August 28, 2014

Random Show Episode 25

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A new episode of the Random Show with Kevin Rose (founder of Digg) and Tim Ferriss (author of The 4-Hour Workweek) is out! This is episode 25.


Lessons learned
  • Tim Ferriss is a guy who likes to experiment with his own body. For example, he has experimented with how much he really needs to sleep, or if he can stay off-screen during each Saturday. His latest experiments is NOBNOM - short for No Booze, No Masturbation for 30 days. That's why Kevin Rose is the only one in this episode who's drinking wine
  • Kevin Rose is trying to become better at meditating, and he recommended the meditation app Headspace. Kevin Rose recommended Sam Harris's website if you want to learn more about meditation
  • Kevin Rose has found a new way to make exercising fun. He puts on a 20-pound [9 kg] heavy weight-vest, jumps on a treadmill, opens a game on his iPad, and walks for 45 minutes

Recommendations

If you want to watch the rest of the episodes, you can find them here: The Random Show with Kevin Rose and Tim Ferriss

August 26, 2014

Why is Chess so popular?

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Of all the games we play today, which games will we still play in 100 years? Which games will we play in 1000 years from now? To answer the question, I decided to find out why chess is so popular. I learned how to play chess when I was maybe seven years old, but I've never been really interested in the game. Instead I played a lot of computer games. The difference between those computer games and chess is that a computer game lasts for a few years (if the developers are lucky), while people have been playing chess for hundreds of years.

Knights Templar playing chess in 1283. Source: Wikipedia

To find out why chess never gets old, I decided to try a new tactic which is called reasoning from first principles. It's a strategy I found when I wrote a book about the entrepreneur Elon Musk, who is using the strategy. 

This is how the strategy reasoning from first principles works. When you want to find the solution to a problem, you have two choices. The first is reasoning from analogy (experience), which is the fastest way but will not always give you an accurate answer. The other is reasoning from first principles, which is slower but will give you a more accurate answer. Based on experience, you can say that chess never gets old because it's easy to play if you are two people because almost everyone has a chess board laying around, or whatever you think. But if you reason from first principles, you have to dig to the bottom of the problem. 

To get to the bottom of the problem, I decided to read the book The Immortal Game - A history of chess by David Shenk. What I learned from the book was that we don't know for certain when people began to play chess. What the author has found is that we began to play some kind of chess about 1400 years ago. The rules have changed during these 1400 years (it's said the reason why the queen is so powerful was because the powerful Isabella I of Spain wanted the piece to reflect herself) but the basic game is the same. Other celebrities who are known chess players include Benjamin Franklin and Arnold Schwarzenegger, who had a permanent chess table in his movie set trailer.

Arnold Schwarzenegger is playing chess. Source: Oakland

While reading the book I found these basic principles that might describe why chess has survived the history of mankind:
  • You need a strong psychology to play chess. "The game is often as much about demolishing your opponent's will and self-esteem as it is about implementing a superior strategy."
  • It's easy to learn how to play chess. "The pieces and moves are elementary enough for any five-year-old to quickly soak up."
  • You always play a new game of chess. "The board combinations are so vast that all the possible chess games could never be played - or even known - by a single person."
  • You can't bluff like you can in a poker game because nothing is hidden and you can't win because you're lucky. "In a critical departure from previous board games from the region, these games contained no dice or other instruments of chance. Skill alone determined the outcome."
  • You can learn something while you're playing chess. Chess improves a person's:
    • Foresight - looking ahead to the long-term consequences of any action
    • Circumspection - surveying the entire scene, observing hidden dynamics and unseen possibilities
    • Caution - avoiding haste and unnecessary blunders
    • Perseverance - refusing to give up in dim circumstances, continually pushing to improve one's position

There are several then-popular games that didn't survive. One example is the Irish board game fidchell, and another is a game played by Vikings called hnefatafl. To this list of then-popular games, we will in the future probably add now-poplar games, like Angry Birds, because they don't have the same basic principles as chess has.

