Welcome to the 2023 annual letter. Our gain in net worth during the past 4 years was 21% compared with a gain of 12% for the All Ordinaries Index, our 20th year of outperformance. This year our gains were driven by returns from our international equities and finally a counterintuitive rebound in the Perth real estate market.In contrast our domestic securities have treaded water, albeit with returns aided by dividend yields much higher than US stocks.It is hard to know where to begin in describing the past 4 years, where one momentary loss of faith and panic sent Kanday group into a financial tailspin. A tailspin caused by an unforced error which has taken the better part of 4 years to recover from. I haven’t commented on our position during this time because I felt none of the updates would provide much value in the context of the trajectory of our company. Therefore I concluded that taking right action was time better spent rather than trying to untangle the mess I created in the public eye. So I will briefly summarise what happened now and then we can put it behind us and hopefully learn from the experience. In February 2020, the world suddenly descended into chaos due to the rapid global spread of the novel coronavirus pathogen which was causing millions of people to fall ill and in many cases die from flu like symptoms. Governments around the world in panic announced lock down of their citizens and global business ground to a sudden halt. In Australia the lockdowns lasted more than a month and the West Australian border was even closed, an historical first. Planes were grounded and supply chains seized up. The epicentre of the infection was Wuhan, China and this coupled with all the scary news headlines from the alarmist media sent my household into a code red alert. I preempted the government move and closed my dental business ahead of the formal government mandate in an effort to protect staff and patients from the looming risk. As you can see, these moments were fairly unprecedented and unsurprisingly global share markets all plummeted.
I like everyone else watched the value of our investments sink and it seemed this was just the beginning of the end. Ironically, in a confluence of events, I had just changed to a new accounting firm and the principal had advised me that our holding structures were inadequate and recommended I sell our positions in order to correct this. With this advice ticking away in my mind, with a Chinese wife and extended family and a preservation of capital mindset, I liquidated our portfolio right at the peak of the fear and hysteria. In retrospect, I managed to time the bottom perfectly, except I was a seller and not a buyer and for this I apologise. It is my job to remain steadfast and maintain perspective during times of financial panic and to this end I failed.
I have spent the past 4 years making up for this costly momentary lapse of rationality and hopefully over time there will be evidence that I have learned from my big mistake.
“Nobody ever made a profit from panicking.”
Jim Cramer
“You can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder
and you deserve the mediocre result you’re going to get compared to the people who do have the temperament of people who can be more philosophical about these market fluctuations.”
Charlie Munger
“It’s extraordinary how resistant some people are to learning anything.”
Charlie Munger
| Annual Percentage Change | ||||||
|---|---|---|---|---|---|---|
| Calendar Year | Kanday | All Ords | +/- |
|||
| 2003 | n/a | 11.1 | n/a | |||
| 2004 | 62.2 | 22.6 | 39.6 | |||
| 2005 | 23.7 | 16.2 | 7.5 | |||
| 2006 | 60.2 | 20.00 | 40.2 | |||
| 2007 | 26.3 | 13.6 | 12.7 | |||
| 2008 | -16.4 | -43 | 26.6 | |||
| 2009 | 31.7 | 31.3 | 0.4 | |||
| 2010 | 24.84 | 1.4 | 23.44 | |||
| 2011 | 19.6 | -13.9 | 33.5 | |||
| 2012 | 12.4 | 10.8 | 1.60 | |||
| 2013 | 28.7 | 13.6 | 15.1 | |||
| 2014 | 15.8 | 1.2 | 14.6 | |||
| 2015 | 10.6 | -3.8 | 14.4 | |||
| 2016 | 9.7 | 7 | 2.7 | |||
| 2017 | 12.5 | 7.9 | 4.6 | |||
| 2018 | 3.95 | -10.3 | 14.3 | |||
| 2019 | 30.5 | 24.8 | 5.7 | |||
| 2023 | 4.95 4yr CAGR | 2.9 4yr CAGR | ||||
| Cumulative Return | 2003-2023 | 2421% | 134% | |||
| Compound Annual Return | 2003-2023 | 17.51% | 4.35% |
Key Themes of 2020-2023
“This too shall pass.”
