New Berkshire Hathaway annual letter

New Berkshire Hathaway annual letter is out.  I love to read this thing every year.  If Warren Buffett weren’t busy running a 362 billion dollar company he would be a very talented business writer.

He’s funny, compelling, a calm and sunny optimist, and thoughtful about dimensions beyond the monetary, one of the great American characters alive.  Here are some highlights if you are too busy to read:

Some common sense social policy:

About rail cars:

A brief history of auto insurance in the United States:

Advice:

A non-apology for GEICO advertising:

Discussion of the realities of economic change on people’s lives:

Here is the scariest part, a warning about cyber, biological, nuclear or chemical attack on the USA:

Damn I hope I have the time to make it to the annual meeting:

If I make it to Omaha I would like to challenge Ariel Hsing at table tennis:

Should you buy Twitter? Plus: Advice to Jack Dorsey

I’ve noticed that writing about investing is very popular on the Internet so I’m gonna try it.  

This post is about Twitter (TWTR).  At the moment: the stock is priced at 15.88, I don’t own it.

Twitter is one of my favorite products in the world.  If I’m being real, I probably spend minimum an hour a day looking at Twitter.

Lots of people hate it — my Great Debates colleague Dan Medina, for instance, claims to find it unusable.  Yet there he is:

and he’s fascinated by it.

How can you not be?  Here are entertainers, comedians, athletes, famous people of all kinds, plus millions of strong-opinioned randos, bots, sex bots, ordinary citizens, kids, organizations, Vine people, all gabbing away at some fantastically weird party / school assembly gone mad.

On the one hand maybe Twitter is a negative in my life, because I read fewer books.  On the other hand, while I’ve been putting off reading William Gibson’s books, I’ve been enjoying his Twitter feed:

Little Esther tells me Twitter is for losers, but her feed is hilarious:

Twitter is a fiendishly perfect invention for distracting comedians because so many of them

1. Crave instant feedback/laughs
2. Are desperate for connection
3. Are bored
4. Are traveling / waiting around for something
5. Are video game addicts

If anything, the biggest problem I have a user of Twitter is how much stuff there is I want to look at, and how to sift it out from all the garbage.

I’ve solved that problem more or less to my satisfaction by making private lists.  The second biggest problem might be the jarring combos of information:

but maybe that’s a feature, not a bug.

For all this entertainment, hours and hours of it, Twitter charges me…

NOTHING?!  Zero dollars?

That is ridiculous.

I mean, I guess sometimes I have to look at ads.  But I gotta tell ya, these ads don’t tend to get in the way.  Often they are wack enough to be part of the fun:

(What?  The Embassy of Poland wants to brag to me, specifically, about its military expenditures?)

What kind of wonderful company is this, that gives me entertainment, information and amusement for free?!

Should I get in on?

When a product becomes a part of your life, you have to ask yourself if maybe you should go ahead and own part of the company by buying shares in it.

SHOULD YOU INVEST IN TWITTER (TWTR)?

What I know about investing is cobbled together from skimming and half-reading investment books, blogs and articles (and Twitter) plus mistakes plus talking to people.

First, big believer in the Peter Lynch method.

Peter Lynch of Fidelity Investments.(Story/Paulson)

Peter Lynch was a wealthy Bostonian of my youth who got his start caddying for the president of Fidelity Investments, became an intern there, and rose up to manage Fidelity’s Magellan fund:

From 1977 until 1990, the Magellan fund averaged a 29.2% return and as of 2003 had the best 20-year return of any mutual fund ever.

and also wrote some bestselling investment guides:

which I haven’t read.  But which Wikipedia helpfully summarizes:

His most famous investment principle is simply, “Invest in what you know,” popularizing the economic concept of “local knowledge“. Since most people tend to become expert in certain fields, applying this basic “invest in what you know” principle helps individual investors find good undervalued stocks.

Lynch uses this principle as a starting point for investors. He has also often said that the individual investor is more capable of making money from stocks than a fund manager, because they are able to spot good investments in their day-to-day lives before Wall Street. Throughout his two classic investment primers, he has outlined many of the investments he found when not in his office – he found them when he was out with his family, driving around or making a purchase at the mall. Lynch believes the individual investor is able to do this, too.

OK, great.

I would say I’m not an expert but I’m pretty serious about:

• comedy

Twitter is a great way to get comedy in quick, easy form.  Every comedian I know is on Twitter.

• written entertainment

Not every writer is on Twitter but a lot of them are, and there’s neat writing on Twitter every day.

