifts. For example, the emergence of AR/VR technology did not significantly impact the gaming market due to high costs and limited consumer interest.

Economic Factors

The industry’s economic environment has been affected by rising development costs, higher consumer expectations, and the saturation of certain game genres and markets.

Notably, China’s gaming market has grown substantially, becoming a major player both as a consumer and producer of video games, which has shifted global market dynamics.

Future Outlook

Looking forward, the analysis suggests that without the introduction of new growth engines or significant changes in market strategies, the video gaming industry might continue to face challenges in achieving previous growth rates.

Potential areas for future growth include further integration of user-generated content, enhanced social gaming experiences, and possibly the leveraging of new technologies like cloud gaming and AI to create novel gaming experiences.

And more

The analysis also talks about Roblox, Nintendo Switch, Call of Duty, GTA, and many more videogames and platforms like Steam.

Download the full industry analysis HERE

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I first became aware of Lifeway Foods (NASDAQ: LWAY) in 2021, when its stock was trading at ~$6/share. At the time, I was intrigued by its position as the market leader in kefir in the United States and its exposure to the growing demand for functional foods. However, I eventually stopped following the company, thinking its story had no major surprises.

That changed last week when I came across the news that Danone, its second-largest shareholder, attempted to acquire LWAY. This news made me take a fresh look at the company, its fundamentals, and its future. In this post, I take a quick look at why Lifeway rejected Danone's offers, what its true intrinsic value might be, and how this story could play out.

Ezra.

Company Overview

Lifeway Foods, Inc. is a U.S.-based company that produces and markets kefir, a cultured dairy product that is rich in probiotics. Founded in 1986, Lifeway introduced kefir to the American market, initially targeting ethnic communities in the Chicago area. Over the years, the company has expanded its reach and grown into the largest producer of kefir in the United States. Its flagship product is drinkable kefir, a tangy and protein-rich dairy beverage that contains 12 live and active cultures, delivering billions of probiotics per serving.

In addition to kefir, Lifeway offers a variety of dairy products, including drinkable yogurt, European-style cheeses, and kid-friendly probiotic drinks under the ProBugs brand. The company operates several manufacturing facilities in the U.S., with most of its products being produced domestically. A small portion of its offerings is manufactured through co-packers in Ireland and California to serve European and other international markets.

The microcap distributes its products through retail chains, distributors, and a direct store delivery system. While the U.S. remains its primary market, the company also exports to regions like Mexico, South America, Europe, and the Middle East. Its marketing emphasizes the health benefits of probiotics and positions its products as nutritious, better-for-you food options.

Lifeway Foods operates in the thriving probiotics and functional foods industry, driven by increasing consumer focus on gut health and demand for nutritious, better-for-you products. Key tailwinds include the growing popularity of probiotics, a shift toward healthier eating habits, and the expansion of functional dairy markets globally. Kefir stands out with its high probiotics, protein, and calcium content, catering to health-conscious and wellness-focused consumers.

In fact, the company is the largest U.S. producer of kefir, offering a diverse product line and leveraging its established brand to lead in this niche.

The management team has skin in the game. The Smolyansky family has maintained ownership of Lifeway Foods since its inception. Michael Smolyansky founded the company in 1986. After his passing in 2002, his daughter, Julie Smolyansky, became CEO, and his son, Edward Smolyansky, took on the role of CFO. The family continues to hold a significant ownership stake, with Julie, Ludmila, and Edward Smolyansky collectively owning approximately 47% of the company's common stock.

Danone owns 23.4% of Lifeway Foods' outstanding stock, making it a major shareholder since 1999. Its ownership is governed by a Stockholders' Agreement, requiring Danone's consent for key corporate actions, which gives it significant influence over Lifeway’s decisions. Danone a history of acquiring full ownership of companies in which it has a minority stake when the timing is right.

Looks like 2024 might be the perfect time for Danone to crack open the checkbook and slide some cash the Smolyansky family's way.

Danone's offer and why LWAY rejected it

In September, Danone sent a takeover offer to LWAY for US$25/share to buy all the shares in the company.

In November, Danone sent a second offer for US$27/share, which represented a 72% premium over the average share price over the last 3 months.

