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Invest Like the Best with Patrick O'Shaughnessy

Bill Gurley & Michael Mauboussin - Putting Theory into Practice

Tue Apr 23 2024
Investment ResearchAILLMsStartup Market DynamicsGrowth of Larger CompaniesValue PropositionIntangible InvestmentsRecombination of IdeasOpen Source InnovationRegulatory CaptureVenture CapitalPrivate EquityCapital AllocationMarket DynamicsCost DynamicsExtreme EventsInvestment StrategiesChallenges in HealthcareInsights from GeniusesSynthesizing InformationPersonal GrowthWriting and Understanding Concepts

Description

This episode covers a wide range of topics including investment research, AI and LLMs, growth of larger companies, value proposition and intangible investments, recombination of ideas and open source innovation, regulatory capture and venture capital, private equity and challenges in the venture industry, capital allocation and market dynamics, market dynamics and innovation, cost dynamics and extreme events, investment strategies and opportunities, challenges in healthcare and insights from geniuses, synthesizing information and personal growth, and writing and understanding concepts.

Insights

AI Expectations

Expectations around AI and LLMs may be unrealistic in the short term, with caution needed to keep things in context.

Shift in Startup Market Dynamics

Foundational model companies like Tropic, OpenAI, and Mistral have seen huge valuations, leading to a shift away from traditional startup market dynamics.

Game-Changing Advancements in AI

Initial versions of models may have structural flaws in providing personal memory but potential for game-changing advancements if addressed.

Amplification and Reorientation with New Technology Waves

New technology waves like AI tend to initially amplify existing workflows before leading to reorientation and increased productivity over time.

Embracing AI by Big Technology Companies

Existing big technology companies are effectively embracing AI, raising questions about the concept of disruptive innovation and their adaptability.

Superstar Firms and Intangible Investments

Superstar firms have emerged due to their substantial investments in proprietary software that leverages scale and customization. Technology giants are investing significantly more in intangible assets like R&D compared to traditional industries like energy.

Network Effects and Successful Business Models

Network effects and increasing returns play a crucial role in successful business models, exemplified by companies like Uber.

Open Source Innovation and Rapid Diffusion

Open source can promote innovation by allowing ideas to be shared and built upon freely. Historical examples like the open source consortium for automobile manufacturers show how sharing technology can lead to rapid diffusion and innovation.

Regulatory Capture and Incumbents' Advantage

Regulation tends to benefit incumbents in industries with close ties to regulators, such as healthcare, finance, and telecom.

Challenges in Venture Capital

Venture capital plays a significant role in innovation but there are concerns about the current state of the venture capital ecosystem compared to public equities.

Chapters

  1. Introduction
  2. AI and LLMs
  3. Growth of Larger Companies
  4. Value Proposition and Intangible Investments
  5. Recombination of Ideas and Open Source Innovation
  6. Open Source Innovation and Patent Protection
  7. Regulatory Capture and Venture Capital
  8. Private Equity and Challenges in the Venture Industry
  9. Capital Allocation and Market Dynamics
  10. Market Dynamics and Innovation
  11. Cost Dynamics and Extreme Events
  12. Investment Strategies and Opportunities
  13. Challenges in Healthcare and Insights from Geniuses
  14. Synthesizing Information and Personal Growth
  15. Writing and Understanding Concepts
Summary
Transcript

Introduction

00:00 - 06:56

  • Teagas is an investment research platform for fundamental investors, offering insights on companies' business models and management quality.
  • The Founders podcast by David Senra explores the lives of legends to distill ideas for work, with over 300 episodes available.
  • The 'In Best Like The Best' podcast hosted by Patrick O'Shaughnessy covers markets, stories, and strategies to help with investing time and money.
  • Guests Bill Gurley and Michael Mobison discuss topics like increasing returns to scale, regulatory capture, AI, and hardware in a wide-ranging conversation.
  • Bill Gurley and Michael Mobison share insights on artificial intelligence (AI), disruptive innovation, incumbents vs. new businesses in the AI space, and the role of LLMs in AI development.

