Habits vs Goals : A Look at the Benefits of a Systematic Approach to Life

“First forget inspiration.

Habit is more dependable.

Habit will sustain you whether you're inspired or not.

Habit is persistence in practice.”

— Octavia Butler

***

Nothing will change your future trajectory like habits.

We all have goals, big or small things which we want to achieve within a certain time frame. Some people want to make a million dollars by the time they turn 30. Some want to lose 20lb before summer. Some want to write a book in the next 6 months. When we begin to chase an intangible or vague concept (success, wealth, health, happiness) making a tangible goal is often the first step.

Habits are processes operating in the background that powers our lives. Good habits help us reach our goals. Bad ones hinder us. Either way habits powerfully influence our automatic behavior.

The difference between habits and goals is not semantic. Each requires different forms of action. For example:

• We want to learn a new language. We could decide we want to be fluent in 6 months (goal), or we could commit to 30-minutes of practice each day (habit.)
• We want to read more books. We could set the goal to read 50 books by the end of the year, or we could decide to always carry one (habit.)
• We want to spend more time with family. We could plan to spend 7 hours a week with family (goal), or we could choose to eat dinner with them each night (habit.)

The Problems With Goals

When we want to change an aspect of our lives, setting a goal is often the logical first step. Despite being touted by many a self-help guru, this approach has some problematic facets.

Goals have an endpoint. This is why many people revert to their previous state after achieving a certain goal. People run marathons, then stop exercising altogether afterward. Or they make a certain amount of money, then fall into debt soon after. Others reach a goal weight, only to spoil their progress by overeating to celebrate.

Goals rely on factors which we do not always have control over. It’s an unavoidable fact that reaching a goal is not always possible, regardless of effort. An injury might derail a fitness goal. An unexpected expense might sabotage a financial goal. A family tragedy might impede a creative output goal. When we set a goal, we are attempting to transform what is usually a heuristic process into an algorithmic one.

Goals rely on willpower and self-discipline. As Charles Duhigg wrote in The Power of Habit:

Willpower isn’t just a skill. It’s a muscle, like the muscles in your arms or legs, and it gets tired as it works harder, so there’s less power left over for other things.

Keeping a goal in mind and using it to direct our actions requires constant willpower. During times when other parts of our lives deplete our supply, it can be easy to forget it. For example, the goal of saving money requires self-discipline each time we make a purchase. Meanwhile, the habit of putting $50 in a savings account weekly requires little effort. Habits, not goals, make otherwise difficult things easy.

Goals can make us complacent or reckless. Studies have shown that people’s brains can confuse goal setting with achievement. This effect is pronounced when they inform others. Furthermore, unrealistic goals can lead to dangerous or unethical behavior.

The Benefits of Habits

“Habit is the intersection of knowledge (what to do), skill (how to do), and desire (want to do).”

— Stephen Covey

***

Once formed habits operate automatically. Habits take otherwise difficult tasks—like saving money—and make them easy.

The purpose of a well-crafted set of habits is to ensure we reach our goals with incremental steps. The benefits of a systematic approach to achievement include:

Habits can mean we overshot our goals. Let’s say a person’s goal is to write a novel. They decide to write 200 words a day, meaning it should take 250 days. Writing 200 words takes little effort, and even on the busiest, most stressful days they get it done. However, on some days that small step leads to them writing 1000 or more. As a result, they finish the book in much less time.Yet setting ‘write a book in 4 months’ as a goal would have been intimidating.

Habits are easy to complete. As Duhigg wrote;

Habits are powerful, but delicate. They can emerge outside our consciousness or can be deliberately designed. They often occur without our permission but can be reshaped by fiddling with their parts. They shape our lives far more than we realize—they are so strong, in fact, that they cause our brains to cling to them at the exclusion of all else, including common sense.”

Once we develop a habit, our brains actually change to make the behavior easier to complete. After about 30 days of practice, enacting a habit becomes easier than not doing so.

Habits are for life. Our lives are structured around habits, many of them barely noticeable. According to Duhigg’s research, habits make up 40% of our waking hours. These, often minuscule actions which add up to make who we are. William James (a man who knew the problems caused by bad habits) summarized their importance as such:

All our life, so far as it has definite form, is but a mass of habits – practical, emotional, and intellectual – systematically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be.

Once a habit becomes ingrained, it can last for life (unless broken for some reason.)