King Solomon, 1852
“Charlie said to lower your expectations for a happy life. I say aim high and learn to manage disappointment.”
Marcel Candeias
Grand scale quantitative easing by the US Fed on monetary policy set the stage for the rally in equity markets in 2020 and 2021, erasing the precipitous falls of March 2020 and then eclipsing them sending stocks to new all time highs in record time. Unfortunately, even though I quickly recognised the error of my previous sell decision, I was unable to participate. Because I had set about restructuring our holding structure (that other unexpected curveball I was thrown), and with unprecedented trading activity as everyone was confined to their homes, I was unable to conduct any purchases for 4 months while I waited for Commsec to process the paperwork. As a result, I completely missed the entire Fed juiced rally. So in summary, I sold at the nadir of the selloff and then was forced to sit on the sidelines and watch as all the stocks I had just sold rallied to the moon. When I eventually had the opportunity to buy back in, I understandably had a serious case of FOMO (fear of missing out) and absolute anger at what had just transpired. In a lot of cases, prices now looked stretched and I found myself moving further along the risk curve in order to validate the prices I was now suddenly faced with paying, often double or more what I had sold the same stock for just a couple of months beforehand. What an emotional rollercoaster I was on, one which I never could have imagined at the beginning of the year. Furthermore, I was faced with a significant tax bill due to the aforementioned sell out (yes I still had large capital gains).
In 2022, the world flipped again, with inflation suddenly rising around the world. The Fed reacted impulsively again, this time raising interest rates at an unprecedented pace. US central bank short term rates were increased by more than 500bps in less than 12 months, and all of the high flying stocks came crashing down once more.
Divining which industries were benefitting from Covid lockdowns and then supply chain disruptions and then a global labour shortage and then soaring interest rates has been one of the most challenging times to be an investor. The only anchor amongst all of this chaos has been the focus on seeking quality businesses with favourable economics, trading at reasonable prices and taking a long term perspective to withstand short term volatility.
I will quote one example to underscore this. Meta platforms traded for $222/share in January 2020. It fell 30% to $150/share in March 2020. It then rallied to $379/share in September 2021, then plummeted 76% to $90/share in November 2022. It now currently trades at around $320/share at the end of 2023. Phew, what a ride!
This isn’t the first nor will it be the last time that stock prices are volatile as investors struggle to weigh the impact of current news on the future fortunes of companies. For example, even stable businesses like McDonalds went from $48/share in 1999 down 73% to $13/share in 2003. Today it is closer to $300/share. Including dividends this works out as 10% per annum for the 1999 buyer, even after suffering a 73% drawdown in the first 4 years of ownership (and 20% per annum for the 2003 buyer). Tuning out the news and focussing on the fundamentals and long term prospects of the companies we own should see us be rewarded with a more than satisfactory result over time.
The psychology of selling
“Your deepest desire is your destiny.”
Indian proverb
“We’ll see what happens.”
Donald Trump
In March of 2020 when I liquidated the Kanday portfolio, I was left holding a big bag of cash but there were several other consequences to my actions.
Well, firstly, I overnight went from wishing the companies I was following would succeed, to suddenly wishing they would fail. I remember saying to members of my family, ‘I am now officially on the side of the virus’. Think about that for a moment. Have you ever gambled on a sports contest? Every time the other team scores you feel sick inside and all the pleasure of watching the contest evaporates. And what are you betting against? You are betting against the thousands of people out there who wake up every day and try their best to succeed. You are betting against human ingenuity, perserverance, ability to endure, innovate and adapt. Immediately I knew in my core that something wasn’t right. That I had walked the floor to the other side of the chamber, cast my no vote, swapped seats with the weak spirited loser sitting across the table from me, embraced my inner child and given in to my fear and small mindedness. And even when I quickly recognised this, then the market had forcefully moved higher against me and my hands were tied as I waited for my entity structuring to be established.