Both offers were rejected by the LWAY board, which adopted a limited-duration shareholder rights plan to prevent Danone or any other entity from gaining control without offering an appropriate premium or giving the board sufficient time to act on shareholders' interests.

But why did they reject the offer?

The management itself gave the answer:

• Lifeway has achieved 20 consecutive fiscal quarters of YoY topline growth.

• Over the past 5-y, Lifeway achieved a TSR of 788% (as measured through September 23, 2024, the last full trading day before Danone's initial unsolicited proposal was publicly disclosed), far outperforming other high growth food and beverage peers as well as the S&P 500.

• From 2019 to 2023, the Company's annual revenue has grown from US$94 million to US$160 million, a 71% increase and a 14% CAGR.

• Over that same 5-y period, gross profit increased 92%, representing an 18% CAGR, with continued Operating Income and Adjusted EBITDA margin expansion over the same period achieving US$17 million in Operating Income and US$22 million in Adjusted EBITDA in 2023.

• The Board and management believe that Lifeway has reached an inflection point, with strong momentum in core kefir products, new product adjacencies and ongoing operational efficiency programs, which have rapidly improved profitability and which the Company expects to continue to rapidly improve profitability

• Lifeway forecasts annual Adjusted EBITDA to grow from US$22 million in 2023 to between US$45 million and US$50 million in 2027.

• Based on the expected 2027 EBITDA range, the Danone proposal of US$27 per share implies a very low multiple of ~7.5x – 8.5x EBITDA, even prior to accounting for substantial synergies and additional operational efficiencies that Danone (or another strategic acquirer) could realize.

LWAY back-of-the-envelope valuation

I made a back-of-the-envelope valuation considering 3 scenarios. In each scenario, I take into account the following and being a little bit conservative in my numbers:

• The 2027E EBITDA mentioned by management of US$45-50 million.

• Current Outstanding Shares of 14.82 million

• Current stock price (11/29/2024): US$24.25/share

Bear Case

Here I take into account a multiple of 12x EBITDA, which is approximately what LWAY has been trading at in the last 5y. This would take LWAY to:

• Implied 2027E EBITDA: Between US$540 — 600 million

• Intrinsic value/Share: US$36.4 — 40.5

• Upside: 49-66%

Base Case

• 13x EBITDA (5y. average Daily industry EBITDA multiple)

• Implied 2027E EBITDA: Between US$585 — 650 million

• Intrinsic value/Share: US$39.5 — 43.9

• Upside: 62-80%

Bull Case

• +15x EBITDA (taking into account synergies and the growth that Danone can provide to LWAY)

• Implied 2027E EBITDA: Between US$675 — 750 million

• Intrinsic value/Share: US$45.5 — 50.6

• Upside: 86-107%

My Two Cents

Danone's offer of 7.5x EBITDA is frankly insufficient, considering Lifeway's historical growth and leadership in an industry with strong tailwinds.

Taking into account the growth of this microcap that is a leader in its market in an industry with a lot of growth and future, if I were the majority shareholder I would ask for at least +13x EBITDA, justifying the potential of Lifeway Foods under Danone's umbrella, taking advantage of its size to grow faster and enter with more presence in the overseas markets where LWAY already operates.

I think Lifeway's negotiating position is solid, but the outcome will depend on the strategic vision of its majority shareholders who prefer the company to be sold arguing that "Julie is prioritizing family legacy over shareholder interests."

Do you think Danone will end up paying the fair price?

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Hey, guys!

Last weekend I had the chance to read Gwen’s write-up on Ingles Market. I came across her write-up a few months ago, but finally, I had the opportunity to take a look.

I first met Gwen on LinkedIn (and she happens to be a member of MOI Global as well) when she posted her Ingles write-up and it was a hit on the social network. Several investors shared their comments about Gwen's great work.

I agree: Gwen has done a great job and the quality of her write-up is of the highest quality; going beyond the company filings and searching the public records to discover the true value of Ingles Markets.

Without further ado, I am sharing my notes on Gwen's write-up, with her permission, and at the end of the post, I have attached the complete write-up in PDF format.

P.S. If you want to know more about Gwen's work and career, you can follow her on LinkedIn (an interview with her on MOI Global is coming soon).

And if you are looking for a valuable analyst for your investment team, Gwen is the choice.

Ezra.

