Newsletter IX - Human Nature, $XYL, & ROIC

Recapping a Week in the Markets: Sept.18 - Sept.22

Week Recap

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News

Unity Tries to Calm the Storm

On the heels of Unity’s announcement of a runtime fee to be introduced in January 2024, member of the board and founder of Unity Software, David Helgason, announced that the company “f****** up” and would be making changes to their policy after the number of developers boycotting the platform reached more than 500 just a week after the original announcement. More recent updates from the company have clarified that they are engaging in talks with their customers to try and find a solution, but exact amendments to the policy have not yet been cemented or released to the public. Unity shares are down nearly 20% since the Runtime fee was initially announced.

Rate Hikes Expected to Remain High

While the Federal Reserve did elect to pause rate hikes at this week’s meeting, and are for the moment hovering at the 5.25%-5.5% mark, rates are nonetheless expected to remain high for the foreseeable future as a result of a stronger-than-expected American economy, according to data from the central bank. The market isn’t currently eyeing up rate cuts until late 2024 at the earliest. While there have been a number of healthy indicators on slowing inflation over the last few months, the feds are evidently still seeing a lot of hotter indicators and aren’t willing to ease up anytime soon.

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Weekly Read - The Laws of Human Nature

By Robert Greene

As regular readers could probably start to guess, given the number of times I’ve recommended similar books on previous newsletters, some of my favourite investing books weren’t really about investing at all, but rather about psychology and the quest to understand the human brain. I find these books immensely helpful for a number of reasons, not only that it helps me master some of my less desirable investing qualities and helps me to understand why I’m making decisions. Well, we’re back with another this week, ‘The Laws of Human Nature’ by Robert Greene.

In ‘The Laws of Human Nature’, Greene makes the point that understanding human psychology is crucial to success, and that by understanding our emotions and those of the people around us, we can find this success. Most of the book is centered around the actual laws, go figure, of human behaviour, with each chapter explaining a different law, providing examples of it in action with different notable figures, and showing how it can be applied in the reader’s life. These are the laws:

Through understanding how each of these ‘laws’ drive our own and other’s daily decisions, the reader can use this information to their advantage in personal and professional relationships. I won’t say it’s the most enthralling book out there, but it’s a great one if you’re interested in understanding how some of these different laws influence how you make decisions as an investor and the broader market psychologies, to some degree. It’s actually one I read a number of years ago and only recently remembered, so I’m hoping to get a re-read in here pretty soon.

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Investing Tidbit

Return on Invested Capital - ROIC

For this week’s investing tidbit, I wanted to get into one of my favourite metrics to follow for high-quality businesses, rather than the usual investing framework/mentality stuff. This is one of the very first things I look at when analyzing the quality of a company, as well as what stage the business in.

Return on Invested Capital (ROIC) is a great metric to follow to analyze the efficiency of a business and its ability to generate growing profits. In essence, this metric measures how effectively a company uses its capital to provide returns to the business and its overall capital efficiency. A higher ROIC often indicates that a company has a strong advantage over competitors, and that management is able to reinvest their earnings very efficiently, which can lead to faster growth and returns to shareholders. ROIC goes beyond how much money a company is making, but how effective it is at making money and its ability to extend that into the future.

It’s not always a perfect metric, though - ROIC is a fantastic measurement of mature businesses, but it’s fairly limited when it comes to growth companies. The reason for this is that ROIC is a backwards-looking metric, in that it’s analyzing the returns that the company has already achieved on investments they’ve already made - while it can be a good indicator for the potential of future returns on investments (for example if management has been generating solid returns on capital for 5-10 years), it doesn’t necessarily tell you the returns they’re receiving on investments they’re currently making or going to make. In this way, ROIC can actually catch you - if a business realized fantastic returns on previous investments, but is currently entering a stage of decline (as many mature businesses eventually do), the company’s ROIC figure would still look fantastic. So, like any metric, it’s important to understand the data behind the metric and not make a decision exclusively on one stat that appears really attractive.