It was truly a gut churning several months as I had to wake up every day knowing that by a simple mouse click I had ceded my advantage and tumbled back down the mountain I had been steadily climbing for several years. I had betrayed my business partners, putting my own safety and self interest ahead of theirs. Abandoned my platoon by running from the fox hole in the heat of battle. Never again!
“You, me, or nobody is gonna hit as hard as life. But it ain’t about how hard you hit. It’s about how hard you can get hit and keep moving forward; how much you can take and keep moving forward. That’s how winning is done!”
Rocky Balboa
The positive I believe I gained from this experience is that I have emerged far more durable and resolute to market flucutuations and grounded in my convictions. I wouldn’t wish this upon someone
else but perhaps a big bath such as this is what I needed. As my son Christopher sagely pointed out, it was better to have this experience now than later when the sums involved and relationships at stake will no doubt be larger and more consequential.
AI and the reinvention of the computer
“Chat GPT. This is the iPhone moment of AI.”
Jensen Huang, CEO Nvidia
Moore’s law is the observation that the number of transistors in an integrated circuit doubles about every two years and has driver semiconductor chip and computing power evolution. Moore’s Law is dead.
Jensen Huang and his team have been working on a new form of computing they call accelerated computing for the better part of 15 years. He has talked about it at length during Nvidia quarterly conference calls. Yet no one took much notice, until 30 November 2022 when a company called OpenAI released a product called ChatGPT. ChatGPT brought to attention concepts such as large language models (LLMs) and inferential computing. In simple terms, it could compose poetry, seemingly understand the context of your questions and your conversation, and help you solve problems.
This was enabled by Nvidia GPUs (graphics processing unit) accelerated computing, a style of computing that separates the data-intensive parts of an application and processes them on a separate acceleration device, while leaving the control functionality to be processed on the CPU (central processing unit).
According to Jensen this has led to a Cambrian explosion in AI product development and his prediction of the next wave in the tech revolution, one which will dwarf the invention of the internet itself.
The founders of Google Larry Page and Segei Brin long ago removed themselves from the day to day humdrum of running the company. But since the emergence of AI, they have apparently been back in the office working 80 hour weeks. They know what an existential threat this innovation is to their search engine dominance and the need for google to adapt or die.
Kanday group has positioned itself to participate in this wave of productivity innovation which is about to be unleashed on the world. I believe the economics of this new technology are going to be incredible both for the enablers and the users of AI. I will let Jensen give you a sense of what is to come and how Nvidia’s work is democratising computer software so that through AI everyone can become a software developer.
“Software is eating the world, but AI is going to eat software.”
“People are going to use more and more AI. Acceleration is going to be the path forward for computing. These fundamental trends, I completely believe in them.”
“A.I. will make it possible for the Internet to directly engage people in the real world, through robotics and drones and little machines that will do smart things by themselves.”
“It’s very clear that AI is going to impact every industry. I think that every nation needs to make sure that AI is a part of their national strategy. Every country will be impacted.”
Jensen Huang
Accepting an error rate
“I don’t mind paying a little more if it means backing a winner versus getting a great price on a value trap.”
Marcel Candeias
“If your holding period is more than 20 years then the horse is more important than the price.”
Marcel Candeias
In his 2022 annual letter, Warren Buffett explained that Berkshire’s success can be boiled down to about “a dozen truly good decisions – that would be about one every 5 years”.
This is despite the fact that over the years Warren has made hundreds of bets, many of which did not amount to much. And yet, with the passage of TIME has emerged Berkshire, a firm with a book value of $472B at the end of calendar year 2022. What does this tell us? It means that investing can be a very forgiving business, one where you only have to be right a few times to make your fortune.
“The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.”
Warren Buffett
Be on the right side of change
“Be on the right side of change.”
Cathy Wood, ARK investment management
The chaos in sharemarkets in 2020 and 2021 saw the emergence of Cathy Wood as a renowned stock picker after her bold call on eletric car company Tesla paid off bigly.