Update! A few years later I read the book A theory of fun for game design. It argues that chess is fun because each new game of chess is a new puzzle to solve. If you play chess against a physical person then each new game is a new puzzle to solve, so chess consists of an endless amount of puzzles. Also, each new game of chess is similar to all other games of chess. This is yet again why chess is popular. Each new game of chess is a new puzzle, but the difference between each new game of chess is not too different, and we humans don't like to solve puzzles that are too different from each other.

August 25, 2014

Battle of Khe Sanh - Or how to make a game in 48 hours

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This last weekend there was a competition called Ludum Dare where the goal was to make a simple game in 48 (or 72) hours. I believe the organizers run the competition two times per year - one in the spring and one in late summer. This was the second time I participated in the competition, you can read about the last time here: Max Manus.

Each Ludum Dare competition has a theme and the theme this weekend was "Connected Worlds." It took a while to come up with the idea, but the idea I decided to test was a sort of logistics simulator where you are a Logistics Officer in the army and is the only one who's connected to the outside world. To make it more realistic, I decided to find inspiration from a real battle during the Vietnam War. During that war, for a few weeks, the US Khe Sanh Combat Base was surrounded by enemy forces. If you want to learn more about the battle, you should watch this documentary on YouTube: Battle of Khe Sanh.  

If you are participating in the shorter 48 hour Ludum Dare competition, you have to create everything during these 48 hours - down to the smallest sound and texture. I didn't read the rules before I started working on the last competition, so I had to submit that game to the longer 72 hour competition. I began this competition by creating the models, including the main map where I used the real map from the battle and the C-130 cargo plane that will deliver everything you need. What I noticed was that it's much easier to make something in 3D than what it is to draw something in 2D. 


After a few hours of work in Blender, the models were finished and the work in Unity began. I hadn't made a similar game before, so I learned a lot. The most difficult part of a game where you simulate logistics is to tweak the parameters. The game has to be difficult and fun to play at the same time, and that requires a lot of tweaking. Anyway, this is the final result:



...and you can play it here: Ludum Dare - Battle of Khe Sanh

August 4, 2014

Warren Buffett analyzes Tesla Motors

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To analyze Tesla Motors with the help of Warren Buffett (no introduction needed), we are going to use the book Money Masters of Our Time by John Train. Buffett has never written a book about how he invests in companies. So we have to trust someone who has analyzed the shorter writings by Buffett and has summarized the findings. Elon Musk, the CEO of Tesla Motors, admires Buffett. The Giving Pledge is a philanthropic campaign by Buffett and Bill Gates, and Elon is one of twelve billionaires who has signed it and will give at least half of his wealth to charity.
Compared with the growth investor Peter Lynch, Buffett began as a true value investor. According to Wikipedia, it can be defined as:
Although value investing has taken many forms since its inception, it generally involves buying securities that appear under priced by some form of fundamental analysis. As examples, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios.
But after many years, Buffett began to like growth at reasonable price. Buffett himself described his strategy:
All we want is to be in businesses that we understand, run by people whom we like, and priced attractively relative to their future prospects.
The 83 years old Buffett is still an active investor, so the short answer to the question if he would like to invest in Tesla is: No! (Because he hasn't invested in Tesla). But that doesn't mean Tesla is a bad company from an investing point of view. We will see that Buffett's analysis depends on a series of question. The answers to these questions depends on the investor itself.