• news/information/infotainment.

from this I’ve had my biggest insight of all: journalists are obsessed with Twitter.  They give better, faster, more interesting news directly to their Twitter feeds.

Plus, the news makers and influencers are themselves talking directly to the Twitter user:

and

That’s how I identified Twitter as a possible opportunity.  Now let’s run it through a rigorous Lynchian checklist.

Do you use it yourself?

Yes, so much so that I have to impose rules on myself that I then break.

Do people you know use it?

Oh God they’re obsessed.

Does it seem like a good product?

Well, I dunno.  For instance I have no idea how or if they make money.

That brings us to the next level.

Buffet analysis.

Everybody knows billionaire investor and Omaha cheapskate Warren Buffett, he is one of the great American characters.

You might also know his partner and former WWII Army Air Corps meteorologist Charlie Munger:

A good intro to some of Munger’s ideas can be found here on the blog of Tren Griffin, who rounds up a lot of wisdom.

Buffett and Munger’s insights are many and not easy to summarize, but a crudely simplified version in three quotes might be:

1:

Buy into a company because you want to own it, not because you want the stock to go up.

2:

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.

(that quote I can’t 100% track down to the source but it appears legit). 

and 3:

Never invest in a business you cannot understand.

Buffett is a value investor.  He asks, is the business valuable?  For instance, a railroad.

Only a few companies control all the railroad track in North America:

and they’re not building more.  People continue to ship things on railroad.  Warren Buffett decided that he understood railroads I guess, because he bought one.

Presumably before he did that, though, he ran BNSF through the third level of investment analysis, which is the level of numbers.

This is the level that is so boring.  You almost can’t believe it.

Try, for instance, to read the wikipedia page on valuation (finance) and if your eyeballs don’t turn to mush maybe investment banking is for you.

For me, I can only handle the very basics.  There’s P/E (price of the stock to earnings), for instance.  Should be simple enough:

Theoretically, a stock’s P/E tells us how much investors are willing to pay per dollar of earnings. For this reason it’s also called the “multiple” of a stock. In other words, a P/E ratio of 20 suggests that investors in the stock are willing to pay $20 for every $1 of earnings that the company generates. However, this is a far too simplistic way of viewing the P/E because it fails to take into account the company’s growth prospects.

So says investopedia.  Ugh, everything is always far too simplistic with these guys.

Let’s take it down to basics.

Hmmmmmm.

OK, I can do this.

EBITDA is earnings before interest, taxes, depreciation, and amortization.  A measure, right, of how much money the company is making.

Twitter’s is negative two hundred and eight million dollars.

Coca-Cola, by comparison, is $124 million.

Amazon’s is $7.8 billion.

Netflix’s is $368.1 million.

Chipotle’s is $908 million.

How about profit margin, that seems simple.

Coca-Cola: 2.7%

Amazon: .56%

Netflix: 1.81%

Chipotle: 10.57%

Twitter: -27.99%

OK, so let us answer the key question:

• How much money is Twitter making?

Negative a lot?

• How is that possible?

Well, I took to the Internet.  Here are some things I learned:

• Twitter makes huge amounts of revenue, but not a profit.

From this week’s earnings call, we learned that Twitter’s revenue in the fourth quarter totaled $710 million, up 48 percent year-over-year.

Most of that money ($641 million) comes from ad sales, with the rest ($69 million?) coming I guess from data sales.  Although apparently Twitter has somehow screwed up selling that up — last year it made $147 million from data sales before they shut off their data “fire hose.”

I ran all this by my colleague Anonymous Investor.  Here’s what he has to say:

Let’s say you owned a pizza shop. In 2015 you sell a million dollars worth of pizza (or said another way, you made a million dollars in revenue). At first glance, that might seem good. But if your food, labor and rent costs add up 1.3 million, you would have ended up losing money for the year.   (a $300,000 loss for 2015).

Likewise, Twitter sold 2 billion dollars worth of stuff (mostly advertising sales).  But they spent around 2.5 billion dollars doing it.  I haven’t dug deep into it, but lots of their costs seem like wasteful spending — such as 778 million on research and development, which seems ridiculous for a company that’s basically not much more than a slightly-advanced message board.

Seems the company could be profitable if google or someone else bought it.  They could slash costs and make some profit off that revenue.

• Twitter wastes lots of money.

How much does it cost to run Twitter?  I honestly have no idea, but the brilliant thing about the business is that the users are doing the hard work of generating the content.  All Twitter should have to do is run the servers and so on, right?