Company Overview

Ingles Markets, Inc. (NASDAQ: IMKTA) is a family-owned regional supermarket chain headquartered in Asheville, North Carolina. Founded in 1963 by Robert P. Ingle, the company operates 198 supermarkets and 93 shopping centers across six Southeastern U.S. states: North Carolina, South Carolina, Georgia, Tennessee, Alabama, and Virginia. The company's supermarkets operate under the "Ingles" and "Sav-Mor" brands, and it offers additional services like fuel stations, pharmacies, Starbucks kiosks, and curbside pickup.

Ingles is highly vertically integrated, with 1.65 million square feet of distribution and warehouse space and a fleet of tractors and trailers to manage its logistics. Through its subsidiary Milkco, Ingles also manufactures a significant portion of the dairy products sold in its stores. Furthermore, Ingles Leasing handles the company's shopping center properties, leasing out spaces to third-party retailers. This diverse business structure enables Ingles to maintain tight control over its supply chain and operations.

Undervalued Real Estate Portfolio

• Ingles Markets owns significantly more land than disclosed in financial reports, including 3,700 acres compared to the reported 160 acres.

• The estimated fair market value of Ingles' real estate portfolio is US$1.39 billion, which includes US$657.7 million in off-balance-sheet value. This suggests a substantial hidden value that is not fully reflected in the company’s financials.

• Gwen projects that by 2033, the real estate portfolio could grow to US$2.27 billion through appreciation and continued acquisitions.

Business Segments

Ingles Supermarkets

• Ingles generated US$5.9 billion in revenue in 2023, a 161.6% increase from 2005 to 2023.

• The company has an average 41.8% market share across 119 local markets, remaining competitive against major chains like Walmart and Publix.

Since 2014, an average 19.3% of annual EBITDA has been allocated to real estate acquisitions, but closer analysis reveals marked shifts in that allocation. From 2013 to 2017, total supermarkets owned increased by 2%, while owned shopping centers increased by 7.4%. In 2018, management accelerated their real estate acquisition strategy, but shifted the bulk of capital allocated to shopping center acquisition. Hence, from 2018 to 2013, Ingles’ shopping center ownership increased 27.4%, compared to just 7.1% for supermarket ownership.

Milkco (Dairy Division)

• Milkco provides 72% of the dairy products sold in Ingles supermarkets and also sells to third-party retailers.

• Milkco has a strong EBIT margin of 7.6%, contributing to the overall profitability of Ingles.

Ingles Leasing

• Ingles Leasing, which handles the company’s shopping center properties, is a key driver of growth. It generated US$21.5 million in FFO (Funds from Operations) in 2023.

• The division has an FFO margin of 86% and has grown at an annual rate of 14.7% between 2014 and 2023.

The impact of management’s decision to focus on the expansion of Ingles Leasing is significant. Not only does shopping center ownership reduce retail space availability for competitors, but the property leasing industry is substantially more profitable than the supermarket industry. Consequently, the rise of Ingles Leasing likely to result in company-wide margin improvement over time.

One critique of measuring FFO as a percentage of EBIT may be that it unfairly exaggerates the impact Ingles Leasing has on pre-tax margins in the absence of like add-backs for the depreciation of owned real estate by Ingles Supermarkets. To get a like-comparison, the addition of depreciation, less capex unrelated to changes in land and buildings needs to be calculated. For the purposes of this report, the aforementioned adjustments are calculated as change in land and buildings, minus: change in leasehold improvements, change in construction in progress, change in transportation equipment, and change in store, office, and warehouse equipment.

Competitive Landscape

• Ingles competes with large national chains like Kroger, Trader Joe’s, Aldi, and Walmart but maintains an impressive market share. Across the 119 markets analyzed, Ingles holds a 41.8% market share, while Walmart averages 26.1% and Publix averages 21.1%.

• The company owns 84.3% of its supermarkets, making it one of the highest store ownership rates among publicly traded U.S. supermarkets. This ownership of both stores and land restricts competition from entering their markets.

Inflation-Resistant Business Model

• Ingles has demonstrated strong resilience against inflation, with net profit margins expanding from 2.9% in 2020 to 5.0% in 2022—a 163.2% increase.