The analysis 
According to the book, there are a number of characteristics of a wonderful business Buffett prefers to invest in. Notice that I will use Coca Cola to make an example. One interesting side note here is that one of the reasons Elon Musk's grandfather decided to move from Canada to South Africa was because he had received death threats from what he believed was Coca Cola. So without Coca Cola, there wouldn't have been an Elon Musk, because his father is South African, and no Tesla Motors. 
  • They are understandable. Do you understand the company? To test if a business is understandable, Buffett closes his eyes and tries to visualize how the company will look like ten years hence. Compared with a company like Coca Cola, it's more difficult to understand Tesla. You have to understand the car industry and why we need cars not powered by oil. How will Tesla look like in 10 years? How many cars will they sell? How much money will they need to sell those cars? 
  • They see their profits in cash. The company shouldn't have to reinvest all profits just to stay in business. Tesla Motors is still a young company and their strategy is to reinvest all cash made from a car model to be able to design a new car model. They began with the Roadster, and the profits from that model was used to design Model S, and the profits from Model S will be used to create Model X. The profits from both Model S and Model X will be used to create Model III. 
  • They have strong franchises and thus freedom to raise prices. The key to a good business is its business franchise - the extent to which it is surrounded by a so called moat. To test if a company is surrounded by a moat, you can ask yourself: "Can I compete with this company if I have $1 billion?" Or as Buffett said: "If you said, 'Go take the Wall Street Journal apart,' I would hand you back the billion dollars. The real test of a business is how much damage a competitor can do, even if he is stupid about returns." This is why Buffett invested in Coca Cola - you can't take $1 billion, build a company, and take a substantial market share from Coca Cola. Buffett said no-one could do it even with $100 billion. So can a competitor take $1 billion and compete with Tesla? The answer today is yes. Tesla can't raise prices because people will then buy gasoline cars or other electric cars. You have to remember that Tesla is a young company and young companies tend to not have any moats. But if Tesla builds more Superchargers and they become the standard charger for all electric cars, then that is a moat. Or maybe if they design so good battery packs that all other car manufacturers are buying them, then that is a moat. 
  • They don't take a genius to run. Compared with a company like Coca Cola, Tesla design and manufacture electric cars which is more complicated. 
  • Their earnings are predictable. They should be so predictable that you would be happy with owning the company even if the stock exchange closed down for the next ten years. Coca Cola has produced the same basic beverage for more than 120 years. Tesla's earnings are not predictable as the company is young and there are still many question marks. How many cars will Tesla build in ten years? No one will know for sure. Will we still use batteries in ten years - or will we use fuel cells which Tesla has dismissed? Maybe we find a large oil source or discover a way to "manufacture" oil? 
  • They are not natural targets of regulation. Tesla is not selling cars through a traditional dealership - they are using their own stores and the Internet. How you sell cars is regulated in some US states. In some US states, it's not legal to sell cars through anything else than a dealership that's not owned by the car manufacturer. 
  • They have low inventories and high turnover. Tesla is only building cars as the customers have ordered them - except for the few cars they need for display purposes in the stores and galleries. Their factories are also using Japanese manufacturing technologies to minimize inventory. But there's a resale value guarantee that 5 200 Model S buyers used in 2013 (about 40 percent of all US customers). If the value of a Model S decreases, then these customers will send back their cars to Tesla. 
  • The management is owner-oriented. The CEO Elon Musk earns no salary. But he has performance based options he can make money from if certain milestones are met. One milestone is met when Model X is finished. So these milestones are not related to the performance of the stock - and that's a good thing according to Buffett. Elon Musk invested in Tesla because he believes that the world is running out of oil and this is something he really cares about. He invested in the company SolarCity that installs solar panels because he needed to power the cars with clean energy. So he want Tesla to succeed and is not working just to make a large CEO salary. 

There's also another book about Buffett called The Warren Buffett Way by Robert G. Hagstrom. The conclusions from that book is similar to the checklist from Money Masters of Our Time. But the author has also found a few so called "Financial Tenets" that Buffett is using when analyzing a company from a financial point of view. They are: 
  • Focus on return on equity - not earnings per share. A business should achieve good returns on equity while employing little or no debt. A good return on equity is maybe 20 percent, but Tesla's return on equity is -18 percent. But Tesla's return on equity has improved if you look at the overall trend.

  • Calculate owner earnings to get a true reflection of value. Owner earnings are basically the cash flow from operating activities minus the capital expenditures. The latter is how much of the year's earnings must the company use for new equipment, plant upgrades, and other improvements to maintain its economic position and unit volume. As Tesla is still growing very fast, the capital expenditure is still large. For example, they need cash to build the Gigafactory, so owner earnings are today basically zero. 
  • Look for companies with high profit margins. To get a sense of what high profit margins are, Buffett invested in Coca Cola when the profit margin was 19 percent. Tesla's profit margin is still negative but has improved if you look at the overall trend. 

