The Lots-of-Low-Satiety-Calories Business Isn't What it Used to Be

In this issue:

The Lots-of-Low-Satiety-Calories Business Isn't What it Used to Be—Consumer packaged goods stocks have done well for investors over many decades. Just not the last one. It's interesting to explore why.

The Other Net Present Value—A company is worth whatever change in cash flows it produces to its owner, which is not the same thing as the cash flows it produces on its own.

Capitulation—It's tough out there for short-focused investors; it's a good strategy but not an easy to sell financial product.

Insurgent Advertising—Why Lyft wants you to think about how Uber is more popular.

Alignment—The AI tools we're allowed to use need to be as powerful as the ones adversaries choose to use.

Math—Thoughts on conjectures.Talk to this post with Read.Haus.

The Lots-of-Low-Satiety-Calories Business Isn't What it Used to Be

The single best-performing stock over 1926-present, the period covered by the CRSP database, is Altria, formerly Philip Morris. It grew an investor's wealth 2.65m-fold over that period. If you're trying to reverse-engineer durable long-term returns, you might look at what drove that:

It's a consumable product. Or, put in terms more relevant to analyzing growth stocks today, Philip Morris applied a usage-based pricing model in which customers who liked it more spent more on it. In fact, addiction makes willingness to pay rise (or at least stay inelastic) as consumption increases—it’s easier to kick a “one bummed cigarette every few months” habit than a two-packs-a-day one! So, in SaaS terms, the higher a customer’s “ACV” the higher the future NDR, up until some saturation point, at which you have a fairly long duration annuity at a relatively high level of spend (though the higher the level, the shorter the duration.)

There's more brand differentiation than product differentiation. The underlying product is nicotine, and while there are many delivery mechanisms, the cigarette turned out to be the logistical winner for a long time: a pipe requires bulkier equipment and some setup time, a cigar assumes that you're going to be doing little but nicotine consumption for an extended period, but cigarettes can be consumed quickly, or continuously. It helps those 1926-and-onward returns that cigarettes got incredible product placement a decade earlier, when they were included in soldiers' rations, and those soldiers later came back to countries where the economy was booming and the labor force of young men was a bit smaller than it had been a few years back, i.e. they were primed to enjoy some new kind of consumption.

They're addictive, though this has an ambiguous effect: great for business in the short term, but, bad news on many dimensions if customers get addicted to a product that kills them. This made tobacco a target for regulators. Which, as those long-term returns show, is not the worst thing that can happen to a business; what the US did, in effect, is what plenty of other countries do: nationalize the tobacco business and have it operate as a monopoly, because monopolistic pricing discourages consumption and also raises more revenue. In the US case, they let the private sector keep running it. under constraints. But if you look at the price of a $10 pack of cigarettes (the national median), roughly $3 of that will be state and federal sales/excise taxes, another dollar will be for funding settlements with the states, and the manufacturer and retailer together earn enough contribution margin to add another dollar or so in tax liability. Or, put another way, cigarettes are an 80% net profit margin business in which the government is a 62.5% shareholder.

Warren Buffett, fond of one- to two-page offers for sometimes-complex businesses, naturally had a pithier explanation: I'll tell you why I like the cigarette business... It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty." Buffett doesn't mind telling jokes, sometimes on fairly dark topics. But his usual public-facing persona is a little less willing to talk about a direct link between profits and negative social effects like this. To be fair, he wasn't speaking publicly; this quote comes from Barbarians at the Gate, and he's no doubt steamed that somebody shared that memorable zinger with the book's authors. To be fair, the context was his refusing to invest in the buyout of RJR Nabisco on the grounds that he was rich enough that it wasn't worth the moral culpability to own a tobacco company. [1] RJR itself was another monster long-term winner, though the time series gets interrupted because of the buyout described in Barbarians. One of the reasons that deal closed at the price it did was that the Nabisco part had so much growth potential. Nabisco shares just enough of the economic characteristics of the cigarette business that there was a plausible synergy between the two: consumable products, more brand loyalty than brand differentiation (Oreos are not that much better than the knockoffs, but part of what you're paying for is the certainty that they're exactly what you expected).

Consumer packaged goods companies in general have been friendly to investors for many decades. Like some consolidation stories in media, that's partly a function of survivorship bias: the period when national brands got big was tough for the regional ones, so there were more losers than winners overall. But the winners kept on winning: these businesses tend to have high margins and returns on equity relative to other manufacturers, and that's been going on for a long time. (In the wonderful The Crash and Its Aftermath —wonderful specifically for anyone who's read a work of financial history and wished there were more tables, because it has a lot of tables—shows food and dairy companies earning returns on equity in the teens, with General Foods and Standard Brands in the high 20s, during the Great Depression.)

There are a few reasons that processing agricultural products into boxed, bagged, and canned foods is a better-than-average business. The biggest companies turn into a term for the entire category (if a writer says someone ate a Hershey bar, they're saying they ate chocolate, with basically no other connotation—it's a completely neutral descriptor, which is another way of saying it's the default, can't-go-wrong expectation). National distribution (through the rise of railroads) and national marketing (radically improved by TV) synergized nicely: the company that could get the biggest returns to scale from manufacturing and distribution could also amortize its media spend over more unit volume. And that played nicely with their grocery store relationships: stores charge for eye-level shelf space, endcaps, and other attractive in-store real estate. And just as digital advertisers get better results when they factor in click-through rate, the store is looking not just as who pays the most for shelf space but what shelf placement gets the best combination of slotting fee revenue and contribution profit from units moved. And these things are cheap to move! A box of Kraft Mac 'n' Cheese requires a lot less care and handling than, say, a pear. They're also cheap to handle or the manufacturer. Kraft can fill an entire truck with pallets full of master cases of blue boxes of pasta-with-quasi-cheese; they're shipping a box of boxes of boxes of boxes, which gets predictably and continuously subdivided as it gets closer to customers.

But the grocer-CPG relationship is a strained one, because it's a bad customer experience—not to mention a big logistical problem—for some brand to disappear from store shelves. This happened a few years ago between Heinz and Tesco, and it's costly to both sides; Tesco will have customers who've had the same item on their shopping list for decades, and who will feel ripped off if they don't get it. But if they try something else and decide it's an acceptable substitute, or that they can't believe they've been sett…