• During this same period, Ingles’ EPS grew by 309%, compared to Walmart’s 38.7% and Kroger’s 70.3%, highlighting the company’s ability to manage costs and drive earnings growth despite rising prices.

Management

• The company is led by Bobby P. Ingle, who holds 22% of shares outstanding and has repurchased 20.4% of shares over the past decade.

• Ingles has also reduced its debt by US$403 million, improving its debt-to-equity (D/E) ratio to 38.2%, down from 131.7% ten years ago, giving it a stronger balance sheet than its competitors

Valuation

• Ingles is currently trading at a P/TB ratio of 0.87x, which is 52.3% lower than its historical average of 1.28x.

• When accounting for the US$657.7 million in off-balance-sheet real estate, the P/TB ratio adjusts down to 0.61x, indicating that the company is highly undervalued.

• Ingles’ current market capitalization is US$1.4 billion (As of the date of the write-up), while the total asset value, including its real estate and supermarket operations, is estimated at US$5.1 billion, suggesting that the company is trading at only 31% of its projected 10-year value.

Related Party Transactions

Gwen mentions that related party transactions have been a point of concern for investors, given their volume and nature. Specifically, in 2023, Ingles engaged in several notable transactions with entities related to its chairman, Bobby Ingle. These included:

• Loans amounting to US$330,000 issued to insiders in 2023 (there were no loans in the prior year).

• Two properties, with a combined fair market value of US$5.8 million, were sold to Ingles by an LLC in which Bobby is a principal.

• An additional property owned by Bobby’s LLC was traded for a similar property owned by Ingles.

She clarifies that these types of transactions are unusual compared to past activities. Between 2012 and 2023, around US$13.3 million in assets have been exchanged between Ingles and Bobby’s LLC. The most notable historical transaction was a US$2.5 million sale of Bobby’s private plane to Ingles in 2012.

While such related party transactions are always worth investor scrutiny, Gwen suggests that they do not pose a material risk to the company’s overall financial health, as Ingles has generated US$2.2 billion in acquisition-adjusted FCF since 2014, making these transactions inconsequential relative to its overall wealth. Furthermore, these deals are not significant enough to suggest any concerted effort by management to defraud shareholders​.

Conclusion

Gwen Hofmeyr concludes that Ingles Markets is substantially undervalued, with a real estate portfolio alone worth more than its current market cap. The company’s inflation-resistant supermarket business, rapidly growing leasing division, and strong financial management make it a compelling investment.

Here’s Gwen’s full write-up in case you wanna take a look a it.

Ingles Market Gwen Hofmeyr

11.8MB ∙ PDF file

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In recent years, private credit has emerged as one of the most talked-about asset classes on Wall Street. According to recent data, private credit assets reached approximately US$2.1 trillion globally in 2023, growing from US$250 billion in 2010. This growth is driven largely by demand from companies, especially those backed by private equity funds. In the United States, the private credit market has grown at an annual rate of 20% over the past five years, now accounting for 7% of total credit to non-financial corporations.

But what exactly is private credit?

What Is Private Credit?

At its core, private credit involves direct loans to privately owned companies, real estate, and infrastructure projects. Unlike traditional bank loans, which are often syndicated and involve multiple banks, private credit is typically arranged between a single lender and a borrower. This market has gained traction due to its ability to offer higher yields, especially in a higher interest rate environment.

Why the Surge?

Several factors have contributed to the meteoric rise of private credit:

• Higher Interest Rates: As interest rates have climbed, investors are increasingly turning to private credit to seek higher returns. The floating rate nature of these loans means they adjust with market rates, providing attractive yields in a rising rate environment.

• Bank Retreat: Following the 2008 financial crisis, regulatory changes led banks to pull back from riskier lending. This created a void that private credit has stepped in to fill. With banks focusing on safer assets and higher capital requirements, private credit has become a popular alternative.

• Institutional Interest: Pension funds, endowments, insurance companies, and sovereign wealth funds have poured capital into private credit. Unlike retail investors, these institutions have the means to invest in these illiquid, higher-risk assets.

• Demand from Smaller Borrowers: Many small and medium-sized companies find it difficult to access public debt markets due to deal sizes being too large for their needs. Private credit offers a more flexible and tailored solution.

• Speed and Flexibility: Private lenders offer a faster approval process, without the need for lengthy investor roadshows or ratings agency reviews. This allows companies to obtain capital efficiently.

