Sunday Briefing: On Constellation Software, complexity investing, and narrative distillation

Sunday Briefing: On Constellation Software, complexity investing, and narrative distillation

Welcome to the Sunday Briefing newsletter where I share some of the interesting lessons in life, business, and investing that I’ve come across during the week.

Latest on Junto

Today I posted my write-up on Constellation Software (membership required). I was originally going to do a write-up of, but as got more and more into it, I realized that it wouldn’t work without writing up Constellation Software first. So I changed the write-up to Constellation and will write up one on Topicus next.

I touch on Constellation’s trajectory as an HPC, the economics of a VMS, returns on capital, challenges in organic growth, the runway for M&A, the company’s incentive system, and the prospects for the future allocation of FCF.

What I’ve been reading

Complexity Investing. NZS Capital’s paper on how to act without making narrow predictions about the future.

At a high level, we are simply shifting the mental starting point for the range of potential outcomes. Because of the relatively narrow assumptions believed and taught by traditional economists and academia, most of us have come to accept that outcomes in the world should be narrowly clustered around a mean (although most of us also grapple with this assumption intuitively). In the real world, many events fall outside of the narrow cluster, and human beings aren’t good at predictions.

Narrative Distillation. As narratives begin to drive valuations to a point where they become self-fulfilling (e.g. through cheap access to financing), the public markets increasingly start to resemble private ones. When a high multiple becomes a too important driver of the company’s ability to succeed, investors got to be careful.

Another characteristic of the current landscape is that the revenue multiples companies can get in the public market have a very wide range. Look at the multiples we’re seeing: everything from 2x to 2000x. This is true both for small SPACs and large direct listings. What separates these companies is how effective they are at conveying a compelling narrative to the public markets.

Company of the week

Our company of the week is Netflix Inc. If you’ve read my Disney write-up in its entirety, you might have gotten the impression that I’m very fond of Netflix as a company. And you would be right. Reed Hastings is admirable, and Netflix is at a powerful scale in which it can continue driving down content acquisition costs while harvesting pricing power for years to come.

But even so, the stock is too richly priced. In the highlight sheet below, I’ve capitalized Netflix’s advertising costs and stripped out cash from invested capital. Stretching my assumptions, without having dived deep, the stock price is far away from comprising a margin of safety. You can download the full Sanity Check model with my accounting adjustments here and make your own assumptions for the valuation.

Netflix stock valuation

Quote of the week

Richard Feynman on passion.

“Study hard what interests you the most in the most undisciplined, irreverent, and original manner possible.”

A thought

To hop on the Compounding Knowledge train, read 200 pages, write 1,000 words, and delete 500 words every day.

Have a great coming week,
Oliver Sung

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