As for growth investors, you’ll find negative returns on invested capital for nearly every high-growth business. This is completely normal, and shouldn’t scare you away from a business. These companies are currently investing the capital, but not yet achieving the returns on it. This is especially true for companies that are expensive to start - they have to sink a ton of money into starting the business, which may show up as -900% ROIC figure while they’re in the growth phase, but as they start to mature and begin realizing profits and eventually income on those investments, that ROIC metric will start to become more attractive. In this way, it is still useful for growth investors to track the movement on ROIC for a company (is it going up as they mature? or is it continuing to decline even as they get closer to being profitable?), but is not inherently telling of the ability of a business to make effective investments.

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Investor Spotlight

DTF Capital - Sleep Well Investments

Sleep Well Investments provides deep dives into some very high-quality and incredibly boring companies - which are exactly the kind of companies I love to read about - including, Shimano (bike parts), MIPS (bike helmets), and VAT Group, which shot straight to the top of my watchlist after learning about it through the Sleep Well Investments newsletter. This company has a leadership position in vacuum valves and systems, which is about as boring as you can get, but is indicative of the sort of businesses that you can expect to read about if you follow Sleep Well Investments; companies with dominant leadership positions in their markets; companies that have been, are currently, and will continue to perform exceptionally, regardless of market cycles; companies, in short, that let you sleep comfortably and worry-free at night because your capital isn’t tied up into high-flying names, fad industries, or risky investments.

When I say the companies are boring, please note that I couldn’t offer higher praise - these are exactly the kind of companies I’ve more recently begun to follow, and Sleep Well Investments put me on to a lot of great names with this qualification. That’s also to say nothing about the newsletter itself, which is far from boring - on top of deep dives into fantastic businesses, I’ve been really impressed with the amount of work that DTF Capital puts into tracking investment theses on companies, transparency around their investing framework and checklists, regular updates through Substack Notes, and quality content on Twitter (which is hard to come by).

I really can’t recommend Sleep Well Investments enough if you’re looking for information on stocks that let you sleep well while providing stable, compounding growth. You can find DTF Capital on Twitter, but be sure to follow their Substack for all the really good stuff!

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Weekly Watchlist Stock

Xylem

This is another watchlist stock that’s already in my portfolio, having received some shares of Xylem when they acquired Evoqua, a previous investment of mine. I decided to keep the shares with an identical thesis of wanting a water play in my portfolio, given the critical nature of this portion of infrastructure and its growing importance in a warming climate.

It’s back on the watchlist with a recent downturn on the share price. As a side bonus, Xylem is a super simple business to understand - they are focused exclusively on water, but have a wide range of products, services, and solutions:

• Testing equipment

• Hydro turbines

• Software

• Water treatments systems & products

• Pipe assessment services

• & so much more

Xylem is one of the leaders in their space, and their recent acquisition of Evoqua gave them a fast-growing business with particular expertise in treatment and filtering products & solutions. The company is a steady grower with lots of continued growth potential as synergies are realized with Evoqua, water becomes a more valuable commodity, and water & wastewater solutions are required more and more around the world. If the slump continues and Xylem falls below my cost basis, I will certainly be adding.

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What’s New at Hourglass

Unity - Brilliant Business, Mediocre Management?

Building on the Unity news at the top of this episode, I released an episode of the Hourglass Investing Podcast on Wednesday discussing in more detail my thoughts on the announcement of the runtime fee. I also go over the business model, some of the growth levers, and Unity’s ability to protect its market position before I rip into management and discuss their many flaws. Check it out below, and if you like what you hear, consider following the podcast on Spotify!

Upcoming - Aritzia Deep Dive

I’m currently working on a deep dive into the women’s fashion boutique brand, Aritzia, which is going to get released early next week!

This has been a fun one to research - the company is often compared to Lululemon in its early days and the beginning of its expansion into the United States, a very similar trajectory to that of Aritzia at the moment. A few bad quarters have hurt the business, and with its next quarterly results being announced next Thursday (Sept. 28), I thought it would be a good time to analyze whether the long-term thesis on this company remains intact, or the recent results are indicative of Aritzia becoming just another fashion dud. Stay tuned for that coming out, and hit that subscribe button below if you want it sent directly to your inbox!