Profile of Borrowers and Key Sectors

Companies seeking private credit tend to be smaller and have higher leverage than those accessing public debt markets. The technology and healthcare sectors are the most represented within private credit, reflecting the strong presence of private equity in these industries.

An important point is that around 70% of companies obtaining private credit are backed by private equity funds, highlighting the close relationship between both sectors.

Risks and Concerns

Despite its growth and attractive returns, private credit is not without its risks:

• Market Bubble: Some experts, including UBS’s chairman, have raised concerns that private credit might be experiencing a bubble, potentially leading to a financial crisis if not managed carefully.

• Quality and Transparency: The market's rapid expansion has raised concerns about the quality of loans and the transparency of private credit funds. Under-regulation and a lack of oversight could pose significant risks, especially if economic conditions deteriorate.

• Default Risks: As interest rates remain high, borrowers may struggle with increased debt servicing costs. This raises the risk of defaults, particularly among those who are already financially strained.

• Potential Losses: Private credit often involves lending to smaller companies with higher levels of debt. In an adverse economic environment, unexpected losses could be significant, particularly for investors like insurance companies and pension funds that have increased their exposure to these assets.

• Multiple Layers of Leverage: The structure of the private credit market presents multiple layers of leverage. Funds, borrowers, and even the investors themselves use debt in their operations, potentially amplifying losses and triggering ripple effects in financial markets in the event of a downturn.

• Valuation Uncertainty: The lack of secondary markets and comparable transactions in private credit leads to more uncertain valuations. The International Monetary Fund (IMF) has pointed out that unclear valuations can result in a loss of confidence in the asset class, which poses a significant risk.

• Liquidity Issues: Although retail participation in private credit markets is currently low, the IMF warns that liquidity risks could rise if retail interest grows. Additionally, many private credit deals include revolving credit facilities, which could result in increased cash demands if borrowers simultaneously draw on their lines of credit.

Mitigating Factors and the Role of Private Equity

Despite these risks, private credit has shown some resilience. Historically, losses in this market have not exceeded those of high-yield bonds and are comparable to leveraged loans. One factor mitigating risk is the backing of private equity. Since private equity firms sponsor many of the borrowing companies, they often inject additional capital if they believe that financial stress is temporary.

Moreover, most private credit loans are secured, which helps limit losses in the event of liquidation.

Conclusion

Private credit has grown to become an essential part of the financial landscape. While the interest rates and flexibility it offers are attractive, the associated risks should not be overlooked, especially in a context of rising interest rates and volatile markets. The backing of private equity and long-term relationships helps contain these risks but does not eliminate the potential for unforeseen events.

Sources

1. How Private Credit Became One of the Hottest Investments on Wall Street. CNBC.

2. The Private Credit Playbook. Stephen Clapham. (Part I & Part II)

I’d love to hear from you! What do you think about the growth and risks of the private credit market?

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Taking notes and truly learning from them can be a struggle for many. Often, we find ourselves overwhelmed by information, unsure of how to organize our thoughts or retain what we’ve learned. Traditional note-taking methods, like writing long paragraphs or summarizing entire chapters, can leave us with disjointed ideas that are hard to connect later. Worse yet, we forget key points or lose track of how one idea relates to another. If this sounds familiar, you're not alone. Luckily, the Zettelkasten method offers a solution—a way to capture, organize, and link ideas that mirrors how our brain naturally works. This approach transforms note-taking from a frustrating task into a powerful tool for long-term learning and creativity.

The Zettelkasten Method

Unlike other note-taking methods, the Zettelkasten system focuses on capturing brief ideas on small index cards, recording only one idea per note, and connecting each idea with others, either directly or indirectly through their content.

If we usually take notes while reading a book and write them down on a page, with the Zettelkasten method, we would break down the key points of the reading into separate ideas, with each idea written on a single note.

This method is considered a ‘second memory’—a ‘second brain’—because it is not organized hierarchically or categorically. Instead, each idea is linked to another, much like how our brain works.

Origin of the Zettelkasten Method

Zettelkasten is a German word that translates to ‘box of notes’ or ‘file box.’