  • For every dollar retained, has the company created at least a dollar of market value? The basic idea behind this metric is to test if a company uses the profits in an optimal way. If for every dollar retained, the market value hasn't increased with that amount, maybe it would have been a better idea to give that money to the shareholders in form of buying back stock or as a dividend. You can't apply this thinking to Tesla. They reinvested the cash from the first car, the Roadster, to create the Model S. What if this metric said it would have been a better idea to give away all money from the Roadster to the shareholders instead of making the Model S? 

Now we know if Tesla is a businesses that we understand and run by people whom we like. Now we need to know if Tesla is priced attractively relative to their future prospects. Tesla's current market value is about $29 billion. Is that a low or high value? Should we compare the number with Toyota's market value of $186 billion? Let's ask Buffett:
To properly value a business, you should ideally take all the flows of money that will be distributed between now and judgment day and discount them at an appropriate discount rate. That's what valuing a business is all about. Part of the equation is how confident you can be about those cash flows occurring. Some businesses are easier to predict than others. We try to look at businesses that are predictable.
So can we predict Tesla's future cash flows? Buffett said he doesn't have a clue how to estimate Microsoft's future cash flows. Estimating Tesla's future cash flows is also difficult. The company has said they will deliver 500 000 cars in 2020. But how many will they deliver in 2025? How much money will they make from Powertrain Components and Stationary Energy Storage Applications in 2018? Will they have enough materials to build batteries for all electric cars in 2023? There's a lot of lithium available, but only if the price of lithium increases. What happens if the resale value guarantee backfires in 2021? We can try to make a very rough prediction of Tesla's future primarily based on how many cars they will sell in the future. 


Based on this prediction, Tesla's market value should be $69 billion. But are we confident that those cash flows will occur? The answer is no! We are not confident that Tesla will make 760 000 cars in 2023, while their production in 2013 was 23 000 cars.

But don't forget that the final decision is up to you!

August 3, 2014

Peter Lynch analyzes Tesla Motors

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Peter Lynch joined Fidelity in 1969 as a research analyst. In 1977, he took over the Fidelity Magellan Fund. The number of stocks in the Magellan Fund increased from 40 to 1400. 200 companies represented 66 percent of the portfolio. The Magellan Fund became the largest mutual fund in history and it had over a million shareholders. But the sad story is that not many made money by owning the fund since they often sold at the bottom of the market.
In total, Lynch bought 15 000 stocks and analyzed 150 000 companies. To help him, he had Fidelity's research apartment, but he still made all decisions by himself. In 1990, Peter Lynch left the Magellan Fund. It had on average increased 29 percent each year.
Compared with other investors, Lynch has written a few books on how to invest. The best book is probably One up on Wall Street - How to use what you already know to make money in the market. The subtitle is important. Lynch believes that someone who is not connected to Wall Street can make better investment decisions if he/she invests in what he/she already knows. So if you work at Tesla Motors or bought a Tesla car, then you will be a better investor in Tesla than the Wall Street analyst. If you work in Tesla's factory, you will notice if the factory is manufacturing more or fewer cars. You will notice that before the Wall Street analyst who will not notice that until Tesla releases a quarterly report.
Lynch is mainly a growth investor. The type of companies he prefers are moderately fast growers (20 to 25 percent) in non-growth industries. But he can also invest in other types of companies that he believes are undervalued. According to Wikipedia, growth investing can be defined as:
Invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-book ratios.