Habits can compound. Stephen Covey paraphrased Gandhi when he explained:

Sow a thought, reap an action; sow an action, reap a habit; sow a habit, reap a character; sow a character, reap a destiny.

In other words, building a single habit can have a wider impact on our lives. Duhigg calls these ‘keystone habits.'

These behaviors which cause people to change related areas of their lives. For example, people who start exercising daily may end up eating better and drinking less. Likewise, those who quit a bad habit may end up replacing it with a positive alternative. 

Habits can be as small as necessary. A common piece of advice for those seeking to build a habit is to start small. Stanford psychologist BJ Fogg recommends ‘tiny habits’, such as flossing one tooth. Once these become ingrained, the degree of complexity can increase. If you want to read more you can start with 25 pages a day. AFter this becomes part of your routine, you can increase the page number to reach your goal.

Why a Systematic Approach Works

“First we make our habits, then our habits make us.”

— Charles C. Nobel

***

By switching our focus from specific goals to creating positive long-term habits, continuous improvement can become a way of life. This is evident from the documented habits of many successful people.

Warren Buffett reads all day to build the knowledge necessary for his investments.

Stephen King writes 1000 words a day, 365 days a year (a habit he describes as “a sort of creative sleep.”) Athlete Eliud Kipchoge makes notes after each training session to establish areas which can be improved. These habits repeated hundreds of times over years, are not incidental. With consistency, the benefits of these non-negotiable actions compound and lead to extraordinary achievements.

While goals rely on extrinsic motivation, habits are automatic. They literally rewire our brain.

When seeking to attain something in our lives, we would do well to invest our time into forming positive habits, rather than concentrating on a specific goal.

Zuckerberg or Gates? Billionaires Try Opposite Paths for Online Education in India

Rushi Parmar lives in Keshod, a Western Indian town so small it has one park, a single-screen movie hall and no shopping mall. For clever kids like Parmar, who is 12 and heading into seventh grade, the only option for a decent education used to be traveling to a bigger city at least three-and-a-half hours away. That wasn't happening, so Parmar downloaded an app from the online education company BYJU'S and started learning math and science at her own pace. A year later, she just topped her class in sixth-grade exams. 

“I like to impress my teachers with my knowledge of advanced chapters like monocots and dicots in the biology class and thermal equilibrium in the physics class,” Parmar brags. “My teachers love it.” Impressed with her performance, several of her school friends have enrolled with BYJU’S for the seventh grade.

Online learning is exploding in India, and no company is poised to benefit more than BYJU'S. Its app has been downloaded 8 million times, and more than 400,000 students are paying an annual fee of 10,000 rupees (just over $150) in a country not known to pay for subscriptions of any kind. The company says the app is adding 1,000 subscribers every day and has reached an annual renewal rate of 90 percent. BYJU’S has won several big investors, among them Sequoia Capital, Lightspeed Venture Partners and Sofina. The company is also the only startup in Asia backed by the Chan Zuckerberg Initiative, started by Facebook founder Mark Zuckerberg and his wife Priscilla Chan.

“I want to Disney-fy education in India,” says founder Byju Raveendran in a recent conversation at his Bangalore headquarters. “I want to do for education what Walt Disney did for entertainment. I want to make it engaging and fun not just for the Indian kids but kids everywhere.”

Raveendran grew up in a small village in the southern coastal state of Kerala, where his father taught physics and his mother math at the local school. Young Raveendran was an unconventional student who skipped classes to play football and preferred to teach himself at home rather than listen to his teachers. He later enrolled for an engineering degree, then worked as a service engineer on a ship, sailing around the world for 33 months. Later, while vacationing in Bangalore, he found himself helping friends pass their entrance exams to get into top Indian engineering and management schools. “I’ve always enjoyed learning things on my own and also taught myself to hack exams, so it was easy to tutor others,” Raveendran says.

In 2006, he began coaching students in a college classroom. When the numbers doubled week after week, the classes spilled into sports stadiums. At his peak as a teacher, Raveendran was commuting between five cities each weekend, his classes projected on multiple giant screens for the thousands of assembled students to follow. He recruited his best students to teach and ran 41 coaching centers, setting up Think and Learn Pvt Ltd in 2011. He continued to prep students for college but mostly focused on lessons for school-age children.