In looking into it, I found that Twitter spends an insane amount of money on research and development.  This is from a 2013 Fortune article:

According to its IPO document, in the third quarter of the year, Twitter shelled out nearly $90 million on R&D. That was equal to more than half, 52%, of the company’s revenue in the same period. It is Twitter’s largest cost, nearly 50% more than it spent on marketing. And it’s far more than most of its rivals spend. Facebook, for instance, spent just 14% of its revenue on R&D in the the quarter right before it went public. It has since ramped up that spending to 26%. But Facebook FB 0.10% makes money, unlike Twitter.

Google spends just 15% of revenue on R&D. And Google is working on a self-driving car, high-tech glasses and, maybe, space elevators.

There is no sign that Twitter is working on anything that cool. Twitter actually gives very little detail about what it spends its R&D budget on in the offering documents for its IPO. It says that R&D expenses are to “improve our products and services.” And it doesn’t appear that Twitter is building some kind of high-tech lab or supercomputer. In fact, the bulk of Twitter’s R&D expenses go toward personnel-related expenses. And a good portion of that expense, about a quarter, was the cost of handing out stock options.

Twitter doesn’t say how many employees work in its R&D groups. The company has a total of 2,300 employees. That would be $104,000 per employee if all of its employees were in R&D, which they are not.

That sounds crazy.  And it seems like the problem has not been solved.  Take a look at this:

Again, I am no expert, the whole point of writing this is to educate myself, but Twitter is spending $800 million dollars on research & development?!  WTF?  To research and develop what?!

Your job is to bring me this shit as simply as possible:

And you don’t even do a good job of that!

Much of that money, apparently, is stock distribution.

• Twitter’s employee stock distribution system is screwy.

So I learn from this Quora post.  I don’t entirely understand this.  Neither do the folks at Vox I guess, who proclaim:

At the same time, depending on how you count Twitter employees’ stock options, the company is either still continuing to lose money or only modestly profitable.

That murkiness definitely makes me uneasy.

Is this an accounting anomaly that’s falsely inflating how much money Twitter is spending?

Or is Twitter like giving away too much of itself to its employees?

• Twitter is not gaining users

That seems to be what’s making “Wall Street” so mad, since when they bought into it at its IPO with a valuation of $30 billion dollars they were assuming it would be the next Facebook or whatever.  Not happening.

As far as I can tell at least some significant percentage of Twitter users are bots anyway.  If some of your users are artificial sex picture machines, and you’re still losing users?

• Twitter has untapped revenue potential?

So says this bullish article:

According to Twitter, there are 500 million people who consume Twitter that don’t actively use Twitter, or have accounts. These people see tweets on websites, mobile apps, in articles, or in Google search among other places. After much debate, and criticism about how Twitter can convert those users to the platform, Dorsey made the decision to begin showing promoted tweets to its logged out userbase of 500 million, rather than wasting money trying to convert those consumers to users.

I don’t really understand this.  Does it mean you’re gonna get users back to Twitter?  Doubt it.  We’ll watch the test case of our colleague Dan Medina, but in my experience people don’t come back to social media apps they left.

• This guy has a terrible idea.  Or is it genius?

To let everybody pay to push up their Tweets.  Users eat it.

The title of his article is:

How Twitter could be 10X bigger, 100X more profitable, and 1000X more awesome

and I have to say this is a case of what we might call Bro Exaggeration.

• What about the exact opposite?

Twitter pays you if your tweets get 2,500 RTS.  Celebrities excluded, can only win a few times, scams will have to be dodged etc., but: essentially Twitter becomes a joke casino where anyone can play.  Americans love casinos.  Casino owners do not go broke but they sometimes get murdered I guess.

OK so those are the things I know

Can I pass any of Buffett’s tests?

Do I want to own Twitter as a business, not just as a stock?

Not if it costs ten billion dollars, no, which is market cap as of this writing.

If the stock market shut down for five years tomorrow, would Twitter emerge well?

Ehhhhhh…. yes I think so but not worth ten billion dollars or its five year equivalent.

Do you understand the business?

Not really.  It is a simple mobile entertainment company where the content is generated for free but somehow it costs TWO billion dollars a year to run it?  Where all the ads are like garbage and increasingly young people tell me it is for losers?

I don’t understand that.