AI and LLMs

06:40 - 13:58

  • Expectations around AI and LLMs may be unrealistic in the short term, with caution needed to keep things in context.
  • Foundational model companies like Tropic, OpenAI, and Mistral have seen huge valuations, leading to a shift away from traditional startup market dynamics.
  • Initial versions of models may have structural flaws in providing personal memory but potential for game-changing advancements if addressed.
  • New technology waves like AI tend to initially amplify existing workflows before leading to reorientation and increased productivity over time.
  • Existing big technology companies are effectively embracing AI, raising questions about the concept of disruptive innovation and their adaptability.

Growth of Larger Companies

13:41 - 20:29

  • In 2023, larger companies on the American Stock Exchange are outperforming smaller companies in terms of growth, valuation, and execution.
  • Major companies like Microsoft and Adobe quickly integrated AI into their products due to the shift towards cloud-based and API-based technologies.
  • The top companies, referred to as the 'Magnificent Seven,' generated about 45% of the economic profit for the US stock market.
  • Since around 2000, larger companies have been experiencing higher returns on capital compared to smaller companies.
  • Superstar firms have emerged due to their substantial investments in proprietary software that leverages scale and customization.
  • Technology giants are investing significantly more in intangible assets like R&D compared to traditional industries like energy.
  • Network effects and increasing returns play a crucial role in successful business models, exemplified by companies like Uber.

Value Proposition and Intangible Investments

20:06 - 26:56

  • Value proposition to the other side should ideally increase exponentially, which is rare but powerful.
  • Value-based strategy framework by Brandon Berger and Stewart helps in understanding consumer willingness to pay, price, cost, and economic profit.
  • Network effects can lead to increased value of a service or product, impacting willingness to pay and pricing strategies.
  • Creating increasing returns to scale is rare but highly advantageous for companies.
  • Intangible investments have become larger than tangible investments, offering scalability but also risks of obsolescence and theft.

Recombination of Ideas and Open Source Innovation

26:38 - 33:06

  • Digital building blocks are being manipulated more effectively, leading to strategic implications with positives and negatives.
  • Recombination of ideas is a subset of increasing returns to scale, allowing for greater outputs through manipulation of inputs.
  • Endogenous growth theory focuses on manipulating inputs over time for greater outputs.
  • Genetic algorithms involve breeding computer programs to improve fitness functions and solve problems.
  • The concept of recombining ideas, like 'ideas having sex,' is crucial in solving specific problems and achieving goals.
  • Rival versus non-rival goods are discussed in terms of excludability, with some non-rival goods being partially excludable for economic benefits.
  • Open source innovation is highlighted as a significant contributor to human prosperity, enabling rapid adoption and sharing of ideas.

Open Source Innovation and Patent Protection

32:43 - 39:22

  • Open source can promote innovation by allowing ideas to be shared and built upon freely.
  • Historical examples like the open source consortium for automobile manufacturers show how sharing technology can lead to rapid diffusion and innovation.
  • Companies sometimes use open source as a defensive strategy against competitors, as seen in the cases of Android and Google's Kubernetes technology.
  • The concept of complimentary goods and services affecting willingness to pay is illustrated through Google's strategy with Android and advertising.
  • There is a debate on the balance between incentivizing R&D through patents and promoting innovation for the greater good of humanity.
  • Concerns exist about the length of patent protection in industries like pharmaceuticals compared to software, with calls for reform in drug patents.

Regulatory Capture and Venture Capital

39:04 - 46:20

  • George Stigler won a Nobel Prize for figuring out the issues related to regulatory capture in Washington, affecting both lobbyists and politicians.
  • Regulation tends to benefit incumbents in industries with close ties to regulators, such as healthcare, finance, and telecom.
  • Distinguishing between public interest regulation and regulatory capture is crucial for addressing the current challenges in the system.
  • Bureaucratic red tape and excessive regulations hinder progress, as seen in examples like delays in infrastructure projects.
  • China's more centralized decision-making process gives them an advantage over the US in implementing new policies without bureaucratic obstacles.
  • Venture capital plays a significant role in innovation but there are concerns about the current state of the venture capital ecosystem compared to public equities.

