I review the 2018 Rebel Allocator by Jacob Taylor and it is so good that Charlie Munger called Jake to share some advice. This book shares essential lessons on how to allocate capital from the point of view of running a business.
If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.
I give a quick synopsis of the fictional plot featuring the student Nick and billionaire Mr. X (a composite of Warren Buffett and Charlie Munger) but I mostly focus on the non-fictional insights and key takeaways of capital allocation and how to succeed in business. Nick essentially learns that capitalism isn’t out there to screw the little guy over, but capital allocation done right is actually good for society and the sustainability of the planet.
The book opens and ends with a Warren Buffett 1987 Berkshire Hathaway annual letter quote in which capital allocation or making money decisions on a company’s behalf seems to be a critical skill that eludes many CEOs. Buffett prefers to control companies so he can decide how he wants to allocate capital.
An analogy with a hawk is used to describe how we should pay ourselves first. When a hawk is slightly hungry it will still hunt, and this is called a state of “yarak,” as it’s not fully fed yet so it’s not sitting around being fat and happy. Placing this artificial constraint on ourselves motivates us to be more creative and to strive for more, while retaining more of our earnings or profits.
Companies improve their competitive positions when they focus only on strategic expenses that delight customers and eliminate unnecessary costs. This is known as zero based budgeting where companies don’t just carry over expenses ever year but critically evaluate them if they are necessary.
There’s the Iron Law of Economic Survival where you have Cost, Price, and Value as illustrated by straw diagrams in the book and where I demonstrate some of the basic examples. Between Cost and Price there’s Profits and between Price and Value there’s the Company’s Brand in the eyes of the Consumer.
Value is highly subjective, and companies should think about what makes people happy. I use the example of a first edition Pokemon Pikachu card on eBay whose price or perceived value has compounded from a $4 pack at 32.64% to be $2K from 1999 to 2021 as an example of subjective value people place on goods and services that a company delivers.
The moat of a business castle is having a barrier to competition and includes having a brand or being the low cost producer. If you want to improve your brand, be either the best, cheapest, or most convenient.
More businesses provide commodities than they realize. IPOs are usually a losing bet. Deals often fail in practice but never in projections.
The Net Promoter Score (NPS) is derived from asking how likely a customer is to recommend the business to a friend and asking Why? The NPS serves the purpose of getting feedback from customers on what’s working or not, and how well the business is solving their problems.
The higher the business earns on invested capital, the more cash it is producing, the more value is created.
Return on Invested Capital (ROIC) can be used to measure how effectively you are delivering value. The book’s fictional Cootie Burger uses ROIC to measure how long term strategies rather than projects are performing in order to delight customers and reduce operational costs.
Also issuing your company’s stock is like issuing your own currency where you want to make sure you are getting as much intrinsic business value if you do this. Warren Buffett made this mistake with Dexter shoe.
There’s the BBQ factor where people like to brag by pursuing mergers and acquisitions without identifying if the value is legit.
I found this super key to keep in mind: Buffett doesn’t have a long term strategic plan since things change. He simply decides what’s best for Berkshire’s owners or shareholders.
When there’s easy money, returns on capital suffer. But in the Cootie Burger example, this Wizard of Wichita Mr. X (much like Buffett and Munger) sat on the sidelines in cash patiently waiting until their opportunity came along. They use a pine cone germinating after a forest fire as an analogy.
Doing nothing is a also a decision, and sometimes it’s the best thing to do. Sometimes we should wait for a better menu to choose from.
In the book, Nick said that it can be limiting yourself to pre-decide what the best option 10 years from now is, but we should pick among the best options since we don’t know what the future holds.
When there are bubbles, you can choose to either be a fool as you miss out in the build up or be a fool after it bursts. Bust follows boom sure as night follows day.
There’s a Buffett quote about how seldom it is in upper management to use the discipline of buying and holding passive investments.
There are at least 8 ways to put a roof over a customer’s head, in addition to the different ways of building a restaurant or taking some over, you could also buy a competitor’s stock or do share buybacks.
Ideally the price of a company should be the same as its intrinsic value (fair). Stock buybacks can help put in a floor if some people want to get out as the company is willing to buy it back from them at book value.
An awesome Buffett quote from the 2001 Annual Meeting:
“In allocating Berkshire’s capital, we ask three questions: Should we keep the capital or pay it out to shareholders? If pay it out, then you have to decide whether to repurchase shares or issue a dividend. To decide whether to retain the capital, we have to answer the question: do we create more than $1 of value for every dollar we retain? [… and …] the cost of a deal is relative to the cost of the second best deal.”
Charlie Munger’s Margin of Safety concept is mentioned, and it’s a risk management strategy to never go to the edge by buying something at a lower price in case we’re wrong about the future value.
Companies may not be making the best investment decision by giving out dividends, they’re often “doing it wrong” as the book’s Mr. X says. Dividends should only be the last resort if the CEO can’t reinvest it into the company to keep generating increasing returns on capital. Not everyone wants dividends, either.
Misallocation is bad for society and the environment as it is wasted energy and resources. Good capital allocation is doing more with less resources to result in happier customers.
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