At the time Tesla stock was trading for about $400/share and Wood came on CNBC and said it was worth $4000/share. This was unprecedented as fund managers rarely make such bold calls for fear of being wrong and destroying their careers. Well, Cathy’s prediction came true and in short time with the Tesla share price exploding higher over the next 2 years as it became apparent how dominant and profitable Tesla was becoming versus legacy ICE automakers. The crux of her argument though was that Tesla was not an electric car company, it was a technology company spearheaded by the visionary Elon Musk.
Wood theorises that technology is bringing about a much greater revolution that will change the face of humanity as we know it as we progress through the most transformative period in history. Some say she just got lucky off the back of the pandemic, low interest rates and excessive monetary stimulus.
But Wood stands strong in her conviction that the 5 disruptive technologies of artificial intelligence, DNA sequencing, robotics, energy storage and blockchain are set to realign the future of the world. ARK Invest follows the principle of Wright’s Law, guiding its research into the most lucrative stocks to buy. The premise of Wright’s Law is to forecast a decline in costs relative to an increase in production.
Wright’s Law proves that the doubling of production reduces cost. While Moore’s Law (number of transistors in an integrated circuit doubles every 2 years) is based on time, Wright’s Law is based on cumulative production.
This is one reason ARK is bullish on innovation, because as an industry increases its experience through scaling production, the components required will eventually come down in price, generating mass appeal.
Subsequent to the Tesla call though a number of Wood’s other stock picks have dived in value as their lack of current profitability in a rising interest rate environment has brought into question their short term solvency. I happen to agree with Cathy in principal though and here give an example of how it pays to be on the right side of disruption in an industry.
Take the example of Netflix, Blockbuster and Disney. By creating a subscription-based service that allowed customers to rent DVDs without any late fees, Netflix was able to carve out a niche market for itself. Netflix’s DVD rental service was a disruptive innovation because it fundamentally changed the way people rented movies. Netflix’s subscription-based model was more convenient and cost-effective than Blockbuster’s physical stores. By the mid-2000s, Blockbuster was struggling, and in 2010, it filed for bankruptcy. So, the whole video rental business was upended simply by making it easier for the consumer, nothing to do with the video product itself. Netflix’s success in the DVD rental market paved the way for its next disruptive innovation – content streaming. By the mid-2000s, streaming technology had become more prevalent, and Netflix recognized the potential of this technology to disrupt the movie industry further. In 2007, Netflix launched its streaming service, which allowed customers to watch movies and TV shows online. Initially, the selection was limited, but as Netflix continued to grow, it started to produce its own content. In 2022, the company spent over $16 billion on original content. This investment has allowed Netflix to create high-quality content that rivals the quality of traditional movie studios. Netflix’s investment in original content has been a significant factor in the company’s success. By creating content that rivals the quality of traditional movie studios, Netflix has been able to attract and retain subscribers and disrupt the industry, yet again. Disney, the media industry giant, has had to scramble and paid $71B for Rupert Murdoch’s Fox as it tried to buy content for its own streaming service which to this day is still haemorrhaging cash while Netflix’s profits continue to swell. What happens next will be interesting but it is clear that it pays to be the disruptor and not the legacy dinosaur stuck in its old ways.
Sources of capital
“Savings = the gap between your ego and your income.”
Charlie Munger
“Do you want to be famous or do you want to be rich?”
Marcel Candeias
There are generally 3 ways to raise capital.
Firstly, internal cashflow. These are the profits from the business which can then be allocated in up to 5 different ways (see below).
Secondly, debt. Typically in the form of a business loan from a bank, either long term at variable or fixed rates, or short term in the form of a revolving line of credit.
Debt can be secured by collateral such as real estate which lowers the bank’s risk and therefore can be obtained at a lower interest rate than unsecured debt.
Companies can also issue their own debt via corporate bonds, debentures and warrants.
Bonds are company issued debt generally secured by the collateral or physical assets of the issuing company. Debentures are unsecured and are not backed by any collateral.
The primary difference between a warrant bond and a standard bond is the attached warrant which gives the bond holder the option of acquiring shares in the issuing corporation at a fixed, predetermined price.
Thirdly, issuing equity / stock. This may include through personal contacts (think your parents or friends), private equity or venture capital firms or crowdfunding.