I kind of do understand it like the world’s news feed and it’s free.  Something like an AP wire that anyone can post on, that (mostly) sorts itself out but has as it’s biggest problem filtering, a problem it has to solve fast or it will be replaced like MySpace by something nimbler and cooler that doesn’t cost two billion dollars to run.

It all comes down to the final piece of the Hely Investment Method: look at a photo of the CEO.

Does he look like he knows what he’s doing?  Would you trust this man with your money?

Hrmm.  I dunno.  How can you tell with these tech guys?

Maybe Jack Dorsey will:

• figure out innovations that draw new users to Twitter without antagonizing the existing users
• find deep new trenches of revenue
• cut operating expenses

and Twitter will be an amazingly valuable company.  OR, maybe he will

• appear or come close enough to doing that so the stock price goes way up.

Very possible.

Another possibility is

• they go too far and drive off the users they do have.

Jack Dorsey, knowing he has to do something, uses his neuro-atypical brain to change interfaces in ways that actual humans hate.  No new users join, Wall Street freaks out.  The company stock plummets.  Maybe some giant buys it out of perverse experimentation or nostalgia or valuation of scrap parts at some lower level.

One thing I can almost guarantee:

• Twitter will not grow in new user gain numbers

New people are not lining up to join Twitter.  Everyone in the world has had a chance to try it out.

What I would suggest to Jack Dorsey?:

• DON’T DO ANYTHING.

Some huge number of people are insane devotees of your site as is.

Let them keep entertaining and informing themselves with it.

Change nothing.  You won’t gain any new users, but you won’t lose any either.  In the meantime, you can figure out how to sort out operating expenses and improve advertising.

Wall Street investment banks overvalued the company because they were in a hysteria about tech and had no idea how to value a company that had nothing but enormous user growth, so they overvalued it.  Now the user growth has stopped and they are panicking.  But it’s fine.  Maybe Twitter isn’t worth $10 billion / $15 a share, but it is worth something.

At this price I would suggest do not buy Twitter.  Marc Cuban agrees with me, here’s what he said to CNBC on Feb. 11 (funny how their transcripts are in all caps):

WAPNER: THAT LEADS ME TO MY LAST QUESTION. SINCE WERE TALKING TECH AND SO-CALLED FALLING KNIVES, WHEN YOU LOOK AT A TWITTER, WHAT DO YOU SEE IF YOU ARE PART OF AN INVESTMENT GROUP OR IF YOU WERE A CEO OF ANY NUMBER OF TECH COMPANIES OUT THERE, WOULD YOU LOOK AT THIS PROPERTY AS AN ASSET YOU WANTED TO HAVE?

CUBAN: YEAH, YOU KNOW, A LITTLE BIT LOWER I CERTAINLY WOULD. I THINK NOW IT IS AT THE QUESTION POINT WITH THE $10 BILLION MARKET CAP, BUT $6 BILLION MARKET CAP WITH $2 BILLION IN CASH, I WOULD BE A HUGE BUYER OF THE STOCK.

If you believe him, and I guess I do, somebody will buy Twitter soon.

So, there’s some stock price point at which that news will come out, and then the stock will go up some (probably).  So if you want to gamble on that exact moment you can make money.

Seems like a sucker’s game to me, but if you love gambling it’s probably fun.  Says Anonymous Investor:

Despite the fact that the company can’t make any profit, the stock is still selling for a high price.  It’s selling for 5 times its revenue. That’s higher than average.  The high valuation means that investors have the belief that in the future some of those revenues can be converted into profit.  And other investors might have the belief that twitter could be bought out by another company for a market cap north of 10 billion dollars (or to be more accurate: north of around 8 billion, since Twitter holds about 2 billion in net cash).

It’s all a matter of opinion.  To me, both assumptions have a pretty high risk of not happening. So in order for me personally to buy Twitter, I’d need to be compensated for that risk with a lower price.

Did you know Jack Dorsey has a whole other company he’s CEO of?

Wait what?  You’re telling me he’s working at most half time on fixing Twitter?

Yes he’s also busy being CEO of Square, the credit card payment company that might be hugely profitable or might be about to collapse?

Haha this guy.  How does he explain that?

He says it’s easy with his “theme day” system:

The way I found that works for me is I theme my days. On Monday, at both companies, I focus on management and running the company…Tuesday is focused on product. Wednesday is focused on marketing and communications and growth. Thursday is focused on developers and partnerships. Friday is focused on the company and the culture and recruiting. Saturday I take off, I hike. Sunday is reflection, feedback, strategy, and getting ready for the week.

HAHA amazing.  This guy.