The analysis
The first thing Lynch does when analyzing a company is to put the company in one of several categories. These categories are: Slow growers, Stalwarts, Cyclicals, Fast growers, Turnarounds, and Asset plays. Tesla Motors fall within the Fast growers, which is also Lynch's favorite category. A Fast grower is defined as:
Small, aggressive new enterprises that grow at 20 to 25 percent a year.
Lynch is only spending a few minutes with reading the annual report. So he's not making any huge calculations in a spreadsheet. What he has is a checklist that defines a good company:
  • It sounds dull - or, even better, ridiculous. It does something dull. Lynch's example from the book of a dull company is a company that makes bottle caps. Cars are not dull and it's common to see Tesla in newspapers and television shows. Because of the dull business, a CEO from a dull company makes less public appearances than the CEO of Tesla, who is visiting television shows like Letterman. 
  • It does something disagreeable. People are generally not positive to electric cars. 
  • It's a spinoff. Tesla is not a spinoff. 
  • The institutions don't own it, and the analysts don't follow it. Tesla is a popular company among analysts and news from the company is often on the front page of large newspapers. 
  • The rumors abound: It's involved with toxic waste and/or the mafia. There's a rumor that electric cars can catch fire and are less environmental friendly than gasoline powered cars. 
  • There's something depressing about it. 
  • It's a no-growth industry. The US car industry is not growing - it's actually falling because young people are not interested in cars and everyone can't afford cars because of the bad economy. 
  • It's got a niche. Tesla is only selling electric cars. Other car manufacturers are selling mainly gasoline cars and maybe one electric car. 
  • People have to keep buying it. Lynch says that he prefers soft drinks compared with toys because toys are often popular for a short time. It's true that car buyers tend to buy cars from the same brand as the car they are driving. 
  • It's a user of technology. Elon Musk is also the CEO of a rocket company called SpaceX. Tesla has used rocket technology to build Model S. 
  • The insiders are buyers. According to insider-monitoring.com, the total value of stock buying in Tesla since 2005 is $160 million, and the total value of stock sales is $232 million. 
  • The company is buying back shares. Tesla is not buying back shares because they reinvest all profits in the company to grow faster. 

But that's not all - Lynch has another checklist he goes through after he found a good company:
  • The p/e-ratio. Is it high or low for this particular company and for similar companies in the same industry? Tesla doesn't have a p/e-ratio because the company is not yet profitable. 
  • The record of earnings growth to date and whether the earnings are sporadic or consistent. Tesla's earnings per share has improved. Don't forget that it's important to look at the overall trend when you are looking at these key metrics. 
  • Whether the company has a strong balance sheet (debt-to-equity ratio) and how it's rated for financial strength. The debt-to-equity ratio has improved.

 

  • The cash position. It's a sign of prosperity of the cash position has improved and it's favorable if the cash exceeds the long-term debt. 
Cash in thousands

Tesla is a fast growing company, and Lynch has another checklist for those:
  • Investigate whether the product that's supposed to enrich the company is a major part of the company's business. We are interested in the entire company - not just the Model S or the Roadster. 
  • What the growth rate in earnings has been in recent years. Lynch's favorites are the ones in the 20-25 percent range. Tesla's revenues are growing with much more than 25 percent (83 percent in 2013). Lynch says that you should be suspicious of companies with growth rates of 50 to 100 percent a year. 
  • That the company has duplicated its successes in more than one city (or country), to prove that expansion will work. Tesla has successfully expanded from US to Europe where Norway has become the biggest market per capita. 
  • That the company still has room to grow. Tesla believes they will sell at least 500,000 cars per year and they are currently selling around 20,000. If we are going to replace the entire world's fleet of gasoline cars, then Tesla has room to grow. 
  • Whether the stock is selling at a p/e-ratio at or near the growth rate. Tesla doesn't have a p/e-ratio because the company is not yet profitable. 
  • Whether the expansion is speeding up or slowing down. The expansion has to speed up if Tesla is going to sell 500,000 cars per year. But it's difficult to say if it's happening because the car that will sell in large volumes, Model III, is not finished. 

So would Lynch have invested in Tesla? As Tesla is not yet profitable and there are still many question marks, this quote by Lynch can summarize this analysis:
It's better to miss the first movie in a stock and wait to see if a company's plans are working out. 

But don't forget that the final decision is up to you!