Although it has origins dating back to the 16th century, this system wasn't perfected until the 20th century, when it became well-known thanks to German sociologist and philosopher Niklas Luhmann.

Luhmann referred to this method as his ‘second memory’, using it as a tool to be more productive in learning, reflecting, and reasoning. In fact, Luhmann wrote 90,000 interlinked notes, averaging six notes a day.

Through the Zettelkasten method, Luhmann was able to publish 70 books and 400 papers.

How Luhmann Used the Zettelkasten Method

Since personal computers didn't exist during Luhmann's career, he took notes physically using index cards.

Once he had written down an idea per note, these were stored in wooden boxes for future reference.

To identify his notes, Luhmann assigned a sequential identification number, starting with 1, located in the top left corner.

If he added branches to these, he would create a new note and assign it an ID: the number of the card from which the branch emerged, accompanied by letters or numbers. For example: 1a, 1b, 1/1, 1/2, etc.

Luhmann had two different filing systems:

1. Bibliographic or Literature: This contained small notes about the content of texts read and the bibliographic sources of each.

2. Main: This contained ideas that arose based on the content read.

Fortunately, today we can create our own ‘second brain’ using applications like Obsidian or Roam Research to make the Zettelkasten method easier without having to add ID codes to the notes.

The Keys to the Zettelkasten Method

The core of the Zettelkasten method revolves around two fundamental ideas:

1. Modular Notes: When reading a book, you take notes of what you are learning. The idea of taking modular notes is that you break down these notes into individual slips of paper. Each idea that comes from those notes (each quote, story, example, etc.) should be filed individually.

2. Linking Notes: Forget about "filing" notes hierarchically or categorically, as is traditionally done. Organizing notes in this way is a hindrance because many times ideas can relate to each other and do not fall exclusively into one category.

Remember, our brain doesn’t work like that; it links ideas together without paying attention to any kind of hierarchy.

And that’s the Zettelkasten method: like a second brain, trying to replicate how our brain functions.

Types of Notes in the Zettelkasten Method

• Quick Notes: These are created on the spot without precision, capturing as much information or key ideas as possible without worrying at that moment about how they will be linked. These are temporary notes that will later disappear from the system. Once processed into permanent notes, they are deleted.

• Bibliographic or Literature Notes: Luhmann wrote bibliographic notes on the back of his literature notes. Literature notes explain in our own words the ideas from the textual quotes of external sources that we’ve written in the bibliographic notes.

• Permanent Notes: These reflect our mental models (how we think, how we believe the world works). These are the most important notes in the Zettelkasten system.

• Keyword Notes: These are notes with keywords that redirect us to entry points in the Zettelkasten system.

• MOC or Structural Notes: These give a global context view of other permanent notes. They are the glue that links them together within a specific context.

Zettelkasten with Obsidian

Personally, it's more difficult to enter one idea per note because my ‘second brain’ would be filled with thousands of notes, and it would be harder for me to link them together. So, I prefer to summarize my readings in one note. I link them with other related notes in my second brain. For example, last year when I published my analysis of the Silicon Valley Bank collapse, all the notes I took on the topic were interconnected:

Each note I take has the following structure:

• Main Ideas

• Source: Including the title of the post/book/paper…; link; author, and publication date (i.e. 'Lessons from Silicon Valley Bank. Howard Marks’ Memo published on April 17, 2023’).

• Related to: In this section, I link notes/ideas from my second brain that are related to the topic.

I'm not an expert in Obsidian for note-taking, but this system works well for me. Either way, I recommend the following links if you want to use Obsidian for your notes:

How to Use Obsidian as a Zettelkasten: The Ultimate Tutorial

Obsidian-Zettelkasten Starter-Kit

How Do You Use Zettelkasten in Obsidian?

Conclusion

• Write one idea per note.

• Each note must be linked to others. The links prevent us from overlooking information that may be useful later. Here, you should briefly explain why you linked.

• Each note should be written in your own words.

• Avoid creating hierarchies or categories for notes.

• Add the bibliographic source of each idea.

• Over time, notes begin to group by theme. When this happens, create a note to group them and show their connections.

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I’d love to hear from you! What note-taking method do you use? Do you prefer traditional methods, or are you ready to give Zettelkasten a try? Let me know in the comments, and feel free to share any tips or tools that have helped you along the way.

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