Buffett, Nike, Blockchains

Buffett’s History

When markets are down, it can be a helpful exercise to review market history to see what lessons we can learn about how people handled volatility in the past. Warren Buffett’s 40 years of annual public letters are an excellent resource for reviewing market history, and you can view them here. Even the most successful investor of all time has had some pretty rough down years.

• 1974 (-48.7%) vs SPY (-26.4%) (…ouch)
• 1990 (-23.1%) vs SPY (-3.1%)
• 1999 (-19.9%) vs SPY (+21.0%) (…also ouch)

Despite these dramatic drawdowns and wide gaps in performance, Buffett’s best investments were waiting for him in the years and decades that followed. His first investment in Apple, in 2016, has led to a greater than $100B unrealized gain, making it the most successful investment by a professional investor, ever. The best returns for you are likely yet to come as well, and that’s something to look forward to once we eventually exit the bear market. Following that 1974 drawdown, in the next five years, Buffett saw two years with triple-digit returns:

• 1976 (+129.3%) vs SPY (+23.6%)
• 1979 (+102.5%) vs SPY (+18.2%)

Additionally, Buffett has a habit of holding onto his investments for many decades: American Express (since 1999), Coca-Cola (since 1988), and Wells Fargo (for 30+ years, but no longer a holding). Holding through wars and ever-changing political regimes, you will see many ups and downs along the way. Coca-Cola, for example, represents a nearly 23x return even though the asset had flat to negative performance for almost 15 years, from the late 1990s to the mid-2010s.

This bear market can feel exhausting when we were at all-time highs just six months ago, and the forward-looking sentiment is negative. Looking at the context of Buffett’s portfolio history should give some consolation that all investors have to stomach bland, low, or depressing return environments at some point. With the Fed continuing to tighten markets to fight inflation, we are unlikely to see the bull market resume until inflation numbers subside. Covid, Ukraine, civil unrest, Roe V Wade, and so on can make it feel like bad news will never end, but that’s not true. When it rains, it pours. With this context, it’s fair to consider that the best is likely yet to come.

Nike story

Nike is a retail powerhouse and an interesting story during this market reset. For context, Nike is one of the largest apparel brands in the world, with roughly $45B in annual sales. Revenue is up 12% since the start of the pandemic to an all-time high, free cash flow is at an all-time high, and earnings per share are at an all-time high. Their stock is down -40% from six months ago, back to the pre-pandemic price.

What’s most interesting about Nike is the pace of its digital transformation. Before the pandemic, 15% of sales were digital; today, it’s 25% and expected to reach 40% in the next few years. Digital sales through their apps are far better for margins and open the door to incredible customer interaction opportunities. Nike has cut their wholesaler relationships in half while going direct to the customer. Despite the clear opportunity for digital sales, it’s taken a giant like Nike this long, with a nudge from Covid, to get customers to adopt digital sales. This demonstrates how far we still have to go and the upward potential that remains when it comes to digital transformation at large.

(Disclaimer: This is not an endorsement for investment in NKE, and we don’t have any current plans to invest in NKE.)

Blockchain Updates

Narratives follow price, and since the prices of most crypto assets are down between 70-100%, the dominant narrative at the moment is that crypto’s final day of reckoning has arrived. In other words, the “crypto is dead” narrative is popular. In the spirit of the negative narrative, here is a look at one of the best critiques of Bitcoin and the blockchain that I’ve read to date: Nassim Taleb’s Bitcoin paper from 2021.

The two critiques that resonate the most with me are:

• Related to comment #1 in his paper: Gold requires no supportive maintenance, while bitcoin requires an active mining community to simply exist. Take away the bitcoin miners, and bitcoin ceases to function. Therefore, any asset with the smallest possibility of ceasing to function must have an expected value of zero. (This is my attempt to translate the point into more basic language. The technical term he uses is the “absorbing barrier”, which is a great concept worth studying.) To restate, gold relies on nothing and Bitcoin relies on constant GPU processing, so IF at any point in time those miners lose interest, Bitcoin can simply cease to exist. That IF is why you can’t compare it to gold.
• Related to comment #4 in his paper: Real life is too messy to use an immutable and irreversible blockchain. The original The Dao Ethereum hack in 2016 split Ethereum into two separate paths, Ethereum and Ethereum Classic. Phishing scams frequently steal material assets from victims with little to no recourse. The majority of the reason we all have to pay 2% on our credit cards is to compensate the network workers for all of the heavy lifting needed to combat fraud, theft, and chargebacks. Life is too messy to use an irreversible transaction system.

Nassim’s critiques are directed at Bitcoin, not the future of blockchain technology. His critiques lay out opportunities for solutions by the next set of blockchain entrepreneurs. I’ve said in previous articles that we need far better custody tools for blockchain assets. The secret passphrase and MetaMask or ledger wallet are too complicated for anyone who is not a devoted hobbyist. The current design leads to basic mistakes and permanent losses. That’s a design issue waiting to be solved.

My best guess is the general narrative going forward will shift towards a basic appreciation of “blockchains” and away from crypto, Web3, NFTs, or DeFi narratives. With prices down, the next few years need to be spent on patching the many holes in the existing infrastructure (see the billions in hacks, over-leverage, under collateralization, and misplaced assets for evidence). I still love that this space continues to divide people into equally passionate believers and non-believers. That divide indicates opportunity.