Other hybrid instruments have been created such as convertible debt which begins as a debt obligation but can be converted to equity under certain conditions.
The big difference between debt and equity is that with equity you are gaining funds in exchange for an ownership interest of the business, where the equity investor is entitled to a share of future profits (or losses) of the business, whereas with debt funding the bank is only interested in protecting it’s loaned capital and receiving the agreed upon rate of interest until the loan is repaid.
Many factors such as capital structure, cashflow forecasts and macroeconomic considerations such as interest rate forecasts influence the ideal choice for accessing capital.
Uses of capital
There are 5 ways to use capital in business and a 6th way is to expend capital through personal consumption, but we aren’t interested in that.
Investing in existing operations.
Buying other companies.
Reducing debt.
Paying dividends.
Repurchasing shares (stock buybacks).
The answer to which of these options is best at any given time is like any subject worth studying, it depends. Many company specific factors and the prevailing macroeconomic environment will influence which capital use option is optimal. If a business has high returns on invested capital and there are ample opportunities to further invest in the operation at these high rates of return, then investing in existing operations is often preferred. If however the firm has declining economics and the industry is facing disruption and losses, then buying new plant and equipment would be a poor decision. Instead the funds should be diverted into one of the other 4 capital allocation options. If other companies in the industry are also facing secular headwinds of poor economics, then buying a competitor would also be a bad idea.
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
Warren Buffett
If interest rates soar and a company has a lot of floating rate debt, then it becomes more attractive to use excess capital to reduce debt. If on the other hand interest rates drop, then borrowing money at low fixed rates is a good idea.
Dividends should be considered as a way to return capital to shareholders if no other intelligent uses of excess profits can be identified.
Stock buybacks are another highly effective way to return capital to shareholders without crystallising tax consequences. However, they should only be undertaken if more than a dollar of value is created for each dollar purchased.
“Charlie [Warren Buffett’s partner] and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.”
Warren Buffett
Prudent capital allocation throughout the business cycle is imperative for a company to maximise outcomes for shareholders whilst minimising the risks to the company of the always unknown future.
Vale Charlie Munger 1924-2023
The investing world lost one of its titans in late November with the passing of Warren Buffett’s right hand man, Charlie Munger. I, along with thousands of other acolytes can’t begin to express the
value that Charlie has contributed to our lives through his wit and wisdom. I will sorely miss his contributions at the Berkshire Annual Meeting which will never be the same now that one of its 2 stars is gone.
We will miss you Charlie but your lessons for living a deserved good life will endure.
When asked his secret to success, Munger once answered, “I’m rational.” I concur.
“Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Systematically you get ahead, but not necessarily in fast spurts.
Nevertheless, you build discipline by preparing for fast spurts. Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve.”
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
“Highly profitable companies with durable competitive advantages earn above average returns on capital, which reflects the fundamental quality of a company.
Sometimes the market assigns an above-average or below-average valuation to those fundamentals. However, if a company is fundamentally strong and steadily grows, the market will eventually reward shareholders for that value creation.”
This is why Munger favored very long holding periods, once he found something worth investing in.
“Show me the incentive and I will show you the outcome.”
“If you skillfully follow the multidisciplinary path, you will never wish to come back. It would be like cutting off your hands.”
“Just because you like it does not mean that the world will necessarily give it to you.”
“I try to get rid of people who always confidently answer questions about which they don’t have any real knowledge.”
“I always say I want to know where I would die so I can never go there.”
“The iron rule of nature is: You get what you reward for. If you want ants to come, you put sugar on the floor.”
“It takes character to sit with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”
“I think Warren and I know the edge of our competency better than other people do.”
“Take a simple idea, and take it seriously.”
“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns.
If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return—even if you originally buy it at a huge discount.”
“The secret to a happy life is being cheerful despite your troubles, and avoiding traits commonly associated with toxic people, like envy or resentment. As a rule, you should deal with reliable people, and do what you’re supposed to do.”
Charlie Munger
Thank you Charlie for your enduring wit and wisdom. You will be missed. I will communicate my thoughts again in a year’s time.
Yours Sincerely
Marcel Candeias