Before long, Raveendran decided to move the stadium to the smartphone, two years ago launching a K-12 self-learning app focused largely on math, science and English. The app proved popular in a country where good teachers are scarce and methodologies antiquated and where many people first access the web by phone. Today BYJU’S is India’s largest edutech startup with plenty of room to grow.

“We touch less than 1 percent of the country’s student population today," says Raveendran, who is 39 and speaks with the fierce energy of a passionate teacher, frequently rocking forward and gesturing rapidly. "Even if we cover just 10 percent in the next years, we’ll be setting off a learning revolution."

Experts agree that there’s gigantic potential. As smartphones proliferate and internet quality improves, India’s online education industry is projected to grow five-fold to 9.6 million paid users by 2021, according to the Google KPMG Online Education in India report released last month. The segment is set to become a multibillion-dollar opportunity in India, says Nitin Bawankule, the industry director of Google India.

Dozens of companies have rushed in. BYJU’S competitors include Khan Academy, which offers free YouTube videos; startups such as Toppr ,which mainly focuses on test prep for elite engineering and medical schools; Cuemath, which teaches math; and Vedantu, which offers live online tutoring. BYJU's works to distinguish itself by making lessons engaging and interesting.

Raveendran isn't kidding when he says he wants to bring Disney to the classroom. The app features a mix of video, animation and interactive tools to bring clarity to subjects such as fundamentals of geometry and Indian history. Tutors bring the real world into the act—using pizza to explain fractions, a birthday cake to teach circles and segments, a basketball game to demonstrate projectile motion. Science experiments are overlaid with animation.

In cubicle after cubicle in Bangalore, hundreds of twenty-something filmmakers, musicians, animators and graphic designers create the lessons. It's not Walt Disney studio scale, but content, media and tech teams make up half of BYJU's 1,150 employees, personalizing each student’s learning and allowing him or her to track progress. Two in-house bands compose and perform background scores.

In one studio, Divya Gokulnath, a biotech engineer and one of about a dozen teachers who appear in the videos, is rehearsing for a math tutorial. A chatty woman dressed in a red tunic over jeans, she was once Raveendran’s student, then a teacher and now his wife and board member. The session is on circles and she talks about diameters, tangents and chords, practicing the motions in the air while pretending to hold the shapes in her hand. This is as much a performance as a teaching session.

After 100-plus hours of post-production work, this recording is edited down to a taut two-and-a-half minutes. “The sessions have to be compelling and fun or the kids will simply tune out and switch off the device,” Gokulnath says. The point is to provide a compelling contrast to the content pumped out by most education startups, which consists mostly of teachers standing in a classroom, lecturing away and writing  on a blackboard.

BYJU's approach contrasts with that of the non-profit Khan Academy, which has won the backing of billionaire Bill Gates and his wife Melinda Gates. Because Khan Academy videos are free, they are available to anyone with an internet connection and impose no financial requirements on students. Raveendran respects the effort, but he argues the for-profit startup model has advantages: “We can invest so much more into making the content engaging and personalized.”

Math of Khan Sweeps U.S. Classrooms Winning Bill Gates as Fan

While Khan Academy and its ilk are global, no fee-based online school has successfully crossed boundaries, says John J-H Kim, a senior lecturer at Harvard Business School who recently co-authored a case study on BYJU's.  "I wrote the case on BYJU's because it has many essential assets that may help them be one of the first companies to  accomplish this goal including a very efficient and effective learning app, significant financial resources, supportive investors, and good timing."

It's BYJU’S approach that attracted investors like Zuckerberg and Chan. “I’m optimistic about personalized learning and the difference it can make for students everywhere,” Zuckerberg wrote in a Sept 2016 Facebook post to announce the investment in BYJU’S. “That’s why it’s a major focus of our education efforts, and why we’re looking forward to working with companies like BYJU’S to get these tools into the hands of more students and teachers around the world.”

One of Raveendran's earliest backers was Ranjan Pai, the billionaire who presides over one of India’s largest healthcare and education empires and invests in tech startups through multiple venture capital funds. The two bumped into each other in a café and Pai immediately agreed to back Raveendran. “He stands out as one of the brightest entrepreneurs in the country yet is a teacher at heart,” says Pai, whose early investment yielded 5x returns in two years. He only has a small stake left.

