Greetings Fools,
Using my Anti-fragile framework, I wanted to show how PSTG stacks up.
Barbell Strategy
Mission Statement
“to deliver data storage that transforms business through a dramatic increase in performance and reduction in complexity and costs. .”
Simple: Yes, if I’m an employee, I can simply ask: “will this (1) increase performance while (2) reducing complexity and cost?”
Optionable: Yes. There’s a whole host of ways to increase performance and reduce cost and complexity – and I’d be willing to bet those ways will change over time.
Inspirational: If that’s your thing.
+1.5 points
Moat
Brand: Pure Storage has an audited net promoter score of 83.7 – which is very high. At the most basic level, this means that Pure’s customers are very likely to suggest using Pure to someone else. That said, the company was only founded 7 years ago and FlashArray is barely 5 years old. Therefore, I’m only giving it a half-point.
+0.5 point
High Switching-Costs: The evergreen upgrade-ability without downtime is a big deal. Customers who use Pure Storage and purchase the hardware are much more likely to be sticky. That said, this is still a very young company, and even though the business model is specifically designed to service customers for a minimum decade, the recurring revenue that’s the hallmark of a high switching-cost business isn’t really there yet.
+1.0 points
Network Effect: The company is pushing machine-learning, predictive AI analytics. With anything like this, the more data you can feed the AI, the more accurate it can become over time, and the greater the edge is against competitors who don’t have access to the same database that Pure Storage does. It’s still early in this game, so I’m not giving it two points, but clearly, this tool gets more powerful for everyone involved with each additional customer.
+1.0 points
Optionality
This is a really tough one for me. I’m not exactly an expert on storage technology. That being said, I will give this one point. There are other products they can provide, and the evergreen state means that applications can be continuously updated.
That said, the big bet here is on solid-state devices – which is the disruptive technology of the day that Pure Storage is betting on. The problem: disrupters can often get disrupted as well.
+1.5 points
Skin in the game
Role of founder: John Colgrove is Chief Technology Officer.
+1 point
Insider Holdings As of the last proxy, insiders together owned 66.5% of voting power.
+1 points
Glassdoor: The company has a 4.0 rating (out of 5 stars).
+1 point
Financial Fortitude
Financial statements
Cash: $551 million
Debt: $0
Free Cash Flow: ($4 million)
This is a really, really tough one to peg. There’s no doubt that Pure Storage has a healthy balance sheet and cash flow statement. But I don’t think it’s so powerful that it could undercut the competition in the scenario of a massive market downturn. It’s simply robust: safe, but not adding any additional long-term strength.
+0 points
Concentration Risk
At the end of fiscal 2016, two channel partners represented 22% of revenue. That dipped to one channel partner representing 11% at the end of fiscal 2017. That being said, it’s probably a safe bet that two still make up over 15% of revenue.
The company also relies on just a few providers for its solid-state devices
-1 points
Total Score: 6.5 points
I’ve run companies through this framework for well over a year, but I do it anew every time (I find that doing so…while laborious…forces me to be more aware of the current situation). As such, I don’t have a huge database to draw from. This lands PTSG near the middle of the list, though it would likely be much higher when compared against all companies.
It’s important to note that I’m nowhere near as “agile” an investor as the average member of Saul’s board. I prefer to buy my companies with a decades long time horizon and – for the most part – following through on that intention. I might make ten to twelve trades in an entire year if I don’t need to free up money for real-world expenses.
The real risk here is commoditization. Pure Storage has the first-mover advantage. The real key is whether the company can build in higher switching-costs and a better AI machine because of this early-mover advantage. That’s no guarantee, but it also means that it could be sitting on a winning lotto ticket if things play out optimally.
Brian
See all my holdings here: http://my.fool.com/profile/TMFCheesehead/info.aspx
What is Antifragile framework and how has it performed?
There are few books that have affected the way that I approach the world quite like Nassim Taleb’s Antifragile. In it he makes a few key observations that have shifted the lenses I use on a daily basis. Some of these things others have said many times, but for some reason, the way it was said stuck with me.
The future is completely unpredictable, and if we use a narrative to try and predict how things will unfold in the world beyond our immediately control, we will likely be wrong.
We cannot reliably measure the likelihood of anything happening.
In the absence of such things, we should measure the fragility of things, which is entirely possible, and eschews relying on any predictions.
In essence, everything in the world can be broken down into three categories
The Fragile: These things will break as a result of time, chaos, stress, pressure, and unexpected occurrences. Think of a china plate set, on the edge of a table, near a train track
The Robust: These things will stay exactly the same, regardless of the passage of time, or addition of chaos, stress, pressure, or unexpected occurrences. Think of a solid piece of metal that will never be exposed to extreme heat.
The Anti-Fragile: These things will grow stronger over time as a result of exposure to chaos, stress, pressure and unexpected occurances up to a point Think of how our muscles grow by creating micro-tears when we lift weights.
Crucially, antifragility means being ok with not understanding the world. That’s key, because most of us get in trouble when we think we can understand everything. The framework assumes that we don’t, and only measures the variables which are clear enough for us to see and measure.
Applied to Foolish Investing
As an investor, I want to put my money into as many “Antifragile” companies as I can. After reading much of Taleb’s work, there are three major concepts that play a role in how do this. In order of importance, they are:
The barbell strategy
In the realm of business, this means having one aspect of your business that is very reliable and accounts for a majority of your time and resources. But on the other end of the “barbell”, you tinker with high risk/high reward experiments.
The first end, I call the MOAT. In my criteria, there are only four main moats a company can have. Here’s how I break that down by points.