Private Equity and Challenges in the Venture Industry

45:54 - 52:40

  • Public equities versus private equity, with a focus on venture capital and its market size compared to public equities.
  • Investors moving towards private equity for higher returns in low rate environments.
  • Venture capital as an asset class with high persistence of past winners being future winners.
  • Challenges in the venture industry including low barriers to entry and high barriers to exit, leading to structural flaws.
  • Decrease in the number of public companies going public and implications on institutionalized investing in private companies.
  • Discussion on regulatory capture and bureaucracy affecting the dynamics of public markets and IPOs.

Capital Allocation and Market Dynamics

52:12 - 58:55

  • The speaker appreciates the core principles consistently applied by successful investors over multiple decades.
  • During a period of low interest rates, companies did not behave as expected in terms of capital allocation, with investments down and cash balances up.
  • Research shows that companies use a hurdle rate twice as high as their cost of capital to accept projects, and are sticky with their capital structure decisions.
  • Buybacks increased during the zero interest rate period, mostly driven by offsetting dilution from stock-based compensation and being accretive to earnings per share.

Market Dynamics and Innovation

58:26 - 1:05:25

  • The Magnificent Seven and price wars may be a result of more educated participants in the market.
  • Companies at the foundation models burning large amounts of capital may not indicate high-quality capital allocation.
  • Innovation continues to emerge in unexpected areas, such as AI and energy usage.
  • Investing in physical world technologies like energy or robotics presents challenges different from software.
  • Learning by doing, as outlined by Ken Arrow's work, leads to increased productivity and cost reduction in industries like solar.

Cost Dynamics and Extreme Events

1:04:55 - 1:11:45

  • Rights law explains cost dynamics for various technologies like solar and lithium batteries.
  • Learning by doing leads to cost reduction and efficiency improvements.
  • Cumulative output plays a significant role in cost per unit advantage, as seen with Tesla.
  • Pattern recognition is valued in venture capital but can be limited by changing dynamics and biases.
  • A small percentage of companies generate the majority of market value, highlighting the importance of capturing extreme events in investments.

Investment Strategies and Opportunities

1:11:26 - 1:18:09

  • Extreme events can significantly impact a portfolio's performance.
  • Research shows consistent patterns across markets worldwide in terms of company value creation.
  • Investors should focus on identifying and owning companies that create significant value.
  • Maintaining a positive and proactive attitude is crucial during investment discussions.
  • Thorough research, building relationships, and avoiding price losses are key factors in successful investments.
  • Competition is common in successful investments, but non-consensus decisions can still lead to great returns.
  • AI development, physical world innovations, and healthcare are highlighted as areas of interest for potential change and investment opportunities.

Challenges in Healthcare and Insights from Geniuses

1:17:40 - 1:24:24

  • Challenges in accelerating progress in healthcare due to regulatory issues and lack of transparency in pricing.
  • Historical shifts in perception towards psychedelics and nuclear energy, highlighting the impact of regulations and societal views.
  • Insights on working with geniuses like Daniel Kahneman, Cormac McCarthy, and Murray Gell-Mann, each offering unique experiences and perspectives.

Synthesizing Information and Personal Growth

1:23:56 - 1:31:02

  • Michael is praised for his ability to synthesize complex information from books and lectures.
  • A story is shared about a moment of embarrassment related to the observer effect and the Heisenberg uncertainty principle.
  • The importance of seeking out truth seekers and being open-minded in discussions is highlighted.
  • The podcast guests emphasize the value of hard work, diverse influences, and exposure to different ideas in mastering one's craft.
  • Teaching, synthesizing, and giving back are seen as beneficial actions that can lead to personal growth and reputation building.

Writing and Understanding Concepts

1:30:35 - 1:32:26

  • Writing down ideas can lead to deeper understanding and help in sharing knowledge with others.
  • Teaching and writing are closely related and compel thinking to truly understand concepts.
  • Expressing ideas through writing allows for a deeper comprehension of the connections between them.
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