Sequoia Capital came aboard in 2015, followed by a flood of investors impressed at the speed with which technology was taking learning into India’s small towns. Sofina and Lightspeed Venture Partners invested in 2016, along with the Chan Zuckerberg Initiative, which participated in a $50-million round. By early 2017, the app had enrolled 10 or more students in more than 1,700 Indian towns and snared Verlinvest as an investor.

BYJU’S was most recently valued at 45 billion rupees (about $700 million). Given a rapidly growing population and parents' determination to give their kids the best education, the company may soon achieve unicorn status. More children are entering the school system than exiting and Raveendran wants to take BYJU’S to the country’s most far flung corners. One limit to his ambition is the countryside's backward digital and payment infrastructure.

Eventually, Raveendran wants to fly in foreign teachers so BYJU’S can enter English-speaking markets like the U.S., the U.K, Australia and Canada with lessons in native accents. He foresees hurdles. “Asian parents willingly spend on education but will American and Canadian parents pay?” The startup is also scouting for acquisitions in these and emerging English-speaking markets so they can get a head start on K-12 education. 

The app has begun to create content for children as young as three or four years old and going up to the fourth grade. His son is a three-year-old pre-schooler and Raveendran knows he has a lot of work ahead to create engaging lessons for this new crop of youngsters. “This is the smartphone generation, born with devices in their hands.”

Analysing Investment Performance - Short and Long Term

The Investment Management industry is fixated on short term performance. 

Oaktree's Howard Marks has said "short term performance is an imposter - "The investment business is full of people who got famous for being right once in a row.” 

Unlike most professions, a rookie investor can do better than a professional over the short term. You'd never expect an amateur to beat Roger Federer in a tennis match but plenty of amateur's portfolios will outperform Warren Buffet over the short to medium term.  It's only over the longer term that you can ascertain the skill of each investor.

"In the short term, there will always be winners and losers. But in the long term, there are very few winners. " Li Lu

The majority of investment managers, asset consultants and investors obsess over short term performance.  As many individuals cannot access their pension funds until retirement it would make more sense to analyze a style of investing or an asset class that outperforms over the long term.

“If you know one style does best in the long run, maybe you shouldn’t care about short term performance comparisons” Chris Browne

Investment Managers that underperform the market over short periods are vulnerable to having their funds taken away. 

"Many mainstream portfolio managers, judged as they are on short-term performance, feel they must be swinging all the time. They must focus on the present, on survival. If they don't meet the relentless present demands, they'll have no corner office from which to build a great long-term track record" Frank Martin

"Most of our competitors feel intense pressure from their clients to generate short term performance and have trouble maintaining a truly long-term perspective, whether in bad or good markets" Seth Klarman

“It’s still true that the biggest players in the public markets – particularly mutual funds and hedge funds – are not good at taking short-term pain for long-term gain. The money’s very quick to move if performance falls off over short periods of time" Jeffrey Ubben

Having permanent capital or investors with a long-term mindset allows investment managers to focus their attention on longer term opportunities or 'time arbitrage' which tend to be less crowded.

“That is the secret sauce: permanent capital. That is essential. I think that’s the reason Buffett gave up his partnership. You need it, because when push comes to shove, people run" Bruce Berkowitz

No investment style can guarantee outperformance all the time. Even the Investment Masters, who are renowned for their long term investment performance, have short to medium term periods where they have underperformed or lost money.

“I’m 76 years of age.  I've been through a number of down periods.  If you live a long time, you’re going to be out of investment fashion some of the time” Charlie Munger

“To capture superior long-term results you have to be willing to endure short-term underperformance” CT Fitzpatrick

“We expect to have negative years on occasion (and our record makes that point clear!). Those who take a longer term perspective – and their shorter term fluctuations in stride – tend to be amply rewarded in the long run (our record makes that clear as well)” Frank Martin

Francois Rochon has beaten the index by 6.1%pa since 1993 (Remember a few extra percentage points compounded over a long period leads to significant outperformance).  Yet Francois historically has, and expects to, underperform the index on average every three years.

"Over the 22 years of its track record, our US portfolio has underperformedthe S&P 500 on six occasions (or 27% of the time). This is in line with our "Rule of Three" which stipulates that we accept to underperform the index one year out of three on average. This average, if we can maintain it, would be far superior to the overall performance of portfolio managers. It is a difficult task to maintain outperforming the S&P 500 but it is our mission. We must accept the fact that we will sometimes underperform the index over the short term when our investment style or specific companies are out of favor with mainstream thinking. And we try to welcome rewarding periods of portfolio outperformance with humility." Francois Rochon

"To be aware of this fact ['Rule of Three'] is vital so we can be psychologically prepared for the inevitable periods when we will have results that are worse than average. We have to accept from the start that it is impossible to be always the best in that field even if one is competent and loaded with motivation and efforts." Francois Rochon

The key is to ensure any negative returns reflect short term volatility rather than the permanent loss of capital due to deteriorating underlying business fundamentals.