Low-Cost Production
+1 point if it would take a competitor up to three years to match this advantage.
+2 points if it would be prohibitively expensive and take (in my best estimation) over three years for a competitor to match.
Example: Think Amazon’s fulfillment network – it can offer one-or-two-day delivery service for less than anyone else can afford, internally.
High Switching Costs
+1 point if these high switching costs are clearly demonstrated, but for less than five years. Or the overall switching costs are somewhat weak.
+2 points if the switching costs have been demonstrated as robust over a long timeline.
Example: I will probably always use Intuit’s TurboTax because it has so much of my prior data in it and it makes filing taxes so much easier for me.
Network Effects
+1 point if the network effects are weak or slowing, or if they are strong but have not been demonstrated over five years.
+2 points if the effects are strong and have been for over five years.
Example: Facebook’s properties get more valuable with the addition of each user.
Intangible Assets
+0 points if a company has a strong brand, but hasn’t proven itself over seven years minimum.
+1 point if a company relies on patents, or has a strong brand with over seven years of proof.
+2 points for regulatory protection of some kind.
Example: Apple has, by far, the most powerful brand in the world.
On the other end of the barbell, we have optionality, or multiple futures. Here’s how that breaks down.
Optionality
+3 points if the company has shown it can branch into other industries, and has a history of rewarding small, risky failures.
+2 points if the company has shown that it can grow in multiple ways within its current industry.
+1 point if the company has a clear history of trying to branch out into new areas, but has yet to succeed.
Example: Amazon is famous for rewarding small failures, which has led it to go from being an online bookstore to “The Everything Store”
In addition, I like think a company’s mission statement is paramount. It needs to be simple (a compass to help an employee make a difficult decision), inspirational, and optionable. Here’s how that is evaluated:
Mission statement
+2 if it meets all three criteria
+1 if it meets two of three
+0 if it meets one of three
-1 if it meets none.
Skin in the game
Taleb points out that the best way to mitigate hidden risk is to evaluate skin in the game. He points out how, using Hammurabi’s code, ancient cities would require a bridge architect to sleep underneath the bridge after it’s completion. Since the city elders weren’t architects themselves, this was the best way to assure that no corners were cut.
I evaluate this on three different levels
Role of founder
+1 point if founder is still involved in some part of the operations or is on the board.
+0 if he/she is not
Insider holdings
+1 point if the group as a whole owns more than 10% of shares, or one individual owns more than 5%
+0 points – in between the above and below
-1 points if the group as a whole owns less than 5% or there are no individuals owning at least 2%
Glassdoor Employee Reviews
+1 point if the overall score is a 4.0 or higher
+0 points if the overall score is between 3.6 and 3.9
-1 point if the overall score is at or below 3.5
Redundancy and robustness
This is the third major aspect that I evaluate. This is the boring stuff that only becomes important in times of crises. If a company has these characteristics, it is less likely to suffer over time due to unforeseeable stressors.
Financial Fortitude – involves looking as cash, debt, and free cash flow
+1 point if it would clearly benefit – relative to competition – from a downturn
+0 points if it would remain unchanged
-1 point if it would be weakened – relative to competition – in a downturn
-2 points if it might go bankrupt in a downturn.
Customer Concentration
+0 points if it has no concentration issues.
-1 point if top three customer are 15% to 25% of sales
-2 points if top three customers are more than 25% of sales
The big question: Does this work?
I have identified two huge blind spots with the Antifragile framework. First, if a company has none of the four moats I mentioned above, but has incredible business momentum, it can do very well despite the low score. NVIDIA is a great example of this.
Furthermore, because of the binary nature of results in the pharmaceutical industry, it is a poor indicator of success in this realm.
I don’t really view this as a problem, so long as it’s understood, and you decide not to short such stocks.
In terms of the results, I have three data points for you, all fairly encouraging.
My own personal results
I haven’t explicitly used the Antifragile framework from the get-go (I began formulating it about 30 months ago). That said, I’ve unknowingly been using pieces of it throughout.
The results, according to My Scorecard:
Compounded annual growth rate: +20.7% per year
Versus the S&P 500: +5.8 percentage points per year.
That might sound like a small amount of outperformance, but it’s pretty signficant over time.
Cross referencing with a portfolio I started in 2011
When I started at the Motley Fool, I brashly made something called “The World’s Greatest Retirement Portfolio”. You can read about it here:
https://www.fool.com/retirement/general/2012/02/02/the-world……
Well, I went back and constructed what the Antifragile score would have been at the time, and cross-referenced it with the returns on those stocks over the past six years.
The results were pretty shocking, an r-squared value of .69. In other words, 69% of the variance in returns could be explained by variance in the scores.
That’s pretty high, but it should be said that it also is a very small sample size.
Votes for Explorer Missions
Over a smaller timeframe, I’ve voted on David Gardner’s Explorer missions for the past three years. While I won’t reveal any of the data here, if I would have chosen the “Antifragile” pick every time (I didn’t start using it until 6 months in).
Of the 34 picks I’ve made between two stocks:
The “Antifragile” one has outperformed 17 times (50%)
The average “Antifragile” pick has outperformed the other by 27 percentage points!
I bring all of this to your attention because, inspired by TMFTypeoh, I’m going to be running many stocks in the Motley Fool universe through this framework, and wanted to have a posting to refer back to to explain how certain stocks got their scores.
I hope you find it as educational, amusing, and enrching as I have, and that it helps you to invest – better!
Fool on!
Brian Stoffel
See here for my holdings: http://my.fool.com/profile/TMFCheesehead/info.aspx