"In my view, the biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital." Li Lu

When evaluating an investment manager it is important to analyze long term performance to ensure it wasn't a result of luck.

“Short term results often benefit from luck and have no connection with skill. For example, take a short period, not even one or two years long. At any time, even one or two weeks, there will always be some rock stars." Li Lu

"Since a multitude of variables move stock prices around, particularly in the short run, it is virtually impossible to distinguish skill from luck without a large sample size, i.e., a long record." Tweedy Browne & Co

"In a bad year, defensive investors lose less than aggressive investors.  Did they add value?  Not necessarily.  In a good year, aggressive investors make more than defensive investors.  Did they do a better job? Few people would say yes without further investigation.  A single year says almost nothing aboutskill, especially when the results would be expected on the basis of the investor's style" Howard Marks

Short term outperformance doesn't imply a well constructed and low risk portfolio.

“Any asset class or strategy can have its moment in the sun, yet as time passes we learn what risks were employed to achieve those periods of outperformance” Christopher Begg

Investment consultants and investors have a tendency to place excessive emphasis on past results.  More often than not, short term out performance is followed by a period of subpar performance. 

“Most people seem to think outstanding performance to date presages outstanding future performance. Actually, it’s more likely that outstanding performance to date has borrowed from the future and thus presages subpar performance from here on out.” Howard Marks

So funds can have good performance for the long run yet still be a dangerous investment.  A brilliant long term track record of returns will turn to nothing if the portfolio suffers a zero or significant loss.

“And never forget that anything times zero is zero. No matter how many winners you’ve got, if you either leverage too much or do anything that gives you the chance of having a zero in there, it’ll all turn to pumpkins and mice”  Warren Buffett

"In business and also investment, success is measured through the compounding of a series of returns.  Mathematically, the biggest risk to a compounded series of returns is large negative numbers or even a single negative number, if large enough.  Take however many spectacular annual outcomes and multiply them by just one zero and the answer is of course, zero"   Marathon Asset Management

A classic example of this was the hedge fund Long Term Capital Management. The fund, managed by legendary traders, a former vice chairman of the Federal Reserve and two Nobel prize winning economists, delivered exceptionally stable positive returns with low volatility until it all came crashing down. 

Source: Wikipedia

LTCM's performance is analogous to the 'Thanksgiving Turkey' in Nicholas Taleb's book 'Fooled by Randomness'. 

"A turkey is fed for a thousand days by a butcher, every day confirms to its staff of analysts that butchers love turkeys "with increased statistical confidence".  That is until Thanksgiving.  It is mistaking absence of evidence (of harm) for evidence of absence."

Similarly, the absence of volatility and losses in Madoff's Ponzi scheme was not evidence the strategy was a sound investment. LTCM and Madoff highlight that an impressive long track records does not shelter you from the risk of terminal destruction. It's paramount to understand the risks behind the returns.

As Buffett has long said he would not take any risk of permanent loss of capital.

“We will never play financial Russian roulette with the funds you’ve entrusted to us, even if the metaphorical gun has 100 chambers and only one bullet. In our view, it is madness to risk losing what you need in pursuing what you simply desire.”

The Investment Masters acknowledge the folly of being focused on short term performance. 

“We think fixating on short-term results is bound to harm investment managers and investors alike. High scores are rarely shot while being critiqued mid-swing on each and every hole” Allan Mecham

“We place no weight on short-term results, good or bad, and neither should you. In fact, we have and will continue to willingly make decisions that negatively impact short-term performance when we think we can lower risk and improve our long-term returns.” CT Fitzpatrick

"While it’s not always easy, we try to remain unaffected by short term results, both good and bad." Francois Rochon

"We never take the one-year figure very seriously. After all, why should the time required for a planet to circle the sun synchronize precisely with the time required for business actions to pay off? Instead, we recommend not less than a five year test as a rough yardstick of economic performance" Warren Buffett

Instead of focusing on short term performance the Investment Masters tend to focus on the underlying performance of the companies they own.

"The best way to track the development [of the fund] is through the development of the earnings of the underlying businesses. Share prices can do pretty crazy things from time to time. The earnings by contrast provide a reliable indication of progress after taking into account the overall economic picture." Robert Vinali

"We do not evaluate the quality of an investment by the short term fluctuations in its stock price.  Our wiring is such that we consider ourselves owners of the companies in which we invest.  Consequently, we study the growth in earnings of our companies and their long term outlook" Francois Rochon

Don't forget successful investing is hard work and Long term outperformanceis difficult.

“Preserving private capital for long periods of time is the exception, not the rule, in history” Paul Singer

The General Theory of Reverse Float

The General Theory of Reverse Float

by Cole Smead 

Reverse Float’s effeBuffett and Munger are trying to help people think rationally about the real costs of depreciation. When a company purchases physical assets, they typically capitalize them on their balance sheet. One benefit of capitalizing instead of expensing is that it shows higher earnings the year the asset is purchased. After capitalizing the asset on the balance sheet, generally accepted accounting principles (GAAP) allow you to depreciate the value of the asset in future years, thus lowering earnings slowly over time. The following is a depiction of how this looks theoretically for a company.

The chart is a depiction of a 10-year period where a company buys a 5-year asset and depreciates it over a 5-year period. With a 5-year asset, this would happen twice. We assumed a 3% inflation rate for the chart. The dark grey area of the chart is the lost economic value due to inflation’s effect on the time value of money. We would note that the higher the inflation, the larger the economic value lost. To harken back to Buffett and Munger’s thoughts, it’s reverse float. You pay a large expense today on something you don’t receive economic value from until out into the future. Berkshire’s insurance company gets to benefit from float. They receive money today. They don’t have to pay liabilities until the future. By not accounting for the lost economic value from depreciation in EBITDA, an inaccurate picture of a company’s future costs is established.

Reverse Float’s effect on Owner Earnings

In 1999, companies with high-flying multiples didn’t expense employee stock options in their GAAP earnings per share. Buffett railed against this practice. The joke was that if it’s not an expense, what is it? Today’s practice of stock compensation is accounted for in earnings, compared to then, but is not included in free cash flow. Stock based compensation is added back to net income in calculating free cash flow. At Smead Capital Management, we don’t believe that giving away ownership improves free cash flow in the long run. What this requires us to do is adjust free cash flow by the amount of stock-based compensation. We refer to this as owner earnings.

Proponents of stock-based compensation would say that it is the life blood of any growing entrepreneurial endeavor. While we agree employee stock ownership is good, in today’s practice it’s a hidden nightmare for shareholders. In effect, it is a way for Wall Street and insiders to overstate their economic earnings. To use an example, below are reported numbers for Amazon (AMZN):

Market Cap (as of 6/2/2017): $485.4 billion

Free cash flow for 2016: $9,706.0 million

Consensus free cash flow for 2017: $11,583.3 million

If an investor looks at these numbers, they would conclude that Amazon is trading at 50 times free cash flow on a trailing basis and 40 times 2017 free cash flow estimates. Here is the heart of the deception in these numbers. Not included in the free cash flow for Amazon is stock-based compensation, which per their 2016 fiscal report was $2.975 billion. Below is what the real economic costs would look like if their 2016 free cash flow was adjusted for stock-based compensation. We also adjusted 2017 owner earnings for stock-based compensation using a consensus estimates of $3.6 billion in stock-based compensation for the year.

2016 Owner Earnings (adjusting for stock compensation in free cash flow): $6,731.0 million

Trailing 2016 Price/Owner Earnings Ratio: 72

2017 Consensus Owner Earnings (when counting stock compensation as an expense): $7,983.3 million

Forward 2017 Price/Owner Earnings Ratio: 60.8

Investors are buying stocks like these using mistakenly high free cash flow numbers. After adjusting for owner earnings, they are paying roughly a 40% higher multiple based on 2016 trailing earnings and roughly a 50% higher multiple based on 2017 forward earnings. They see future Wall Street earnings estimates telling them its trading at a lower multiple. People at the end of an era have often told us that if it’s working, why change it?

The following is a chart of how this type of reverse float affects the compensation costs of a business:

The chart assumes a 3% inflation rate for cash compensation. For what we call real compensation costs, we assumed half of the company’s compensation was cash and half of the compensation was stock. Please note that this looks at earnings growth only, not stock price. Based on our model, compensation ended up being 7.5% higher over the ten years if the business grew earnings 6%. If the business grew at a higher rate of 12%, the costs over ten years were 26.5% higher than the cash compensation.

If we look at these numbers over 20 years, it is a crisis for businesses that grow immensely. For the company that grew earnings at 6%, real compensation costs were 18.5% higher. Obviously more, but not excessive. For the company that grew 12% in earnings, expenses were 84.1% higher than the actual cash compensation. For those that believe Amazon will grow faster, we would argue this evidence makes stock-based compensation look worse, effectively giving away the farm in the long run.

Stock-based compensation is yet another form of reverse float, but far more detrimental than the costs of depreciation. You pay the costs now and the financial damage rises in the future. Stock-based compensation is prevalent among many companies today. It is hard to find companies like Berkshire Hathaway that have no stock-based compensation and are run for the success of the owners of the business. Much like the fact that we are all sinners, there is stock-based compensation in the companies we own and we want to limit its effect on the future success of our portfolio. We can do this by adjusting for owner earnings and asking if today’s price is what we’re comfortable with as an owner.

We believe there is no perfect business out there. It’s like family. It’s going to be messy. All businesses make mistakes. Currently, investors and stock market participants are willing to overlook these forms of reverse float. In the discipline we run at Smead Capital Management, we are interested in what the true owner earnings are of our companies. We don’t have the luxury to overlook this. Like Buffett said, “…it’s reverse float. And it’s not a good thing.”

Why don't many people from Tamilnadu support Narendra Modi's Government?

There are two sides to the BJP - the Hindutva side and the capitalist side. Both have trouble penetrating TN due to ideological differences. There are 4 factors - language, religion, caste and economics.

Hindutva politics plays well in places with about 20% minority population. BJP could take Jammu because the Hindus there fear about the Muslim minority. In most parts of Tamil Nadu, it is 90%+ Hindu and in some parts it is all Hindu. You can see Hinduism everywhere - in offices, government symbols [only state with a Hindu temple as the official symbol], schools and colleges. Thus, Hindus in most of TN don't see a big threat of other religions and don't see the need to protect their religion. Selling Hindutva to Tamils is like selling ice to Eskimos.

The only two regions in Tamil Nadu with a higher concentration of minorities is in the extreme south - Nagerkoil and extreme northwest - Nilgiris. These are the only places BJP has historically won in TN.

Then there is the Brahmin factor. Since the 1960s, Dravidian parties have made Tamil society think national parties as Brahminical forces. First, it was the Rajaji-led Congress that was the tool of Brahmins and now the BJP. Given the strong anti-Brahmin wave since the 1960s, it is hard to get anyone elected with a Brahmin background and plenty of BJP leaders are Brahmins. Jayalalitha was the only Brahmin leader in present TN politics and she got through by being mentored by MG Ramachandran and through populist measures like drastically increasing caste quotas.

Now, coming to the capitalistic part. Tamil Nadu economics have been traditionally government driven. It is among the most socialist of Indian states. The trust for government has been traditionally higher than in other states. Government sector accounts for a big chunk of employment and government employees at lower rung tend to hate capitalism as their job is in line. The movies are filled with all sorts of rants against capitalism and I have never seen a good Tamil movie that actually praised the power of liberalization. While it is not as bad as the neighboring Kerala, but anti-capitalism is a very popular theme in many parts of TN.

The final element is language. BJP has traditionally pushed Hindi as the common language for India and this irks many Tamils. Tamils point to the idea that India is not an homogeneous entity and the thing that makes it special and unique is diversity. Whether you agree with that idea or not, it should be understood that anything that threatens the existence of Tamil is a very hard sell in Tamil Nadu. When a state's name starts with the language's name, you can realize how important language is to its existence and identity.

Some lessons for BJP:

1. Rediscover the idea of Hinduism: Tamils are used to listening to sophisticated Hindu philosophies from the likes of S. Radhakrishnan, Rajaji, Aurobindo, Bharathiyar etc. Even non-Hindus like Abdul Kalam had superior understanding of Hinduism. Crude versions of Hinduism from some BJP leaders doesn't sit well in TN.
2. Rediscover the idea of India: Some non-Tamils have this preposterous idea that Tamils resent to being in India, just because they oppose Hindi as a national language. If Tamils resent to India, Tamil Nadu would be having separatist movements. Rather its sons like AR Rahman are composing patriotic songs. Tamils like Subramanya Bharati had the vision for a unified India and I hope BJP leadership learns from that. Nationalism doesn't mean homogenisation. Instead of blindly copying other countries, BJP leaders should understand that India's uniqueness lies in having strong national bonds without a national language. Just as a swan doesn't need to imitate a duck, India doesn't need to drive everyone to a single language.

India has made primary education universal, but not good

The world’s biggest school system is also one of the worst

IN 1931 Mahatma Gandhi ridiculed the idea that India might have universal primary education “inside of a century”. He was too pessimistic. Since 1980 the share of Indian teenagers who have had no schooling has fallen from about half to less than one in ten. That is a big, if belated, success for the country with more school-age children, 260m, than any other.

Yet India has failed these children. Many learn precious little at school. India may be famous for its elite doctors and engineers, but half of its nine-year-olds cannot do a sum as simple as eight plus nine. Half of ten-year-old Indians cannot read a paragraph meant for seven-year-olds. At 15, pupils in Tamil Nadu and Himachal Pradesh are five years behind their (better-off) peers in Shanghai. The average 15-year-old from these states would be in the bottom 2% of an American class. With few old people and a falling birth rate, India has a youth bulge: 13% of its inhabitants are teenagers, compared with 8% in China and 7% in Europe. But if its schools remain lousy, that demographic dividend will be wasted.

India has long had a lopsided education system. In colonial times the British set up universities to train civil servants, while neglecting schools. India’s first elected leaders expanded this system, pouring money into top-notch colleges to supply engineers to state-owned industries. By contrast, Asian tigers such as South Korea and Taiwan focused on schools. Of late, India has done more to help those left behind. Spending on schools rose by about 80% in 2011-15. The literacy rate has risen from 52% in 1991 to 74% in 2011. Free school lunches—one of the world’s largest nutrition schemes—help millions of pupils who might otherwise be too hungry to learn.

Pointless pampered pedagogues

However, the quality of schools remains a scandal. Many teachers are simply not up to the job. Since 2011, when the government introduced a test for aspiring teachers, as many as 99% of applicants have failed each year. Curriculums are over-ambitious relics of an era when only a select few went to school. Since pupils automatically move up each year, teachers do not bother to ensure that they understand their lessons. Overmighty teachers’ unions—which, in effect, are guaranteed seats in some state legislatures—make matters worse. Teachers’ salaries, already high, have more than doubled over the past two rounds of pay negotiations. Some teachers, having paid bribes to be hired in the first place, treat the job as a sinecure. Shockingly, a quarter play truant each day.

Frustrated by the government system, and keen for their children to learn English, parents have turned to low-cost private schools, many of which are bilingual. In five years their enrolment has increased by 17m, as against a fall of 13m in public schools. These private schools can be as good as or better than public schools despite having much smaller budgets. In Uttar Pradesh the flight to private schools almost emptied some public ones. But when it was suggested that teachers without pupils move to schools that needed them, they staged violent protests and the state backed down.

India spends about 2.7% of GDP on schools, a lower share than many countries. Narendra Modi, the prime minister, once vowed to bump up education spending to 6%. However, extra money will be wasted without reform in three areas. The first is making sure that children are taught at the right level. Curriculums should be simpler. Pupils cannot be left to pass through grades without mastering material. Remedial “learning camps”, such as the ones run by charities like Pratham, can help. So can technology: for example, EkStep, a philanthropic venture, gives children free digital access to teaching materials.

The second task is to make the system more meritocratic and accountable. Teachers should be recruited for their talents, not their connections. They should be trained better and rewarded on the basis of what children actually learn. (They should also be sackable if they fail to show up.) The government should use more rigorous measures to find out which of a hotch-potch of bureaucratic and charitable efforts make a difference. And policymakers should do more to help good private providers—the third area of reform. Vouchers and public-private partnerships could help the best operators of low-cost private schools expand.

Mr Modi’s government has made encouraging noises about toughening accountability and improving curriculums. But, wary of the unions, it remains too cautious. Granted, authority over education is split between the centre and the states, so Mr Modi is not omnipotent. But he could do a lot more. His promise to create a “new India” will be hollow if his country is stuck with schools from the 19th century.